Readers have asked for Dr. Genetski’s and The Meyers Report views on the current state of the stock market in light of both the issues surrounding sequestration and the debt ceiling. We are growing increasingly concerned over a correction in the market. Neither of our concerns revolves around sequestration or the budget ceiling, although we know both will be blamed if the market heads lower.
The good news. From a longer-term perspective we continue to believe the market is undervalued. Looking at the current price for the S&P 500 compared to earnings for the 4 quarters (ending in the 3rd quarter of 2012), the earnings yield is 5%-6%. This compares favorably to a yield of roughly 4% on AAA bonds. While current interest rates are artificially low due to Fed policy, any increase in rates is likely to be accompanied by an increase in the pace of spending. Such an increase would be far more beneficial to stockholders than bondholders. Hence, given current interest rates, stocks are cheap.
We are favorably impressed by how the market rebounded Friday, Feb. 22nd, to maintain its upward momentum. Both the overall market and the Russell 2000 were able to rally at or above the upward moving line on our chart above. The Russell was even closer to the line before rebounding. Also, the S&P 500 found support at the 1495 level we had previously mentioned.
On the downside, we are concerned over the high volume associated with the sharp declines on Wednesday and Thursday (Feb. 20th and 21st), followed by the very low volume accompanying the rebound on Friday. This is the opposite of a healthy market.
We also are concerned over what appears to be a slowing in bank loans and investments. During the six months ending in January, growth has slowed to a 4.6% annual rate. If the latest numbers (the first two weeks of February) are characteristic of the entire month, the growth rate for bank loans and investments in the six months ending in February will be 4.2%. This slowdown suggests to us that the substantial increase in bank reserves simply is not getting through the banking system to boost money or spending. Hence, the upward pressure on stocks from the growth in bank reserves is not as great as we would hope it would be.
Finally, commodity futures prices in February are down 5%. Since the dollar is up by about half that, there has been some weakness in commodity prices. This development is more consistent with economic weakness than strength.
Bottom line. The odds of a decline in stock prices have increased. Our inclination is to begin to hedge against a downturn in the market by purchasing some VXX1, a proxy for the VIX volatility index. At this point Dr. Genetski intends to move from a fully-invested position to a neutral position if the market moves below the recent support levels. He would anticipate moving to a defensive position if the 10-day moves below the 50-day average.
1VXX is best described as a proxy for the VIX. The VIX is a measure of volitility. It tends to move inversly to the stock market. If stocks decline, the VXX tends to rise rapidly.