Where We Have Been, Where We Are, and Where We Are Going
Where We Have Been
Through the first 6 months of the year, the stock market has been basically flat, and I mean flat. It isn't just the fact that the indices are at or near their January 1 levels, but also the action in either direction has been rather subdued. There really hasn't been a sustained trend. The NASDAQ finished 2003 at 2003.37, and it now trades at 2006.66. Its high was notched at 2153.83 (+ 7.5%) and its low was 1865.40 (- 6.9%); the Composite Index has spent only a few more days above 2000 than below. The S&P500 has put in a slightly better performance being up 1.4% for the year, but let's face it, this index has traveled in a very narrow range as well. Highs for the year were reached at plus 4.7%, and the lows were only 3.2% below the end of the year levels.
With strong performances from almost all asset classes in 2003, many analysts came into the year with high expectations. These clearly have not been met, but the year is not over. The markets have weathered terrorism, the prospect of higher interest rates, inflationary pressures, soaring crude oil prices, a Federal Reserve that many perceive as being too easy and yet hopelessly behind the curve, and an economy that has produced record growth but very few jobs. So all in all you can say that things aren't too bad - considering.
On the other hand, the last 6 months could be just a big distribution phase before the markets head lower. Almost all the good news this past year has been met by selling. The hand off and transition of power to a self governing Iraq, a Federal Reserve that has telegraphed every move and promises to raise rates in a "measured" manner, the much awaited and improved job reports, lower crude oil prices, and record earnings growth have done little to advance prices.
In sum, much indecision has been reflected in the price action of this year's market. We all know the market hates uncertainty but why all the uncertainty? Is it the Presidential election? Possibly. Or more likely, as I believe, we are going through a transition phase where the winds are no longer in the market sails. Despite all the good news, the investing back drop looks rather precarious.
Where We Are
In keeping with the theme that the winds are changing and monetary policy is becoming more restrictive, the indicators on the following data have turned decidedly bearish or neutral with in the past 2 months:
1) short term interest rates (bearish)
2) long term interest rates (bearish)
3) yield curve (neutral)
4) CRB futures index (bearish)
5) CPI (bearish)
Of the indicators and data that I follow that shed light on the monetary environment that continue to be bullish are the M3 money supply and the prime rate indicator. In sum, considering all the monetary indicators and data that I follow, these indicators suggest higher inflation and higher interest rates - two conditions usually not synonymous with gains in the stock market.
With regards to valuation, PE ratios continue to be high relative to historic norms. However, with the 13 week moving average of the PE ratio equal to 21, decent rallies have started with PE ratios this high. Some writers and analysts would consider the market overvalued and it might be, but let's keep an open mind and realize that back testing shows that money can be made when PE ratios are at this level. So I will call PE ratios and stock valuations a neutral. Valuing bond yields to S&P500 stock earnings yields (inverse of the PE ratio) shows this measure to be "bullishly" in favor of stocks.
Investor sentiment is becoming very bullish, and the composite indicator that I use, which tracks the investment opinions of 4 different market participants, has become bearish for higher prices in equities. My "smart money" indicator that looks at where professionals are putting their money remains in neutral territory. Anecdotal evidence from the headlines that I read would suggest that investors remain complacent yet have low expectations for future gains.
What about price action? I follow the price action with two methods: my Price Structure Analysis indicator and confirmation. On the NASDAQ, the Price Structure Analysis indicator, which tracks the trend utilizing pivot points and relative strength, remains neutral. On the S&P500, this is in bullish mode. With respect to confirmation, I am looking for a broad participation by major sectors in the markets during any advance in prices. With respect to the NASDAQ, there has not been confirmation as the semiconductors have been woefully lagging other key sectors. In the "old line" stocks, the Dow Industrials have not confirmed the price action in the Dow transports. With declining volume and a lack of broad participation, price action remains suspect at best.
Where We Are Going
I wish I knew, and anybody who tells you that they know is full of it......
So what is the point of the above analysis? Well all this tells me is that the current environment is not favorable to higher equity prices. Things can change in the future. The future could be tomorrow or it could be in 3 months or in 3 years. I can tell you that I have back tested every piece of data and indicator above, and when the indicators are bearish, you don't make money investing in the stock market. The market environment is not favorable to long term gains. Yes, there have been times the markets went substantially higher but these were the rare event. For example, in my previous report on the yield curve, I showed that only 1 time in 10 where the trend changed in the yield curve in the last 50 years did prices head substantially higher. For example, the rare event.
Another way to understand what I am saying is this: price action is paramount. We make money on higher prices not on the indicators. I have combined seven of my best monetary indicators into one "super" indicator and even this is subject to plus 20% draw downs. But using some method to determine the price action, such as the Price Structure Analysis indicator or broad confirmation, to get you into out of the market can reduce draw downs to less than 5% without sacrificing returns. So I continue to monitor and monitor......I follow the price action and adjust risk based upon the market environment.
Predicting the future is not my game.....
In the fairness of disclosure, approximately 60% of my accounts are long a combination of the QQQ and SPY; 40% of my money is in cash. The QQQ trade is a combination of short and long term trades with a cost basis of $36.40, and the SPY has a cost basis of $110.45. These trades were initiated almost 2 months ago. Although it is my opinion that the investing backdrop has changed since then and now is precarious, I will let the price action dictate the results of these trades.
That is The Technical Take!
The Technical Take
$ monetary environment is not favorable to higher prices
$ valuations are neutral
$ sentiment is bearish for stocks
$ price action is neutral at best and appears to breaking down
Thanks for reading and I hope you have found my analysis informative, insightful and profitable....
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