Earnings Are The Key

Despite all the bad news out of Europe last summer, corporate earnings remained strong. The same cannot be said this year as earnings estimates are being ratcheted down as a result of slowing global growth. Valuations are very reasonable so an earnings slowdown will not necessarily lead to a down market.

The key to the market will be the extent of the earnings slowdown. The bursting of the tech bubble and the real estate bubble led to massive declines in earnings and large market declines. The current situation is different in that valuations are starting out at a much lower level and there are much fewer excesses in the economy and on the corporate level. I believe the market will remain in a trading range until the extent of the earnings slowdown becomes clearer.

I have been talking about a trading range recently due to Europe. Friday's news of an EU agreement got us to the very top of that range. If the ECB follows through on Thursday with more help for Spain and Italy its likely that the  trading range will move higher with the yearly highs marking the high end of the range.

In the shorter term I believe the market is getting extended. The market has generally been going up for four weeks now but it seems like Friday the crowd finally started to embrace it. We are not at a bullish extreme but gains should be harder to come by.

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