This blog should be read in conjunction with my earlier blog, “In a Year of Multiple Transitions: This one is the most Important to your Financial Health!”
Which camp are you in?
There are two camps of thought about this equity market. The bearish camp, where deflation and hyperinflation are the topics of choice, and so much can go wrong in an interconnected world where financial transactions can occur with a push of a button on one’s iPhone. The bullish camp, as I posited in an earlier blog, must take a ‘Leap of Faith’ that the economy can grow on its own without US Federal government help – both fiscally and monetarily – or said differently increasing business confidence can encourage the private sector to invest, spend and hire.
We are at a critical juncture with the US economy with everybody taking sides – bullish versus bearish views – with no middle ground in sight.
Add this uncertainty with having a US equity market that hasn’t had correction for close to 600 days and one has to conclude the inevitability of the equity markets taking a powder.
Model Price Chart of the S&P 500
As long time readers have come to expect, here is our calculated model price chart for the S&P 500 up to February 3rd, 2014.
S&P 500 Index with weekly price bars and EBV Lines (colored lines).
For new readers 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.
“Stuck in the Middle with You”
Remember the song by Stealers Wheel, “Stuck in the Middle With You”; well that’s where investors are finding themselves when talking about the S&P 500 in terms of Model Price Theory (MPT).
For new readers to MPT, stock and index values can trade (move) within our calculated EBV Lines without consequence. It’s only when market values have negative or positive transits of our EBV Lines that signify changing fundamentals. So markets can roam within EBV zones without consequence and for a period of years.
The only actionable steps users of MPT should consider as S&P 500 Index falls closer to EBV+3, allocations to equities can increase. Market corrections are a time investors can initiate purchases of companies included on their wish list for lower prices or better still adding to already established profitable portfolio positions.
As you can observe from our model price chart (above), and after Monday’s downward action, the S&P 500 Index is less than 100 S&P points away from EBV+3 or 1646 or on a percentage basis this differential represents only 5.5%. To have the S&P 500 back to EBV+3 or support this would be a welcomed opportunity for those who wanted to add additional exposure to US equities.
The upside is of course EBV+4 or some 18% higher than the market close last night. The risk reward for equity investors is getting skewed in favour of rewarding investors. This is as it should be. As the market goes lower the more potential value accrues to the investor.
You can almost hear the sucking sound. Investment dollars are being sucked out of emerging and secondary markets and heading towards the United States. I’m sure global investors were shocked when the Canadian dollar and other peripheral currencies were trounced in January as investors fled in droves.
In times of transition, all markets go down and over a period of time strong fundamental markets will drive to new highs. Obviously we are in the ‘all markets go down’ phase of this transition giving opportunistic investors or followers of Model Price Theory (MPT) confidence in increasing their asset allocations in favor of US equities.
Macro forces are at work; with global investment flows being the primary driver to both currency and equity markets. This could be a confusing time for investors because company specific data, such as earnings, will be taking a back seat. Friday morning will be interesting with the monthly US employment numbers from the Department of Labor. Severe winter weather along with seasonality adjustments will make this number a ‘crap shot’. Seat belts may be required for both, upside and downside action.