Stocks' head-snapping rally since March could be in for its first real test as markets bump up against a number of potentially key levels.
The market is coming off a three-day decline that dropped the Standard & Poor's 500 2.4% and put the benchmark back slightly into the red for the year.
Getting solidly back in the black for 2009 and staying there is one of many concerns for investors who have watched a rally that still has the S&P 500 31% off its March low show signs of fatigue. "It's very touch-and-go," says Todd Salamone of Schaeffer's Investment Research. "Should some tests fail, there could be tremendous downside. If the market passes, there could be tremendous upside." A few of the precarious tests stocks are facing and investors are watching include the:
•Runat the 200-day moving average. When stocks move above their average closing price over the past 200 days, that's viewed as a positive sign the uptrend is real. And stocks are getting close to testing the line. At its close Thursday of 888, the S&P 500 is just 52 points, or 6%, from its 200-day moving average of 940, says Ken Winans of money-management firm Winans International. "We're right up against it," he says.
Bulls would like to see the market pull over the 200-day moving average and stay there, something it hasn't been able to do since 2007.
•Removal of extreme fear from the market. Investors' unease with stocks reached historic proportions in November 2008, virtually paralyzing buyers, according to the CBOE Market Volatility index. But despite an 8% increase Thursday, fear has eased the past month and is less than half last year's peak levels. Now, the popular fear gauge is testing levels considered to be average. If the fear levels can at least hold where they are, it's a sign buyers are willing to step up, Salamone says. "What we're seeing is the unwinding of extreme fears, not growing optimism," he says.
•Probe of investors' willingness to pay for future earnings. The trailing price-to-earnings ratio for the S&P 500, a measure of how much investors are paying for every $1 of earnings, excluding one-time charges, is above 20 for the first time since the fourth quarter of 2003, says S&P. With charges, the P-E is 129, a high since at least 1988.
Investors are willing to test these lofty P-E levels because they expect earnings to start improving by the fourth quarter, says Howard Silverblatt of S&P.
If corporate earnings deliver and stocks pass these tests, investors get proof they crave. But if not, "The sellers will take over," Silverblatt says.