CVI CVR Energy Inc

The current relief rally in equities is a thing of beauty. I stayed short all my naked put positions in Cummins (CMI), Suncor (SU), Southern Copper (SCCO), National Oilwell Varco (NOV), and CVR Energy (CVI) and took some profits today on three of them.

And I added some leverage to my prediction that the successful test of 1,120 on the S&P 500 would carry us up toward 1,225. I did that via buying an ETF intended to produce 3 times the returns of the index, the ProShares UltraPro S&P 500 (UPRO). I bought it at $49 the morning of the Jackson Hole speech and have traded the swings all the way up to $59.

Can the Chart Still Tell Us Which Way Now?

Since it is highly likely that there isn't much more upside in this relief rally -- 1,250 is optimistic -- we should look at short-term scenarios while we trade in this range and play the "recession waiting game."

This is especially important since I don't think we can say the bottom is definitely in, though you will hear money managers start to say so, like Brian Belski of Oppenheimer on CNBC this morning.

Recall that on August 5 in "How Long Will the Correction Last?" I proposed that the market would trade sideways between 1,150 and 1,250 on swings of optimism and pessimism until more data was received and processed about the "probable recession."

I didn't foresee the extreme of pessimism taking us to 1,120, but the basic idea has held up for the past 3+ weeks. And even though we have had a good amount of data pointing in both directions from the consumer and manufacturing fronts, we still don't know if the third quarter's GDP result is more or less likely to register a dip into recession territory.

Since I believe that markets will always continue to fool people and overreact on emotional extremes of optimism and pessimism, below is my view of the S&P chart now. I see a good 30% chance that we can head down, break the 1,100 "extreme value area" as I've called it, and then put in a bottom at 1,050 in the next six weeks once we see that GDP won't slip much below the zero line.

Note that this is a weekly chart and that the red moving average is the 200-week around 1,150. Just because I see 1,050 as the bottom part of the major support "band" along with 1,150 as the top, it doesn't mean we can't overshoot and touch 1,000. But that line will definitely be make or break.

I've heard technical guys talk about 980 and I say, "Listen, if that's your extreme oversold/bottom level target, there will be plenty of guys like me -- and many with a few billion more dollars than I -- buying between 1,025 and 1,050."

In other words, while a spike below S&P 1,000 is certainly possible, buying good stocks anywhere within 50 points of it will a fantastic long-term opportunity. This is, of course, in the "gray skies" mild recession scenario.

But even in worse cases, I will still be buying there because I am definitely not in the Dow 5,000 camp of long-term doom.

Gray Skies and a 30% Chance of S&P 1,050

As we process the data, investors from the top research houses down to me are still handicapping the probably recession. In my "Just 2 Scenarios: Recession or Not," I highlighted the work of UBS. Here's a recap of their outlook...

No Recession, 60% chance: Earnings estimates of $95 to $100 for the S&P 500 stay intact even with 2% growth into 2012 and the index makes new recovery highs above 1,400 by the end of this year.

Gray Skies, 30% chance of mild recession: Here, corporate profits could fall 13% as GDP declines 2% over the next year, taking the S&P likely below 1,100 but finding its legs somewhere in the middle of that period above 1,000.

Black Skies, 10% chance of severe recession: In this ugly view, GDP would fall 4% over six quarters and take down earnings as much as 27%, knocking the index down to 900 for starters and likely bottoming near 775 one year from now.

And here was my rationale for going with "Just 2" scenarios...

I'm going to ignore the "black skies" scenario for a few weeks. We just don't have enough evidence to support it.

And the first two scenarios are consistent with what I've been saying for the past few weeks anyway. So I'm still only interested in talking about whether we have a minor recession at all, and then how long it will actually last.

As I pointed out last week before I even heard of this UBS report, a 13% drop in S&P earnings to $85 per share, that is followed by a rebound in the economy, will make money managers buy stocks at compelling valuations around 1,100 on the index. And I am quoted in this week's Barron's saying as much.

My "rebound" assumption is based on the economy still being in a sweet spot with exceptionally low interest rates, lots of corporate cash, and global growth dented but not derailed.

I could be wrong and I am open to new evidence. And that's why I await more data for or against the probability of recession.

Confidence Will Conquer Politics

The recession waiting game became more interesting this week as I wrote about yesterday in "Shock & Awe Cavalry is Coming." Why? Because Ben and Barack are going to make it more interesting with potential economic stimulus.

Obama brought on a new jobs czar who will be instrumental in the fiscal proposal we are likely to hear next week and Bernanke will try to rally his troops and reach monetary consensus at the extended September FOMC meeting.

There are political hurdles of course. But the recent tension created when Congress almost burned the country to the ground could just as well have a snap-back effect on confidence. People want to believe in their country and their future.

From chaos and crisis often comes the most amazing of recoveries. I think Obama and Bernanke know this is the time to shine.

Give Me A Shout

I've always found that the best market insights evolve from an exchange of opposing views. So please consider this an open conversation, or even an opportunity for fiery debate. Just jot down your views in the comments section below and let's figure this stuff out together.

Kevin Cook is a Senior Stock Strategist with Zacks.com
 
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