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Why the stock market rally might not have legs

NEW YORK — The latest on developments in financial markets (all times local):11:45 a.m.Stocks are little changed as Wall Street looks ahead to key trade talks between the U.S. and China this week. (The Associated Press)

North American stock markets have staged quite the comeback since falling into bear market territory at the end of 2018. But stocks will have to clear a series of hurdles to prove it has legs.

The TSX (^GSPTSE) is up around 9 per cent year-to-date and the S&P 500 (^GSPCis up around 8 per cent. A more dovish tone from central bankers, especially the U.S. Federal Reserve, has been the biggest catalyst.

The S&P 500 and the TSX have rebounded sharply from December lows

“The January bounce was led by energy and financials, which were the factors that were hurt the most in December,” Greg Taylor, chief investment officer at Purpose Investments told Yahoo Finance Canada.

“It was led by the companies that had been oversold from tax loss selling. But now it’s going to be interesting if they can keep going for the balance of the year or if that was just an oversold bounce.”

Another round of trade talks between the U.S. and China begin this week. Markets have essentially priced in a deal being reached and Taylor doesn’t expect talks to fall apart.

“But if there are any headlines to come out that say that this isn’t going well or Trump comes out more negative on trade or more hostile on China, I think that could be a negative surprise to the market, which could make us go back close to the December lows,” says Taylor.

Taylor says he’s watching the U.S. dollar closely. If it goes lower in response to a more accommodative Fed, we could see a bigger rotation into laggard value sectors like energy, material, and financials.

Technically speaking

Both the S&P 500 and the TSX have recovered 50 per cent of their losses from the previous closing highs.

Brooke Thackray, research analyst at Horizons ETFs, says markets might have moved too fast and could consolidate at the current levels.

Thackray looks at technical indicators when making investment decisions. He’s watching for key levels on both indices.

“If the S&P 500 were to break below, its 50% re-tracement level from its closing bottom of 2351 set on December 24th to its peak of 2931 set on September 20th, 2018, this could spell trouble for the US stock market,” says Thackray.

“If the S&P/TSX Composite Index were to break below, its 50% re-tracement level from its closing bottom of 13,780 set on December 24th to its peak of 16,567 set on July 12th, 2018, this could spell trouble for the Canadian stock market.”

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