Line in the Sand for the S&P 500 Redux

By David Nelson, CFA

After the steep declines last week and the complete drubbing in the tech heavy NASDAQ markets are deeply oversold. However, an oversold market on its own is hardly an investment theme. The slightest spark could send us a few hundred points higher but it’s going to take more than dovish comments by the Fed to keep us there.

Redrawing the Line in the Sand

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S&P 500 Daily Chart

At the start of the month I talked about The Line in the Sand for the S&P 500 being the 120 day moving average. It didn’t take long to breach that level and here we are 6 trading days later sitting just above the 200 day. My good friend Rob Funk who’s one of the best at looking through all the technical noise pointed out in his Tumblr Post that we aren’t going back far enough and need to draw the trend line starting with the correction in October 2011. (Check out Rob’s Tumblr Here)

The chart isn’t a prediction and in the end you can draw these trend lines any way you want but I found it interesting that a month from now if that trend line is reached, we would be sitting exactly where we started 2014.

Earnings are the Lifeline

Tomorrow starts a heavy week of earnings with Banks taking center stage. In the end that’s what owning a stock is all about. As a shareholder you are entitled to your pro rata share of the earnings and or dividend stream of that company. Earnings will be where markets make its stand or gives way to more selling.

3 Problems for the Bulls

Deteriorating Global Growth – Europe has been the most recent concern with the continent close to a triple dip recession. Add an escalating trade war with Russia and it looks even worse. The New York Times points out the International Monetary Fund’s warning that the Eurozone’s economy, Germany’s in particular, might face a recession turned what had been an academic discussion into a major political issue. 

China has been a problem for some time. The government is still trying to unwind excesses in their system and has said they have no intention of initiating a stimulus. In September China’s Finance minister said that despite weakening economic indicators there would be no policy changes. In other words China was willing to live with less growth.

We did get some good news overnight. Its Central Bank Chief said, China will meet its growth target of around 7.5% this year helped by urbanization and economic restructuring.

Rising Dollar – A rising dollar forces investors to rethink sector weights and international exposure. Obviously it weighs on oil and commodity prices which are priced in dollars. Oil and commodity stocks have been hard hit ever since the rise of the currency.

The S&P 500 is dominated by large multi nationals that have all made big pushes into the emerging markets. This is where growth at the margin is supposed to come from. A rising dollar makes our goods less competitive. With few equity alternatives working, the S&P became the large cap lifeboat.

Falling Oil Prices – Yeah I know. How can falling oil prices be bad for the economy? Sure it’s true that it acts as a tax cut for consumers especially at the low end where gas prices make up a larger percentage of their discretionary income. However, like any story there are two sides.

Oil Prices in particular WTI (West Texas Intermediate) may be approaching break-even levels for many U.S. producers. The enormous strides we’ve made on our path to energy independence could be put in jeopardy if some start shutting down production or worse, some of the marginal players go under. There seems to be huge disagreement as to just what break-even prices actually are but given the massive selloff in drilling stocks I have to believe we’re closer than you think.

Strong job creation in the energy sector has been a big boost to our labor markets. That could end quickly if the scenario above unfolds.

Its unlikely oil prices will get much help from OPEC. The once powerful cartel is in complete disarray. Saudi Arabia has increased production on the back of falling prices causing some members to panic. Venezuela recently asked for an emergency meeting of member nations. Given that backdrop, there is little the cartel can do to support pricing. The huge variable of course is the conflict taking place in the Middle East. If ISIS were to push into southern IRAQ threatening production that dynamic could change.

The Wrong Leadership

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Relative Rotation Graph

Since the start of the recent selloff the leadership has been turned upside down. The chart below is not what bulls want to see. We aren’t going to push higher on the backs of Utilities and Staples the current market leaders. The laggards of course are Energy, Industrials and Materials with Tech, Financials and Healthcare weakening. This picture needs to reverse before we can be confident a turn is in place.