We have been waiting to predict the next move in the market, but current technical and fundamental data is flashing warning signs of a near term pullback. The question is: When will this downturn take place? Since the S&P’s low of 676 on March 9, the market had soared upwards 40% to 946 over the past three and a half months. Yet, the past five weeks of the rally have shown a clear range, with support levels around 890 and resistance around 950.
During the recent rally, we have witnessed a reduction in the extreme fear generated by the fall of Lehman Brothers and the accompanying financial crisis. Such measures confirming fear retreat include the falling volatility index (VIX), decreasing credit spreads, and rising Treasury yields.
The reality may be, however, that the market has come too far, too fast. While cognizant of the fact that the market tends to lead the economy by three to six months, we simply do not see the type of economic recovery that has been built into current market prices. A survey from our business-owning clients confirmed this belief, as the general consensus was that they do not see their businesses getting any worse, yet they do not see the level of optimism that Wall Street has been projecting. Much of the optimism from the market centers around a recovery in corporate profits, but according to Doug Kass, founder and president of Seabreeze Partners Management, “63% of companies in the S&P 500 missed first-quarter revenue goals, but 67% beat profit expectations. That smacks of accounting games and unhealthy cost cutting via layoffs, not real progress.” Additionally, as NYSE volume has lightened up from its March 20 peak at 2.4 billion to its 20-day exponential moving average of 1.3 billion, buying pressure has eroded from its recent highs, and selling pressure has continued to move sideways; we tend to believe that momentum may be exhausted for now.
From a financial planning standpoint, one positive note that has come from the recession has been consumer deleveraging, which can be seen from a 5.7% savings rate reported in May, and is a vast improvement from the negative rate of last year. Unfortunately and ironically, what is good for the individual is not necessarily good for the economy in the short-term, as this increased emphasis on postponing discretionary spending essentially hurts corporate profits. In the long-term though, it will be good to get away from a debt-based economy. However, the U.S. government continues to print money and spend at an increasingly alarming rate. This has led Federal Reserve Chairman, Ben Bernanke, to encourage Congress to confront spending issues, including Social Security and Medicare, highlighting that a crucial component was the setting of tax rates that “achieve an appropriate balance of spending and revenues in the long run.” According to Liz Sonders, Senior Vice President and Chief Investment Strategist for Charles Schwab, “While we have few doubts that some government action was necessary to address the financial crisis, the danger is that the U.S government won’t know when, or how, to stop its interference in the private markets.” We will see how this all plays out.
In the meantime, with unemployment and debt keeping consumers on the ropes and our recent occurrence of big moves off the bottom, the potential for revisiting the lows and disappointment in economic results remains a real threat. Therefore, caution is warranted. We continue to use covered calls to protect our high dividend stock holdings and have used puts and Proshares to hedge our gains. As always, we continue to trade the ranges and stay diversified with gold stocks to enhance our clients’ yields. For any specific questions, call us if we can be of assistance.
Filed under: Economy, Investments
