Taking The Market's Temperature. (Where We've Been)

It is no secret that the market has had a rough go of it for the past week. Investors hoping for further clarity from the Federal Reserve as to when it might be done raising interest rates were disappointed last Wednesday with the signals coming from that meeting. Further economic reports such as today's consumer price index (which seemed to show inflation a bigger problem than the markets had previously thought) did nothing to soothe investor's interest rate jitters. "The fears we have are coming to the surface," says Steven Goldman, market strategist at institutional brokerage firm Weeden & Co. Investors are not going to wait for inflation to be a huge problem but are responding while it is still a relatively small one," he said. Investors may be using the latest scare of inflation in order to dump stocks yet from my perch I think what we have really been seeing are the symptoms of a market that had grown tired and simply needed to sell off.

As you know I think that looking at the S&P 500 is the best place to take the overall temperature of the market. I have included two charts of the S&P Spyder* (SPY) which I often use as a proxy for illustration purposes for the actual index. (You can double click on each chart to enlarge them.) The chart at the top is a longer term weekly view of the SPY going back to the bear market bottom that stocks put in between July, 2002 and the spring of 2003. From that period till today we can present several points. The first is that the trend line from those bear market lows is still intact. Even with this weeks retracement we are still longer term biased to the upside. The second thing of note is that even though the SPY has increased well over 50% since the spring of 2003, the majority of that move came in the last nine months of that same year. Since early March, 2004 the SPY has returned only about 9%. In other words the market has basically meandered albeit with an upwards bias for over 2 years, returning something like 4 1/2% on an annualized basis during that time.

The second chart is an enlarged and daily view of the markets from the period starting roughly a year ago to the present. This is a market that was deeply oversold early last fall and experienced a healthy rally of over 13% from its trough to its peak. Yet early in the spring this market was showing all of the characteristics of being tired. I commented on April 1 that when you strip away the first 11 trading days of this year that the SPY had largely done nothing year to date. http://lumencapital.blogspot.com/2006/04/rally-where.html. In addition the market's leadership had increasingly narrowed with commodities and certain industrials being the few areas to show any substantial appreciation during that time. As of today, if you strip out those first 11 days of 2006 the market is negative for the year and is now trading at levels also seen in mid December of last year. In fact many components of not only the S&P 500 but also other indices such as the NASDAQ 100 have basically gone nowhere during that time. As mentioned above what has held up the SPY this year has been the almost parabolic rise in commodities and commodity related stocks. Outside of this index there have been large moves in foreign stocks and in smaller cap names. See these posts to review: http://lumencapital.blogspot.com/2006/03/magazine-cover-curse.html & http://lumencapital.blogspot.com/2006/03/thousands-as-in-dollars-are-sailing.html.

From where I sit I think a large portion of what has carried this market in 2006 is being unwound. I think that it is possible that new leadership is going to emerge in the market. That possible change of leadership spells opportunity for investors and yet I also want to inject a note of caution as we head into the summer months. We'll discuss this in detail next week.

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