Well folks we finally have action in the US equity markets unfortunately not positive.
The last time I wrote about the S&P 500, remember back in May (see here), the S&P 500 Index was at the top of the zone between EBV+4 and EBV+3. Hopefully you recall the S&P Index has been here since February of this year and as we entered the first few weeks of August (yes, this month) certainly I was prepared for another month of low variability Index action that we have seen over the past six months.
Well this week the market reacted negatively to a series of global financial events (macro) and probably more importantly to the Federal Reserve Board’s eagerness to hike interest rates in the coming months. The Federal Reserve hasn’t increased interest rates since 2006 and my feeling is market participants don’t like this idea one bit.
So let’s have a look at our Model Price chart for the S&P 500 Index
S&P 500 Index with weekly price bars and 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 observe the US equity market, as defined by the S&P 500 closed Friday, August 21 at 1970.89. If the market rallied to EBV+4 (2197) this would represent a gain of some 11.5%. If the market corrected back to EBV+3 (1756) investors would be suffering Index losses of almost 10.9%. So in the past week, trading in the S&P 500 Index has fallen to the middle of the zone.
For people new to Model Price Theory [MPT] the index value or equity price can move within an EBV zone with no real consequence. However when a transit occurs – index value or equity price crosses one of our parallel lines – our EBV line, either positive or negative this gives Model Price users a signal that fundamentals are improving or deteriorating, respectively.
What is the market telling us?
To me, the S&P 500 is telling me it wants to go back to support or EBV+3.
Yes, our Model Price EBV Lines calculate a form of possible support and resistance areas just like in Technical Analysis (TA) but based on Model Price Theory (MPT) or fundamentals – or if you prefer balance sheets of relevant publicly traded companies.
As 2015 progressed the global financial unknowns started to add up. North American investors were looking east as Greece and Europe occupied center stage in the financial press. And after months of rumors about a possible economic slowdown in China, North American investors had to quickly look west as China’s central bank devalued their currency by 3.5% all but confirming an economic slowdown was indeed going on.
Suffering whiplash, and looking closer to home, investors have to evaluate daily the Federal Reserve policy of ‘soon, but not yet’ interest rate policy that seems poised to hike interest rates, and as I said above the first interest rate hike since 2006, in September (or is it December?).
With all the above – macro financial events – going on it only seems reasonable to me that the market is looking for some fundamental or policy support while these macro issues get ironed out.
Yes, the Fed in the coming weeks could make their position known to the financial markets – whether they are going to hike interest rates or not (And my guess is probably not). China could find the right policy actions to get their economic engine back on track. And Europe and Greece can find a way to kick their economic problems down the road in the coming months. And as these issues get resolved the S&P 500 Index may feel better about its valuation and go back up at the top of the zone where we have been since February.
Over the last few weeks the global financial unknowns finally rattled the US equity market. I’m sure in the coming weeks financial institutional officials will do their best to calm financial markets concerns. However if they don’t the S&P 500 Index will be looking for fundamental support at our EBV+3 while the above noted concerns and possibly others get resolved.
If the S&P 500 quickly falls to EBV+3, yes some 11% lower, look for a big tradable rally off this level.
Remember Model Price Theory (MPT) can interrupt what the market seems to be communicating and right now the market is looking for reassurance. This reassurance certainly can be given by global institutional policy makers but if not the US equity market through the S&P 500 Index can lower valuations by 11% and find fundamental support at EBV+3.
The coming weeks will be interesting indeed, as to which way the market will look.