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The S&P Has Been Testing New Lows - Here's What The First-Time Investor Needs to Know

|Includes: DowDuPont Inc. (DWDP)

 As the market adjusts itself from the exponential rally from 2009, six months into the year we’re just slightly below where we started in January. The first six months of the year is lost; the S&P 500 was up 8% for the year from January 4th at 1,133 to 1,219 reached on April 26th; but then yesterday closing down nearly 13% from that high and only 2% higher than the lowest the index has read for the year, reached on February 5th. Think about it – in six months, you’re IRA or the pension fund your company offers likely earned nothing and considering furious inflation may be just around the corner and interest rates could soon rise if this recovery regains traction, you’ll need to be earning at least something. Need a quick brush up lesson?

Inflation occurs when a country prints and spends more money without backing it with a firm, tangible asset (most currency is on the gold standard). That means the purchasing power of $1 is will be weakened, meaning you can’t buy as much tomorrow as you can today. Inflation erodes returns, causing investors headaches; today, we’ll need to make at least 3% returns just to keep up with historical inflationary rates. Interest rates are the percentage rates borrowers pay to investors to use their money, and of course the government lowers standard inner-bank interest rates to spur lending (lower interest payments entices borrowers to borrow, creating economic growth and opportunity).
The government agency that controls these rates is the Federal Reserve System (Fed), who has kept interest rates at rock-bottom levels basically since 2000, in response to the tech stock market crash of the same period. The Fed then raise interest rates when economic growth and stability is apparent and solid to curb lending, and subsequently, discourage inflation and potential bubbles (case in point: if the Fed had raised interest rates in 2003-2005, people would not have been able to take advantage of cheap credit and buy expensive homes – maybe the housing crash of 2008 would not have been so severe?)

So you see the cyclical challenges that lie ahead (remember: while the nature and severity of every recession may be different, typically, the solutions and weapons used to bring economic growth back are the same. In other words, each recession adheres to a timeline or cycle). But there’s much, much more when it comes to guessing what trend we’re on today in terms of growth, and I’m going to break it down for you.

Fundamentals

The fundamentals of the S&P 500 are strengthening. When you read about fundamentals, remember that we’re talking about evaluating the strength through sound financial practices, and tangible, measureable, and justifiable reasons why you think an entity will succeed or fail. For example, a company that has little debt, plenty of cash, is generating revenues and profits and just recently declared a dividend, has what you would call strong fundamentals. A company that is missing one or two of those characteristics has decent fundamentals. A company that is missing most of that has weak fundamental strength. Fundamentals in stock markets and the overall American economy are based on compiled and regularly released economic data and the strength of the companies selling on that particular market or index.

The fundamentals of the S&P 500 are what I would call “decent” – corporate spending has been up this year as durable goods orders last week were way better than expected thanks to a boost in non-commercial airplane sales. Consumers are beginning to spend too – measured by Consumer Confidence, a report released monthly, shows a third consecutive monthly gain. Jobs data has improved, but the numbers are tricky because of the consensus poll that was taken this year that showed nearly 80% of those hired were temporary workers. While unemployment is down about half a percent, as those temporary workers are released and next month’s data comes out, unemployment will probably rise again. Corporate earnings for the S&P 500 companies have been tremendous since around this time last year, with companies from all nooks and crannies of the index crushing their analyst’s estimates. These figures come as companies release quarterly earnings while averages are compiled for all those companies as they report. But there’s a catch to this one too: in the face of severe recession and expected declines in sales, companies aggressively cut costs (most obviously labor and work force) and maximize revenues, actually resulting in record earnings and profits for companies across the board. What we as serious investors want to see is top-line growth; we want to see economic and company-wide expansion and growth and the ability to strengthen balance sheets and cash flow in the process. Aggregately, we may be a long way away from that kind of prosperity in the S&P companies, although there is some good news: some of the S&P’s biggest names are performing at incredible capacities and are projected to continue growth, like Apple and Exxon Mobile, lifting the averages for the entire index.

Technical’s

Technical’s are much more complex and just as important to recognize and understand as fundamentals. While the reasons for the importance of technicals and the application of technical’s as a standard investor’s tool have evolved and changed over the years, the basic idea is simple: momentum. In its most simplistic form, technical analysis involves looking at a chart of a company or index and identifying trends in the way the stock moves at certain intervals of time. You may look at a chart and say, “OK. Here is where the price of this company was highest, and that’s a resistance level, meaning if the price ever goes higher than that point it will likely continue on higher. And here is the lowest point the price has ever been, and that’s its support; if the price should dip below this point it’s equally likewise it will continue on lower”. Congrats! You’ve just conducted technical analysis. Practicing technical analysis is completely different from fundamental analysis; in fact, trading on technical indications completely ignores the fundamentals of a company or index, with the idea being basically “who cares if this company or index is strong if no one is buying it – just look at the chart!”

The technical’s for the S&P aren’t pretty. The price on the index has been battling overhead resistance at 1,090 for some time now while testing lower and lower support levels more often. In fact, since the highs of April, the S&P has been setting lower and lower support levels while testing that higher resistance level only once or twice. The question is this: are these drops a trend that will continue all year long, or is it simply a bump in the road, understandably so considering how far the index has come off March 2009 lows (about 75%!) For techies, the answer lies in the charts.

Here’s where we’re at. Investors have been selling off the S&P since April, shedding about 13%, more than what we would consider to only be a “correction”, defined as a 10% drop after a massive rally and then continuing the massive rally again. The sell-off has been on foreign debt concerns out of Spain, Portugal, and of course Greece, and as of yesterday, Turkey too. Add to that increasing trade and human rights conflicts between Taiwan and Korea; massive devastating earthquakes, floods, and other natural disasters in Haiti and all over China; uncurbed and wild growth in China that could eventually be a bubble; continued and unimproving social unrest all over Afghanistan, Pakistan, and Israel; and domestic issues like debilitating unemployment, stunted economic growth and massive government debt, and of course what’s now been called the largest oil spill in the history of the US in the Gulf caused by BP’s rig explosion and sinking in April. The news all around us is bad at a time (considering the financial meltdown and worldwide stock market crisis and panic in 2007-2008) when we need and we’re expecting good news. Millions of Americans are in homes they can’t afford and foreclosures are rampant, and there could be the equivalent of the same real estate debt and investment explosion happening in commercial prosperity just around the corner. Investors are beat and tired, and if they continue to sell the S&P below that low reached in February 5t, 2010 low of 1,044 (we’re only 2% away), then watch out – we could be reliving 2008 all over again.

As always, post comments or email me at tom@bullworthy.com and share your thoughts, experience, and opinions.



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