Where We May Be Going
This is an update of the chart we posted on March 16th. We discussed then the importance of what we saw as three resistance levels. Here is a synopsis of what we said then: "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 {and} also represents a level from which stocks broke out to the upside during the last leg of the 1990's bull market.....Lines 2 & 3 are the trading range that we've previously established throughout February and most of March....The reaction to all three of these levels will likely tell us if we are in correction mode or in need of more consolidation."
The updated chart shows that stocks have so far managed to hold our first resistance level {line 1} and subsequently rally. So far stocks have marked time at line 2. I think we have the potential to trade through this level. I also think that probability is suggesting that stocks are in the process of carving a trading range that could persist into the fall.
We use statistical evidence derived from our playbook and the study of money flows to form our market observations. Here is what the weight of that evidence is telling us.
Seasonal Variations: We noted back in Part IV of our series on stock valuation that "{T}here are seasonal variations or patterns that come into play in most years......The study of these bullish and bearish phases means that I accept as a given that stocks at some point this year will experience a sell off between 8-20%. This is simply the normal course of how markets behave in most years. It is part of the seasonal variation of how in a normal investment year stocks will cycle between bullish and bearish phases as measured by money flows."
While market declines can come at any time, statistically stocks are most prone to major sell offs in between the months of March and October. There is not enough space to go into all the theories of why this pattern persists and of course there is also no law that says this has to occur. However we have to add this factor into the equation given the fact these seasonal patterns exist and given where we are in the calendar.
Unexpected Events. In Part V of our series on stocks we gave a list of possible outlying risks that had the potential to undermine markets. We prefaced that list by saying, "What would likely knock the market off its axis is a major event coming over the transom that is unforeseeable and considered a lasting event with a large economic impact....If such an event should occur though it will likely be one that I haven't thought of here." While we listed the prospect of a natural disaster occurring, we limited our concerns to such an event occurring in the United States and not Japan. We also looked for wars in places not named Libya. That is of course how it works. Markets position themselves for events that they can foresee a probability of occurring. It is the unknown lurking in the shadows which introduces increased risk. Both Japan and Libya have introduced previously non-discounted economic concern. This is an unknown so far in terms of the effect on the global economy.
Earnings Revisions. Markets react to foreword earnings revisions. In general negative revisions impact markets negatively. The same generally works in a positive manner as well. According to BeSpoke Investment Group** Analysts have been revising earnings lower. "At current levels, net revisions are now at their lowest levels since October, 2010. Higher input prices hurting margins was a big enough concern, but with tensions boiling in the Middle East and crisis in Japan, analysts are becoming less and less positive on the outlook going forward."
I stated in my March 16th post that I felt that 2011 earnings estimates are unlikely to reach some of the more aggressive levels that economists have been projecting. It is likely we will start to see those numbers pulled lower as first quarter 2011 reporting commences. While economic expansion keeps me comfortable with my 1,350-1,400 earnings estimates for the S&P 500 for 2011, I see nothing at this point to make me want to raise our estimates.
Positives: I balance this with the fact that the global economy is still in growth mode. US GDP should be around 3% this year. Our corporate balance sheets are in pretty good shape. While housing continues to be a damper to growth, I think that time is beginning to make it less of a factor on the overall economic picture. Banks are beginning to have their TARP restrictions removed and the unemployment rate, while still unacceptably high, has come down somewhat in recent months. Stocks also are still competitive with other investments at this point.
So we are now in a market where positives and negatives may balance themselves out and stocks could swing back and forth, trading in perhaps a 4-10% range from here until we find further economic clarity. Given the push pull nature of things right now I will reiterate my March 16th stance regarding the most recent market top, "Probability also now suggests that that upper band {line 3} will be a significant resistance level for some time....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 {many of the negatives} 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."
We have now opened the defensive pages of the playbook. That does not mean that we are in a sell everything mode. In fact reflecting our short term NET MARKET POSITIVE rating we have actually been net buyers into this sell-off, but we do have more of a defensive mindset in place now, especially if the news should continue to become more negative. In most accounts and strategies that means we have a bit more cash on the books than we did earlier in the year. It does mean we are also in the process of evaluationg postions and sectors. We have therefore modified the game plan and have taken into account certain critical market levels that could cause us to raise a bit more cash as well.
Stocks could fool us all, burst through the top end of the range and head higher. That right now seems like a lower probability event, but if it should occur then we will still participate given how we are invested. Prudence and the weight of the evidence suggests we take a more cautious approach until the dust settles.
Seasonal Variations: We noted back in Part IV of our series on stock valuation that "{T}here are seasonal variations or patterns that come into play in most years......The study of these bullish and bearish phases means that I accept as a given that stocks at some point this year will experience a sell off between 8-20%. This is simply the normal course of how markets behave in most years. It is part of the seasonal variation of how in a normal investment year stocks will cycle between bullish and bearish phases as measured by money flows."
While market declines can come at any time, statistically stocks are most prone to major sell offs in between the months of March and October. There is not enough space to go into all the theories of why this pattern persists and of course there is also no law that says this has to occur. However we have to add this factor into the equation given the fact these seasonal patterns exist and given where we are in the calendar.
Unexpected Events. In Part V of our series on stocks we gave a list of possible outlying risks that had the potential to undermine markets. We prefaced that list by saying, "What would likely knock the market off its axis is a major event coming over the transom that is unforeseeable and considered a lasting event with a large economic impact....If such an event should occur though it will likely be one that I haven't thought of here." While we listed the prospect of a natural disaster occurring, we limited our concerns to such an event occurring in the United States and not Japan. We also looked for wars in places not named Libya. That is of course how it works. Markets position themselves for events that they can foresee a probability of occurring. It is the unknown lurking in the shadows which introduces increased risk. Both Japan and Libya have introduced previously non-discounted economic concern. This is an unknown so far in terms of the effect on the global economy.
Earnings Revisions. Markets react to foreword earnings revisions. In general negative revisions impact markets negatively. The same generally works in a positive manner as well. According to BeSpoke Investment Group** Analysts have been revising earnings lower. "At current levels, net revisions are now at their lowest levels since October, 2010. Higher input prices hurting margins was a big enough concern, but with tensions boiling in the Middle East and crisis in Japan, analysts are becoming less and less positive on the outlook going forward."
I stated in my March 16th post that I felt that 2011 earnings estimates are unlikely to reach some of the more aggressive levels that economists have been projecting. It is likely we will start to see those numbers pulled lower as first quarter 2011 reporting commences. While economic expansion keeps me comfortable with my 1,350-1,400 earnings estimates for the S&P 500 for 2011, I see nothing at this point to make me want to raise our estimates.
Positives: I balance this with the fact that the global economy is still in growth mode. US GDP should be around 3% this year. Our corporate balance sheets are in pretty good shape. While housing continues to be a damper to growth, I think that time is beginning to make it less of a factor on the overall economic picture. Banks are beginning to have their TARP restrictions removed and the unemployment rate, while still unacceptably high, has come down somewhat in recent months. Stocks also are still competitive with other investments at this point.
So we are now in a market where positives and negatives may balance themselves out and stocks could swing back and forth, trading in perhaps a 4-10% range from here until we find further economic clarity. Given the push pull nature of things right now I will reiterate my March 16th stance regarding the most recent market top, "Probability also now suggests that that upper band {line 3} will be a significant resistance level for some time....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 {many of the negatives} 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."
We have now opened the defensive pages of the playbook. That does not mean that we are in a sell everything mode. In fact reflecting our short term NET MARKET POSITIVE rating we have actually been net buyers into this sell-off, but we do have more of a defensive mindset in place now, especially if the news should continue to become more negative. In most accounts and strategies that means we have a bit more cash on the books than we did earlier in the year. It does mean we are also in the process of evaluationg postions and sectors. We have therefore modified the game plan and have taken into account certain critical market levels that could cause us to raise a bit more cash as well.
Stocks could fool us all, burst through the top end of the range and head higher. That right now seems like a lower probability event, but if it should occur then we will still participate given how we are invested. Prudence and the weight of the evidence suggests we take a more cautious approach until the dust settles.
*Long ETFs related to the S&P 500 in client accounts.
**BeSpoke Earnings Estimate Revisions, page 1. BeSpoke Investment Group, March 18, 2011.
posted by CR English at 3:15 PM
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