Market Now Faces Numerous Hurdles

To see what is in front of one's nose requires a constant struggle.
-- George Orwell

Over the last two months, the market has rallied on better-than-expected earnings and economic data which have helped to support the theory that the worst of the credit crisis is over. The general market consensus is that we have priced in all our problems and woes, and that we will slowly but steadily see an improvement in the market from here.

The million-dollar question for us to ponder is whether this belief that the worst is over is really correct. The bulls' argument is that the market certainly knows what the issues are and the discounting mechanism has taken them into account. There is no secret about the issues we face, and we are now looking beyond them and can see the light at the end of the tunnel.

The bears' argument is that the bulls are simply too optimistic and hopeful. They can provide a long list of things such as housing, inflation, commodity and food prices and more losses from the likes of AIG (AIG - commentary - Cramer's Take) to illustrate their point. The argue that things just aren't as good as the bulls would like to believe, and even if the worst is over, we aren't going to go up in a smooth and steady manner.

I believe quite strongly that we are at a junction now where the idea that the worst is over is going to be more carefully scrutinized and will cause some market weakness. We have a number of factors combining here that will make further upside much more difficult.

Technically, we are extended and momentum is slowing. While we are still holding over key areas of support, there are some cracks appearing, and it won't take much selling to cause some technical breaches.

Seasonality is now starting to work against us. We are entering a traditionally weaker time of the year, and as earnings season winds down, that will no longer serve as a positive catalyst like it did over the last month or so.

Much of the recent rally was a product of low expectations, and as hopes have climbed that will no longer be working for us. Economic reports have generally been better than expected lately, and that has gone a long way in supporting the "worst is over" idea. Unfortunately, higher expectations means that we are more prone to selloffs when we have earnings news like we have this morning from AIG.

The continued rally in crude oil prices also prevents a market hurdle. While the market has generally been able to shrug off the advance in crude prices over the last several years, we are now getting to a point where the acceleration is affecting sentiment and causing some real worries about inflation.

Despite some pretty obvious negatives, the indices have been holding up fairly well. I suspect that is just some stubborn hope that will eventually give way as the market fails to advance. As always, we need to let the price action be our guide, but the conditions remain ripe for some downside.

No positions.

ALL REV SHARK BLOG ENTRIES | POST A COMMENT | READ COMMENTS  

---

James "Rev Shark" DePorre is the author of Invest Like a Shark: How a Deaf Guy with No Job and Limited Capital made a Fortune Investing in the Stock Market. He is founder and CEO of Shark Asset Management, an investment management firm, and he also operates sharkinvesting.com, an interactive online community that serves and educates active investors. DePorre holds business and law degrees from the University of Michigan, is a member of the Michigan Bar Association and a former tax attorney and CPA. He lives in Anna Maria Island, Fla., with his wife and two children. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Rev Shark appreciates your feedback; click here.