Why the S&P 500 Refuses to Lay Down

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About a month ago, I suggested that another correction was coming. Over the week or so following that article, we did see a succession of down days in the stock market, and about a 4% drop in the S&P500 from a high two days later of 1709 to the 1639 level. I guess it was a correction of sorts, but I am not about to claim predictive powers on the back of a small move like that. Thursday and Friday of last week saw modest gains in stocks again. It would seem that the downturn is over and we are back on an upward track. The price action would suggest that this is a remarkably resilient market.

To understand why, we must look at what is driving the buyers. The basic reason for “up” being the default direction comes down to something I often say when looking at markets, whether domestic or global…money has to go somewhere.

There has been much talk of the Federal Reserve gradually reducing the amount of QE and eventually ending it. The first mention of such by Chairman Ben Bernanke caused a drop in stocks back in May and another when he talked of it again in June. The fact is though, that so far talk of tapering is just that…talk.

Maybe I am giving the Chairman too much credit here, but it seems to me that one of the things Bernanke has shown himself to be good at is managing market expectations. By talking openly and frequently about the Fed reducing the amount of cash that it pumps into the financial system, while continuing with the policy, he has created the ultimate “sell the rumor, buy the fact” scenario. The series of mini-panics when the subject of tapering is brought up has made it more likely that, when the policy actually changes, the effects of that change will be muted. Like any good parent, he is making the monster in the closet seem less scary by talking to his children about it.

While the prospect of a reduction in, and eventual ending of, the Central Bank’s bond buying program has traders concerned, so, as the news is being digested, the program continues. Financial institutions are collectively being handed $85 Billion a month that the Fed creates out of thin air. No money manager can justify their salary by sitting on cash, so as I say, that money has to go somewhere. Bonds, and treasuries in particular, were at historic highs before the talk began. Some kind of move back to normal levels was inevitable and has happened, but even now that market doesn’t look particularly attractive. Stocks are benefitting, if only by default.

 

This is why, as the chart shows, each move down only serves to embolden buyers and we are still looking at a fantastic year for the S&P. The month of September is often a bad one for stocks and we will likely see some volatility as analysts adjust forecasts down following a mixed earnings season. As this is happening, however, and even as talk of tapering intensifies, there will still be cash seeking a home.

In general, I regard “buy the dips” as one of the most useless pieces of advice one could give. Obviously, buying at a lower price than now, just before the price pops back up again, is a great strategy. Most of the time, however, the problem is that while you are waiting for a 5% drop to signal a buy the stock or whatever edges up about 10%. In this case, though, it may be sensible advice.

More “taper talk” and some downgrades are to be expected and, as money managers have an eye to protecting returns from a good year; it is likely that the reaction to any such news will be significant. I am confident that, for those holding significant amounts of cash, opportunities will present themselves.

We all know the, over long periods of time, equities represent the best investment available. The problem for many investors right now is that they don’t want to be the one that buys right at the top before a complete collapse. I understand that, and waiting for some move down before jumping in means that at least you cannot have bought at the very top.

Given the careful parenting of Mr. Bernanke and the amount of money still seeking a home, finding a way to overcome that fear of hitting the top is a good idea. In a couple of years, these now elevated levels are going to look cheap.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: News Headlines , US Markets , Bonds , Economy

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Martin Tillier


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