Tuesday, September 22, 2015

Rolling toward reality

It is not without some trepidation that I take exception to last weeks Goldman Sachs projection of S&P 500 at 2100 by year end.  I recall during the tech bubble war of 2000, the press made great import out of an apparent difference of opinion between Steve Roach, Morgan Stanley's head of research and Abby Joseph Cohen of Goldman Sachs.  The headline made them disagree, when in fact one was talking of level and the other about time.  Both were right if one cared to read what they actually said.

Following the Federal Reserve decision to leave interest rates unchanged last week Goldman presumably turned more bullish.  I doubt it. 

 This weekly chart of the S&P 500 shows the index rolling out of the remarkable bull market that has been devoid of correction since 2012.

Although I would be the first to admit that the stock market does not necessarily reflect the general economy I believe it too early to infer a disconnect yet.

The global economic outlook is moderating and forward looking indicators are not constructive.  China is still digesting a slowdown.  Valuation of the S&P is not remarkably lofty but is still on the high side of average.  Interest rate policy has created a no alternative investment climate.  If pension funds are to possibly approach their projections, fixed income investments cannot reach performance benchmarks.

The 2007 mortgage debacle was created because no fixed income investments could provide returns needed.  The investment community satisfied the need with mortgage backed securities (housing has only ever gone up was the cry).  The combination of leveraging what had previously been a conservative investment sector and destroying the quality of such loans with No-Doc and similar over engineered lending criteria (i.e. none) created a global crisis the likes of which hadn't been seen since the 1930's.

Stock market performance based in general on two psychologies.  Valuation is the first and most frequently spoken of.  When a stock is bought it is the purchase of the long term dividends of a company.

The second aspect of market movement are the animal spirits of acceptance of risk.  Recently we have been seeing a lessening of risk tolerance as shown by stock market internal indicators.  Fewer and fewer companies have been responsible for market performance.  The breadth of the market has narrowed significantly.

The daily chart indicates a broad market no longer particularly oversold, but today buyers are absent.  In order to take the market back to the 2100 level a herculean effort will be required at best.  If the S and P 500 should manage to get back to 2100, I project the sellers will come out in droves to take advantage of the temporary reprieve.  Timing is the only arguable point in the development of this equity market.

While I foresee no global meltdown a la 2007, I believe the best outcome will be a long lackluster market until we can grow into the valuations already baked into the cake.  Today's financial markets are not known for patience so an expectation of volatility to get us to "reasonable" is probably not misplaced.

Coincidentally a 38% retracement (fibonacci) takes the market back to the top of the 2007 market collapse.  Just to put my neck out, I project an S and P level of 1575 in the next six to twelve months.