Big Test Ahead for US Stocks

10/26/2010 8:00 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

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

Several key technical indicators stalled in the last few days, as if they’re waiting for something to happen. Monday, October 25 started out with a bang, but the markets stalled again in the afternoon.

I think that “something” is probably the Federal Reserve’s meeting November 2-3. Wall Street wants to know more from Fed 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 Federal Open Market Committee, I think we could get a correction that retraces part of this rally.

Look at the Dow Jones Industrial Average to see what I mean. At the October 22 close at 11,133, the index traded within 90 points of its April 26 high at 11,205.

Since moving above 11,000, 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 up side. A break below 10,900 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 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 investors to take a pause here to see if that expectation is correct.

(Here are some more reasons why markets may pause.)

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.

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund (JUBAX), may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund as of the end of the most recent quarter, see the fund’s portfolio here.

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