Saturday, August 25, 2012

Late summer rally into resistance

Hi there, and welcome back to CRI's S&P 500 blog.

 

As has been the case now for more than a couple months, the US stock market (as measured by the S&P 500 stock index) has been moving higher after a rather healthy spring correction. So much so that it has broken the spring highs and looks like it wants to move higher in the short term. The trading sessions around big holiday pivots (NewYears, Easter, July 4th, and Labor Day) often see some wild gyrations. This year's Labor Day transition period may see very much the same. The market is moving higher, but we are approaching a significant resistance zone. 

So what may take the wind out of our proverbial sails? Well there are several 'normal' seasonal drivers this time of year as well as some more pressing short term market issues that need to be dealt with. Firstly, the commodities markets are subject to their seasonal issues (the end of the driving season is near and that means a transition of focus away from natural gas and unleaded and back to heating oil for the energy market; construction season is winding down so that means copper and metal markets need to reprice demand; and fall harvest is fast approaching and that means a glut of agricultural supply ought to hit the market in the coming months). Secondly, from a supply/demand perspective of equity (ie stock ownership) the sessions following the Labor day weekend are when many market professionals come back from their summer holiday's and look to take advantage of higher prices to lock in some profits. They will often dump their under performers and look to acquire new names into the anticipated fall dip. And lastly, from a more shorter term perspective, there are several fundamental drivers (specifically from Europe and votes on bailouts of the PIGS nations) that will take place through the end of September. These events ought to inject some uncertainty and fear into the market. So, put it all together and one ought to temper their bullish enthusiasm through the next few months. We have enjoyed a nice rally in many markets through the first eight months of 2012 - now is not the time to get too greedy when it comes to capital gains.

If one were to look at the chart above, it should be fairly clear to see the current support and resistance zones the equity market is working with. We are now brushing up against the underside of a rather significant trendline that ought to keep a lid on price for at least the short term. That trendline appears to come in at or near the 145 area so there is still a little wiggle room higher should we get some sort of burst higher in the coming sessions (holiday pivot volatility). Conversely, we are more than 10% higher than any real support as the current '50% rule' level is more than 15 points lower than where we closed Friday. Considering too the historic nature of September (it is often the worst performing month in the calendar year), the converging trendlines and the noticible gaps and we have a building list of reasons why price ought to correct. I will be expecting that correction to test the spring lows (126.48 on SPY) and for the market to ultimately trade back to the 50% level (124 area). I say 'correct' and not 'crash' because 1. The yield curve is still very healthy and the US Fed has just recently suggested it will add liquidity (not take it away). 2. Corporate earnings are still very robust. 3. November is a US presidential election and very rarely do markets break in earnest ahead of such events. 

Once past November, all bets are off as the looming 'fiscal cliff' shall dominate trade. Is the market getting ready for that event now by topping out? That could very well be the case but we won't know for sure until we start to actually see some price deterioration. One of the biggest mistakes I see new investors make (and I still make) is to assume something has happened (or is going to happen) before it actually does. As of now, our time tested 'investor signal' (that being the relationship between the weekly 13ema and 30sma) is still positive and has been so since the market turned up late last year. One would have been remiss to step in front of that indicator and as long as it remains positive 'investors' ought to sit tight and hold on to their long positions.

Trader stance: this camp ought to be long from the significant breakout through 137.80. Stops on that trade still ought to remain below the 132.50 area as no new support zone has been established since the breakout. The break above the spring highs (141.48) does imply a massive bullish ab=cd formation; so until the market does actually breakdown, one still ought to be looking for higher, not lower prices...

Investor stance: As outlined above, 'Investors' were given the signal to get back into stocks almost a year ago (when the 13ema crossed back above the 30sma) at or near the 120 area. They ought to be sitting on the better part of a 16% capital gain as well as dividends paid along the way. Does it seem realistic for the market to give a bit of that back? Considering the historic average return for stocks is 11% (capital gains plus dividends) and I think one could argue that yes it does. Having said that, our time tested indicator is still bullish so one ought to sit tight and enjoy the nice late summer warm weather - just be ready to act, should the market tell us to do so. 

That's all for this week,
Brian Beamish FCSI
The Canadian Rational Investor
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