SP 500 Index Near Critical Break Point

By: Martin Weiss | Mon, Jun 26, 2006
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Money and Markets

Back in March of 2000, the S&P 500 Index catapulted to 1,553, its highest level in history.

But from that point onward, it suffered its worst decline since the Great Depression, plunging by HALF -- to 776 by July of 2002.

It was a devastating wipe-out: WorldCom filed for Chapter 11, the largest corporate failure of all time. Investor confidence all but vanished. And for months, Wall Street struggled desperately to recover.

It wasn't until 2003, as the U.S. was preparing for war in Iraq, that the S&P finally turned back up, and it's been rising virtually nonstop ever since.

The main source of funding: The Federal Reserve.

The Fed pounded interest rates to the mat -- a meager 1% for Federal Funds -- and then pinned them down to that low level for a full year, the longest period of rock-bottom interest rates since World War II.

Cheap money poured into the economy and into the pockets of millions of Americans. So naturally, they poured that money back into stocks. But last month, the tide began to shift:

Last Fall, I warned about a similar breakdown in the S&P, which later turned out to be a false alarm.

But the breakdown this time seems to be deeper and more sustained. It's coming with a parallel breakdown in tech stocks, in corporate earnings and, not coincidentally, in the same Iraq war which originally launched the stock market rally over three years ago.

Most convincing of all ...

The Bond Market Has Been
Sinking Virtually Nonstop
Since June 13

Treasury bonds, which compete with stocks for investor funds, have already been falling sharply in price.

They peaked over a year ago. And on June 13, just when Wall Street had finally convinced itself that the Fed was going to stop raising interest rates, they began to plunge anew.

Now Treasury bond prices are at their lowest level in two years as their yields have soared. This one event, more than any other, illustrates how quickly Wall Street has lost hope for interest rate relief.

This bond market decline (and interest-rate rise) can slap stocks in two ways:

First, it threatens to suck money out of the stock market. Many investors know that stocks are a gamble. They know that the dividends most stocks pay don't amount to a hill of beans. And they know they can get a guaranteed 5% income in Treasuries, no matter which way the market goes. That's a key reason an exodus out of stocks is already under way.

Second, rising interest rates dig a hole in the profits of thousands of companies, especially big banks and mortgage lenders.

Bottom line: The latest decline in the bond market could drag down the S&P 500 Index and mark the resumption of the bear market that first began in 2000.

Some Major Stocks Are Already in
Their Own, Individual Bear Markets

Even if the S&P 500 does not keel over, there are quite a few household-name companies that are already in a bear market of their own.

Ford (NYSE:F) is a prime example.

Last week, its shares plunged to $6.40, breaking BELOW its rock-bottom low of the 2000-2003 bear market.

Investors who put $10,000 into the company at its peak seven years ago would now be holding shares worth $1,748, a loss of nearly 83%.

Even those who were lucky enough to pick up the shares at the very cheapest price of the decade are now in the red.

Can investors take solace in the idea that Ford is an exceptional situation? Or should they be worried that it could be the harbinger of what's to come for the S&P as a whole?

If Dell (NASDAQ:DELL), also a major S&P 500 stock, is any indication, the prognosis is not good. Its shares hit a peak of $59.69 in March 2000, and plunged precipitously to $16.01 just a year and a half later.

Suppose you got lucky and happened to buy Dell at $16.01, its very lowest price of the decade?

At first, you would have done quite well, riding the stock all the way up to its peak of $42.57 reached in December 2004.

But since then, Dell's results have turned sour quickly and steadily ... the stock has plunged back down to $23.72 ... and you'd have given back close to 90% of your gains.

That's why Tony Sagami has issued clear warnings to get the heck out of Dell -- not to mention Micron Technology, Intel and Juniper Networks. So be sure to read Tony's current reports and heed his words.

Financial Stocks
Could Be Next

The shares of big brokers, banks, and insurance companies could be among the next to head toward their bear-market lows.

E*Trade (NYSE:ET), for example, a stock we've been tracking very closely, was on a steady upswing until April.

But now that trend is history. The stock started breaking down in early May and then went into a swan dive two weeks ago.

We see a similar pattern in other major brokerage stocks. And it looks like nearly all financial stocks -- especially those whose fate is closely tied to interest rates -- are going to take it on the chin.

As Mike Larson explains in his preview of this week's rate hike, Fed Chairman Bernanke has just two choices right now:

Either he raises rates gradually for a long time ... or he raises rates sharply for a short time. But barring an unexpected disaster coming from out of the blue, rates are going up.

That's bad news for companies that have a habit of borrowing money short term, at rates that are now rising, and then lending it long-term, at rates that are now locked in at lower levels. And unfortunately, nearly all major banks, insurance companies and brokers do precisely that, in varying degrees.

Among the S&P 500 companies, we believe Fannie Mae (NYSE:FNM) is especially vulnerable in this regard.

Not only does the company get hurt by rising interest rates directly, it's also a sitting duck for a housing bust, an industry that's also getting slammed by rising interest rates.

If Fannie Mae's accounting were in order, we might have some idea of how vulnerable Fannie Mae really is. But unfortunately, that hasn't been the case for years, and massive efforts to clean it up are still ongoing.

During the early years of the bear market, the company dazzled Wall Street. It zoomed from a low of $47.88 in March 2000 to a high of $89.38 in December 2000, giving many investors at least one major stock to gloat about in their otherwise sinking portfolios.

Even as the S&P 500 was getting sliced in half, Fannie Mae shares held up pretty well as investors sought it out as a haven of relative safety. All that abruptly ended last year when the stock plunged below its 2000 low and just kept on falling.

And now, after a 4-month rally, its on its way to doing it again: On Friday, it fell to at $46.37, a buck and a half below its worst level of the bear market.

Exceptions That
Prove the Rule

Are there exceptions in this sinking scene? Absolutely!

Energy companies, for example, which make up an increasingly large share of the S&P 500's market cap, have shown no sign whatsoever of giving up their long, 3-year pattern of steady increases ... and for good reason.

Their profits are largely driven by oil prices. And oil prices -- despite all the talk and banter to the contrary -- are locked solidly in a rising channel, marching continually upward with little more than minor interruptions.

Could oil prices break out of that channel at some point, either turning sharply lower or jumping more rapidly? Sure. But until they do, the channel sets the parameters very clearly: Not much less than $70 on the low end and as much as $85 on the high end for the next several months.

Moreover, the strength in energy doesn't detract from our argument about the shaky state of the S&P 500 Index. It reinforces it.

The surging cost of energy is precisely what's helping to drive up inflation and interest rates ... while driving down the earnings of companies like Ford and Fannie Mae. (For details, see my report "The Cycle of Debt and Energy.")

What to Do in This
Scenario Is Clear ...

You sell the many stocks that are going down, and you buy the few that are going up. And then you stick with that strategy until something changes that proves you wrong.

What might that be? Here are a couple of the things we're watching vigilantly:

First, we're on the look-out for the possibility that the S&P 500 might repeat its feat of late last year -- silencing the alarm bells that are now ringing so loudly and regaining its earlier uptrend. With the Fed about to raise rates this week, we don't see that happening. But if it does, we'll do our best to let you know.

Second, we're on the look-out for the outside chance that crude oil prices might break below their upward channel. Without peace in Iraq and a major breakthrough in Iran -- two mission-impossible events -- it's going to be tough. But stay tuned.

Until then, stay the course: Reducing your exposure to the stock market overall while keeping a solid stake in the exceptional stocks that continue to move higher.

"But I can't sell my stocks now," say nearly half of investors today. "I can't afford to take the loss."

And ...

"I can't sell now," say the other half. "I can't afford to take the profit and pay Uncle Sam."

My answer: Baloney!

If your stocks are selling for less than what you've paid for them, you're already losing money. And whether or not you convert "open" losses to "realized" losses doesn't alter that reality.

Conversely, if you have an open profit in your stocks, never forget that Uncle Sam is your constant partner. You or your heirs are not going to get rid of him. He'll be there, hat in hand, ready to take his share whether you sell now or you sell later. So always look at the numbers in your broker statement net of any future taxes.

Then, base your sell or hold decision on just two simple questions: Is your stock more likely to go up? Or is it more likely to go down?

Unfortunately, with most stocks, dividends are not a significant factor. They're too small. The total income they give you is often less than half ... less than a quarter ... or even less than one-tenth what you can get by just stashing your cash in Treasury bills.

But, here too, there are exceptions.

Take Enerplus (NYSE: ERF).

Unlike the S&P 500, this Canadian energy trust, has continued along its upward path through thick and thin.

It's sporting a dividend yield of 8.62%.

And, like crude oil prices themselves, as long as this trend doesn't change, why change your strategy?

How To Protect Yourself
From A Broad Market Decline

For starters, you can make sure you keep a big chunk of your investments in cash equivalents like short-term Treasuries. You can already get close to 5% on your money right now, and with the Fed's likely rate hike this week, you should get even more.

But watch out! As I showed you earlier, long-term bonds -- and even medium-term notes -- are sinking in value right now. So make sure you stick with short maturities.

Second, you can buy some "bear market protection" with a mutual fund that was created especially for this kind of situation: Rydex Ursa, designed to rise 10% for every 10% decline in the S&P 500 Index.

Third, you can buy what I call "crash insurance," using put options on stocks most likely to fall.

Fourth and most important, remember that no investment is forever. Don't fall in love with stocks or even bonds. No matter how great they may be, when it's obviously time to sell, do just that: Sell.

Good luck and God bless!



Martin Weiss

Author: Martin Weiss


Martin Weiss, Ph.D.
Editor, Safe Money Report

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MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Jennifer Moran, John Burke, Beth Cain, Red Morgan, Ekaterina Evseeva, Amber Dakar, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others.

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