Is the monster rally that took the S&P 500 up 39% from the March 9th low to its 2009 high of 929 on May 8th over? Recent market action is clearly warning that a near-term top may be at hand. Look at the chart of the S&P 500 below. The red circles indicate a “double-top” that failed just below the downward-sloping 200-day moving average. The 200-day moving average represents very strong resistance, and the market’s inability to break through that level on two attempts signals that the rally is exhausting itself.
After a nearly 40% rally in two months, it’s hardly surprising that the market is having difficulty breaking above this key level. Furthermore, as we’ve written for weeks, the rally was built on economic and corporate earnings data that was rather ugly, but certainly better than most investors expected. So while the banking system has stabilized, investors are beginning to question bullish assumptions of when economic growth will return, and how strong and sustainable that growth will be when it does return. After all, consensus earnings expectations for the S&P 500 this year are less than $30, implying a current P/E ratio of over 30 times. If recovery is delayed, or not as robust as the $60 in earnings expected in 2010, then stocks are rather expensive at these levels.
Yesterday’s market action demonstrated the inherent risks. Standard & Poor’s cut the outlook for Britain’s sovereign debt to “negative” and warned that the country’s triple A rating could be cut. Some in the U.S. warned that this country’s debt could be at risk of a downgrade, given multi-trillion dollar deficits as far as the eye can see. As a result, bond prices declined along with stock prices. In addition, weekly new claims for unemployment were reported to be down slightly, but still at a high level of 631,000. As the Financial Times said this morning, “Investors who have piled back into risky assets such as equities on the assumption of growth should ponder America’s job losses, lest they also find themselves all at sea.”
The next week or so should be critical to the equity markets. We expect bullish investors to mount another assault on the 200-day moving average. If a breakout on strong volume is not achieved, we recommend reducing equity exposure. At this time we’re not convinced that the market will fall to its March lows, but a correction on the order of 10% should be expected.
One final thought: if I had told you in early March that the market was poised for a monster rally of 30%-40% in two months, what would you expect me to do with your money after that rally occurred?
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