U.S. Markets closed

Market consolidating but still bullish

David Russell (david.russell@optionmonster.com)

I remember the day well: May 20, 2008. One session before, the index tried to rally above its 200-day moving average but failed. It was already trending lower as the economy slowed and the mortgage crisis simmered. The first thing I did that morning was short the S&P 500, and it wound up being one of my best trades ever.

At that time, almost everyone was positive. They were heartened by a rally earlier in the spring and confident that the Federal Reserve had fixed all the problems. My bearish trade worked because I ignored the talk and focused on the charts. That's the same reason that I remain bullish today, though I do believe there are some modest risks in the near term.

Let's consider that moment in 2008, when the S&P 500 was trading at roughly the same level as today. Over the preceding 10 months then--starting in August 2007--it had bounced several times around 1400. But it broke through that support in early 2008 and then hit resistance around the same level. Totally bearish.

Today, the opposite appears to be happening. In the last month we have rallied above that same level and are now consolidating in the same price range where the market previously broke down. Most other stocks that have returned to these respective levels on their charts since the crash have continued to rally, and I expect the same thing from the S&P 500.

Yes, we know that earnings will be poor, and yes, we know that the global economy is weak. But the main factor driving this market over the last five years has been fear of contagion. And now that central bankers in Beijing, Brussels, Washington, and even Canberra are printing money, a crisis isn't in the cards. (Long term, there will be other problems, but those are not yet clear.)

Trading in the Australian dollar fund (FXA) also supports the bullish case. It's been holding support around $102 despite lots of negativity from China and an unexpected rate cut from the country's central bank. Economic news from the mainland has been improving slightly in the last week as Shanghai rebounds.

All of these factors could break down, but they'll give us fair warning before the selling ensues. Maybe the S&P 500 makes a lower high or the euro breaks below $1.28. Or maybe real volatility (not the implied rate of the VIX) starts to rise. I'll be watching all of those, and you should too.

My conclusion is that we consolidate in this range, followed by more upside in coming weeks. Some dips down toward 1400 are possible, so keep some dry powder and don't get frustrated too quickly. The volatility index has also been climbing, so it makes sense to sell options--either writing puts in lieu of buying stock or selling upside calls against long positions.

In the meantime, there are plenty of interesting opportunities everywhere. This week I asked researchLAB for S&P 500 companies that have been trending higher but were below their 30-day moving averages. Below are some results . (As always, treat them as starting points rather than outright recommendations.)

Edwards Lifesciences (EW): This maker of heart devices got annihilated on Tuesday after weakness in Europe caused it to lower revenue guidance. The stock is now back to its 200-day moving average and a consolidation level from earlier in the year. Given that the cut was attributed to cyclical issues rather than something inherent to its products, investors may now consider this a good entry point.

eBay (EBAY): The online auction site fell after Wal-Mart and American Express announced a new payment system that could potentially compete with its PayPal business. But that remains to be seen and the stock looks interesting, with the current $46 level appearing to be solid support from August and September.

Apple (AAPL): The world's largest company by market cap continues to look amazing and is now bouncing above its 100-day moving average. It may not make new highs right away, but a bounce back toward at least $675 is in the cards.

Masco (MAS): It might get a little closer to $14 but looks very interesting after the recent breakout and pullback.

Sprint Nextel (S): This stock has been a monster but is now pulling back to its 50-day moving average. Bulls were recently active in the November 5.50 calls, as well. (Editor's note: See updated story here .)

Two others outside the S&P 500 that look interesting include software makers Sourcefire (FIRE) and Fortinet (FTNT) .

(A version of this article appeared in optionMONSTER's What's the Trade? newsletter of Oct. 10.)

More From optionMONSTER