For stocks to rekindle the long journey higher, they have to take that first small step. It wasn’t clear what it would look like a week ago, but after last week the major indices have dropped some key hints about where the short-term lines in the sand are.
For the S&P 500, the big line to watch is 1172 – a level the market has jumped above in early Monday trading. The reason it’s important is simply that on a closing basis that level has contained the index for better or worse all week after last Monday’s decimation.
Until last Friday, that is, when the index closed above that mark. That sets a bullish tone for the coming week. Just don’t count on it lasting forever.
It’s a notion that raises an important question, though: Have we really burned off all the excess we needed to?
I believe the answer is yes, for two reasons:
The first one is that, from its high to its low, the S&P 500 bled off 18% of its value. The average corrective move is on the order of 12% to 16%, and most such moves don’t kill bull markets. As harsh as it felt, this decline wasn’t anything historically unusual except for the speed of it, which was more a function of nervous investors than of earnings results or economic strength. Either way, it was big enough to dole out a proverbial ‘reset’ of attitudes and price action.
The second reason I suspect we’ve already been through the worst of any needed pullback is most readily seen on charts of the Dow Jones Industrial Average and the S&P 500 from last Friday.
Not only have the recent losses been harsh, but the daily ranges over the past four days have been enormous as well as easily reversed. Though it can be overwhelming at that time, this extreme up-and-down action is ultimately beneficial in that it shakes off all the weak bearish and bullish (mostly the weak bullish) hands like a dog shaking water off its fur coat. With all that antsy trading money on the sidelines, even the smallest of bullish catalysts will draw it back in.
That said, there’s a caveat.
I look for the buyback happen in waves rather than in a straight line. Each dip from here should be followed by a rebound, and vice versa. We may need to go through the cycle three or four more times.
In other words, I don’t know that we’ve hit the bottom. I do think we’ve seen the bulk of the shake-out though, and I don’t see significantly lower lows from here.
That view might put me in the minority among financial journalists/commentators, but I just have to call ‘em like I see ‘em. And what I see now is a market that is as cheap as it’s been on a trailing-12-month basis since 1990. As of the last look, the S&P 500 is trading at an operating (TTM) P/E of 12.9.
More than that, second-quarter earnings from the S&P 500 were the best ever, at $25.25 a share.
The past isn’t the future, and eventually things will have to change for the worst. The market was almost acting as if it was hoping for a miserable second quarter however, fueled by the fallout from Japan’s tsunami and measurable decline in consumer confidence, underscored by troubling data regarding unemployment. Yet corporations sailed right through those problems even though they “weren’t supposed to”. In the meantime, we just learned retail sales for July were strong, and unemployment claims edged lower. Perhaps all is not lost.
The fact is we still have no hard evidence that a recession is looming, but we do have evidence – via earnings – that companies are still making good money.
In the short run, tensions remain high, and I expect more volatility as described above. But, a little technical progress above these key lines in the sand right now should set up decent trading opportunities for a few days. Just don’t linger in trades too long, as there’s still a bull/bear tug-of-war going on.
In the long run though, any dips – against a backdrop of ultra-low valuations – make for great long-term entry spots. Don’t let fear blind you to those opportunities.
