May 20, 2008
- In January Berkshire Money Management offered that the “Risk Level” for the S&P 500 in the first four-to-five months was 1,300 points. We further argued that the stock market would behave better during the remainder of the year.
- Berkshire Money Management expects the stock market to move upward from the lows of the year and into early 2009.
- On the path to a higher stock market we would consider a near-term pullback to 1,365 points to be ordinary and regular.
Monday’s surge to new-rally highs by all the major market indexes fizzled late in the trading day. I don’t typically comment on a day’s market activity, but we are approaching critical technical junctures for many indices. Yesterday’s rally pushed all the major indexes above their 200-day moving averages, which historically has proven to be a key resistance level. However, only the Dow Industrials were able to close above the possible resistance level.
Based on our inspection of stock market breadth (a measure of increases and decreases of share price, as well as volume), the cause of the aforementioned fizzle did not appear to be caused so much by selling, but rather from buyers’ fatigue (remember, the price of anything is defined by the law of supply and demand, or selling and buying). The inability of buyers to keep the indices above this possible resistance level shortly after breaking it is likely a function of a tired rally – one where, for now, all the buyers at these levels have come in to the market. To get new demand, in other words to get buyers buying again, we might first need to see lower stock prices.
The type of dancing around a resistance level that the stock market has been doing typically leads to one of two things. The first is a punch right through that resistance level. The second is a retreat in prices before experiencing rejuvenation in buying demand (i.e. higher stock prices). Granted, there is a third possibility of the market simply bouncing off that resistance level and dropping to new lows. But given the market’s ability since mid-March to register higher-lows and higher-highs that more bearish scenario currently seems to be at be at best a possibility, but not yet a probability.
Investors forget this but, on average, in any given calendar year, there are three-and-a-half 5% stock market corrections from an intermediate top. That would make a pullback to about 1,365 points on the S&P 500 perfectly regular and ordinary and within the context of a market that is destined to go higher over the rest of the year.
That being said, we do consider ourselves to be risk managers. On November 15, 2007 we wrote an article titled “Cut and Run at 1438.” Without going into the same details written about in that article, you can apply the same concepts and rationale to our decision to hedge against (or outright reduce) US equity exposure should the S&P 500 drop below 1,312 points.
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