We make investment decisions fundamentally, but fundamentals seem to be out the window in the market right now.  The general dash to safety in the face of the credit market situation is crushing markets, punishing good and bad companies, whether fairly valued or not.

So let’s try to look at the technical crystal ball.

The image below shows the 16-year arithmetic chart for SPY which tracks the S&P 500 index.

What might that chart be saying?

Please note the following is intentionally limited to what is in the charts and does not take into consideration any fundamental information.  The fundamentals may paint a different picture, but this article is purely about a chart perspective.

We do not belief that charts are necessarily predictive, except to the extent that market participants make them predictive through their behavior by following the signals that charts are commonly understood to convey. There may be more to technical analysis than that we do admit, but at a minimum charts inform a material group of market players who act upon chart signals.

click image to enlarge

The red horizontal bars on the left are “volume at price”
The black vertical bars below are volume per period.

Most technical reviews involve periods much shorter than 10 years — often 10 minutes, 10 days, or a few months, maybe a year or two.  This chart looks at 16 years with 10 years in focus.

Observations:

1. Far more more shares are held at a cost basis above the current price of $116.61 (line “C”) than below that price.  That may create overhead resistance as distressed owners seek to bail out as the share price rises to near their cost.
2. The 2007 high and the 2000 high (line “A”) look like a double top
3. The much heralded July 15 2008 “bottom” at $120.99 (line “B”) was pierced on September 15 and 17. If the price stays below $121 for a few more days, then $121 will become important resistance.
4. The July 15 “bottom” may have been called because it might have been seen as supported by the price consolidation areas on the way up in 2005 and 2006, as shown by the red circles at points on line “B”.
5. The next level of support comes at about $105 (line “D”) [about 10% below the current market price] which represents a 2/3 retracement of the rise from the 2002-2003 triple bottom (line “E”) to the 2007 high (line “A”) — that retracement level being a popular Fibonacci threshold of change between a test of support and a solid reversal
6. The Fibonacci 2/3 threshold support at $105 is confirmed by line “F” which connects today with the prior major bottom in 2002 and 2003 with a “beginning” point nearly 14 years ago
7. If the Fibonacci 2/3 threshold (line “D”) is pierced and remains pierced for a few days, then the only visually remaining support is the 2002-2003 triple bottom (line “E”) at about $80 [about 31% below the current market price and 48% below the 2007 high (line “A”).

That sounds pretty scary, but it can happen.  It did happen in the US from 2000 to 2002.

Given all the fear in the market and the wholesale exit from risk, testing the $105 level seems likely, and reaching the $80 seems possible.

Compound Rates of Return:

Various price levels today represent the following 15-year long-term growth rates for SPY (proxy for S&P 500) from the September 17 1993 starting point of $35.99:

• $155 = 11.2% return
• $121 = 9.2% return
• $105 = 8.2% return
• $ 80 = 6.0% return

A 6% return ($80 share price) would be deeply disappointing, but not impossible to conceive.  The often referenced 8% to10% long-term rate of return for US equities lines up with the $105 next support level and includes the current price.  A 10% return would put the index at about $133. If you stretch the long term growth possibilities to 12%, a price of $171 could be imagined — not too likely looking at the charts.

Combining the charts and the compound return calculations, we reach into our magic hat and pull out a rabbit that predicts a price range for SPY in the current time period in the range of $105 to $133.

What are we doing?

We are 50% or more cash in accounts we manage and have all cash in money market funds that invest only in Treasury Bills.  See our recent article calling for investors to switch to Treasury money markets during the current troubled situation.  We also encourage caution in allocating assets to ETNs which pose counter-party risk in this market with counter-parties going bust (see article).

At the same time, we do believe that the current situation is creating value in some cases that deserve investment consideration for careful accumulation.

In this market, though, beauty is definitely in the eye of the beholder.  The level of disagreement about what is a value and what is a trap, and when the pull the trigger is so high that we don’t wish to add to the noise with one more voice.

We are willing to stick out necks out and say that prudence would suggest dividend paying companies are a better choice than those that do not pay dividends — because you may have to live with your position for a while before it appreciates — plus we are somewhat biased toward equity-income with or without a crisis.

As a do-it-yourself investor, you should keep your head about you and begin to scan the investment horizon for value, then screw up the courage to accumulate positions when your research and opinion tells you good value is present.

Richard Shaw
QVM Group LLC

This entry was posted on Wednesday, September 17th, 2008 at 9:06 pm and is filed under Market Conditions, Real Assets, Risk Management, US Stocks. You can follow any responses to this entry through the RSS 2.0 feed. You can skip to the end and leave a response. Pinging is currently not allowed.