As the S&P 500 hovers just above the 1,550 level and is trading only a few points away from an all-time nominal high, the question many traders and investors are asking is: where do we go from here?
In May 2012 I wrote an article entitled The Curse of Sisyphus: Will The S&P500 Decline 50% From The 1,550 Summit Once Again?', showing how the S&P 500 plummeted 50% the previous two times that the index touched the 1,550 level over the last 15 years. Will this number once again prove to be a "cursed" number for the index? Are we in store for another 50% decline in the S&P 500, or will this time be different?
The last time the S&P 500 hit the 1,550 level was in October 2007. By examining the relative price action between the S&P 500 and two important sectors of the U.S. economy, we can see that the current approach to 1,550 looks very different from the one that occurred in 2007.
The U.S. housing industry accounts for approximately 18% of U.S. GDP - so it always important to note in which direction this industry is moving.
Let's look at the current level and trend for the U.S. Housing Index. After a long consolidation phase between July 2009 and October 2011, the Housing Index has been in a strong and well-defined uptrend that began in November 2011. Although the index has risen 100% since November 2011, it is still 39% below its peak of 290 that it hit in April 2005.
In 2007, the S&P 500 hit the 1,550 level twice: July 2007 and October 2007. Between these two peaks the Housing Index had already declined 22%.
Today, we have a very different price relationship between the Housing Index and the S&P 500.
In 2007, the Housing Index was well below its 2005 peak and accelerating to the downside while the S&P 500 was still hitting all-time highs.
Today, as the S&P 500 floats around 1,550 and approaches new all-time highs, the Housing Index is in a strong bullish trend and still 39% below its own all-time high.
Want to know the health of the U.S. economy? Just look at the banking sector. As of December 2012, deposits at U.S. banks exceed loans by an unprecedented $2 trillion. On March 7, 2013, the U.S. Fed released the results of its latest stress test for the U.S. banking industry showing that 17 of the 18 banks tested (representing 70% of total bank holding company assets in the United States), had passed the test.
In 2007, the S&P 500 formed a double-top near 1,550 in July 2007 and October 2007. This double-top turned out to be the beginning of the end of the stock market bull cycle that began in April 2003.
The U.S. Financials ETF (NYSEARCA:XLF) formed a double-top of its own in February 2007 and May 2007 - XLF topped out five months before the S&P 500. By late July 2007, XLF was already 14.0% below its May 2007 peak - the weakness in U.S. Financials preceded the weakness and imminent collapse of the S&P 500. XLF bottomed out between September 2011 and November 2011, and has been in a well-defined uptrend since then. Although XLF is up 59% from its November 2011 low, it is still 41% below its peak of May 2007.
In 2007, both the Housing Index and U.S. Financials had already peaked and had started to decline when the S&P 500 was trading at 1,550 and setting all-time highs. Today, with the S&P 500 once again at the 1,550 level and only a few points away from a new all-time high, the Housing Index is still 39% below its all-time high, and XLF is 41% below its all-time high.
Yes, Dorothy, this time may be different.
With the U.S. housing industry climbing out of a catastrophic six-year bottoming process and starting to show signs of sustainable growth, and with U.S. banks sitting on fortress-like balance sheets, the S&P 500 at 1,550 may be the beginning and not the end of a bullish cycle for U.S. equities.
As always, we will not assume anything but simply follow the price action of the S&P 500 and act accordingly.