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All eyes are on company earnings as the stock market has overshot to the upside

The Fed’s accommodative stance has produced a rally in stocks. Disappointing company earnings could put a stop to it. Read More...

Earnings season is ahead. So this is a good time to review your stance on the U.S. stock market.

Let us explore the issue with the help of a chart.


Please click here for an annotated chart of S&P 500 ETF SPY, +0.08% For the sake of transparency, this is the same chart, without any changes, that was previously published. Investors may also want to observe similar behavior on the charts of the Dow Jones Industrial Average DJIA, -0.32% Nasdaq 100 ETF QQQ, +0.25% and small-cap ETF IWM, -0.17% Not all of them produce a golden cross or a death cross at the same time. Please note the following:

• The chart shows a golden cross. A golden cross occurs when the 50-day moving average breaks above the 200-day moving average.

• A golden cross is a bullish pattern.

• Since the chart was published, the market has risen, as was foreshadowed by the golden cross.

• The chart shows the Arora buy signal given on Christmas Eve. In hindsight, the Arora buy signal was given at the exact low of the present cycle. Since the Arora buy signal, the stock market has jumped about 23%.

• The stock market has staged a strong rally ahead of earnings season.

• Earnings are the single best determinate of future stock prices.

• The stock market has rallied in the face of slowing earnings growth because of a complete reversal in the Federal Reserve’s policy.

• When interest rates fall, as has happened, each dollar of earnings is worth more for the stock market.

• Progress in China trade talks has helped, but in our opinion, the Fed’s policy has been the main driver of this rally.

• Technical patterns of popular stocks such as AMD AMD, -1.55% Amazon AMZN, +0.68% Facebook FB, -0.45% and Apple AAPL, +1.57% are such that they indicate the market is likely to rise. However, no one should exclusively rely on technical patterns, as they do not always work.

Read: How the worst earnings season in years could trip up the stock market

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

Key question

Here is the key question for investors: Is slowing earnings growth, relative to lower interest rates, fully discounted in the stock market? There are a variety of opinions on the subject. In our analysis, it is more likely than not that the market has overshot to the upside. For this reason, as earnings are released, the market is vulnerable. Investors need to be careful.

This does not mean that investors should sell stocks wholesale. The reason is that the market is controlled by the momo (momentum) crowd. The momentum is to the upside. The momentum can easily carry the market to new highs. Many short-sellers likely have stops above the old highs. If the old high is taken out, these stops will trigger more upward pressure on the stock market.

What to do now

At The Arora Report we provide precise levels of cash, hedges and positions to hold. We use the ZYX Asset Allocation Model with inputs in 10 categories and not just rely on momentum. (Please click here to see the 10 categories.) Momentum is great as long as it works, but it can also reverse quickly. Do you remember December 2018?

Earnings season will provide many new opportunities for short-term trades as well as long-term investments. The key is to look for earnings surprises.

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at [email protected].

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