3 Rally-Killing Questions?

After several months of uncertainty, equities have rallied as investors have signaled that they see light at the end of the tunnel…

For the first time since the August correction, small stocks are leading the household names. Over the past four weeks, the Russell 2000 is up more than 9.3%, while the S&P 500 has risen 8.2%. It’s not a massive difference, especially considering how impressive overall performance has been this month. But it does show the market’s willingness to once again add riskier names on the long side �� a marked improvement compared to the August sell off.

However, stocks aren’t out of the woods just yet…

Over the next several weeks, the markets will need to prove to investors that October’s rally is for real. In order for an end-of-year rally to stay intact, the stock market will need to answer three important questions.

Can the market survive more European sovereign debt squabbling? If summit talks break down again this week, will U.S. markets continue to rise? These are questions geared more toward investor sentiment �� as in, will investors buy stocks in spite of negative events? For several weeks, I’ve been writing that we will need to see the markets rally against the headlines. So far, we’ve seen some evidence of fatigue toward downside action. Now, we will have to see if positive momentum can continue after such a sharp rally off the lows.

Will earnings become a market driver? As of Friday, less than 20% of S&P companies had reported earnings. Of these, approximately 67% have beaten estimates. These are solid numbers, especially when you consider that the majority of the financial media has determined the economy to be on the brink of recession.

Despite solid preliminary numbers, the market has also chewed up several momentum darlings. Former Street favorites Netflix and Green Mountain Coffee Roasters have both been completely gutted during the Octob! er rally . Adding to the carnage this morning, Amazon gapped down 10% after predicting a potential fourth quarter loss. Other popular stocks will need to throw out solid third quarter numbers. If not, investors might have little reason to buy this rally.

Will stocks attack important resistance zones? The major indexes remain below their 200-day moving averages. Will this longer-term moving average become strong resistance? Or will stocks easily break these important barriers and resume their previous uptrends?

The S&P 500 is edging closer to its 200-day moving average (red line/red dotted line) every week. If it breaks above this mark, stocks will be back to where they were before the August correction began in earnest.