April 1, 2013 -- The General Outlook:
1. The Market continues to rally into April with a sudden pull back during late April, probably about to S & P 1450. Sell before May and go away.
2. There will be some rotation into high-risk stock but the smart money will stay cautious.
3. The pull back will be short lived and there should be a strong summer rally
Well Thursday we had the long awaited S&P 500 break into new all time high territory. Of course this begs the question if we will sell off and have we again reached irrational exuberance. Well the answer to this is very different for the USA and China vs the Nations of Canada, Brazil and Australia.
The Big Picture – You Are Here
First off unless you believe in an apocalypse for the US economy, obviously the S & P must hit new highs one day. One day the conditions will be right for new highs and I think that time is now. Historically when the S&P 500 hits a new high AND the PE ratio of the underlying stocks are in a realistic range the rally holds. Currently the PE ratio for the index is about 15.25.
The average P/E ratio since the 1870's has been about 15. However if you do a ten-year average of the PE ratio it is on an upward slope due to productivity and in today’s terms a PE of 15 is a bargain level for stocks. The modern average is about 19. But the disconnect between price and earnings during much of 2009 was so extreme that the P/E ratio was in triple digits — as high as the 120s — in the Spring of 2009. In 1999, a few months before the top of the Tech Bubble, the conventional P/E ratio hit 34. It peaked close to 47 two years after the market topped out.
This is a long-term chart of the S & P 500. I have marked the famous “Irrational Exuberance bubble” in orange and a long-term trend line for the market in blue. So long as we stay under that blue line I believe the market will be a safe investment. But there is a big qualifier, the United State must have a strong recovery and I will explain in another posting called the new momentum.
Earlier we were talking about the big picture, and the coming long-term rally, but you can go broke waiting for the long term during the near term. The near term is looking like it is setting up for a brief pull back. This is natural and even healthy for the recovery. We always have to “wash out a few weak hands” on our climb higher.
In the past few years the maxim “Sell in May and Go Away” has proven to be good advice. But before the May sell off April is a historically strong month and typically during that month the smart money sells to the dumb money, who are left to hold the bag as the market slows. The news media usually has a scapegoat ready to blame for the sudden bout of “profit taking” (A media euphuism for a sell off). This year it looks like it will be “contagion from Cyprus”, ah whatever. The truth is we have had a good run and people will expect a pull back. Clearly I am cynical about the news driven events. Especially so when you can see the coming weakness in technical analysis long before the “so called” event. Well into the 20th century, coal miners brought common canaries into coal mines as an early-warning signal for toxic gases. Like those miners I have a few charts that are my canaries. To be frank my birds are dropping off their perches.
Before you look at these charts I will give you some guidance, these indicators warn way early. The sell off they are predicting could easily be weeks from now, just in time for a classic May pull back. Also this retrace is during a strong economy and I am not at all expecting a 2008 type crash, just a mild correction of the type we often get a couple of times a year.
Lets begin with canary #1 the Long Term Bull Bear lines. How this works; you stay optimistic as long as the green line is above the red, so we are optimistic bulls. You get nervous when the current price is WAY above the green line, because price reverts to the green line, so we are nervous bulls. In the bottom of the chart is the slope, as long as it is above zero we a going up, BUT if it is decaying (like shown) the party is nearing an end and we will very likely stop growing soon. In other words the best momentum is behind us for now. I often think that as the slope increases the power is from big money like mutual funds and as the slope decays it is from buying by small money like individual investors. Of course the game is to take money from the little guy.
Our next canary is from the technical analysis genius Arthur Hill -- the Nasdaq Summation index. So simple, just pull in your horns when red is atop green – like now.
Next we have Yong Pans Primary Sell indicator based on the Put Call ratio. As option traders get nervous the volume moves from Calls to Puts. The way you use this indicator is you exit the market when the purple upper indicator cross the 0.0 line, as you can see this is likely coming up soon.
Next is another Arthur Hill classic, On Balance Volume was developed by Joe Granville and introduced in his 1963 book, Granville's New Key to Stock Market Profits. -- On Balance Volume, shown here in red. When it fails to keep up with the market, it is time to get cautious.
Finally one from the master himself, John Murphy this is the percentage of NYSE stocks above their 50 day Moving Average. The trouble with this indicator is it can at times like this look like it is not going to drop because late in a market investor head to safety like the NYSE over the rest of the market. However once the 80% line is broken to the downside if it fails to rise above the 80% line again, the sell off follows some weeks later. I have market prior warnings with a red slash on the indicator. Looks like a repeat is in the works, despite the recent rise.
What is Working Now
I am still invested net long in this market but I am re-positioning my portfolio. First since as you will read below, I see an end to the commodity bubble. So I have a short on gold, and I am moving my Canadian dollars in to US funds. I am no forex trader, but clearly the odds are stocked in the favor of the USA for the near term. Most of my Canadian stocks are in retail, financial services, auto parts production and pipelines. I have sold and resource based plays months ago.
I purchased Dollarama a few weeks ago, this stock does well in turn downs and it is the brightest light in the Canadian retail consumer market. I expect a major US firm like Dollar Tree to move in and take this firm out.
Canadian Pipelines are a license to print money. Assured cash flow regardless of the price of oil, no peer competition (like Apple Samsung) and very high barriers to entry. These are steady gainers, with battleship balance sheets; they seldom sell off in a retrace and pay a sweet tax efficient dividend.
In the USA market sentiment is cautious, they have been burned before. So the big name Pharmaceuticals, Defense contractors and Credit Card Companies do well. In healthcare I love my Eli Lilly now in my second year.
Also doing well in Healthcare is Tenet Healthcare, a firm that is expected to do very well under Obama-care.
A great play has been the crack spread play, where gas is selling at high prices but West Texas Crude is going for cheep – who wins -- the refiners do! I love Phillips 66 first mentioned by me here last fall, hope you bought then.
Iron Mountain is a fabulous company in the growing field of storing paper originals as companies use image in computers for day-to-day work. Also shredding is in demand, as secrets must be safeguarded. I love this firm they dominate their market and are the go to name for banks and government contracts. Warren Buffet put his stamp of approval on it too—that can’t hurt. I must admit it did pull back earlier but I used that as a chance to buy more.
Visa or Master Card are great ways to play the financials without exposure to risk. It is like a tax on every card swipe yet they leave the dangerous part (lending money and approving clients) to the banks. All upside and no risk, what a business! As the years go by plastic and electronic payments could replace money, as we know it worldwide.
Don’t forget if you are buying these names now, put in a good trailing stop. Sell in May is on the way.