Investors should stay cautious despite good week

Thursday's pending home sales, leading indicator for home sales increased 5.2%, the stabilizing housing price and record low mortgage rate seemed to be taking effect.

Finally, Friday's nonfarm payrolls showed improvement with fewer job loss and more private jobs added than expected, and July's numbers were revised upward with less job loss and more private job added than first reported.

The market sentiment seemed to have turned on a dime and it's possible that money managers may add exposure to stocks now that danger signs for bonds are flashing.

It's difficult to tell if this rally can carry the market all the way to our target of 1,200 for the S&P 500 index or it may stall in this historically toughest month for stocks and stage another rally later in the year.

There are a few hurdles for the market to clear; one is that earnings expectations remain high even when industry leaders like Intel and Cisco are taking a cautious view on demand.

Currently, the consensus for earnings per share for the S&P500 is $83.04, down only 1% from last month's US$84.11 which may be revised down as we approach the next earnings season come October.

The other obstacle could be the ending of the massive stimulus spending and the expiration of George W. Bush's tax break ending this year.

Unless the tax break is extended yet again, the tax rate for ordinary income and short-term capital gains will be increased by 3% and the tax rate for long-term capital gains will be increased by 5% for most tax brackets.

Investors may opt to take profit before the end of the year to take advantage of the lower taxes; also higher taxes may mean lower spending in the coming years.

From the technical analysis, the market may meet selling pressure when S&P 500 approaches 1,130 and that's only about a 2.3% upside.

From the market-timing perspective, maybe investors should consider reducing stock holdings even as the market rises, thus reducing risk exposure as the economy slows in the second half.

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