January 2015, S&P 500 Market Strategy Update

Sometimes simple is best.

Over the Christmas holidays I overloaded on financial business news. How do I know I was overloaded? I got confused. Like a pilot flying by the horizon on a cloudy day and not by his/her instruments, I was off course and started to stall.

Do you get like this sometimes especially about the financial markets? You want to take everything in. You want to hear from all the so-called experts and go through their PowerPoint decks. But at the end of the day…. what are you left with? What information should you weigh more than others? Speaking for myself I simply get confused and locked in a world where doing nothing, or worse, thinking I should go to cash is the result even though I know it’s not the optimal course of action.

Then I return to my world of MPT [Model Price Theory] and everything starts to make sense to me. All stock prices and index values look logical and rational. And a simple aphorism usually leaps out of nowhere from my subconscious that guides me on the right course. And in this instance it came to me in the form of a question.

“Is the tide coming in or out?”

Yes, I know I’m from the east coast – where tides rise and fall 35 to 38 feet, 40 minutes from where I grew up – but I think this simple question will help you distill all the financial analysis that is currently out there.

Huh?

If you have seen me on television you know I’m a big fan of the US dollar. (If not see my blog here on ‘King US Dollar Returning’.) So what does a strong US dollar have to do with anything? Well if the world is purchasing US dollars they need to purchase something with these dollars…yes? A lot of these dollars usually end up in the bond market, US Treasuries as a matter of fact. However some of these dollars do end up in the equity markets. And like the US Treasuries the instrument of choice for most foreigners is the S&P 500 Index ETF or what is known as ‘Spiders’.

Also big moves in currencies usually take a while to occur, that I like to call ‘secular’. How long is ‘secular’? Probably five (5) years a least. So as the US dollar floats upward this usually begets more buying further increasing the value of the dollar.

So, is the tide (in the value of the US dollar) coming in (up) or out (down)?

The tide is certainly coming in! And will do so for a ‘secular’ period of time. What will that do to US assets as a whole? US assets will go up, again over time.

How simple is that? “Pretty, pretty simple!” as Larry David would say.

And I like simple.

You?

As usual in these monthly blogs, let’s have a look at our Model Price chart on the S&P 500 Index to see what is going on.

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

S&P 500 Index with weekly price bars andEBV 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 observe the US market, as defined by the S&P 500, is still in the middle of the zone bookmarked by EBV+3 and EBV+4. If the market rallied to EBV+4 (2217) this would represent a gain of some 8.2%. If the market corrected back to EBV+3 (1773) investors would be suffering losses of almost 14%.

For people new to Model Price Theory [MPT] the index value or price can move within an EBV zone with no real consequence. However when a transit occurs – index value or price crosses one of our parallel lines – an EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectfully.

Having another look at our long-term model price chart of the S&P 500 Index.

I haven’t published our long-term model price chart for a while, so let’s have a look.

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

S&P 500 Index with monthly price bars and EBV Lines (colored lines).

 

As you can appreciate this long-term chart highlighting monthly price bars doesn’t change very often however I find this chart interesting to look at every once and a while.

What I like to draw your attention to are points ‘A’ and ‘B’ that I have annotated on the above chart. Roughly between 2002 and 2007, 5 years, the S&P 500 Index travelled along EBV+4, finding price support and resistance, along our calculated EBV Line.

Could this happen again?

Absolutely! Investors should consider all possibilities and probable market outcomes including the possibly of the slow upward gird. Less thrilling and won’t sell financial news impressions (‘clicks’) or link-bait but very profitable for investors who are long equities.

Is EBV+4 exceedingly expensive in terms of valuation?

Not really! Certainly the S&P 500 Index travelled this path before with higher interest rates and the US in the middle of raging two very unpopular wars – viewed in hindsight.

Were there scary moments over those 5 years – between 2002 and 2007 – that investors worried about holding equities? Again, I’m sure there were but the market still barreled forward in terms of gains, matching the compounding of book value of companies, included in the S&P 500, but not increasing the valuation of the overall market.

During this time period 2002 and 2007 the US dollar was in general moribund. The ‘action’ or money flows was directed to commodity countries (Canada and Australia) and of course the BRICs. Currently, with positive US dollar fundamentals this ‘tide’ will lift all boats, if you will. Economic fundamentals will count, of course, but money flows will help companies not only maintain valuations but also help during periods of economic and industrial rotations and/or dislocations. In other words, market corrections should be shallower and brief.

Conclusion

I don’t know if it’s me but the financial stuff I’m reading on the Internet is unusually bearish. And as I preface this blog even I get bogged down in the negativism that seems to be everywhere. But don’t be fooled, money flows into the US dollar are now positive – the tide is coming in! This very important and infrequent occurrence will help support the market’s valuation and may help increase valuations, maybe to EBV+5, as our global economic issues dissipate as national governments and central bankers adjust to new economic realities.

There are now millions of financial websites and I’m guessing here but most seem to be negative in orientation. Everyone viewing these sites on a regular basis can get caught up in their own ‘echo chamber’ of regular and recurring negative news even in good equity markets!

For me, this endless series of bad news and market factoids not only clutters up my thought process and at worst a major time waster. But sometimes, like over Christmas vacation, one does, and I did, take a peek to see what’s out there – guilty, your honor! Thank goodness for MPT [Model Price Theory]. At least I (and you) can run back to a world we have created that valuation of equities make rational and economic sense.

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