There were times when the Standard and Poors 500 Index ($SPX) felt like a casino in 2011 with news flows so caustic that pinning a long or short position seemed impossible. In 2012, it likely will be more of the same.
Quite frankly, what I say is at best a guess, and my estimates will only be in the ballpark, but I do want to discuss what I think will happen generally, with some technical analysis targeting thrown in. I will not discuss the Dow Jones Industrial Index, because it is not broad enough a stock index to really matter, and it has been bastardized even more times than the $SPX, so I think it is almost irrelevant in today’s world except for the emotional barometer that it has become. As far as the NASDAQ Composite is concerned, it is a technology-weighted index, and for the next couple of years, attempting to target the value of that index, other than simply for trading it, is a waste of time. I typically do not trade that index, so I will leave it at that. (I do think, though that the index will be guided by INDIVIDUAL names that one needs to research for growth and value/growth measures. No index will tell and individual company’s story, so one must choose carefully which stocks one owns, particularly with ever changing technology). For now, let’s talk only the $SPX.
Why do I care about the $SPX this year? The main reason I do is because the U.S. Dollar value against the Euro in 2012 will likely determine how strong export business is, and that is the main thing that drives large multinational companies for which the largest component resides within the $SPX. Because of U.S. equity market negative correlation with the EURUSD (the Euro/Dollar foreign exchange pair), a stronger dollar will mean more difficult sales abroad and poor earnings performance in 2012 versus 2011. If the opposite occurs, you will likely see better performance against 2011 numbers in 2012. I think correlations will continue strong, and that combined with my belief (however flawed) that the Eurozone as we know it will break up by the end of this year, we are likely to see a lot of crazy action. The action that will likely be the strongest will be the strengthening in the US Dollar, which will pressure S&P 500 earnings in 2012 because of that same negative correlation. According to this Seeking Alpha article, The $SPX should earn collectively 107.60 per share. Since it trades at a ratio of 12.50 times it’s EXPECTED earnings earnings, according to Barron’s. that would set that target for next year at roughly 1345 for the $SPX in 2012. That seems reasonable IF 1) the dollar remains relatively stable and 2) there are no external events in the world (economic or political) that would cause dollar value to change radically. The problem with that assumption is that we know that nothing is completely stable in the current environment.
What would the charts indicate? Well, I can give you a best case scenario and a worst case scenario, but in either case, we will likely 2012 close very near where we are today (1221.75) at worst and 1377.57 at best, in my opinion. The best way to look at this is through a monthly chart. The green lines represent the most bullish scenario and the red lines the bearish scenario. I could explain the nuts and bolts of symmetry in either case (and if you leave me a comment to do so, I will), but here is the bottom line. If we do break above the critical areas of resistance at 1270.05 and 1370.60, I think the $SPX may stage that seasonal cyclical relief rally to 1564.75, and perhaps even slightly eclipse the 1576.09 all-time high of 2007. By spring and summer, though, I think the full weight of the European debt crisis will be bearing down on this index and we will slump back into the high end of the range near 1377.57, the rest of the year we may drift, but end at that level. In the bearish scenario, the $SPX falls below the 1074.77 range and probably ends up around a support level at 978.51 (which would match that previous bear swing down in intensity). The rest of the year we might drift back higher to about where we are now at 1221.75.
I tend to be a bit bearish early on because I think the disease that is the European debt crisis is going to continue to pressure markets and destroy retail investor confidence. Until something is done to rein in spending in the Eurozone, the possibility of breakup increases each day. I simply do not see the political will being enforced there (or here in the U.S. for that matter) to restrain spending. Delaying restraint only makes the pain worse, and threatens further economic damage via interest rate hikes, increased taxation, or some other economy-killing moves that will stunt economic growth.
The other reason I am pessimistic about the high end of this market is simply history itself. I add the current value of inflation adjusted value of already occurring S&P 500 earnings, which is measured at 21.04, which is at the high end of historical ranges (and not just 5 or 10 years, but 130 years of market history). There are two ways for that index to fall into a reasonable area of value, though earning growth (that is, a higher denominator, earnings, can be divided into price to create a lower value of P/E) or by price decline (the numerator declines because market forces press prices down to reasonable levels for some kind of sustainable price appreciation in the future). If one has read Unexpected Returns – Understanding Secular Stock Market Cycles by Ed Easterling, you know that history tends to punish markets valued this richly over time. We would need to see these values at high single digit levels to have a market to sustain a solid buy-and-hold investing approach. We simply do not have that now. We are still in year 12 of a secular bear market, and we are likely to remain there until we can cure the disease of debt accumulation and asset price valuations in real estate. The real estate is slowly beginning to heal, but it is likely to be several more years until that process is completed. The average of the last three secular bear markets was roughly 18 years, so this is nothing that out of the ordinary.
We likely will see sluggish growth as described in John Mauldin’s piece, The Years Ahead. If you are young (in your 20s) you will likely survive this mess as long as a free-market economy exists on the other side of it. I am going to be 57-years-old in July. I was able to bail substantially from the market in 2000, deciding to trade at the margin, and allowing other businesses to grow from which I can make a solid return. I will always swing trade when conditions are right, but I am not very keen on the idea of long position trades until we see this debt crisis resolved. I do own resource names and a few other stocks, but stocks are NOT the major holding in my portfolio at this time. Does that mean I am hiding under a shell like in this 1950s civil defense video? One needs to look at trend following and value techniques to buy stocks that have a high probability of hitting their targets. That requires an understanding of charts (technical analysis) and basic value analysis. There is no way to escape working on both. When valuations become reasonable again, I will invest again with a greater portion of my portfolio.
What you will eventually find is that trend following can work in any market, and can be the source, along with options strategies, of better than average returns if one is disciplined in using them.
Conclusion: I see more volatility ahead for the $SPX, and with very little progress made by the end of 2012. If the bearish case holds, we will lose a little ground again in 2012. If we no hit those highs mentioned, one needs to consider valuations and trend to take profits if they happen. A close in the 1500s would discount a few years of future growth. I do not see a tremendous amount of upside until the debt and real estate crises are put to rest. Good luck with investing and trading in 2012!
I will do a short post tomorrow with regard to the neural net data and what I intend to do with the blog going forward. Thanks for continuing to support this blog!
{ 2 comments… read them below or add one }
Great post, Dave. Thanks for taking the time to put it together.
Thanks, Larry. Will try to do more consistent content going forward (though it might still not be daily again as yet).