S&P 500 Commentary (Part 3)

I have enjoyed writing blogs for CT for a few months now. In the course of developing as a trader, I would like to reflect back on one of the first articles that I wrote for CT. When I began writing for www.commoditytrader.com, I began with an analysis of the S&P 500. In that article, I wrote that the market had made four similar moves since the perennial bull run began in March 2003.

Below are these four corrections that I made note of:

  • Move 1 – 1150-1060 in 8 weeks (7.8% correction)
  • Move 2 – 1225-1140 in 7 weeks (6.9% correction)
  • Move 3 – 1250-1175 in 6 weeks (6% correction)
  • Move 4 – 1330-1230 in 8 weeks (7.5% correction)

click on the chart to enlarge

Interestingly enough, the market was facing a multitude of negative factors; record high oil prices, a Fed monetary tightening cycle nearing its conclusion (albeit we did not know when the last rate hike would be), a cooling housing market (which has gone from luke-warm to down right chilly since), fear of an economic slowdown and geopolitical tensions among other things. In my opinion, the market dropped as it should have; inflation continued to heat up as investors thought it might steady and the market was ripe for a correction after posting multi-year highs amid record high commodity prices.
In either case, as you can see in the chart above, the market found its bottom along the same trend line I drew in early June and has continued moving higher to new multi-year highs. In fact, the Dow Jones Industrial Average (DJIA) has surpassed its all-time closing high, but has had some trouble closing above that level with conviction that satisfies my appetite (another brief correction in sight???).
In light of the recent strength in the market, I would like to point out a reference in the my first post, “Lastly and most importantly, prior to making the correction, the market had reached multi-year highs and proceeded to make new multi-year highs directly after finding their respective bottoms. According to this chart, excluding exogenous factors (Iran nuclear capabilities, energy prices, the Fed, etc), we may see a bottom forming and a quick trek up to new multi-year highs.”
Now that we have made it to multi-year high levels again…what is going to happen next? First of all, let’s take a look at what has happened to some of the exogenous factors that affected the market from May to mid-July.
Oil Prices – Fallen from a August high of $80 to the current price at $60 (25% drop) alleviating gasoline price pressures on consumers
Housing Market – The housing market has seemed to fall off the face of the earth as existing home sales (YOY) actually dropped for the first time in 50 years and new home sales continue to diminish even as builders and sellers continue to add-on incentives to deplete their inventory.
Global Tensions – There was a resolution in Isreal and a cease fire with the Hezbollah. No long-term solutions have been resolved, but the near term looks somewhat civil (as compared to what it was).
Fed Tightening Cycle – The Federal Reserve ended its campaign to tighten credit on September 20th during their latest FOMC meeting. The Fed did leave an open door to more tightening, but it looks unlikely as 10-year bond yields have fallen from a June 20th high of 5.22% to the current 4.77% yield. Effectively, the bond market has priced in a rate cut as the next move by the Fed.
Commodity Prices – Commodity prices have continued to slow. Energy and Natural gas markets have seen the most dramatic decrease, but Gold, Copper and Aluminum have also seen drastic losses.
Economic Slowdown – The economy continues to show signs of weakness. Obviously the housing market is having an effect, and inflation continues to pressure consumers to cut their spending on what I call ‘fruitless’ goods; hopefully becoming more frugal spenders like myself .
Below is a weekly chart of the S&P 500, which shows the recent run up in the markets. Currently, the S&P has again recovered from the latest correction and has ripped up 10% since its bottom in mid-July. During that recovery, the market has not had two back to back losing weeks in the entire run, which effectively is making this market look overbought as it reaches new multi-year highs. We could see this market continue to be overbought as it pushes out new closing highs and finally retreat to a more fundamentally and technically sound level. Another noteworthy topic would be the current VIX environment which has continued to defy odds hovering around 11-12 for months on end. This complacency makes me believe the market may becoming a little too “cocky” for its own good, but I guess we will see.

click the chart to enlarge

As I mentioned in my last article, I still believe that this market is priced for perfection or as media outlets are calling it, a “Goldilocks Scenario”. I would like to see this market continue its trek higher; however, there are several hurdles it must overcome. First and foremost, the S&P 500 has not had a 10% correction since the bull market began in March 2003. Second, a fed tightening cycle has ended in which they typically overshoot and cause some type of recession (whether it is mild or severe, who knows, but equities will follow). Lastly, the best predictor of an economic slowdown has been an inverted yield curve. The United States has never had an inverted yield curve that was not followed by some type of recession. If you ask me, I would be hard pressed to take that bet and as I am currently making my way to Las Vegas right now, I would like to know which ‘house’ is going to make that bet.
Until my next article, enjoy the thoughts.
by Charlie Santaularia
Managing Director
Parrot Trading Partners, LLC
cell 785.766.0773
office 785.749.0000