April 2016 – Monthly S&P 500 Market Strategy Update

 

The year 2016 started with the cold hand of deflation on all global markets and then it lifted: Sending global equity markets to gains, from the lows, that we haven’t seen since the 1930s.

Crazy times.

As I have outlined in my January and February 2016 blogs I believed the markets were focused on two big issues – Chinese renminbi peg to the US dollar and the Federal Reserve (Fed).

I also stated that over time we should have clarification or better yet answers to these two central questions.

Well since my last update these two issues came into better focus or more benign to what investors were thinking coming into 2016. Go figure…

Renminbi (RMB) Currency Peg

Not only did the brouhaha over a possible devaluation of the RMB calm down but we actually witnessed a small strengthening of the RMB against the US dollar in the month of March.

Huh?

That’s right. With a strengthening of the RMB against the US dollar the bears or traders expecting devaluation were last seen scurrying a hasty retreat. As I commented in my February comments (here), I believed China would NOT devalue the RMB against the US dollar and so far, one month later, that prediction looks sound. Of course, and likely, these bear raids will continue for sometime in the future adding to the variability of global markets so we better get use to it.

And once it became obvious the PBOC – China’s central bank – would not devalue the ‘risk-on’ trade was on sending low priced shares and previously hard hit emerging economies, including Canada, up for big gains intra-quarter.

US Federal Reserve

In hindsight, and after two and a half years of talking tough, the US Fed hiked interest rates in December just when global economic growth was slowing down.

Yes, great timing ladies and gentlemen!

Anyway for much of the quarter, and a mystery to financial markets globally, the governors still talked tough and signaled more interest rates hikes – as much as four hikes for 2016 – in the face of clear evidence that slower US economic growth was occurring.

Much to the relief of the financial markets, Janet Yellen – Chairwoman of the Federal Reserve – in a speech during the last week in March simply stated the obvious; in that she and the board of the Federal Reserve indeed observed the same economic slowdown, as the market participants, and that future interest rate hikes would be moderated or no interest rates will be seen for the foreseeable future.

Again, market participants breathed a sign of relief knowing that the Fed was truly data dependent and the data pointed to a slowing down in the global economy.

Model Price Chart

Let’s have a look at our Model Price chart for the S&P 500 Index:

sp500.n238

S&P 500 Index Model Price Chart with EBV Levels and Weekly Price Bars

 

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 April 5th at 2045.17. If the market rallied to EBV+4 (2202) this would represent a gain of some 8%. If the market corrected back to EBV+3 (1760) investors would be suffering Index losses of almost 14%.

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.

Model Price Comments

What is interesting to me is that the S&P 500 index didn’t retreat all the way back to EBV+3 back in January. As you can see this index hit 1810 twice, first in January and then in February with a subsequent rally into March. The only conclusion I can come to as to why the market didn’t need to go to its support level – EBV+3 – is the market internals are strong and healthy. I know this flies in the face of the bad business news we constantly hear, but really, traders tried to sell the S&P 500 hard, twice, and it rallied both times without coming close to EBV+3.

Impressive, yes?

So we are now getting to the top of the zone between EBV+3 and EBV+4. Yes, we are getting close to the top of the zone…and we may stay there for a while with the Chinese RMB peg devaluation rumours on hold as well as further Federal Reserve tightening or interest rate increases.

We have now been in this zone between EBV+3 and EBV+4 for three years now – the original positive transit happening back in May 2013 (here) – with no sign that either of a positive or negative transit. That’s right, we trade up to the top of the zone and then correct to the lower portion of the same zone. And we could be hear for a while longer, within this EBV zone,  as global fundamentals and possible central bank action is contemplated and enacted.

Conclusion

Well that was one interesting quarter. And with 2016 being a US election year, with both sides of the ticket – Republican and Democrat – having issues trying to get a clear leader to represent either party for a November election. Maybe where the future fireworks or volatility will be in the political arena instead of the financial markets for the balance of 2016. But either way the S&P 500 index is certainly comfortable within the zone of EBV+3 and EBV+4 and will probably be here for sometime in the future.

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