Newsletter | April 2014

April 21, 2014 – DJIA = 16,408 – S&P 500 = 1,864 – Nasdaq = 4,095

 

  

“One dog goes one way, the other dog goes the other way, and this guy’s sayin’ ‘Whadda ya want from me?’”[i]

 

The S&P 500, since it broke above the 1,750 level last fall, has been like the two dogs in Mrs. DeVito’s painting - unable to decide which way to go.  Twice it has fallen to 1,750 (most recently in February) but both times reversed and moved higher.  Three times the index has tried to push above 1,850 but has been unable to decisively break through.  In fact the S&P 500 has spent the last couple of months moving back and forth between 1,820 and 1,890.  As shown above, last week’s close was 1,864. 

The dogs join the bulls and bears in struggling whether this sideways slither is a base from which we extend 2013’s rally or a significant top before the long awaited correction.  One worrisome sign is that the rally’s leaders and favorites have cracked.  For example, FireEye (symbol = FEYE), a company offering software products that provide malware protection, approached $100 per share during March’s first week.  By April it was below $50.  The biotech sector gained 60% in 2013 and was up an additional 20% in 2014 in the first two months.  From that peak, the industry index has given up over 20% with many stocks falling much more.  Furthermore, the Russell 2000, a strong leader during 2013, has been among the weakest areas during the January retreat and since the March highs. 

While the Russell has demonstrated clear signs of distribution, the Dow Jones Industrial Average and S&P 500 have showed relative strength.  In fact both large cap indexes recently reached all-time highs.  And while this is an undeniably positive development, it is at the same time a warning sign.  First, the weakness in the Russell, Nasdaq, and favorite sectors relative to Dow and S&P’s is a troublesome divergence.  These indexes moved together during last year’s rally so this breakdown in the pattern is another sign that things are changing. 

Also, two weeks ago the Russell finished a few points of its 200 day moving average (DMA).  Remarkably this last happened almost 1 ½ years ago (November 2012) which we interpret as an important trend change. 

Applying this analysis to the S&P 500, it has been over 350 trading days or 17 months since this index has touched its 200 DMA.  This streak is the 10th longest since 1928, the 4th longest since 1965 (soon to be the 3rd longest) and the longest in 15 years.  As MKM Partners describes this, “To say that the SPX (S&P 500) is ‘due’ for a 200 DMA test would be a bit of an understatement”[ii] The current 200 DMA for the S&P is around 1,761 or about a 7% correction from the recent highs. 

What does this mean, if it were to happen?  History tells us that one week to one month returns are negative after the test.  Again quoting MKM Partners, “after such a sustained period of a steady rise, once it finally breaks, weakness tends to persist in the near term.  In fact in 8 of the 9 longest streaks, returns were negative a week later by an average of nearly 3%”[iii]

Beyond this indicator, further worries are supported by the fact that defensive asset classes (bonds and utilities) are strongly outperforming equities.  Remembering way back to the beginning of the year as we are learning to dislike the polar vortex, everybody’s 2014 forecast included higher interest rates.  This once again proves that when everyone thinks the same way, nobody is thinking - interest rates are lower as the 30-year Treasury bond has provided a 10.52% year-to-date.   Furthermore the Dow Jones Utility Average is up almost 9% in 2014. 

Taking a look at where the major averages stand, they rebounded strongly last week after some nasty selling two weeks ago.  We start the week, except for the S&P, lower on a year-to-date basis.  We’ve also included the 1st quarter numbers. 

 

                                              2014 YTD   2014 1st Qtr
Dow Jones Industrial Average       -1.0%            -0.7%
S&P 500                                   +0.9%            +1.3%
Nasdaq Composite                      -1.9%            +0.5%
Russell 2000                               -2.2%           +0.8%


The Wall Street Journal, April 12, 2014

                    

indices are unmanaged, do not incur fees or expenses, and cannot be invested into directly. These returns do not include dividends

Before looking one way (forward), we look the other way (backward).  The S&P 500’s first quarter marked the 5th consecutive positive quarter.   This has happened 5 times in the past 40 years.  In 4 out of those 5 occurrences, the next quarter was negative.  The fifth time it was part of an historic streak of 14 consecutive quarters in the mid-1990’s.  It’s little wonder that the dogs can’t make up their mind.  

On a shorter term and despite these divergences and warning signs, April has been a good month.  April has been the best month for the S&P 500, the Dow, and the Nasdaq over the past 10 years, averaging 2.33%, 2.33%, and 2.56% gains respectively.  The Dow hasn’t had a negative April since 2005.  Of course, this could be a prelude to a “sell in May and go away” moment.

For the investor with a longer time frame, we think the economic back drop continues to be ok and that some exposure to the stock market makes sense.  However, the markets may offer a better entry point in the intermediate term.  Of course, as we have seen in 2014, sectors can present buying opportunities without the averages declining.  For example, “old” technology and energy have performed well this year and we expect similar sector rotation throughout the rest of the year. 

An important part of the investing process is managing risk and the recent price action has flashed some warning signs that should not be ignored.  This is not to suggest an oncoming bear market but rather some the possibility of some painful turbulence.  For those prepared, it presents an opportunity.  This is especially true for those with a time frame beyond the next quarter.  This brings back to our belief that 2014 will be a choppy year with an agonizing pullback or two.  Or as part-time art critic Tommy DeVito describes it, “Ping! Pow! Boom! Bing!”[v]            

 

 

 



[i] “Goodfellas”, 1990

[ii] MKM Partners, Technical Strategy, April 13, 2014

[iii] Ibid

[iv] The Wall Street Journal, April 12, 2014

[v] “Goodfellas”, 1990

 

Past performance does not guarantee future results

  


  

  

 

 

 
  
  
Sincerely,
  
Jeffrey Kerr, CFA
President
Kerr Financial Group

 


This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty. The Dow Jones Industrial Average is a price-weighted index of 30 actively traded blue-chip stocks. The NASDAQ Composite Index is an unmanaged, market-weighted index of all over-the-counter common stocks traded on the National Association of Securities Dealers Automated Quotation System. The Standard & Poor's 500 (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Russell 2000 Index is an unmanaged market-capitalization weighted index measuring the performance of the 2,000 smallest U.S. companies, on a market capitalization basis, in the Russell 3000 index. It is not possible to invest directly in an index. Investing involves risks, including the risk of principal loss. Additional risks are associated with international investing, such as currency fluctuations, political and economic instability and differences in accounting standards. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. All economic and performance data is historical and not indicative of future results. Market indices discussed are unmanaged. Investors cannot invest in unmanaged indices. If assistance is needed, the reader is advised to engage the services of a competent professional.

Past performance does not guarantee future results

 

Jeffrey J. Kerr is a registered representative of
LaSalle St. Securities, LLC, a registered broker/dealer.
Kerr Financial Group is not affiliated with
LaSalle St. Securities, LLC. Securities are offered
Only through LaSalle St. Securities, LLC
940 N Industrial Drive, Elmhurst, IL   60126-1131
Member FINRA/SIPC