Stocks have jumped all over the place in the past two months, and yet have gone nowhere.
The S&P 500 Index closed the month of June at 1,280. It closed July at 1,267. It closed August at 1,282. Yes, it’s taken three months to move a grand total of two points!
No wonder this market is driving everyone crazy, and has given hope and fits to both bulls and bears. This summer reminds me of a Dr. Seuss story in which there’s a lot of action but nothing actually happens. Maybe we should turn to the good doctor for analysis rather than economists, fund managers or corporate titans: "From there to here, and here to there, funny things are everywhere."
It’s not just the S&P 500 that is acting like a Lorax with its head cut off. It’s the same with the Dow Jones Industrials Average and the NYSE Composite. All made bear-market lows in July, and have since traced out patterns that appear to be short-term counter-trends that are running out of steam.
So is the market about to fall over? Probably, but let’s not go straight to the punch line.
The trouble with dismissing the recent rally as immaterial is that a couple of other major indexes are actually doing quite a bit better.
The Dow Jones Transportation Average ($TRAN) made its low back in March and has been up quite strongly since, suggesting that a stealth bull market is under way. Heck, the Biotech Index ($BTK) was even making a new high as recently as two weeks ago.
Meanwhile, we must observe that this going-nowhere market has occurred against a backdrop of news that would normally be considered extremely bearish. After all, banks are being shut down for insolvency every week now; mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE) are seeing their balance sheets blown up and their shares sinking below $7; oil and gas prices are steadfastly above $110; Russia has decided to reignite the Cold War with the invasion of a neighboring sovereign state; brokerages are desperate for capital; loan growth is shrinking; earnings are withering across Europe and the emerging markets; and the outcome of the upcoming U.S. presidential election is thoroughly uncertain.
So really, couldn’t all of this sideways action be a precursor to a fourth-quarter surge in prices, as sellers have had an opportunity to exit the scene and be replaced by stronger hands?
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Yes, it could be. Yet I would counter that you could make the same argument against the bulls. After all, interest rates have come down essentially to zero (2% Fed Funds rate minus inflation); gasoline prices at the pump have come down from a peak of around $5 two months ago to around $3.95 today; the SEC has changed trading rules to impair the rights of short-sellers; the Federal Reserve has made billions of dollars of cheap loans available to investment banks through new collateral rules; the U.S. Treasury has essentially guaranteed the troubled bonds of Fannie Mae and Freddie Mac; and more than $100 billion in fresh money was pumped to consumers via tax rebates.
After all of this, stocks have gone nowhere? Imagine what would have happened had the government not intervened.
I hate to be pessimistic, because the two-century history of the U.S. market shows that, over time, demographic change and product innovation help push corporate earnings, and stock prices, higher.
Yet my best estimate is that stocks will have a rough September and October due to a few key factors:
- The dollar has risen very sharply for two months. This will reverse a lot of the currency translation gains that greatly benefited many of the most successful companies this year, such as IBM , and drag down their third-quarter earnings reports.
- Falling home prices put current mortgage loss estimates for banks and brokerages in jeopardy, so we can likely expect a new round of estimate cuts and a renewed scramble for new capital infusions.
- A bailout of Fannie Mae and Freddie Mac by the government will necessitate the sale of as much as $100 billion in U.S. Treasuries per month. This will likely slam Treasury prices, lifting their yields—and making them much more competitive with stocks.
- Credit investors at macro hedge funds are still much more negative than equity investors, and if I’m reading their playbook correctly, they are clearly waiting for their next juicy opportunity to push prices down again as they did last October, January and May.
- More and larger banks are likely to fail and be taken over by the feds.
In summary, for both fundamental and technical reasons I recommend that you remain skeptical of the recent bounce off the July low. I would change my mind if the Dow Jones Industrials Average and S&P 500 manage to close above 12,615 and 1,390, respectively, by the end of October—or above 12,575 or 1,385, respectively, at the end of any week. Those are the 12-month and 50-week moving averages that previously provided support in the 2003-2007 bull market and have since provided resistance in the 2008 bear market.
My strategy recommendation remains the same as it has for the past eight months: Continue to keep a stockpile of cash in insured accounts to preserve capital for the next bull market, and invest a portion of your investable funds in my Trader’s Advantage picks to make some “pirate money” scalping long and short trades in stocks and options.
Jon Markman is editor of Trader’s Advantage and a regular contributor to InvestorPlace.com. To get this type of actionable insight from Jon and other InvestorPlace Media experts go to www.InvestorPlace.com today!