August 2013 – Monthly S&P 500 Market Strategy Update

As possible candidates for the Chair of the Federal Reserve Board are being vetted in the financial press as a replacement for the current Chair, Ben Bernanke, I have a suggestion.

Why not Howard Dean?

I suggest his name knowing there isn’t any possibility of consideration but he was the only sane voice in the ‘hyperbolic free for all’ known as the “Fiscal Cliff” back in December.

As I blogged back on December 30, 2012 “Fall Over the Fiscal Cliff, Please!

Howard Dean, six-term Governor of Vermont and unsuccessful 2004 Democratic presidential nominee said the following according to Ian Bremmer, “If you go over the cliff and stay over, Dow 15,000 in six months.” 

I couldn’t agree more with Mr. Dean.

Well, as we all know the US did fall over the “Fiscal Cliff” and as I look in the financial pages the Dow Jones is at 15,640 as at this writing.

Was anyone else saying this?  Other than myself of course!

I didn’t hear a soul.  And I was listening.  Listening carefully for any voice of economic reason.  Howard Dean was the only one, and I had to quote him indirectly because the financial press was probably not listening, especially to a Democrat.

Model Price Chart

Let’s have a look at our model price chart of the S&P 500 Index.

S&P 500 Index with weekly price bars, EBV Lines (colored lines).

S&P 500 Index with weekly price bars, EBV Lines (colored lines).

As a reminder we aggregate all companies in the S&P 500 Index into one chart on a market capitalized basis (like the S&P 500 Index itself), so we can see where the market – S&P 500 – is trading relative to its EBV lines.

As you can see from our above model price chart the S&P 500 Index since topping out in the third week of May gently touched down at EBV+3 and has rallied to new highs – as of this writing the S&P 500 Index is trading over 1700.  By observing our model price chart investors can clearly see the risk in the US market.  The US market could retreat back to EBV+3 or 1597, a 5.6% decrease at any time.  The upside in this market, that nobody focuses on in the business media, is EBV+4 or 1998, an 18.8% increase.  Considering the upside (18.8%) versus the downside (5.6%) where the S&P 500 Index closed on July 31st offering long only investors considering US large capitalized equities a good risk-reward ratio for profitable investing.

Doesn’t the US equity market seem different?

All publicly traded markets, including equities, have a feel.  Market veterans know what I’m talking about and it’s hard to describe but the US equity market has a different feel to it.  Thanks to a positive transit of EBV+3, back in May of 2013 – see blog, the US equity markets feel that they are functioning normally and with confidence.  It feels safer.  Don’t get me wrong equities are equities, they go up and down, but as the economy gets stronger this certainly gives valuation support to present and future equity valuation.

Another way to describe my market feeling is “boring”.  “Boring” with a positive bias.  Does that sound better?  Don’t you agree?

Tapering Anyone?

Equity market strategists are concerned about the steps the Federal Reserve Board (FED) will take in terms of reducing their monthly asset purchases in the near future.  Remember the ‘FED’ purchases $85 billion in US Treasuries and agency mortgage paper a month.  As the US economy becomes healthier it is only a matter of time, in my estimation, that the FED’s monthly purchases would start to decline – taper.

Instead of worrying about the ‘tapering’ per se let our model price chart on the S&P 500 be your guide.  In my opinion everything will be OK, just as long as the S&P 500 Index stays above EBV+3.    If there is a negative transit of this ‘red line’ then this would be a market signal that any ‘tapering’ maneuvering by the FED is wrong footed and runs the risk of the US economy potentially entering another slow down or recession.

Conclusion

Having the S&P 500 Index above EBV+3 is sending the signal to investors that US equities have a great risk reward balance for long only investors in US large capitalized companies.  The longer the S&P 500 stays above EBV+3, is giving market participants confidence that equity markets are functioning normally and that proper price discovery is occurring based on the fundamentals of individual companies underpinned by economic growth of the US economy.

“Tapering” can be a risk to equity investors.  Don’t let the business press and “market experts” steer you wrong.  The US market will send investors a signal if all is not well with any “Tapering” action if the S&P 500 Index has a negative transit of EBV+3.

As always we will see what happens.

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