Despite recent volatility, we still think stocks are in a cyclical bull market. As we wrote last week, our three rules for investing remain supportive: The primary trend is still rising (don't fight the trend), the time horizon that the Federal Reserve will remain accommodative has likely lengthened (don't fight the Fed), and excessively optimistic sentiment has been worked off (beware the crowd at extremes). Furthermore, as the first-quarter earnings season winds down, earnings and sales have generally been better than expected - actual S&P 500 first-quarter earnings are about 17% higher than the estimate was six months ago and top-line growth is 14% on a three-quarter annualized basis. The next area of support we expect for the S&P 500 is between 1100 (the 200-day moving average) and 1090 (the 23.6% retracement of 14-month bull market). In a more substantial correction, our next expectation of support is around 1010, the 38% retracement of the bull market.
David Fuller's view The Weekly View concludes with a very interesting
graphic showing four different measures of inventory data, which support Rod
Smyth and Co's bullish medium-term conclusion.
What about the rising primary trend action mentioned above?
It has held up longer in the USA than in other major stock markets but volatile churning action following a very good recovery such as we saw last year is usually a symptom of top formation development. Looking globally, the vast majority of stock market indices were still rising at the beginning of the year. The leaders, including those of the USA, resumed their advances following the January to early February correction.
However, steady gains ran out of momentum in mid-April and stock markets have subsequently been hit by the triple waterfall of events which I have mentioned previously. Sequentially, these are the SEC's indictment of Goldman Sach for "fraudulent misconduct", the more economically serious issue of Southern Europe's spiralling government bond yields and Wall Street's sudden and still mysterious meltdown on May 6th. We can also add China's tightening monetary policy which predates the other concerns.
While all of these factors can be described in the past tense, three of them prompt the uncertainty question: Who is next? Additionally, investors are understandably concerned that if high-frequency algorithmic trading on Wall Street can cause one sudden freefall without any known trigger, it can happen again. Moreover, extreme market gyrations seldom occur without collateral damage, although it may take a while before we hear about it. All this adds up to more confidence-sapping uncertainty.
The bad news is that all of us with equity portfolios are experiencing profit erosion. No one should beat themselves up over this, as it will be a periodic hazard. However it serves as a reminder that the time to lighten positions is when markets are doing splendidly and animal spirits are running high.
The good news is that a buying opportunity is returning. Some of us lamented, as you may recall, the absence of a setback in early April when the annual ISA top-up buying season commenced. In this respect, one could say that the markets have been munificent for those who kept some cash in hand. From a buyer's perspective, I feel that most of the favoured Fullermoney themes are back in play, and I will act accordingly in coming weeks.
While the technical action has been deteriorating since mid-April and the events mentioned above have turned this into a bigger correction than might have otherwise occurred, I do not feel that leading stock markets are embarking on a sustained and severe downturn. Monetary conditions remain too favourable for that to occur. Despite an uncertain world, it is very unlikely that the Asian-led global economic recovery will be snuffed out by today's problems. We can all take comfort from the USA's yield curve - a leading indicator - which remains comfortably above the dangerous zero line for equities. (Please listen to the Audio for more detail.)