S&P 500: Where From Here? (2016-01-22)

We have been getting calls, asking where the market is going. To be clear, nobody really knows. Markets can do anything – an they usually do. That said there are some technical tools to take reasonably educated guesses about what might happen in the short-term (excluding exogenous changes, such as central bank policy changes, or shocking macroeconomic statistic releases, or some terrible world event).

Fundamental projections are not any more useful in the short-term than technical indications. Fundamentals do determine where markets end up in the long-term, in the short-term emotions, funds flows and world events (and media hype) have a lot more to do with market behavior than fundamental valuation.

Adam Parker, founder of FundStrat, and former Chief Equity Strategist at Morgan Stanley recently had this to say about market price forecasting based on valuation.

“Trying to figure out where the market is going is like taking something we don’t know how to forecast (the price-to-earnings ratio for the market) and multiplying it by something we aren’t very good at forecasting (the earnings for the market). We have always written that we don’t think anyone can forecast the market level P/E ratio in time frames less than a few years.”

OUR SHORT-TERM VIEW SUMMARY:

The primary trend for US stocks and the S&P 500 in particular is down

The rally last week was contra trend, but was likely not a reversal of the downward primary trend

The current S&P 500 price is far enough below its trend that there is a statistical probability of a contra trend rally to perhaps 1935

There are numerous fundamental and macro issues that are applying negative force to continue the downward primary trend

Internal breadth of the S&P 500 (as well as other major indexes around the world) is decidedly negative

Historical volatility over 1 year, 6 months and 3 months suggest a reasonably likely index price range over the next 3 months between 2250 and 1775

The downward path of the primary trend suggest the lower half of the 2250-1775 range is more likely to be realized

Fibonacci, Price Channel and Pivot Point indicators suggest the index price may experience resistance in 1935 to 1950 range, 1970 to 1975 and the 2015-to 2025 range

INVESTMENT UTILITY OF SHORT-TERM VIEW

Investors in Accumulation Stage (averaging in): This short-term view of the primary trend is not relevant to most investors with a long time-horizon before retirement, who have chosen their appropriate risk profile, and who are continuing to add capital to their investment portfolio.Those investors are probably best served by simply maintaining the allocation risk profile they have selected, and going about the business of earning money and saving as much as they can.

Since downturns don’t last forever, and periodic investments buy more shares during downtrend than in uptrends, short-term trend information may be useful to those periodic investors who can squeeze their household budgets to increase periodic investments during downtrends.

Investors in Withdrawal Stage (averaging out): This short-term view of the primary trend is relevant for those who are in or near retirement who want to reduce the “risk of ruin” (outliving assets) due to having to sell assets during a decline to fund withdrawals.Note that retirement portfolios are depleted at an accelerated rate when selling assets during declines, increasing the risk of outliving assets.

For those investors in the withdrawal stage of their financial lives, a recent statement by Bill Gross (formerly CEO of PIMCO and noted bond manager) is relevant.He said the current market is one for return OF capital more than one of return ON capital.

The risk of ruin is minimized for those investors in retirement who can live out of investment income without selling assets.Dividend investors may have a lower risk of ruin if their dividend stocks have above inflation dividend growth rates, and thus they may have less interest in short-term trend changes.

Investors With a Desire or Need for a Tactical Overlay: Several sorts of investors occur to us to may find short-term trend information relevant:(1) those withdrawal stage investors relying on capital appreciation for a significant portion of their retirement income, (2) those accumulation stage investors who wish to increase periodic investments during downturns, (3) margin investors, (4) options investors, and (5) and other investors in any stage of their financial stage of life who prefer to engage in some form of tactical investing: