Wednesday, May 15, 2013
500 or 2000 but nothing in between
Someone is going to be proven right.
S&P 500 seems to either be going to 500(~ish) or 2000(~ish) but hanging out in between? Don't expect it.
Why 500? My previous post on analogs have made this case (see Dow Jones from 1960s-1970s and compare it to S&P 500 from 1995-Present).
Why 2000? Because when capital flows get moving, the faucet knob gets stuck, especially when interest rates are this low and the velocity of money (M2) is again, this low.
Time frame? Probably sooner than most think.
Below is the chart of the S&P 500 Index Rate of Change from 2000 to Present. The parameters are set at 260 weeks, or essentially 5 years:
I have put Fibonacci Retracements on the 2000 highs (in red) and the 2007 highs (in black) down to each of their corresponding bottoms. What we can see is that from the 2000 high fib rec, in 2007 we peaked out between the 38.2% and 50% marks. In fact, it peaked at roughly 46.5% which is highlighted by the red dashed line.
In 2007, we currently reside right below that same mark, w/ the 46.5% mark in a dashed black line. Below is a closer look.
On the first chart, in purple, I have put a regression trendline from the 2000 high to the most current figure. The regression TL is the dashed purple line. The solid colored purple lines are +/- 1 standard deviations from the mean. As we see in the first chart, the trend is down as we are nearing the +1 standard deviation line, a sign of potential major resistance (cyclical change).
These two factors (retracing the same as 2007 before the "crash" and the fact that since 2000 we ROC is in a downtrend) could easily make one take the bearish case of the S&P 500.
But... there is a bull case to be made...
First, going back to the first chart, after we bottomed and the ROC trended along for some 2 plus years, it moved in a parabolic like fashion. Right now, the current trend in the ROC has not seen such a move. Could this mean we have more to go?
Another bullish sign is that the regression trendline from the 2000 top to the 2007 saw it move +2 standard deviations (red lines). If we look at the 2007 top to the most current top (today), we have not had that large of a move:
There is something to be understood here and that is the ROC at 260 weeks is a sluggish indicator. This is due to the large parameter setting. To emphasize this, I have included a S&P 500 price overlay w/ the 260-week ROC:
As you can clearly see, the ROC chugged along from 2003-2005 as the S&P 500 made a large move off its cyclical bottom, as highlighted by the first yellow box. Then, when the S&P made its last big leg higher, the ROC went parabolic before the "crash" occurred, as highlighted by the red box.
We have seen similar action from the bottom of 2009 up until 2012 and the ROC is finally playing catch-up (it's been roughly 50 months, or 200 weeks, since the 2009 bottom).
The question is, can we expect one last leg higher? Or have we formed a bottom and we should expect much higher prices moving forward? Let's face it, in nominal terms, we have no resistance above as we have snapped through the double top.
Or... is this it? Are we just about tapped out and can we expect a major sell off to occur?
One may argue for valuations and their historically extreme levels (see earnings yield, PE10, Tobin's Q, Market Cap to GNP for a few) while others argue that the Fed's expansive balance sheet has been highly correlated to the rise in equity prices. Both would have valid points.
I leave you with two last charts... charts that I feel tell a story. Anyone who has read my blog in the past has seen this chart before:
Why this chart? It is of my opinion that we are seeing an almost repeat of the 1937 top in the equity markets. More specifically, in the case of this chart, the Dow Jones of 1929-1939 is a representation of the financial sector in the US, such as the XLF ETF.
We are seeing gold miners (and gold) get murdered day in and day out, all while stocks are rip-roaring higher. This is very similar to what we saw in the mid-1930s as gold miners peaked well before the Dow Jones did. However, as the Dow sold off in 1937, Gold Miners based out and caught a huge bid, revisiting their highs all while the Dow sold down further.
During this period, the dollar was backed by gold. Of course, that is no longer the case. The question is, if this should occurs again it would seem that the fundamentals would have to be different. Massive Inflation? Possibly. But time will tell.
And finally, to drive home the chart above, thanks to Doug Short who built this chart for me, I present this:
What is this? Very simple.
The red line is the Market Value of Corporate Businesses excluding the financial sector. The blue line is Wages and Salaries + Corporate Profits.
As we can see, since 1950 these two lines trended very well together, many of times being the same value. Whenever the red line got above or below the blue line, they reconnect, even if it was some years later. However, since the early 1990s, the red line has dramatically moved higher than the blue line.
With corporate profit margins this high, a lack of jobs for the youth, a growing 65+ years and older workforce, structurally threatening high levels of debt both in the public and private sector (see student loans), it is hard for me to wrap my head around the fact that wages and corporate profits are going to play catch up. Also, history shows that the market value of corporations has "chased down" Wages + Corporate Profits, so this occurrence seems very unlikely. With a lack of jobs comes a lack of income and with a lack of income comes a lack of investment. This is coupled with a negative investing demographic in the US. This does not fundamentally speak to higher equity prices in the US.
I think I have made my bias clear: I am negative on US equities and therefore I do see the S&P 500 visiting the levels not seen since 1995 of around 500, BUT I do not rule out the possibility that massive inflows could still be ahead and a price of 2000 on the S&P 500 is NOT out of the question. If this occurs, it will be my belief that this will be driven through more Fed easing plus international investment.