Drizzt: long term market analysis is a series once or twice a month where we take a look at longer term trends in the market to get our bearings right on the general direction of where market prices is going.
On the day US President Obama got re-elected as the US President the market took a dive. Its probably a good time to do a wrap up and to trash out some things.
Weekly S&P500 and STI
The long term indicator we use is the cross over between the 17 week EMA and the 43 week EMA. A cut of the 17 week EMA below the 43 week EMA from above signifies an underweight and risk management position. A cut of the 17 week EMA above the 43 week EMA from below signifies an overweight position in equities.
The weekly S&P500 looks rather decent. However, the pull backs look more pronounced as it goes higher. A rising pattern like this gives a higher probability of more downside than upside.
The STI looks more of a mixed bag. It doesn’t seem to be following the US markets during this period. The region around 3100 and 2700 in this case is important.
We have note in the past on this time scale that RSI going below the .50 mark indicates a loss of momentum.
It looks wise that if you are investing on an intermediate term basis, you wait till MACD goes below 0, RSI goes below 0.50 to make your purchase.
Your prospective stocks have a chance of correcting 10% –20% for you to get at a more attractive price (no guarantees the valuation is good! they could still be very expensive!)
The spread between 3100 and 2700 is about 12-14%. Your stocks are likely to pull back bigger probably 22%.
The impact of the huge head and shoulders
I saw this long term chart from the 1990s to this secular bear market. A lot of people will look at this as a giant head and shoulders. Now I really hope it doesn’t happen because
- The price target is really about the height of the neck to shoulders below the neckline. We are look at a case where capital markets really collapse. The business cycle in that case can be so massive that likely a lot of us will not be gainfully employed
- This might be a good opportunity to buy, but many would look at past history and aim for the neckline to get invested. If the head and shoulders scenario happens, they are still looking for a further 50% downside.
- Now if it does recover, how long do you think it takes to recover when such a large portion gets wiped off from the capital markets? Your REITs will lose tenants, you cell users will be force to downgrade their plans, and all business will struggle since we are so export oriented.
Building on to those three points, take a look at this 1966 to 1982 S&P500 monthly chart. They say the 70s high inflationary period looks very similar to what we have now, and you can again see the similarity.
In the case of that secular bear, the direction eventually invalidate the pattern. The difference then is that the three draw down was 30%, 50%, 20%. This current secular bear is 40%,50%.
Could this work out the same way as in the 1970s, very possible. It is equally likely that a similar draw down the magnitude of 40-50% Is possible.
Either way it makes the punter’s job much difficult.
Presidential Election Cycles
I generally believe that cycles do exist in the markets. The most common being “Sell in May and go Away”.
The results you have gotten if you take two routes are astounding. (Hat Tip Ritholtz.com)
Eddy Elfenbein compiled the Dow’s average for Presidential Cycles using data from 1896 to present.
The clear results seem to point that spending plans take some time to take effect, or put in place or that the government just want to ramp up only closer to election when people can remember better.
Either way, odds are the returns based on historical don’t look good.
All said, many have complained not to find the buying opportunity. When it is given, many do not take the plunge as what happened last year.
Not sure if people still remember the turbulent days and weeks where prices swing between the range. I am sure many do not remember. Today, these investors as well as so many hedgefunds are complaining they missed out on this really positive year.
End of the day, psychologically, we all don’t want to be “vegetable heads” and would want to catch their blue chips at the lowest. The above two charts provides two different magnitude of price targets.
- Catching at the lowest requires skill. I am afraid I might not have that here.
- Managing how you scale in is important, and always have a target amount to invest at different levels of draw down.
- Important to have a funding requirement from your salary.
- A 20% fall in an overvalued stock may still mean its overvalued. Learning some sort of fundamental valuation is important.