The Long-Term Trend Remains Positive

by: Financial Sense

by Thomas J. Smith, CFA

There was a move lower last week fueled by concerns over what was taking place in Russia and fears regarding a slowdown in China. A few weeks back there was another drawdown on Crimea concerns that quickly faded and led to a rally.

I do not think that I, nor the vast majority of pundits on TV, can add all that much to what is or is not going to happen in the Ukraine or any other portion of the former Soviet Union for that matter.

There was a "theory" that developed over the last few years that said we need to see huge growth in China in order for our market to move higher; there needed to be someone to buy stuff from us. Well we know what a long period of sustained growth in China does to the market. It increases commodity costs and it makes all of the things they make more expensive. They export that inflation to us in the form of higher costs. So, we get higher commodity costs and lower profit margins. This leads to slow growth and compressed profit margins. A reduction of growth in China allows us to have more non-inflationary growth here in the U.S. This is the type of growth that leads to expanding multiples.

We all have a tendency to fight the last fight. I read a piece from an economist this week that was particularly insightful. He pointed out that there are a larger number of portfolio managers that simply are not familiar with the concept of expanding multiples. It was back in the 1990s when we had a period of expanding multiples fueled by non-inflationary growth. It is happening in front of our eyes. Some believe it, others come up with reasons why it isn't true or real.

When I wrote last week I talked about there being a divergence between the advance-decline lines and the number of individual stocks that are in good shape technically. After the sharp decline that ended in early February, there was substantial damage done to the technical picture of the market. With a pullback like that, several stocks will move lower through moving averages. When the entire market moves lower like we saw earlier this year, technical damage is done.

The first thing I wanted to see when the decline stopped was to see strong advance-decline statistics. Several A-D lines moved out to either multi-year or all-time highs in recent weeks. This created a potential divergence. While the A-D lines were improving, the number of names that were in good shape technically lagged a little bit. That number reached close to 70% on the S&P 500 as we entered last week. The decline last week followed by the rally so far this week is creating a scenario where names are moving out of the technical dog house on a daily basis. The bottom line is that declines fueled by some sort of global concern over the past several years have been buying opportunities.

In early February the S&P 500 bottomed out at 1737. The resulting rally topped out at 1883. After such a move higher, a pullback was not unexpected. In the past I have talked about retracement levels. It can get bogged down real fast. You are just going to have to take me at my word for it that a retracement of moves that equal 38.2% or 50% of the prior move are quite common. So, let's use those percentages to place last week's decline into perspective.

A 38.2% retracement of the move higher would be viewed as an orderly healthy pullback. The target for such a pullback would have been 1827 on the S&P 500. The low last week was 1839. So, while the pundits on TV were yammering about how many days in a row the market went down, the decline last week was not as aggressive as people attempted to make it out to be.

With that said, the decline last week did take out the support levels I gave for the S&P 500, Dow, NASDAQ and Russell 2000. Those support levels were, and still are, 1868/16,300/4318/1198. As I write this morning we are trading above all of those levels. Resistance levels are the same that I gave last week: 1885/16,590/4373/1214.