today's stock market action (+150 pts)

The US stock market has rallied for three consecutive sessions, with today's gain over 150 pts on the Dow Jones average.  Is the fear over? No, not yet, as shown by the sharp sell off in the closing hour in which the DJ gain fell by over 150 pts.  While this is not a repeat of 2008, the market is still weak from a fundamental perspective.

Since July 21, the DJ has fallen from over 12,724 into a trading range of 11,613 on the high side on August 31 and 10,713 (August 11, but 10,733 on Sept 22--5 days ago).  But volatility has been phenomenal with six declines of over 500 points in a two month period.  This compares to 3 declines of the same magnitude in the prior 10 months of the year. 

Two issues have dominated investor thinking over the last two months, i.e., since July 21.  One is the concern about a meltdown of the EU as a result of fiscal crises in Greece, Portugal, Ireland, Italy and Spain.  But clearly investor concern has been focused on Greece, and the feat that a contagion could spread more broadly through Europe.  As I have advocated in prior posts, this is a solvable problem.  In the meantime, the drip, drip, drip of the crisis has exacerbated market sentiment.  A solution to the European fiscal crisis would reduce volatility dramatically.  However, even a definitive solution would not fuel the US equity markets above the current trading range. 

The second issue is the slowdown in economic growth, both in the US but more broadly in Europe and Asia.  This is a medium term issue; hopefully only a year or two years in duration.  All economic data continues to point to a slowdown at best in economic growth.  Many analysts think that things will deteriorate further into a "double dip".  While anything is possible, there is no data supporting that view.  For instance, weekly US initial unemployment claims continue to hover over 400,000.  While this is clearly not good, and indicative of the economic slowdown since it is not improving, it is not climbing.

The biggest drag on the US economy relates to housing.  This is the most worrisome data point since it is slowly worsening in some respects, such a declining housing starts, with continuing high foreclosure rates and lack of financing creating a drag on that market.  This is one of the two most important markets for the US, both psychologically, and economically.  The other major market is the equity market, again both psychologically and financially.  Many Americans have their 401k invested in equities, and declines in the equity markets have an immediate impact on the American psyche, even of ordinary people. 

While the equity markets have stayed within a narrow range, two important developments have occurred in the last several days.  First, Gold, the biggest indicator of fear, has declined sharply in value-- against all predictions.  Second, the US$ has strengthened against the Euro and other currencies such as the GB£ and CDN$.  These are positive signs for the future.

For the present, I would advise caution.  The economic facts have not changed, and until they do, there is no fuel for a long term rally, just bargain hunting.  This lack of underlying positives from an economic standpoint leaves the equity market vulnerable to any new negative whisper or rumor about Greece or the EU.  Also, we are approaching earnings season in less than a month.  It is likely that some companies will be reporting reductions in guidance due to slower GDP growth.  While this should be already discounted in prices, I would be cautious and believe it when I see it.  

Normally, I would say this is a time to sell into rallies and buy on dips.  But in many cases, the "highs" are lower, and the dips are just as severe.  For instance, companies like CAT, ETN,  JCI, MAN, are all over sold but still suffering lower highs and lower lows.  In the long term, these are all good companies at bargain basement price levels, but they could go lower.  Again, this is a time for caution.  Not fear, just caution.  With a long enough time horizon, I would recommend buying some of the leading brand names which have seen their dividend yields rise to a level that is above 10 year treasuries.  The dividends are relatively safe, and there is a good potential for price appreciation for the medium term.  But I would still not fully commit to equities at the moment.  It is still time for caution until the economic horizon looks a little brighter.