Base Case

We develop different scenarios around market probabilities and incorporate these into our portfolio planning process.  Here is the base scenario that we are currently using for the rest of the summer and likely into sometime after Labor Day.  A base scenario means that we believe these assumptions have the highest probability of occurring.  These are not predictions or guarantees and casual readers of this blog should understand that we bear no responsibility if you act on anything you read here.

For technical reasons first mentioned here  and then here we think the highest probability scenario is that stocks at best are locked in a range bound pattern, likely until sometime this fall.  Higher interest rates, some economic uncertainty and overhead resistance could potentially keep a lid on market advances during this period.  

We are not surprised that stocks have rallied from their lows on Monday into the end of the quarter tomorrow.  High to low stocks had declined about 7% with most of that coming in about a week's time.     In any trend {bullish or bearish}that's usually too much in such a short period.  Including today's open, stocks will have recovered about 3% of this decline and will now bump up against old support levels which are now resistance.  It won't surprise me if tomorrow is a flattish to slightly down day.  If that occurs we'll end the first six months of 2013 with all  major US averages  having recorded nice gains.

However we also think there's a possibility that stocks haven't seen their lows yet in this cycle.   The most obvious reason is the most recent past.  Since this bull market started back in 2009 stocks have developed a nasty habit of giving up most of their gains from the first part of the year over the ensuing summer and early fall months.  A market that would trade back to flat on the year would have still have to lose about 10%.  I am not saying for sure that this is going to happen.  For all I know stocks will turn around now and burst to new highs.  I am saying that I am mindful of what has previously occurred and have to commit that potential factor to memory as we develop the game plan for the rest of the year.  

If stocks are to trend lower the most natural area of consolidation is between 1,500 and 1,550 on the S&P 500 by our work.  A market that trades down to 1,500 would mark a correction of slightly more than 10%.  The S&P 500 at 1,500 would trade with roughly a 14 PE and a 7.1% earnings yield.  Again I will stress that I am not predicting this will occur, I am solely pointing out what our money flow work suggests.  If you trade on this analysis, particularly if you decide to sell securities or short the market based on anything you read here you do so at your own risk.

Irrespective of what may happen these next few months, we have added a few sector ETFs in client accounts based on areas of the market we find attractive and have also put some new client money into the markets.   While I won't go into specifics at this time, I will say that they are more cyclical in nature and these purchases are predicated on our belief that economic growth will favor these sectors in the 12-18 month time period that we typically invest in.  We are still of the opinion that stocks have the potential to resume their advance later this year, irrespective of what may prove to be a period of uncertainty and chop over the summer.  We'll pick up on why we think that longer term markets are better to buy after the 4th of July holiday week.  We're giving this investment thread a bit of a break until after the holiday but we'll continue looking at the markets longer term some time the week of July 8th.  We'll post next Monday-Wednesday next week and then break for the holiday.  Regular summer posting will resume on July 9th.  We'll break in of course if events warrant!

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