S&P Target 1600: The P/E Decompression Stampede - Part VI

by: The Other Street

Return to Part V

Yesterday, I mentioned that a first intraday read of the Dow Model pointed to a new target of DJII 13300. We were at 12997. We close today Friday at 13075, and the final Model numbers show a new trading range of 12888 to 13309 (DIA). This confirmed what I had suspected, as 14 stocks decisively broke their resistance levels over the past two days, and another 6 are testing theirs.

The other news is that the Overbought/Oversold Ratio (OB/OS) is still in buy territory, at 0.43. After this 500 points move, this would suggest a still volatile trading range, but in fact it got compressed, to 3.3% as opposed to the previous three weeks range of 4.7%. This makes sense, unless we get a Stampede - I'll get to this later.

What needs to be watched now are the Momentum Ratios. The MAC (exponential moving average convergence) is even better than on 7/25, at 2.03, and so is the AA (not Alcoa, but our proprietary modified RSI Oscillator), at 2.23. However, I will note that this is the mean number. The median is showing a bit of loss of momentum, at 2.50.

Overall, since July 14, we are up 1.4%, and the standard deviation of individual returns is still a wide 3%. In terms of relative returns, the most notable stocks on the upside have been have been ATT (T) plus 4.8%, General Electric (GE) plus 4.4%, International Business Machines (IBM) plus 4.1%, Caterpillar (CAT) plus 3.5%, Minnesota Mining (MMM) plus 3.4%, and Dupont (DD) plus 3.1%. On the minus side, the notables are Bank of America (BAC) minus 7.9%, Cisco (CSCO) minus 5.3%, McDonald's (MCD) minus 4.8% and Hewlett Packard (HPQ) minus 3.9%.

Dow Jones Industrials Model (c) The Other Street

It seems to me that the market is finally catching up with the concept I have expressed many time before. Simply put, gargantuan worldwide monetization is finding its way into financial assets, in that order: first toxic bonds, second stocks, third... real estate. I know, it seems strange to put real estate into this category but guess what, last I looked, these three assets comprise 90% of Household Net Worth. In plain English, this means that the market may now be willing to accept a lower equity risk premium, as defined by the difference in the 10-Year Treasury Bond Yield and the Earnings Yield (the inverse of the P/E ratio).

Like with any penetrating view of the obvious which has been the subject of controversy, when the opponent concedes, you've got yourself a new wave of believers. The longer the controversy, the bigger the wave. In market terms, it's called a Stampede. Whether you like the Buffalo or the Ocean analogy, it comes down to the same: to qualify, you need more and more, both in numbers (new highs) and in strength (volume). Then the calm returns and you have reached a new equilibrium. We are used to the idiom "it's faster to take the elevator down that to walk upstairs". A Stampede is exactly the opposite -- that's when the elevator takes you up unexpectedly fast.

Now, to be clear, I am not passing judgment as to the merits of the case -- it is not my job to say whether such or such policy is adequate. For one, it's way beyond my pay grade, not for intellectual reasons, but because of the politics involved. All of this "if I was Bernanke, if I was President, if I was Draghi" stuff is worth less than Monday morning quarterbacking.

For two, even if I was, I don't think this would help me pick stocks -- which is what I do. My job is to understand the forces at work. On a micro level, it's a company's product, its financials, its management, its competition. On a macro level, the list is longer and often illusory. But one thing is for sure, if I don't know the players and their motivation, I can't play. And if don't adapt to change, I can't play either. The change here seems to take hold. If this is a Stampede, you will know by Wednesday, 10:43. If it's not, you'll know by Monday 15:41. I may be off by a few minutes...

What does this mean, practically? Look at your stocks, your investment horizon and your tax situation. Put together a list of stocks to buy, or to sell. And do not call your broker -- call your shrink. Sorry, I do not make house calls... My number remains DJII 13300, short term, and S&P 1600 - I can't yet say by year-end, because of the elections.

Disclosure: I am long AGM.A, EXH, GVA, JOE, MXWL, PHM, SANM, TMO, WCC.