The S&P Market Rally Case Needs Revisiting

by Richard Band | August 8, 2012 1:58 pm

Stretching, straining, but almost there!  In the recent past I’ve predicted that the stock market would mount a brisk second-half rally, with the S&P 500 index breaking out to fresh multiyear highs.

Well, Tuesday’s close of 1401, a three-month high, puts the S&P within striking distance of a new high for the year.  (The April peak was at 1419).  So now looks like an appropriate time to revisit the forecast, and make a few tweaks.

First, let’s state the obvious.  I’m very happy to see the market at these levels, as I hope you are, too.  With all the horrible news from Europe (and elsewhere) that U.S. investors have had to absorb in recent months, it’s a delightful relief to have so many of our stocks and mutual funds performing as well as they are.

Just today, among the companies we own, American States Water (NYSE:AWR[1]), BCE (NYSE:BCE[2]), Chevron (NYSE:CVX[3]), Covidien (NYSE:COV[4]), ExxonMobil (NYSE:XOM[5]) and Westpac Banking (NYSE:WBK[6]) all touched new 52-week highs.

In the interest of candor, however, I must also acknowledge that the market hasn’t brought us to this point by exactly the path I foresaw in May and June.  Specifically, we never got a pullback into the mid-1250s or lower, which would have created a deeply oversold technical condition — and set us up for a barnburner of a rally like the ones that occurred in the final months of 2010 and 2011.

Instead, since the June 4 intraday low, stock prices have zigzagged higher, with spiky advances and declines that have dissipated a lot of energy.  For example, the largest number of NYSE stocks hitting a new 52-week high in a single session peaked at 296 on July 3 — five long weeks ago.

Since then, even though the S&P scored successively higher closes on July 19, July 27 and again today, the tally of individual NYSE highs has faded to 250, 248 and now just 203.

This is a classic pattern as a market uptrend gradually loses strength before an important top.

I don’t know the day or the hour when the “big” top will form; nobody does.  However, I suspect we’re now in an extra-innings ballgame.   As this chart[7] from Bespoke Investment Group illustrates, the second half of presidential election years tends to be quite favorable for the market.

Thus, the bull may be able to keep running through November or even December.  But a minor accident, at home or abroad, could easily ditch that hopeful scenario.

Bottom line:  Get a little more defensive here.   Comb through your portfolio and prune some stocks that have raced far ahead, or lagged far behind, the market indexes over the past year.  By offsetting gains and losses, you can keep your tax liability to a minimum.

Among our Niche Investments, I’m cutting loose Ellsworth Fund (NYSE:ECF[8]), a closed-end convertible fund we’ve held since October 2004.  Convertibles, like small-cap stocks, have trailed badly behind the stock market’s blue chip leaders since the April 2012 peak.

  1. AWR:
  2. BCE:
  3. CVX:
  4. COV:
  5. XOM:
  6. WBK:
  7. chart:
  8. ECF:

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