This holiday-shortened week saw a relief rally that began on Monday and carried through until Thursday. The markets still have further to go in the coming week before we once again reach the top of this four month long trading range.
The question that haunts both bulls and bears is when and in what direction will the markets finally break out or break down? As readers are aware, I believe that there is a high probability that stocks will do both in the weeks ahead. We could easily see the S&P 500 Index, for example, reach a new high, possibly 1,900 or beyond.
However, at some point this spring, that index and others will rollover. The resulting decline will be nasty, scary and absolutely meaningless in terms of this 2014’s full-year returns. But the trading range will be broken on the downside, as a result. How bad could it get?
Let’s say the S&P 500 Index begins to rollover at 1,900. A ten percent decline (190 points) would put the average at 1,710. A 15% sell-off would equal 1,615. That would simply put us back to the levels we enjoyed in October of last year.
Readers may recall that back then the Fed was still talking about tapering,although it wouldn’t be until January that the Fed would begin to cut back on stimulus. Market commentators were warning that the market was overheated and due for a big pullback. Investors earlier that month were concerned that the government would be shut down (it was) and we would default on our debt. Job gains were modest at best and the strength of the economy was a question mark. Pimco’s Bill Gross was writing that all risk assets were priced artificially high.
The point of this recent history in hindsight is that dropping 15% would only return us to a level where investors thought the markets were too high anyway. Since then, of course, many changes have occurred and all of them positive. Employment and the economy are showing great gains. Corporate earnings have increased. The political stalemate in Washington has at least quieted down. And the Fed has begun to taper but, contrary to popular opinion, interest rates have not sky rocketed.
Times change, however, since then we have risen almost 20% in six months. Seasonally we are not in October, but moving instead into spring. That is usually a down period in the markets (sell in May and go away) compounded this year by the mid-term election cycle (also a bad time for markets historically). We have not had a 10% correction in over two years—a market anomaly. Bottom line: we are set up for a pullback, but exactly when it occurs is a question no one can answer with any accuracy.
So far, the markets are following my playbook practically page by page. Stocks bounced off their lows on Friday and started this week in rally mood. The technology-heavy NASDAQ led the charge upward with the other averages following. At its low, NASDAQ had dropped almost 10%.
The last two weeks of April have been pretty good for the markets historically. All the tax selling is now out of the way and investors are re-establishing positions in various stocks. Chances are that we should re-test the recent highs and do so quickly. Hold on to your hats.