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Market Outlook: Another New High in Stocks as Economic Concerns Grow

Michael J. Carr

Stock prices reached new highs last week as headlines warned of a weak economy. This might be an illustration of the old saying that "bull markets climb a wall of worries."

Weak GDP and Employment Lead to Gains in Stocks

Last week, second quarter GDP came in higher than expected at 1.7%. Although the economy was stronger than expected, the pace of growth remains slow. For the first half of the year, GDP grew by 1.4%. Federal Reserve statements indicate they expect year-over-year growth to be 2.3% to 2.6% at the end of 2014, a target that is within reach given the results from the first half of the year.

While GDP might meet the Fed's expectations in 2013, this would be the eighth consecutive year that GDP has been below its long-term average annual growth rate of 3.3%.

Also last week, we learned that the unemployment rate for July fell to 7.4%. This drop was once again because more people left the work force and the number of jobs created was below analysts' expectations.

Despite all the negative headlines, the S&P 500 closed above 1,700 for the first time last week.

SPDR S&P 500 (SPY) gained 1.09% last week. SPDR Dow Jones Industrial Average (DIA) also reached a new all-time high last week and PowerShares QQQ (QQQ) traded at its highest level since November 2000.

Traders seem to be ignoring the headlines and buying stocks despite the weak economy. They seem to believe that slow growth is still growth and earnings should rise, at least slightly, as the economic expansion continues. The expectation of higher earnings has pushed SPY to a new 52-week high.

We can run a test to see what happened in the past after SPY reached a new 52-week high. Looking specifically at where SPY was six months later, the test includes the results from 23 times when SPY set a new 52-week high since it began trading. There have been many more new highs than that, but new highs often cluster in time with several coming in rapid succession as we saw last week when new highs were set on two consecutive days. This test assumes you buy the first new high and hold SPY for six months after that signal.

Six months after reaching a new high since 1993, SPY has been higher 91.3% of the time and the average gain has been 6.6%. These values are significantly above the average gain of 2.8% in SPY seen in other six-month periods. On average, SPY shows a gain 66% of the time for six-month holding periods. Similar patterns of above-average returns are also seen in DIA and QQQ after they make new 52-week highs.

Over shorter time periods, the results are less clear. There is about a 50% chance of a pullback in the month following a new 52-week high in SPY, a piece of information that has little value from a trading perspective.

There is also little information to be gained from testing what happens after SPY gains more than 5% in a month like it did in July. The performance after such a large gain is actually no different than the typical performance. This holds true over periods from one week to six months.

Based on the new highs in the major stock market averages, we should expect to see additional gains in the stock market over the next six months. If there is a short-term pullback, that should be viewed as a buying opportunity.

Gold Should Start Building a Base

SPDR Gold Shares (GLD) pulled back and lost 1.88% last week. GLD also delivered a larger-than-average gain in July, closing the month up 7.43%.

GLD does show a clear trend after making such a large gain. In the past, we have seen a pullback over the next month and weaker-than-average performance over the next six months. This result is confirmed when testing with gold futures, which have a much longer history and have been traded for more than 30 years.

iShares Silver Trust (SLV) and almost all mining companies have chart patterns that look similar to GLD.

This sector is extremely oversold. Bottoms usually form slowly in commodities markets, which is one of the ways they behave differently than stocks. In the stock market, we usually see prices form a topping pattern over several weeks or months and bottom on spike lows. In commodities markets, we generally see the opposite with spike highs and extended bases forming to mark bottoms.

Given this behavior, there is no need to rush into precious metals. We should expect to see relative strength (RS) turn up as the base forms, and until RS turns up, GLD, SLV and miners offer little upside potential in the short term.

This Week's News

The second week of the month often seems to be lacking in news after the important reports that are released in the first week. That is the case this week when none of the reports scheduled for release should have a large impact on the markets.

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