Sage Weekly Letter
- Posted by Robert Sinn
- on January 15th, 2012
It is always interesting to analyze the evolution of market expectations in order to gain a better understanding of where the least expected scenarios may lie. From August through late November markets dealt with an endless array of eurozone fears, hope, and speculation. The base case is now for the eurozone to “muddle along” towards a fiscal union under some yet to be determined federal structure – in the meantime the market has decided that the ECB’s cheap money and lax collateral requirements will be enough to take the worst scenarios off the table.
There was also this not so small concern about a China hard landing which would crush commodities and emerging markets. Once again, the market appears to have taken the worst case scenarios off the table – the base case is now that the PBOC will ease policy allowing China to continue to grow at a steady pace (roughly 8%). The PBOC policy easing in the midst of a massive property bubble is eerily reminiscent of Fed actions beginning in August 2007 after the Fed realized it had vastly underestimated the scale of the US housing bubble.
Of course, there are also other issues facing equity markets such as US corporate profit & economic growth, but with the average analyst estimate calling for north of $106/share in S&P 500 ($SPY $SPX) earnings the tone is decidedly optimistic. Perhaps the most interesting transformation in market psychology over the past several months pertains to the US housing market: The base case view is now that housing has bottomed with only a few holdouts still calling for lower prices ahead for housing. The housing optimists have put their money where their mouths are as evidenced by the charts of some housing related equities:
Click to enlarge
If the optimists are proven to be correct and Europe manages to muddle along towards a viable fiscal union, China manages to pull off a soft landing, and US corporate profitability remains at record levels – Then 13 x $106/share in earnings seems like a reasonable target for the S&P 500 in 2012 which would bring the index back up to or slightly above its 2011 high of 1370. The problem for the bulls is that this target lies only slightly more than 6% above Friday’s closing level; therefore, I anticipate the progress toward the 1370s to be uneven and full of minor bouts of euphoria and panic as equities attempt to climb the proverbial wall of worry.
I am most optimistic on the US and US multi-national corporations and I am least optimistic on Europe and economic growth in the largest members of the eurozone. Whereas, I would be lying if I said that I have a strong opinion on China – I view China as a behemoth that faces a multitude of serious demographic and economic challenges over the coming years. However, China also has vast resources which will help it to deal with these significant challenges. Bill Hester at Hussman Funds does an exemplary job of outlining Five Global Risks to Monitor in 2012, risk #5 is probably the most underappreciated and least understood risk.
While I continue to believe that the market’s upside will be contained by significant macro headwinds, I am not highly bearish on US equities. Friday’s closing level of 1289 is still well within my base case range of 1160-1370 for the S&P 500 in 2012. As Derek Hernquist often points out: “Avoidance of future regret is a major driver of market activity”. For the past several weeks the focus has been on avoiding missing out on potential market upside, there may be a little more juice left in this bottle before the tables turn once again toward avoiding downside.
The overall equity market structure is much healthier than it has been since the beginning of 2011 -Correlations between individual equities have drastically declined and we have witnessed a significant sector rotation, moreover there are a multitude of charts in confirmed breakouts or on the verge of breakouts:
$XLV weekly (Health care ETF)
After all the turmoil of the last decade it is pretty amazing to think that large cap technology ($QQQ) is less than 3% from 11-year highs (which could be achieved this week if $GOOG, $INTC, and $MSFT knock the cover off the earnings ball):
However, there are also some signs that not all is well such as heavy distribution in $IBM, a bearish candle formation (evening star) in the energy sector ($XLE), and a bearish RSI divergence on the 60-minute SPY chart:
In summary, the fear of future regret is fairly balanced at this point in time; however, the scales are likely to be tipped in one direction very soon with earnings season and a steady dose of euro news being the primary catalysts over the coming weeks.
The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.blog comments powered by Disqus
Robert Sinn is a professional trader and market analyst who focuses on multiple asset classes including equities, futures, options and currencies. He integrates fundamental and technical analysis. More »