Where does this rally go from here?
1465.77.
If you’re trying to figure out where stocks are headed from here—and who with money in the U.S. stock market isn’t–you have to start with that number, the Friday, September 14, close for the Standard & Poor’s 500 Stock Index. (The index dropped to 1461.19 on Monday, September 17.)
The number won’t tell you where stocks will be in a week or a month or by the end of the year. But it does tell you how to think about the odds of the market moving higher from here or falling back.
Here’s why 1465.77 is important.
On June 1, 2012 the S&P 500 closed at 1278.04, the low for the year. If the index was near that level now, I be willing to bet dollars to donuts that U.S. stocks would keep climbing.
On the other hand, even though the index is at highs not seen since the end of 2007, a correction isn’t a lock. U.S. stocks have built up considerable momentum. Thanks to a falling dollar (thanks to the Federal Reserve’s announcement of a new round of quantitative easing) commodities have broken a downward trend that extended back to May 2011. The S&P 500, the Dow Jones Industrial Average, and the NASDAQ Composite have all broken above resistance on rising volume. The rising volume part of this is important since it says that investors are buying more stocks even as prices rise. That’s good news for any rally.
To simplify the situation radically, in the short term the course of the U.S. market will be determined by what investors and traders decide is the best way to make money for the rest of 2012 from 1465.77.
Some traders and investors will decide that going short on a bet that U.S. stocks will fall from current high levels is the best move. For a lot of traders—and hedge fund managers—that would be a continuation of a bet that hasn’t paid off terribly well in 2012. You could say these traders are doubling down on that strategy, hoping that it will pay off in the remainder of 2012. And for these traders the fact that the European Central Bank and the Federal Reserve have moved is a big plus. That clears the deck for traders to go short without fear of being blindsided by the world’s big central banks.
And some traders will decide to ride the momentum. If their performance is behind the indexes, they’ll be tempted to go riskier in an effort to make up ground by buying stocks with higher betas than the market as a whole. If they’re ahead or even with the indexes, they’ll decide to keep on doing what has worked so well over the last few months and buy stocks that bet on the U.S. housing recovery, that will rise along with commodity prices if the dollar continues to fall, or that will profit if the fall back to school and holiday retail season turns out to be as strong as is now projected.
The winning strategy for the rest of 2012 will depend on which of these two alternatives attracts more money.
And that in turn will depend on traders’ reading of indicators and events over the next few weeks. In December I’ll bet that we’ll see lots of gurus intimating that the winning trend was inevitable or certain earlier in the quarter. But that simply won’t be true. The current market can turn either way for the rest of the year—which makes it a tricky and risky market. And the way that it turns will depend on a news flow that isn’t predictable right now.
I think that the news flow over the next few weeks will seem positive enough to reinforce the market’s current upward momentum. But this certainly doesn’t make the continuation of the rally a sure thing. At the moment it looks like the best chance of making money lies in going with the momentum. But I wouldn’t pile on the risk in the U.S. part of my portfolio at this point. Long U.S. stocks, yes. Aggressively long U.S. stocks, no.
Here’s why I come out on that side of the U.S. market now.
- Growth in the U.S. stands a good chance of coming in above very low expectations. In the last week or so better than expected numbers on inventory levels, retail sales, auto sales, and home sales have led to very modest increases in growth projections from Wall Street economists. Granted the projections are extremely modest—expectations that growth in the third quarter would match the 1.7% annualized growth in the second quarter have yielded to projections of 1.8%, 1.9%, or maybe even 2.0%. But Wall Street is perfectly capable of talking itself into a belief, especially after the Fed’s announcement of QE3, that the economy’s growth rate is picking up significantly.
- Despite all the long-term, unsolved problems that still beset the EuroZone, the news flow there is likely to remain dominated by stories about falling bond yields in Italy and Spain, and progress toward getting the EuroZone’s permanent bailout fund, the European Stability Mechanism, into operation in the coming weeks. EuroZone leaders are about to deliver something that they’re really good at—a series of summits—in October and November that should keep the idea of progress toward a solution alive.
- A stronger euro on that belief in EuroZone progress means a weaker dollar means higher commodity prices. And higher commodity price will push up commodity stocks, which will give the U.S. market the upward leadership from oil, base metals (iron ore and copper) and gold that it needs.
- It looks like Brazil and China, the Big Two among developing economies, could finish the year on a strong note. In Brazil the government has cut its growth forecast for 2012, while at the same time projecting higher growth in the third and fourth quarters. (That seeming contradiction is actually a reflection of extremely weak growth in the first two quarters that has lowered likely growth for the year but left room for a second half performance that outshines the first half.) In China over the weekend government economists reported that China’s growth would pick up in the third and fourth quarter from the 7.6% growth rate in the second quarter. That would push China’s growth rate for 2012 to 7.7% to 7.8%, above the government’s goal of 7.5% growth. Again those numbers aren’t especially strong—for China—but they would represent a clear bottom in China’s growth above the level that many economists had feared. In other words, no hard landing for China.
If the market receives news like this, it’s enough—added to the stimulus from the Fed and the stabilization package announced by the European Central Bank—to keep this rally going into December.
Of course, the news could be significantly more negative than this. Enough negative surprises could validate the shorts and bears’ view of the market and produce a correction in coming months rather than an extension of the rally.
What could go wrong?
- The crisis in Greece—the Greek government has so far been unable to convince the inspectors from the Troika—the International Monetary Fund, the European Commission, and the European Central Bank—to authorize the next payment in the Greek bailout package. The Greek government says it can squeeze through until November, but a major part of the money was set to go to prop up Greek banks. A loss of confidence in the Greek banking system (or let’s say a further loss of confidence) could send this all out of control.
- Right now the markets seem to be assuming that after the U.S. election all the parties will sit down and work out a way to avoid sending the U.S. off the fiscal cliff in January when automatic budget cuts and the expiration of the Bush administration tax cuts could threaten to stall the economy. Politicians? Rational discussions? A compromise solution? How likely is that? If the elections in November embolden or weaken one party significantly, some one may start grandstanding in a way and on a schedule the freaks the market out.
- Spain could wind up in chaos if the government of Mariano Rajoy keeps refusing to request a bond-buying program and the regional governments rise up and refuse to cut their debts.
- The October transition to a new set of leaders in Beijing could produce enough publicly visible infighting to rattle the Chinese and thus global financial markets.
I’ve probably missed a few pluses and minuses, but you get the thrust of my argument, I hope: the odds favor a continuation of this rally but not overwhelmingly so. You certainly want to give your portfolio a chance to participate in any upside, but I don’t think this is the time to pile on risk in the U.S. markets. Dividend paying stocks in general and in the energy field in particular look attractive. Sectors that would appreciate with good retail seasons, such as trucking, but that haven’t appreciated wildly look attractive. Sectors that might be able to score gains even if the general economy doesn’t turn in better than expected growth—such as housing—deserve a dollar or two.
A last reason to be cautious on U.S. stocks is the very real possibility that Chinese and other emerging market stocks could wind up outperforming U.S stocks if the global economy breaks as positively in the remainder of 2012 as it could. Chinese stocks are cheaper than U.S. stocks right now and are nowhere near a high. If traders go for the risk-on trade in the next few months because the U.S. economy looks stronger and the EuroZone looks more stable, Chinese stocks might reap a bigger benefit than do their U.S. counterparts.
Please note that nothing in this post or in these scenarios imagines that the market will rise on fundamentals. The best that I can find to say is that the rest of 2012 will look better than current very low expectations. I’m talking sentiment and cash flows not GDP growth and earnings.
And nothing in my scenario suggests that the global economy won’t have to pay the piper sometime down the road. We’ve witnessed a huge expansion of global credit and global money supply as central banks have struggled with the Great Recession. The global financial system still faces the challenge of coping with the reversal of those balance sheets and the turmoil that will come with a need to continue a deleveraging that hasn’t progressed very far anywhere in the global economy outside the United States.
At some point kicking the can down the road just won’t be a viable solution.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund http://jubakfund.com/ , may or may not now own positions in any stock mentioned in this post. The fund did not own shares of any stock mentioned in this post as of the end of June. For a full list of the stocks in the fund as of the end of June see the fund’s portfolio at http://jubakfund.com/about-the-fund/holdings/
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Jim,
I would suggest you ignore volume in your technical analysis. With a strong technical analysis background, I know the volume doesn’t mean anything these days. There are always equal number of buyers and sellers, otherwise there won’t be a deal. No matter how high or low the price is, there are always people willing to buy or sell. There’s no way to predict the market for the short term. How about we look at the next 5 or 10 years? I bet the market will be up.
For the near term, euro is still the biggest risk to the market. Many people are waiting for Greece’ exit as the time to get back into the market. But can anyone tell me when that will happen? Maybe the end of 2012? early 2013? But didn’t we say that Greece were going to exit in the first half of 2012 last year? Come on, none of us can predict when something would happen, even if we are sure it will happen.
Sooner or later, inflation will be back. That makes keeping cash or buying bond very risky. What else can we do?
I’d add what I think is a major risk to your “what could go wrong” list – the Middle East. Iran doesn’t seem to be backing off from its nuclear aspirations, and at some point, Israel may act. And with radical Islamic – US tensions running so high now, things could get really ugly. And energy prices could get very high.
Plus – just my opinion – but I don’t expect the US election to settle very much. There will still be a huge divide in Washington, because there is a huge divide among the US population. Politicians may well dig in their heels. And the “fiscal cliff” will not go away. We’re up here (40% of every dollar spent is borrowed), and we need to get down there (sustainable finances). True, we may not have to get down there via the sequestration route, but sooner or later, we’ll have to get down there. It can only be delayed so long before the bond market disciplines us. Ultimately, I think that’s what will happen. No politician wants to be caught with the spoon in his hand when we get a taste of the medicine we need to take (witness what’s happened to “austerity” governments in Europe). They may tinker around the edges, but not do the hard stuff. But the sovereign bond market doesn’t care about votes and what we think. I still can’t figure out why people are willing to lend the US government money for 10 years at 1.8% or so interest – with inflation running higher than that and looking to go higher, and prospects of a weaker dollar making the arithmetic even worse for buyers from potentially stronger-currency countries (China). But I’m certainly glad they are still buying – and giving us essentially better-than-free loans in real terms.
dxa
i may have gotten it wrong but i don’t think JJ was using volume here as a piece of technical analysis. rather, i think he was pointing out that rising volume during an uptrend is one of the mid-later typical phases of a bull market. this signals that the masses are getting into the market and it also tends to indicate that markets are closer to a top than a bottom. there may still be significant upside but when everybody becomes convinced that the market can only go up and is throwing everything into it, good time to be selling.
semievolved,
At any time you look at volume as an indicator for identifying trend, momentum, or market top/bottom, you are doing technical analysis. As a computer engineer, I have a database of market data of the past several decades and did lots of research on all the technical indicators including volume and know that volume indicator never gives a consistent result. Volume was only useful for indentifying the temporary bottom after some panic selling. Some people say there’s a distribution period at the market top when “smart” investors pass shares to the rest of herd. Others say that more often they see stupid “smart” investors sell shares to others and only to see the market goes higher after. I listen to others but never follow them without my own research and back test. I don’t know who’s smart and who’s not. But I know I’m not that smart, especially for investment. So the only thing that I could do is to manage the risk.
Do you see what is happening in Syria these days?
Don’t think Iran is becoming increasingly involved do you?
This might be a good indication of what happens in Europe or maybe even the US when the “fiscal cliff” comes up to bite us.
People will not put up with much more from governments that support plutocratic agendas.
I will invest in forged aluminum assets and plenty of brass currency to feed them.
Own GREK …what would happen to GREK if Greece default ?
I’ve got one foot pointed north, the other south, and more dry powder than usual for me. If I had to predict, I think we’re going with the Thelma and Louise solution.