Testing time for the current rally over the next two weeks

10/25/2010 12:54 pm EST


Jim Jubak

Founder and Editor, JubakPicks.com

The next two weeks are shaping up as a critical test for the U.S. stock market.

Last week a number of key technical indicators stalled in the last few days if they’re waiting for something. Today, October 25, started out with a bang but the markets have pulled off their highs as of 12:30. The reaction to this morning’s good news on housing seems relatively restrained so far.

I think that something is probably the Federal Reserve’s meeting on November 2-3. Wall Street wants to know more from Chairman Ben Bernanke on the size and timing of any new program of quantitative easing before moving higher. If the market is disappointed in what it hears on November 3 from the Fed’s Open Market Committee, I think we could get a correction that retraces part of this rally.

Take a look at the Dow Jones Industrial Average to see what I mean. At the close October 22 at 11133, the index traded within 90 points of its April 26 high at 11205. Since moving above 11000, the index has stalled with high trading volume, Arthur Hill pointed out in his market message on StockCharts.com on October 22. High volumes often occur at inflection points in the market. For example, the April high came on a high–volume spike and the reversals in May, June, and July came on high volumes. A stall here is fine, Hill notes, as long as it gets resolved to the upside. A break below 10900 on the Dow would be a sign to watch out for the start of a correction.

The markets aren’t looking for a concrete announcement on November 3 of another wave of Treasury buying by the Federal Reserve. But Wall Street would certainly be disappointed by a Fed announcement that backed away from another round of quantitative easing and is quite possibly is counting on some change in the Fed’s language that indicates that quantitative easing is nearer.

The Fed’s decision is a big deal for stocks. This rally, especially in the last couple of weeks, has been fueled by the belief that the Fed will put hundreds of billions (maybe as much as $1 trillion although maybe not all at once) in cash into the hands of investors and traders by buying Treasuries at a time when interest rates are so low that the stock market looks like the best game in town.

It’s only logical to expect that investors would take a pause here to see if that expectation is correct.

By the way, just so we’re perfectly clear, I’m still expecting a fourth quarter rally. My only question is whether we get it after a short correction or as a continuation of the current rally.
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