The Market Could Reach All-Time Highs. Here's How...

Amber Hestla's picture

Tuesday, October 8, 2019 - 12:00am

by Amber Hestla

Unemployment fell to its lowest level since 1969. That news sparked a stock market rally on Friday and recovered most of the week's losses.

The dashed red line in the chart below shows the small loss for the week. The solid blue line is the 50-day moving average (MA).

That's an important technical level over the next few weeks.

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Before looking at the technicals in detail, I want to review the unemployment report. It was bullish on Friday but, in the long run, I don't believe it holds much information for traders. Here's why...

Unemployment is a lagging indicator. To understand this, think about a local restaurant.

Restaurants hire when business has been good. If sales increase for one week, management pushes the existing staff to meet the increased demand. After a few weeks of a sustained increase in sales, management will hire a new server.

Then, business turns down. Management will see profits drop off but will usually do all they can to avoid cutting staff. When staff cuts are made, it will be because business has declined for some time.

This example shows how employment works in many businesses. Management hires after sales turn up and lays off after a sustained decline in sales. This makes employment a lagging indicator of the economy.

With that in mind, let's look at the details of Friday's report.

Gains were in education and the hospitality industry. We see a gain in education every September when schools reopen after summer break, so that was expected. Gains in hospitality include servers at restaurants (which is why I used the example above).

With the bulk of the new jobs in an industry that reacts to sales, it's safe to say that low unemployment tells us very little about what to expect in the next few months.

Friday's report also showed no gain in average wages. That confirms the jobs created were low-paying jobs. That also provides a green light for the Federal Reserve to cut interest rates at their next meeting. That's why stock market averages soared on Friday.

Money On The Sidelines
The gains were proof that there is money on the sidelines looking for buying opportunities. One indicator that there is money on the sidelines is the fact that there is $3.4 trillion in money market funds. More than $20 billion was added to these funds last week.

These funds pay low rates. That's one reason brokerages like Schwab (Nasdaq: SCHW) and others have been lowering their trading commissions to zero recently. Commissions accounted for about 7% of Schwab's revenue last year -- more than half came from the cash that investors hold in their accounts. Schwab is able to use those funds to make short-term investments that yield maybe 2% while paying investors just 0.2%.

One reason Schwab's customers are holding so much cash is because they are concerned about a market decline. We know that investors are nervous because of the data in the American Association of Individual Investors (AAII) weekly survey.

In an average week, 38% of investors are bullish, 30% are bearish, and 32% are neutral. Last week, just 21.4% were bullish.

Investors have been nervous for the past two months. On August 8, only 21.7% of individual investors were bullish. I marked that date with an arrow on the next chart.

A low level of bullishness in this survey is consistent with a short-term rally in the stock market. The question now is what should we expect?

Now, back to that 50-day MA. I expect that to be a magnet for the S&P 500 for a few weeks. I am looking for prices to stay within about 3% of that level. The next chart shows 3% bands around the 50-day MA. Declines have stopped at the lower line in the last three selloffs.

The upper band provides a target near the all-time highs. That's a reasonable expectation for now.

This may not sound like much, but a 6% range will present multiple trading opportunities. A breakout will indicate a new trend, and that is something we can trade as well.

I expect to see a good market for some time.

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Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.