“One of the funny things about the stock market is that every time one person buys, another sells, and both think they are astute” – William Feather
In the first five months of 2013 we have seen the stock market, as measured by the S&P500, produce extraordinary gains with very little resistance. After starting the year off cautiously optimistic, we have become unusually bullish (for us) on the markets. “Sell in May and Go Away” is a mantra of years past … at least in 2013. We have had very constructive markets that have continued to move up as clients and professionals alike simply hate the market. And we keep hearing from talking heads about why this is not a real rally, it’s all Fed induced, etc. Bottom line: prices continue to move up broadly, based on current market indices with 90%+ of S&P 500 stocks being above their 200DMA as we put pen to paper (Source: Stockcharts.com).
But then it happened … the first possible sign of a break in the Bull. On Wednesday May 22 the market opened up strong and moved decisively to a new all-time high on the Dow Industrials Average ($DJIA), the Russell 2000 ($RUT), and the S&P500 ($SPX). Later on that day Fed Chairman Ben Bernanke spoke in from of a Congressional hearing and implied that there could be a slowdown in Fed purchases of bonds on the open market, known as quantitative easing (QE). On that news, the market reversed down and closed near the lows of the day. From a technical viewpoint we appear to have printed what is referred to as an Outside Reversal Day, and we did it on expanding volume.
Notice that I said “appeared to have printed,” not we “definitively printed” an outside reversal day. Six months from now we will be able to look back and know exactly what did or did not happen last week. In real time, however, technical analysis is more of an art than a science. I bring this up, however, as I believe that this has a chance to be a more significant change than we have seen in quite some time. Why?
- The markets are currently “overbought.” On the Daily chart (above) you can see the RSI has just come off the 70 level. On a Weekly chart it remains above 70.
- The market has become “easy.” There has been very little market volatility and corrections have been limited to 3-4%. Even last week’s decline was only a quick 3% drop. The defensive areas of the market – consumer staples, utilities, telecom – have been putting up great numbers supplying investors with both current price gains and current dividends. However, past performance doesn’t guarantee future returns.
- Everyone appears to be on the long side of the market – Sure, people are “nervous.” But, money has been slowly flowing back into the stock market while the perma-bears have been on CNBC capitulating. Sure, the mailman hasn’t come in with his stock tip of the day … yet.
- According to Magellan Financial, Inc. research, we know that more than 90% of S&P 500 stocks are trading above their 200 Day Moving Average – While it is true that history has shown this is a situation that can continue on for an extended period of time, there are very few areas available for expansion to market leadership. (Source: Stockcharts.com)
- The Dow hasn’t had three down days in a row for 100 days and counting.
- Analysts have been ratcheting up their market expectations based on bullish analysis and expanding market multiples.
As we have said in the past, we are adverse to making market predictions and prefer to stay within the realm of market possibilities while straying into the land of probabilities. Currently, we are at a point where a change in market fortunes, in our humble opinion, has a better than average chance of happening. This change can take a number of forms.
- Full on Market Correction: According to historical research done Capital Research and Management Company, on average the market historically produces small corrections on a semi-annual to annual basis and larger corrections every 3 1/2 years. We have yet to see even a 5% correction in 2013 let alone a 5% or a 10% correction. We also believe based on the historical data that we are overdue for a 20%move down. Ideally, a 10% correction right here would be good for the markets.
- A fast move down to S&P 1595-1600: This would alleviate the overbought condition without taking out the technically important 50 Day Moving Average.
- Sideways Market “Selloff”: Markets can correct in price but also time. In this scenario the market averages would move sideways for a period of time, churning along with seemingly little direction.
- A Resumption of the Rally: This has been the rule and not the exception since the market bottomed in March, 2009.
Only time will tell what will happen in the coming months. We suspect that the market will correct here in one way or the other, with a quick continuation of this rally considered the outlier outcome. Memorial Day has past, the slower, historically less profitable Summer months have begun.
Looking out beyond the next few weeks or even the next few months, as long as The Fed is in this market working to keep asset prices up, we believe any correction should be seen as a temporary adjustment. Yes, there are still problems. But truth be told, the economy continues to gain strength, U.S. household balance sheets continue to improve, and the economy continues to produce new jobs. If things continue to improve, allowing The Fed to start “tapering” its bond purchases, is that really such a bad thing? Just as important, does anyone believe that The Fed has used every trick up its sleeve over the past five years to turn the economy around, just to let it all slip away when it appears they are achieving success?
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Past performance is no guarantee of future results. Dividends are subject to change or elimination and are not guaranteed.
Stocks offer long term growth potential, but may fluctuate more and provide less current income than other investments. An investment in the stock market should be made with an understanding of the risks associated with common stocks, including market fluctuations.
Investments that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than investments that are more diversified.
This and/or the accompanying statistical information was prepared by or obtained from sources that Magellan Financial, Inc (Magellan Financial, Inc is a separate entity from WFAFN) believes to be reliable, but its accuracy is not guaranteed. The report herein is not a complete analysis of every material fact in respect to any company, industry or security. The opinions expressed here reflect the judgment of the author as of the date of the report and are subject to change without notice. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy.
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Jonathan D. Soden Robert I. Cahill
Partner Managing Partner
Ann L. Drescher Jeffrey T. Bogert