Leave it to the world’s central bankers — they know how to fire up a crowd.
From the European Central Bank’s OMT program to the growing likelihood of QE3 that followed Friday’s employment report, investors are getting exactly what they wanted. Predictably, the latest round of policy prescriptions brought a bounce in the markets, driving the S&P 500 to its highest level since January 2008, the Dow to its highest since December 2007, and the Nasdaq to its highest since November 2000.
The question now is whether this move to new high ground is sustainable — and the beginning of a move back to the all-time S&P high of 1,565 — or whether it’s just a head fake to shake out the shorts. With this in mind, here are four events to monitor to determine what happens next:
1. A successful retest of the new S&P support at 1,419: One rule of technical analysis is that after a stock or index breaks out, the old resistance line becomes the new support. In this case, the ideal scenario for bulls would be for the S&P to hold this 1,419 level on any profit-taking that occurs in the days and weeks ahead.
2. Confirmation from financials: Although the large-cap indices have moved out to new highs, the Select Sector Financials SPDR (NYSE:XLF) remains a little more than 2% below its 2012 intraday high of $16.01. A confirmation from financials — which make up more than 14% of the S&P 500 — would be a hugely positive sign for the broader market. The Select Sector Materials SPDR (NYSE:XLB) and Select Sector Industrials SPDR (NYSE:XLI) also remain below their 52-week highs, and a similar confirmation here would be an additional sign of broadening sector leadership.
3. Additional confirmation from the emerging markets: The world’s developing markets have been lagging the United States for a full year now. In the past 12 months, the iShares MSCI Emerging Markets Index Fund (NYSE:EEM) has slogged its way to a loss of 1.3% even as the SPDR S&P 500 ETF (NYSE:SPY) has rocketed ahead by 25.5%. One reason for this is China’s slowing growth and its impact on the materials sector around the world. However, investors now have more reason for hope following the Chinese government’s announcement of a $157 billion infrastructure plan. The market impact was immediate, with stocks such as the Brazilian iron ore producer Vale (NYSE:VALE) gaining more than 8% on the news.
As a result of this bounce, EEM moved back above its 200-day moving average, and it is closing in on the upper line of a longstanding triangle formation. Since the emerging markets are such an important barometer of both risk appetites and global economic growth, a sustained recovery in the asset class would bode extremely well for domestic equities.
4. The iPhone 5 release: Apple (NASDAQ:AAPL) appears on track to release its latest iPhone on Sept. 21. With the stock having run up so hard in the past month, it appears to be vulnerable to either investor disappointment with the product or a garden-variety sell-the-news reaction. With the stock making up such a large percentage of the major indices — about 5% of the S&P and 20% of the NASDAQ 100 — Apple shares need to react well around the release to keep the ball rolling with this rally.
Keep an eye on these four signals in the weeks ahead. If and when the Fed announces QE3, all of the positive policy-related news will be in the rear-view mirror, and investors likely will turn their attention to the upcoming earnings season. In this potentially vulnerable time for the market, these indicators will provide an important gauge of the rally’s underlying strength.
As of this writing, Daniel Putnam did not hold a position in any of the aforementioned securities.