It certainly is looking bad out there now for the S&P 500 (proxies: SPY and IVV and VFINX) - down 2.45% today as of this writing. The monthly S&P 500 chart shows the first clear sign of a developing bear, based on moving averages.
JPMorgan Asset Management says play it down the middle with a balance of bonds and stocks (and presumably some cash) due to the "bimodal" character of the next few weeks in Europe. They say we are going to have a nice rally or a severe correction, based on the elections, decisions and announcements in June from Europe. The China PMI dropping to near contraction and the limp U.S. jobs report today has spook the stock markets.
We've been positioned similar to the JPMorgan suggestion in discretionary accounts, with approximately 40% in credit bonds, 40% in high quality dividend stocks (mostly U.S.) and 20% cash. Some of our accounts have preferred to be fully invested, but that is not our recommendation at this time.
The idea behind the allocation is to not chase the market in a rally, and not get crushed in a sudden drop, with purchasing power should things get really nasty. We are anticipating that governments and central banks will try to pull rabbits from their hats right quick, and the markets today are screaming at them to do something.
In the meantime, safe-harbor Treasury bond markets (U.S. and Germany) are at extremes of valuation that have little room to go up and lots of room to go down. They produce negative real returns and even worse after-tax for taxable accounts. The U.S 10-year Treasuries probably have something like a 10% maximum upside and a larger rate reversal downside, based on duration. The U.S. 10-year at 1.47% is at the lowest yield (the highest valuation) in its history, and all it does is position the holders for purchasing power losses.
Nations may have no choice but to hide in Treasuries, but individuals have other choices, not the least of which are stable price, zero interest Treasury money market funds and insured bank accounts that pay more than Treasuries.
Back to the matter of signs of a bear. If you look at the monthly price of the S&P 500 since the 1990s, there were only two other times that the price closed below the 12-month moving average AND the 12-month moving average has turned down. That's the condition now.
Note: that this signal pattern worked since the late 1990's, but backtesting does not show it to work in the prior 20 years.
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It's not a fully developed situation, but it's starting to look bad.
This shorter-term chart compares now to the beginning of the crash in 2008. We aren't really there yet, but it sure deserves close observation.
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A few important differences between now and then are:
Positives:
- There is no macro-economic surprise here
- Governments and banks are already fully engaged, so delays in action would be less likely than in 2008
- Some lessons may have been learned to not be repeated
- The US is not the center of the problem this time
- US banks are better capitalized now than in 2008
- US corporations have reduced debt and refinanced rates
- Greece is a very minor part of the EU GDP
- Even slowing, China is growing at a rapid rate, and they have lots of reserve fire power for more stimulus
- More stimulus programs are probably in the cards, which may provide a temporary confidence lift
- US economy the best of country choices, and the economy is still growing.
Negatives:
- Sometimes the inevitably obvious is surprising when it happens
- The 2008 solution was governments assuming private debts - who is going to bail out government
- Governments will have to resort to more currency printing to inflate their way out
- The 2008 problem was more one of liquidity, and this one in Europe is more one of solvency
- European banks are not as well capitalized now as US banks were at the beginning of 2008
- Civil unrest was not a factor in 2008, and it is a factor in Europe now, and maybe later in the US (the Arab Spring was more about economics than liberty)
- Contagion spilling over to Spain, and maybe Italy, would be extremely hard to contain
- China is slowing and approaching contraction - rate of change drives much of investor behavior
- Each additional stimulus program seems to produce successively less benefit
- Bond markets are pricing for end-of-days.
If the June 16 Greek election comes out in favor of the bailout package, we should expect a rally. If the anti-bailout parties win, or if no party wins and another election must be scheduled, we should expect a market rout.
The consistent advice from those major research and asset management firms is (1) don't put all money in either stocks or bonds - stay allocated, (2) underweight or avoid Europe equities, (3) overweight or invest mostly in US equities, (4) focus on non-cyclical stocks, with consumer staples and pharmaceuticals overweights - maybe utilities, but they are expensive historically, and (5) stress quality, brand dominance, dividend yield, dividend coverage and payment history consistency. We would add, hold some dry powder.
Short-Term S&P500 Chart:
This 1-year daily chart of the S&P 500 shows the 200-day average (gold line), three percentage offsets from the 1-year high (5%, 10% 15% and 20% in forms of red lines), the 3-month high and low price channel (blue line), and three 1-month 90% price probability projections based on 3-month, 1-year and 5 year historical volatility (green, purple and block cones respectively). The prices end yesterday, and the horizontal dashed black line shows the market price as of this writing today.
For all the commotion, the S&P 500 is just at correction territory now (10% off of its 1-year trailing high -- the dashed red line).
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In our prior article, we presented a series of arguments for year-end values for the S&P 500 based on street earnings estimates, Standard & Poor's earnings estimates, and a variety of noted analysts opinions.
Disclosure: QVM has positions in SPY as of the creation date of this article (June 1, 2012).
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