an tSionna {06.24.13: SPY}

I have no idea where the market will be at any given future point.  What I do is use a weight of the evidence approach which takes into account a wide variety of variables to try and gage different  market scenarios and then assign a probability to that event occurring.  I do this across a short, intermediate and longer term investment time frame.  The following is my attempt to explain what I see and give you an idea on what's going on.  If you are a casual reader of this blog then you act upon what you read here at your own risk.  There is no guarantee that what I am describing is correct as facts on the ground could change.  With that said, here's what I see.

The market seemed to change direction last week.  When we look back with the benefit of hindsight on what transpired, I think we're going to find that investors used Wednesday's Federal Reserve announcement as an excuse to sell and not as the reason to sell.  The reasons to sell can be many at this point.  Here a witch's brew of ingredients for lightening up:  Worries about domestic growth, rising interest rates, worries about growth overseas, lock in performance, markets not as cheap as they were, summer seasonality, concern over corporate earnings....Well you get the idea.  A year ago at this time when stocks were trading at something like 11 times what turned out to be 2012 earnings stocks had a larger margin for error.  At something over 15 times 2013 earnings right now that margin is paper thin.  Given where we are then in the cycle, it is perhaps reasonable that traders have hit the sell button.

The main scenario I'm working through for the intermediate term now is that markets will at best be rangebound probably sometime into the fall.  I've laid out the main technical points why I think that in the chart above.  However, point number 3 listed above needs some further elaboration.  From the period after last fall's elections until late spring, stocks traded in a well defined upward sloping channel and investors were rewarded for buying market dips.  That started to change in May about the time the Federal Reserve hinted that they may be closer than previously thought to winding down their bond purchase programs.   Since then dip buying has not worked.  With last week's action we now have close to two months worth of buyers who are showing losses on their books.  Long term investors won't care so much about this especially if earnings come through and markets can resume their advance sometime later this year.  Traders however do care about the short term and they will be anxious to do something about this into market rallies.  Thus the period you see circled in blue above in the chart represents all those trapped longs.  That kind of resistance doesn't get cleared away in a day.  It has to be chipped away, usually in a consolidation pattern.  That type of pattern can unfortunately mean that the markets could see lower prices at some point before any uptrend resumes.

We'll talk some more about some more implications of the pattern we've seen since last week and some of our investment thoughts for the rest of 2013 starting to tomorrow.