Pullback Whips Bears Into Unsubstantiated Frenzy

by Sam Collins | March 18, 2013 2:25 am

The streak of 10 consecutive gains for the Dow Jones Industrial Average came to an end on Friday. The index opened lower, struggled for most of the day, but unlike prior sessions, a late rally failed to reach breakeven. 

Quadruple witching expiration was a factor, as was a lower-than-expected University of Michigan Consumer Sentiment Survey for March. Volume expanded to the highest level of the year, mostly due to the expiration of options.

At the close, the Dow was down 25 points to 14,514, the S&P 500 fell 3 points to 1,561, and the Nasdaq lost 10 points at 3,249. The NYSE traded 1.8 billion shares and the Nasdaq crossed 893 million. Decliners were slightly ahead of advancers on the Big Board, and decliners were ahead on the Nasdaq by 1.25-to-1.

For the week, the Dow gained 0.8%, the S&P 500 rose 0.6%, and the Nasdaq was up 0.1%.

VIX Chart
Click to Enlarge

The CBOE Volatility Index (VIX), also known as the “fear index,” plunged again last week to its lowest level in six years. The goal of the index is to estimate the implied volatility of the S&P 500 over the next 30 days. Thus, at the current extremely low level, the VIX is telling us that if there is a consolidation it should be very mild since the index is trading at a six-year low.

SPX Chart
Click to Enlarge

The bears have been badly burned by the recent streak of gains, so Friday’s slight pullback has sent them into a frenzy of expectation. The chart of the S&P 500 shows that even if the attack on the high at 1,576 may have temporarily stalled, there is currently no evidence to support a bearish stance. 

Immediate support for the index is at its 20-day moving average at 1,530, and then the 50-day at 1,507. For those who like the Fibonacci method (gold arrows), we will assume calculations based on the February low at 1,485 and the March high at 1,564. The first Fibonacci support is a 38.2% pullback at 1,533, then 50% at 1,524, and finally, 61.8% at 1,515.

Conclusion: It would be normal after so many consecutive days up for the market to take a breather. However, a breather, if it develops, should be used as a buying opportunity at the many levels of support illustrated on the chart. Every indicator points higher, and so it is probably only a matter of days before we see the all-time high at S&P 1,576.09 and the all-time closing high of 1,565.15 exceeded. 

Last week, we briefly discussed price-to-earnings (P/E) multiple expansion from the current 14.3 times earnings on the S&P 500. I noted that Jeremy Siegel, a finance professor at the University of Pennsylvania’s Wharton School, has documented that in periods of low interest rates, P/E ratios often rise to 18-19 times earnings.

Here, then, are some of the reasons behind an expansion of P/E ratios:

1. Low interest rates, which have never been lower than they are now.
2. Drop in home foreclosures to the lowest level since 2007.
3. Economy in slow growth trend.
4. Too many people looking for a pullback.
5. Institutional buying occuring on the slightest declines.
6. Institutional activity picking up in general.
7. Advance has been broad-based not secular.
8. Dow Theory buy signal with the transports sharply up.
9. Dow Jones Transportation Average is predictive of solid growth in the second half of the year.
10. Analysts’ project earnings improvement in the second half of the year.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[1].

For a list of this week’s economic reports due out, click here[2].

  1. click here: http://online.wsj.com/mdc/public/page/markets_calendar.html?mod=topnav_2_3024
  2. click here: http://www.briefing.com/Investor/Public/Calendars/EconomicCalendar.htm

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