Market Update {Continued From Last Night}

Today I'm continuing our discussion about the current state of the markets. I'm also republishing yesterday's chart. Again you can double-click on it to make it larger. Below are my thoughts.

1. In our inter-connected world with instantaneous access to information, markets react much quicker in real-time to natural disasters, wars and economic dislocations. Part of the new normal to events such as this is the so called "risk off" trade. That is everybody heads for the exits at one time and market volatility increases. We've seen this in 2008 with the financial crisis, concerns over the H1N1 virus in 2009, last years fears of sovereign debt default in certain European countries and now the double problem of crisis in the mid-east and the earthquake. This reflex selling during times like this seems to be what me must now live with regardless of how far away the event seems and how tangential the impact to our economy may actually be.

2. I think that on an economic basis US stocks have likely discounted the worst of this disaster. There will no doubt be some economic fall out to our economy. Some supply components for example to US manufacturers may be delayed. Apple Computer announced yesterday that it would delay the launch of the I-pad II in Japan until March 25 because of this crisis. Also some exports may not be shipped over to Japan as planned. In my opinion this will likely trim the most aggressive earnings estimates for 2011 GDP growth and with it those really extreme S&P price estimates for this year. We should also not forget that the rise in the price of oil that we have experienced in the past month may have started to bring those numbers down anyway.

The issue with oil has likely been the culprit that caused the stall in price appreciation these past few weeks. So far I see nothing to change my view that stocks could end the year trading between 1,350-1,400 on the S&P 500. I do think that given what we know today I'd be unlikely to take those price estimates much higher by the end of 2011 right now.

The reason I say this because the tragic events in Japan {taken on their own} are unlikely to influence economic behavior here. People didn't stop going out to eat here over the weekend because of the events over there. The Federal Reserve confirmed yesterday that economic growth was continuing. That should ultimately put a floor under stocks.

3. Our playbook is the situational analysis of markets based on historical results. We study how money flows into and out of securities along with the disciplines of fundamental and valuation analysis to see how markets have responded to historical events. The playbook helps by giving us different market scenarios to current trading activity and helps us formulate a game plan for current market events.


The game plan is a tactical and strategic allocation of clients assets based on what the playbook tells us has historically occurred. It gives us a direction for our various investment strategies and is further refined to the specific risk/reward parameters of our various client groups and our investment strategies. Often the game plan can be implemented across the board in all client accounts or in a specific investment strategy. At other times portions of the game plan will be specifically implemented in individual client accounts or certain investment strategies where events may warrant such action.

Both the playbook and game plan tell us that yesterday was not in my opinion a day to sell. In fact for reasons and criteria we'll discuss below we were buyers in small size in certain investment strategies today. In the words of Barry Riholtz in a posting called Black Swans, 100 Year Floods, "The time to look for the emergency aisles and where the exits are located is before takeoff, not after the wings fall off the plane. You must have a plan in place to deal with unanticipated events, a just-in-case things head south scenario. Ideally, you put this plan together when you are objective and unemotional and calmly contemplative — not when things are figuratively and literally melting down."

We had already raised a certain amount of cash per client mandates and strategies over the course of the past few weeks. Yesterday was not the time to add more.

4. We will garner clues about how the markets will behave in the coming weeks by paying attention to three important levels on the chart shown above. Line 1 which is roughly where we closed yesterday is a very important tell. Not only is it from the level we broke through in January, it also represents the level from where stocks began their collapse back in late 2008. It also represents a level from which stocks broke out to the upside during the last leg of the 1990's bull market. That was back in late 1998. Price has memory and stocks have nor sort of pivoted around this level for over a decade. Probability suggest that a market that fails to hold this level on a sustained basis could be in danger of further price declines. Lines 2 & 3 are the trading range that we've previously established throughout February and most of March. We will need to see how stocks react to both of these lines on any subsequent rally. The reaction to all three of these levels will likely tell us if we are in correction mode or in need of more consolidation.

5. Probability also now suggests that that upper band {line 3} will be a significant resistance level for some time. If I had to guess I think that line will be hard to breach for at least several months. Here's why. Uncertainty with the situation in the middle-east, a flair-up of the European debt crisis and now Japan's problems have all been injected into the investment system. Markets hate uncertainty. Stocks reached levels back in early February that largely incorporated all the good news known about the economy up to that point and had not discounted any of the events mentioned above. The S&P 500 came close to 1,350 back on February 18th. That was near the bottom of my price target for the year. In the face of this uncertainty stocks have retreated. Stocks I think will now need time to see how these headwinds affect economic growth before they can mount a sustained advance that breaches that last level. Time of course will tell.

6. We have been in our shortest time frame measurement of money flows NET MARKET NEGATIVE since back in December. You can click here for a definition of what that term means. Basically it says that on balance we have been net sellers of stocks or ETFs per our client mandates and strategies. Today for our most aggressive investment strategy and for a few under invested accounts we went to NET MARKET POSITIVE. That is we were buyers of certain securities today. We could change this rating in a week or maybe tomorrow depending on how stocks react. Longer term this sort of activity brings us back to levels of attractive valuation where we might be tempted to put more money to work if the markets show evidence of stabilizing so we will leave our longer and intermediate term ratings intact.

As always we will let our indicators be our guide.

*Long ETFs related to the S&P 500 in client and personal accounts.