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$SPX From 50,000 Feet (Part I): Breaking Out The S.W.O.T. Chart

I know everyone who is a true loyalist to this blog (and despite recent lapses of writing, they are still out there and they write, which I greatly appreciate) has been asking me about what I thought might happen next with the previous target I had posted being hit.  I waited until just about the last moment to do it, but I will do my best to summarize what could happen in this post. I was going to make it much longer, but it would be a long discussion. If my friends and I can ever figure a way to drive traffic to this blog (something we are working on currently), I could produce a newsletter that would break down sector by sector and index by index what I think is going on (with targets). The only way I make money, however, is by trading and running a couple of other businesses I have. Until then, I will stick to a good concise summary of things happening in the markets. I am covering three of the four parts of the S.W.O.T. chart today. The opportunities part (O), I will cover in pieces over the next couple of weeks.

We are going to look at the S&P 500 Cash Index on a monthly basis this time. Why? Because I think some discussion needs to be had about important support levels and a near break of the first on last Friday. This post will not be a Peter Schiff discussion of death and destruction (but it might contain elements of it) nor will it be a blissful ever-bullish tirade by Allan H. Meltzer who wrote Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market. Instead, I am going to use an old tried and true technique used at Harvard Business School to define the environment an entity ( a business, or any entity, or even a market index ) exists within, called a S.W.O.T. chart. This was something we used in business school when we were young and stupid (and I heard you folks saying your minds ‘now he is old and stupid’ and know who you are, I am psychic that way…just kidding). It is highly effective as a conditional outline of what potential situations could occur in the future, given the current economic environment in which the $SPX finds itself. Now, let me step into my Scooter and turn the battery on to adjust my typing posture.

One quick note (and I receive NOTHING for this link for full disclosure). I am going to attempt to watch the Super Bowl with friends this afternoon, so I am going to take some shortcuts, using my friend Larry Pesavento’s content, which is quite rich, very informative, and, if you control your risks and use common sense in your trading profit-taking, profitable over time. Much of what I know today came from him and two other mentors. His website is www.tradingtutor.com. Hopefully one day I can have my own subscription site in which I can delve into areas that also include my own neural net models which rely heavily on the research he has produced over the years, with a few wrinkles in the area of momentum. I just wanted you to know that I am borrowing his content on some items here to make some key points.

Read that link to understand what S.W.O.T. Analysis is. Lets get on with the analysis:

Strengths: 1) The $SPX is probably still the best index in a really bad neighborhood, and its trend is still bullish at the moment. If you look at the chart of the monthly $SPX going all the way back to 1963 (when I was 8), you will see that we are still in a cyclical bull market for the last  5 years. (I will do my best to explain in short why I still do not believe that we are in a SECULAR bull market as yet.). We have only just recently surpassed the previous tops in 2013 and have hit the 1.618 extension. I also took the most recent monthly lows (in September 1974) and compared them to the most recent highs to get extensions into the future. The chart package I am using today is not the best at calculating extensions, so I will do them by hand. If you take the low of November 1974 (68.32) and you subtract that from the previous all-time high broken in 2013 (which was set in September 2007), you will get 2 primary targets at the 1.272 and 1.618 extensions of those levels at 1940.30 and 2450.79. Based on previous tests with $SPX index neural nets, the odds are about 70-75% that near target being hit, assuming we do not take out any monthly low that set the trend for that extension. The December 2013 monthly low of 1767.99 was NOT taken out by the close or low of the previous bar (January 2014) and closed at 1782.59. All that occurred as January 2014 was down by 5% (which would tend to invoke the January effect). It too is correct about 72.9% of the time currently. We are still however on the same trend-line path upward despite the very rough start 2014 had. We are, despite everything, still in an uptrend.

2) It is outperforming most of the world and in a shorter-term trend period, seems now to be gaining a little momentum. The only major problem is that the small caps are beginning to outperform again, and there is some concern about the strengthening of the US Dollar Index becoming a threat to U.S. exports, which are a major part of $SPX earnings.

Weaknesses: Probably the most threatening (and potentially destabilizing weakness) is margin interest. As you will see in this video, it is the highest it has even been, and much higher even on a percentage basis than it was in 1929. Any series of economic events could trigger a panic, and with that much margin out there for equities, it could be called in quickly, and it would be a bit like a nuclear warhead tied to a firecracker. You might not hear the pop initially, but you will very soon feel the compression, heat, and fire.

Another weakness from a technical perspective is that the monthly chart exhibits a bearish butterfly pattern, which is generally a good indication (based on the fact that is is of a longer-term nature) that an important correction is likely to occur if the most recent high is not exceeded and the previous monthly low is broken to the downside.

Threats: 1) The biggest threat to the world economy and thus to the $SPX is the total breakdown of currency and debt policy. What I want you folks to do is two things: Read “Central Banker Throwdown” and in fact, all the rest of, the current issue of Thoughts From the Frontline, John Mauldin’s newsletter and watch the Bloomberg video with Raj Rajan when you get tired of watching the Super Bowl this afternoon. The bottom line is this. The U.S. policy of easy money quantitative easing has been done largely in the old 1970s spirit of “we are the only viable economy on the planet, so lets just dump currency on the market to artificially keep interest rates low and somehow let our economy improve, the rest of the world be damned.” What we now are facing in the unintended consequences of the “Matterhorn (the steep rock formation) risk profile policy” on other nations. A great amount of that money is being held by banks and other institutions and they have invested a great bulk of that 85 billion USD a month (now 75 billion USD a month) in foreign businesses, equities and assets. Emerging market growth was good without it, but the addition of foreign capital has falsely-inflated valuations in those markets, and that has created international inflation that is cutting growth there. You will see a direct discussion of that problem with RBI (Reserve Bank of India) Governor Raj Rajan. The Peoples Republic of China is facing similar problems as is trying to reign in growth to prevent inflation and still give a very fragmented population with different economic outcomes a chance to improve (or get very angry, particularly if you do not live in Chinese cities). Right now, China’s two-tiered capital system keeps savings spending (as rates are low) but provides production loans to business. But the real problem happens when panics or capital outflows occur (as mentioned in the video). You can already see that inflation is pressing the value of most emerging currencies. The recent problems with European banks and ongoing stress tests will likely force these banks to restrain trading in currencies. When there is a lot of volatility caused by uncertainty, it sets up the opportunity for short-term panics, and those panics can be overplayed. Currency problems lead to problems with debt markets, and interest rate instability can lead to market panics (remember 1987 anyone?). Currencies cannot ALL drop at once (even though fiscal policy in the Western nations seem rife with that philosophy to pay off massive governmental debts).  This could trigger both a  worldwide panic, and eventually trade wars if some kind of coordination of currency policy is not worked out.  Trade wars, more often than not, lead to shooting wars, which is why we need to be watching this situation closely. It could get sticky quickly. I mean, REALLY quickly.

2) The other corollary effect of the situation above could be a rise in Treasury bond rates in the USA. This, of course, has not yet been the case, but if we see volatility in foreign rate and currency markets, it is a distinct possibility. As we head toward the end of the decade and if debt continues piling up, the threat of rate hikes, even involuntary induced by markets, could crimp things for our economy because of the risk of default. Right now, the real risk is DEFLATION, but with deflation comes the real risk of DEPRESSION. That is a whole different blog post, but I will try to grapple with that soon.

Opportunities: I think day traders are likely winners in this environment as long as they have properly managed stops using volatility (average true range) or other method to manage the risk. Those with long only strategies should be looking at relative valuations to cull your portfolios of nice winners, stockpiling cash until the next correction hits. If you are near retirement, that should also include you. You need to control and capture your gains, get rid of large positions in one equity (like your company stock, for one thing), and be ready for the next major pullback. I will be going over what I think looks interesting as time moves on, but I think a little preparation and risk management is needed.

Targets for the future: I basically gave you the two upside targets should we hold the lows and continue marching forward. I personally do not think we will get to 2500 on the $SPX before we see another correction, but the 1940.20 is a distinct possibility in an overheated volatile bull market. If we do NOT take out the 1850.84 high and roll over, I would suspect that on a monthly chart, we would see a typical 38.2% correction to 1560.79 on a strong pullback. That would represent a 15.7% drop from the all-time highs. A severe correction would take us probably back to at least the 61.8% retracement or to 1373.07, which would be a 25.8% drop. I can go farther into that dire scenario (like a meltdown we had in 2008), but for now I won’t. I may cover that in depth during the next post.

For reference to the technical targets, there is some fundamental justification of them as well. The current level of $SPX is 1782.59 which has a Shiller inflation-adjusted PE of 24.75. If we were to peak at the highest level ever, which was 44.20 in 1999, that ratio would give us an $SPX target of 44.20/24.75 or roughly 3183. That is one reason that I think we will see a correction before then. We are at a historical valuation that is far above average, and has only been surpassed a handful of times.

Bottom line: For now, I think a 1560.79 target in the next couple of months is at least 50% to 75% likely if we do not take out the latest $SPX high.

More content coming up. Once again, thanks for continuing to support this blog!





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