In the present day, we have ongoing concerns about debt levels in both Europe and the United States. On top of that we have the looming end of the Fed’s second quantitative easing program (QE2). From a technical perspective, the advance off the March 16 lows has come on low volume and we have some short-term divergences that are worrisome.
From a bullish perspective, the economy is in decent shape, especially when looking at GDP. Recent corporate earnings have been generally positive. Despite the concerns mentioned above, the market has checked off eighteen of eighteen technical boxes that tend to coincide with the end of a correction.
Thursday brought a few more pieces of good news to support a bullish outlook for the stock market. According to the Associated Press:
Retailers from Costco (NASDAQ:COST) to Victoria’s Secret reported surprisingly good sales Thursday, and analysts said people would have spent even more but for the late Easter.
There are signs now that the cycle is taking off. Ajay Banga, the CEO and president of MasterCard Inc., told The Associated Press that there’s “something changing” in American spending habits. “The 90 percent of the people who are employed, compared with the 10 (percent) who are not, no longer believe that their jobs are at risk,” Banga said. “And their willingness to spend has changed compared with six or nine months ago … when there was a fear.”
On the threat of a government shutdown and possible impact on the markets, S&P equity strategist Alec Young told Breakout we should not be overly concerned based on these facts from the 1995-1996 shutdown as President Clinton and Newt Gingrich butted heads:
- The S&P 500 (NYSEARCA:SPY) gained 4% during the two month ’95-’96 shutdown.
- Energy was up 12.2%.
- Utilities gained 9%.
- Oil & gas drilling stocks jumped 25.4%.
While late 1995 and early 1996 were quite a bit different from conditions in 2011, the point is the last government shutdown did not disrupt the current trend in the markets, which was up. No matter how well established or strong any bull market is there is always something to worry about. One of the primary tasks for investors is to manage risk. Good risk managers tend to be classified as worriers.
With a mixed bag like we have today, it is very difficult to discern between what may be important and what may not be important relative to the sustainability of the bull market. At CCM, we use two very detailed and thoroughly researched market models to assist us in getting a handle on the big picture. The CCM Bull Market Sustainability Index (BMSI) helps us discern between bull market and bear market conditions (more on BMSI). The CCM 80-20 Correction Index helps us understand when the odds of corrective activity are uncomfortably high. Both models calculate a single numerical value for the present day market, which we compare to historical values and subsequent stock market performance (both favorable and unfavorable).
What are our models currently telling us about the stock market (SPY) and the battle between acceptance of risk and risk aversion? The results can be summarized as follows:
- We remain firmly in a bull market.
- The current advance began from a somewhat extended technical state, based on weekly and monthly market profiles.
- The market’s current risk-reward profile remains favorable, but could become unfavorable again, from a short-to-intermediate-term perspective, sometime in the next six weeks.
Our market models help us answer the question, “Is this a good time to invest cash?” Our answer to that question, based on the models, currently is, “Yes it is good, but not great.” A much better entry point was present on March 17, when we had a somewhat rare and extreme oversold condition from a short-term perspective (on a daily chart).
From a strategy perspective, we took advantage of oversold conditions and reinvested a good portion of our cash between March 17, and March 23, adding to our existing positions in energy (NYSEARCA:XLE), oil equipment (NYSEARCA:IEZ), oil & gas exploration (NYSEARCA:XOP), mid caps (NYSEARCA:IWP), materials (NYSEARCA:XLB), silver (NYSEARCA:SLV), and commodities (NYSEARCA:DBC). We have been patient in recent days given the market's rapid ascent in the last three weeks. We are basically content holding and seeing how the market reacts to earnings next week,aftershocks in Japan, and developments on the budget front in Washington.
Risk-reward profiles take into account the odds of the market being higher at some point in the future and the average gain over that period (based on history). Risk-reward profiles also take into account the odds of the market being lower at some point in the future and the average loss over that period (based on history). Since our two models (BMSI and 80-20) have different objectives and inputs, they produce risk-reward profiles from two perspectives.
First we will review a summary the market’s current risk-reward profile relative to a “typical” market. Then, we will review the data in more detail.
The summary table below shows the market’s current risk-reward profile, based on BMSI readings, is better than the median profile found during bull markets when we look out one month, three months, six months, and nine months (see green boxes on top row). The market’s current risk-reward profile, based on BMSI readings, is worse than the median profile found during bull markets when we look out two months and one year (see red boxes on top row). Relative to risk-reward profiles found in bear markets, the market’s current profile is much more attractive, as we would expect (see 2nd row).
(Click charts to expand)
Using the same concepts from the table above, the results from the CCM 80-20 Correction Index are even more favorable. The market’s current risk-reward profile is better than the median profile when we look out between one month and one year.
The risk-reward ratios for numerous (not all) BMSI ranges are shown in the table below. Notice the current BMSI reading is close to reentering the red zone or an unfavorable market profile. Hence the statements made above:
The current advance began from a somewhat extended technical state, based on weekly and monthly market profiles.
The market’s current risk-reward profile remains favorable, but could become unfavorable again, from a short-to-intermediate-term perspective, sometime in the next six weeks.
The table below takes a closer look at the current BMSI profile compared with typical profiles found in bull markets and in bear markets. The higher the risk-reward ratio, the better.
The 80-20 Correction Index, which has a shorter-term focus relative to the CCM Bull Market Sustainability Index, paints a little more favorable picture over the short-to-intermediate term, which is why we believe stocks could advance further before possibly experiencing another bout of corrective activity.
As we outlined in detail on March 14, we believe Fed policy will continue to be a key driver of asset prices, including stocks and commodities. An article from CNBC echoed our comments from April 6 relative to who is in charge at the Fed (from CNBC):
“The question you then need to ask yourself is who is in charge at the Fed and how will they influence policy amid fears over jobs and inflation. If ‘Helicopter Ben’ is in charge, second guessing an end to QE2, higher rates and a return to normal could be an expensive mistake.”
On the budget standoff, we mentioned it may not be all that troublesome for stocks. However, all else being equal, we would prefer to remove that additional layer of uncertainty. On Thursday night, President Obama met with congressional leaders in an effort to find some common ground, leaving a crack in the budget resolution door.