The odds seem to favor another downleg for a couple of reasons. First of all, investor sentiment has gotten incredibly bullish in the space of a couple of weeks, which is contrarian bearish.
More important for the intermediate term, the market is facing a number of macro headwinds of economic weakness starting in 4Q. John Hussman noted in his latest weekly comment [emphasis added]:
As I've noted frequently in recent commentaries, the typical lag between deterioration in say, the ECRI Weekly Leading Index and the ISM Purchasing Managers Index is about 13 weeks, and sometimes longer. The typical lag with respect to new claims for unemployment is about 23-26 weeks (which puts the likely window of deterioration at about the October - November time frame), and the typical lag with respect to the payroll unemployment report is, not surprisingly, about 4 weeks beyond that.Uber-bear Albert Edwards put it more bluntly:
The current situation reminds me of mid 2007. Investors then were content to stick their heads into very deep sand and ignore the fact that The Great Unwind had clearly begun. But in August and September 2007, even though the wheels were clearly falling off the global economy, the S&P still managed to rally 15%! The recent reaction to data suggests the market is in a similar deluded state of mind. Yet again, equity investors refuse to accept they are now locked in a Vulcan death grip and are about to fall unconscious.
Given the sentiment backdrop, where readings improved from investors being ultra-bearish two weeks ago to very bullish today, the market is not likely to advance significantly from current levels. I believe that the more important test will come when it descends once again to the 1020-1040 level. Will sentiment swing once again to widespread fears of a double-dip slowdown or will there be sufficient complacency for it to fall through that important support level? Will economic data weaken to suggest a higher probability of a slowdown to warrant further de-risking?
Only time can tell.