Monday, October 24, 2011

More Puzzling US Equity Market Behavior

As I write this, it's a little after noon on Monday. The S&P500 Index has moved above 1250. Earlier this morning, one pundit opined that if the index moved above that level- probably closed, I would guess- then the US equity market is in fine shape and will continue to rise. For now, the index's return for October is in excess of +10%. Quite substantial.

Meanwhile, last week, another pundit described this October's S&P rebound as a bear-market rally.

Whom to believe?

Well, consider that the vaunted weekend Euro summit to solve their sovereign debt and related bank solvency problems didn't provide a resolution. That got kicked to later this week. As if that would matter. What, exactly, in the year and a half since April of last year, when Greece's debt problems first roiled markets, has changed? What new solution will occur in the next 3-4 days which will magically avoid defaults, write-downs, and the loss of value across a range of European assets?

Other news this morning included a concern that Europe is slipping back into recession. And that's before the effects of whatever value loss recognition will finally occur.

All this and the S&P has climbed back from below 1100 this month. Is this credible and sustainable?

I took a look at how the S&P monthly returns behaved after past triggering of my proprietary equity signal to get out of equities and/or go short.

In 2008, there were no significant positive monthly returns after June, when the signal was triggered, until the fall, when equities collapsed. However, back in 2001, things were different.

The signal was activated in January of that year, but April and November exhibited S&P monthly returns of over 7%. Never the less, the year's total return for the index was nearly -12%.

We often hear that equity markets, to rise, must "climb a wall of worry." And there are other aphorisms, to be sure, for various market situations.

But if you recall 2001 and 2008, there were enough concerns to more than qualify as a wall of worry. Yet the S&P subsequently collapsed. The index posted more than a +20% return in 1999, then flattened to about -1% for 2000, before plunging for the next two consecutive years. In 2008, the S&P lost 36%, then, after a stunning bottom below 1,000 in March, managed to return roughly +26% for the whole year.

My point is that equity market descents of a long and/or excessively severe nature don't necessarily start predictably and monotonically. There can be some healthy monthly index returns amidst what has, in retrospect, become a serious decline.

So far in 2011, the first two S&P monthly returns were each above average. March was flat, followed by April's +3% return. May through September have all been negative, the last month returning worse than -7%.

Wall of worry, or prelude to a plunge?

To me, as I've observed in prior posts on this topic, prudence is a wise course. I became cautious when an early October's intra-day S&P dipped below 1100. That hasn't changed yet, largely due to the context of large, unresolved structural economic and financial problems which exist globally.

When I hear those who argue for a strengthening US economy, I wonder just what about a 9% narrowly-defined unemployment rate is a positive omen to them? I've already explained, as have others, that strong US corporate results reflect global business exposure more than US activity.

Despite today's continuing robust S&P performance, I still would remain cautious for the longer term of at least the rest of the year, pending resolution of some of the existing problems which left the S&P relatively unaffected.

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