A Rest Amid a Historic Rally

NEW YORK (TheStreet) -- During the past three weeks, the equity market has been unsuccessful in breaching the late-September highs. In the lexicon of a technical analyst, the stock market has been consolidating.

This is a rest amid a historic rally. A round of weaker-than-expected economic data at the end of September and in the first week of October have served as the catalyst for the breather. There are two ways of interpreting economic reports:

• first, how they compare to expectations, and;
• second, whether or not they are strong or weak reports.

In evaluating the market reaction to such economic data, it is imperative to recognize whether the market's reacting to the first or second interpretation.

When the market reacts to the miss, but the miss does not portend weakness, an opportunity arises for investors. In such cases, the miss is noise from an investment perspective.

Evaluating the second interpretation is what is important for the investor. Is the number strong or is it weak, signaling the recovery has been knocked off track? Because missed expectations often signal a reversal of trend, the market generally reacts very negatively. If the missed expectation does not signal a reversal of trend, that selloff is often an opportunity. Usually such data are followed by additional positive reports relegating the previous catalyst report to the noise category.

Recently, the disappointing Institute for Supply Management report was an example of a very good number that missed expectations. The report sparked a 2% selloff in the S&P 500 on Oct. 1.

Needles to say, such a reaction means the market was disappointed, but was the number bad? The reading of 52.6 was below expectations of 54, missing on the first interpretation metric.

Investors must remember two important aspects of the ISM. First, it is a diffusion index, so a reading above 50 represents an expansion in manufacturing. Second, because the U.S. is a service-based economy, readings above 41.2 usually represent expansion in the overall U.S. economy. That said, the service sector has been particularly hard hit in this recession.