Technicals or Valuation?

What is driving the market rally — Technicals or Valuation ?

Well this morning, the answer to that question really depends upon your media diet.

This morning’s WSJ makes the case that technicals, and the market internals are what is sending stocks higher:

“[Technical] analysts forecast markets by following supply and demand for stocks, and they say there is enough strength and momentum in the current rally to push the market even higher . . . The number of advancing stocks has steadily outnumbered decliners. And the percentage of U.S. stocks trading at 52-week highs recently moved above 40%, the highest level since 1982, according to Ned Davis Research.

Even more important, the gains are widespread and aren’t showing signs of thinning out. When a bull market is nearing an end, weaker stock groups begin to turn down. Usually among the first to go are small stocks and those of companies most dependent on a strong economy.”

Bloomberg, on the other hand, makes the case that stocks are cheap:

“Even after the biggest rally since the 1930s, U.S. stocks remain the cheapest in two decades as the economy improves.

Earnings estimates for Standard & Poor’s 500 Index companies from Apple Inc. to Intel Corp. and CSX Corp. climbed 9.1 percent on average in April, twice the gain in their prices and the largest monthly increase since at least 2006, data compiled by Bloomberg show. The benchmark gauge for American equities is trading at 14.2 times forecasts for its companies’ profits, lower than any time since 1990, except for the six months after Lehman Brothers Holdings Inc. collapsed.

Income is beating analysts’ estimates by 22 percent in the first quarter, making investors even more bullish that the rally will continue after the index climbed 80 percent since March 2009. “

To be sure, there are other factors at work:

-Money is still cheap with the Fed at zero

-The economic cycle has turned from recession to recovery

-The Dow 5000 Armageddon trade of 2008 is still being unwound

Excessively Bullish sentiment is the biggest risk right now — but even that seems to be moderating (I’ll dig up a chart).

You don’t have to choose what the basis of the rally is — just realize that as we go higher, the risk levels increase.

I believe Stop Losses should only move in one direction: Upwards. For quite some time, I have been an advocate of the trailing stop loss; tether stops to your holdings and get dragged upwards as prices rise.

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chart courtesy of WSJ

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Sources:
Technical Support: Signs Point to More Stock Gains
E.S. BROWNING
WSJ, April 26, 2010
http://online.wsj.com/article/SB10001424052748703988804575205012364446950.html

Stocks in U.S. Cheapest Since 1990 as Analysts Boost Estimates
Lynn Thomasson, Whitney Kisling and Rita Nazareth
Bloomberg, April 26, 2010
http://www.bloomberg.com/apps/news?pid=20601010&sid=ayxUdbONKGwo

Previously:
Volatile markets call for stop-loss orders
Using stops to limit risk, protect profits
Barry Ritholtz
Marketwatch, April 1, 2003
http://www.marketwatch.com/story/volatile-markets-call-for-stop-loss-orders

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