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Wednesday, January 23, 2013

Is the S&P 500 Forming a Dreaded Triple-Top?

 The index is approaching record highs, with the two prior highs being the tops in 2000 and 2007.

By Sam Collins, InvestorPlace Chief Technical Analyst

Stocks opened lower on Tuesday, but quickly overcame the early deficit following better-than-expected earnings from The Travelers Companies (NYSE:TRV) and DuPont (NYSE:DD). Materials and financial stocks led the day, and 9 of the 10 S&P 500 sectors closed higher. Sales of pre-owned homes in the United States fell in December, but sales of houses over $1 million increased by over 60%.
At Tuesday’s close, the Dow Jones Industrial Average was up 63 points to 13,712, the S&P 500 rose 7 points to 1,493, and the Nasdaq gained 8 points at 3,143. The NYSE traded 698 million shares and the Nasdaq crossed 392 million. On the Big Board, advancers exceeded decliners by 2.2-to-1, and on the Nasdaq, advancers were ahead by 1.7-to-1.
On Tuesday, several sources of technical data featured the monthly chart of the S&P 500, noting the index is approaching record highs. The implication is that the index will form a triple-top and that prices will then head south. 
The index is approaching a 19-year high, and it must be considered a major technical hurdle. With the two prior highs at 1,553 in 2000 and 1,576 in 2007, it is understandable why investors might get nervous as the index inches toward what could be a massive triple-top.
But in order to understand the risk of the current market, we must understand what caused the two prior tops and the subsequent bear markets.
The high at 1,553 was made in March 2000. That was the top of the infamous “tech bubble,” which followed by several years the warning of former Fed Chairman Alan Greenspan of an “irrational exuberance” in the stock market that would lead to a crash. And it’s no wonder, the price-to-earnings (P/E) ratio of the S&P 500 stood at a staggering 25.6 times earnings. The market was clearly overbought.
The top in October 2007 was quite different. The P/E multiple was modestly high, at 15.2, but the market was facing huge economic problems with the country sitting on a growing debt bubble, a huge housing bubble, and the lowest auto sales in a decade. 
Now, we appear to be faced with an improving economy and a forward P/E estimate for the S&P 500 of just 13.27 times 2013 earnings (Standard & Poor’s estimate). Technically, the market is in a powerful uptrend with very low public participation, and that is a positive indicator.
Huge cash balances are being held by banks and brokerage houses. TD Ameritrade‘s (NYSE:AMTD) CEO confirmed Tuesday that they were sitting on over $90 billion in cash in customers’ accounts, which is almost double what it was at this time last year. This cash will eventually seek its best rate of return, and that will no doubt include U.S. stocks.
Therefore, I believe that we are not at the end of a bull market, but following Tuesday’s confirmed Dow Theory buy signal (see chart above and Tuesday’s Daily Market Outlook), are entering a period of potentially very high returns. Currently, most investors are bears. When they become bullish and exhaust the huge available cash balances that will be the time to sell. ...

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