Stock Market S&P 500 in Upper Range of 60 Year Mainstream Price Channel

The S&P 500 (US Stock Market) has been going down for sometime, and the S&P 500 went down 6.7% on August 8, 2011, to 1119.46. From the long term view, where is this market headed?

If we look at the S&P 500 chart from 1950 to 2010 (We made this chart the middle of 2010), we see that the S&P 500 Stock Market is now solidly within the mainstream price channel between the years 1950 and 2010. The peaks in 2000 and 2008 can be considered part of an unsustainable "Bubble" period.



Based on the charts, the current price channel (2011) appears to be somewhere between 500 and 1300 on the S&P 500. Over the long term, the trend still is up, but over many years, the S&P 500 might trade within this mainstream price channel for many years.

Stock Market To Stagnate for Years

In June 2010, we blogged about the US Stock Market stagnating for around five years within a Secular Bear Market. We still hold that view.

Lower Highs, Lower Lows, Violent Rallies in a Secular Bear Market

Since 2008, we appear to be making lower highs (around 1500 in 2008, and around 1370 on the S&P 500 in 2011), and maybe we'll be making lower lows.

If we are in a Secular Bear Market, this does not mean we will be going straight down in a straight line. There will be many tradeable and violent snapback rallies when we least expect it, but these will be Bull Markets within a Secular Bear Market.

U.S. S&P 500 Stock Market to Stagnate for Five Years in Secular Bear Market

The U.S. Stock Market, as represented by the S&P 500 Index, could stagnate for a long time period (such as five years).

Long Term S&P 500 Price Channel Since 1950



Since 1950, the S&P 500 Stock Market has been in a consistent price channel, until the year 1995, when the S&P 500 starts the runup at an unsustainable rate, until the peak in 2000. During the time period starting in 1995, the S&P 500 has gone above the long term Price Channel.

We are just starting to see the S&P 500 get back to the top of the normal long term price channel.

In the Reversion to the Mean Theory, this means that the S&P 500 will have to trade sideways for some time to remain consistently in the channel.

Based on the lines above, the S&P 500 should be trading around the level of 500 to 1200.

Five years from now, the S&P 500 could be trading from the 600 to 1500 level, to remain within the long term price channel.

We are in middle of 17 Year Secular Bear Market

Over the long term, the U.S. Stock Market Appears to be in Bull Markets or Bear Markets (Secular Bull Market and Secular Bear Market) for an average of 16 to 17 years.

One grouping consists of:

1. 1906-1921: Secular BEAR Market
   
2. 1922-1928: Secular BULL Market
   
3. 1929-1949: Secular BEAR Market
   
4. 1950-1965: Secular BULL Market
   
5. 1966-1982: Secular BEAR Market
   
6. 1983-1999: Secular BULL Market
   
7. 2000-????: Secular BEAR Market
   

This means that if the current Secular Bear Market started in 2000, and if the average Secular Market consists of 16 to 17 year time periods, then a new Secular Bull may start around the year 2016 or 2017, consistent with the Price Channel Behavior above.

More Details on Secular Bull and Bear Markets including Charts

Today's S&P 500 Chart

Have We Capitulated Yet in the Stock Market? We may break Records. Stock Chart Included.

The US Stock Market as represented by the S&P 500 index went down 78.5 points to 909.92 for a loss of about 7.9%.

We Are Near Record Levels

By almost any metric, we are extremely oversold and near historic levels.

Even before today's big drop, by many technical (related to looking at charts, and price and volume movements and other patterns) standards, we were in extreme oversold conditions.

We could also look at how overextended the S&P 500 Market is from the 52 Week High (and minimize the extension from the 52 Week Low), and we find that we are 42.30% below the 52 week high. In a previous study looking at the S&P 500 in relation to the 52 week high and low, from 1950 to March 2008, we are at the lowest levels since the great bottom of October 3, 1974 with the record of 44.11% HOLU value (mainly how overextended the market is from the 52 week high).

The previous study found that of the 59 trading days from 1950 to March 2008 with the HOLU value greater than 30%, the average one year forward annual return was a market beating 22.13%.


Stock Chart



Previously, we thought that the S&P 500 could hold at 1077, but if the stock market breaks this level, the Stock Market would truly be in trouble. This is the case today as the market sliced easily through 1077 and is now at 909 in a very short time.

We are nearing the congestion around the S&P 500 level 768 (the great bottom from 2002-2003 after the dot com bubble crash) to 936. We might have other support areas such as S&P 840, before we could reach the dot com crash bubble low of 768.63.

Perhaps we are headed towards a re-test of the dot-com crash bottom, and maybe we may form a bullish double bottom around 768.63.

Have we Capitulated and Surrendered Yet?

Common Wisdom States that Stock Market Bottoms often occur after we have Capitulation, where everyone gives up and surrenders on the market often with a crescendo massive sell off.

Today, you could really sense great concern. After visiting a bank, I heard someone say that it is official after looking at the business news program. I hear others talk about losing much of their money.

On common business programs on CNBC, shows such as Mad Money, and Fast Money, were replaced by world wide market news.

The word "crash" is heard all over the news programs. The word "Depression" and "Recession" is thrown around by many people.

The New York Times Internet Front Page talks about the "Markets in Europe and Asia Plunge" and "Nations weighing Global Approach as Chaos Spreads" and "Afternoon Turns Dark as Stocks Plunge."

Photos of traders in shock appear over all the newspapers.

News from around the world shows that many of the world markets are losing around 5% to 10% overnight.

Business programs keep talking about more problems in the future, hedge fund redemptions and record amount of mutual funds being sold as investors show real fear.

The Dow Jones Futures are down big, around 300 points.

There's a good chance that the market could open with a big gap down and continue to sell off. The Big Gap down is good, as this could often be an initial sign of capitulation.

Typically, massive buying comes in, shorts have to cover, and we establish an intermediate bottom and a tradable rally can continue.

But with all the problems all around the world, with all future redemptions still to come, and with traders not wanting to stay long before the weekend (October 10, 2008 is Friday), will we really have the capitulation bottom on Friday October 10, 2008?

But if one is truly a long term investor, this could be a great buying opportunity, or at least a good opportunity to continue accumulating index funds or ETFs for the long term.

Many times near market tops, we often hear that this time, it's different (to justify the market continuing to go up at a fast rate). We could apply this logic near market bottoms, where people proclaim, this time, it's different (to justify a much larger stock market fall).

One day, the stock market will stop falling. And for the patient, disciplined investor, now might be a good time to start or continuing accumulating.

Are we really in Another Bubble? From the Popular Internet Video to Marketwatch.com

This hilarious internet video has been going around the internet lately. The singers, singing a song to the tune of Billy Joel's "We Didn't Start a Fire", sing a song asking if there is another Bubble.

Video Here

This video has been so popular, that even reputable Financial Services company Marketwatch.com has written about the video.

Marketwatch Article About the Bubble Internet Video

But are we really in a Bubble?

In 2000, Jeremy Siegel, in an article in the Wall Street Journal, wrote that of the 33 largest firms based on market capitalization, 18 of those were technology stocks, and their market weighted PE equaled 125.9. Mr. Siegel also mentions that half of the large cap technology stocks had PE ratios over 100.

Compare this with 2007, where even fast growth stock Google (GOOG), has a current forward PE of 32.74, a 5 year estimated growth rate of 34.41%, for a very low Price Earnings to Growth Rate (PEG) of 0.93, a very low ratio under 1.

So while some stocks now could be overvalued, this time it is different. This time there's real earnings, and prices, even for top growth stocks like Google (GOOG), seem fairly reasonable.

Lessons Learned from the Last Bear Market

The Great Bubble ended in 2000, and the Great Bear Market of 2000 to 2002 ensued, and brutalized stocks and portfolios. The Dow Jones Industrial Average dropped 38% from January 14, 2000 (11723) to October 9, 2002 (7286.27). The Nasdaq dropped even further, falling 78% from March 10, 2000 (5048.62) to October 9, 2002 (1114.11).

Investors and traders lost fortunes during this very difficult time.

Can anything be learned from this traumatic event? What lessons can we learn?

1. Valuation does matter.

During the Bubble which preceded the Great Bear Market, the valuations of large capitalization stocks especially tech stocks and tech stocks on the Nasdaq rose to unprecedented and astronomical levels.

Jeremy Siegel, in an article in the Wall Street Journal in March 2000 titled "Big-Cap Stocks are a Suckers Bet", says that of the 33 largest firms based on market capitalization (those with values greater than $85 billion), 18 of those were technology stocks, and their market weighted PE equaled 125.9. Mr. Siegel also notes that half of the large cap technology stocks had P/Es over 100.

Even if we look at the trailing PE of the more conservative of S&P 500 during the Bubble, we notice that the PE ratio went up to 35, when historical trailing PE is 14.1 and the trailing PE of the S&P 500 is 17.1 as of May 2007.

In addition, during this time, many people thought this was a different era, and that new methods were needed to justify the extreme valuations of tech stocks.

In 1999, Louis Corrigan writes about Michael Mauboussin in 1999, the head of value based research at C.S. First Boston. In this article, Louis Corrigan explains Mr. Mauboussin's position:

1. "We disagree with the consensus view that hype and hysteria drive the highflying valuations of Internet stocks," Mauboussin writes in the introduction. "Like all businesses, Internet companies are valued on their ability to generate cash."
   




2. "Mauboussin's work ultimately instructs investors to focus on FCF, to account for the whole cash economics picture."
   



3. In Louis Corrigan's introduction to Mr. Mauboussin's work, Mr. Corrigan says:
   

   "Traditional metrics like book value, the price-to-earnings (P/E) ratio, or even the price-to-sales (P/S) ratio are of limited use in valuing start-ups. They are particularly worthless in examining Internet start-ups."
   

Even Fed Chairman Alan Greenspan repeatedly warned people of "irrational exuberance".

With unsupportable valuations, it was only a matter of time before the market corrected itself to more reasonable levels. Valuations, apparently, does (eventually) matter.

2. Buy and Homework not Buy and Hold

People at the time, had often learned to "Buy and Hold" but people misunderstood this and applied this to Dot-Com stocks and high flying tech stocks.

Professor Jeremy Siegel, economist and author of "Stocks For the Long Run"(1st edition published 1994), proclaimed that over the long term, stocks have nearly always outperformed bonds and inflation. And that even if you bought some of the most expensive stocks at the worst possible time (such as the "Nifty Fifty" growth stocks of the 1970s), you could still make money as long as you just hung on.

Of course, people who followed this strategy without regard to price suffered during the Great Bubble and Bear Market.

In an interview with Money Magazine in 2004, Jeremy Siegel responds to a few questions regarding this:

Q. In the 1990s a lot of people used your finding that stocks nearly always make money in the long run to justify some pretty aggressive investing. Did you feel like Dr. Frankenstein -- you know, like, "I've created a monster"?

A. [Laughs.] Somewhat. I worried that people would interpret my message as "Just buy stocks without any attention to price."

Now I wish that in the second edition of "Stocks for the Long Run" I would have warned much more loudly -- but at that point it wasn't as out of hand as it got. And I was speaking out in 1999 and 2000 against what was going on with Internet and technology stocks.

Still, if you ride the bubble up and down, you do darn well indexing the stock market in the long run -- about 7 percent annualized, after inflation. I never told people that there wouldn't be a bubble or a bear market. I just said that indexing has done well over time.

Q. Would you modify the message now?

A. I now think that you could do better. After what I saw in 2000, I concluded that by applying some common sense and reducing your exposure to the hottest sectors and stocks, you could pick up about half a percentage point more return, on average, each year. If you just stay away from these manias, you've got an edge.

At the top of the bubble, I moved away from tech stocks. I repositioned my-self. I still held money in an S&P 500 index fund, so I didn't entirely sidestep it, but I moved a lot into value. And boy did that help me on the downside.

Then I said, if I did that and it helped so much, let me explore whether staying away from wildly priced growth stocks is something that works over much longer periods of time.

[...]

Q. You observed in "Stocks for the Long Run" that investors could make money even if they bought the high-flying stocks of the 1970s at their peak. Now you're saying that investors shouldn't buy expensive stocks. A contradiction?

A. I'll tell you why it's not contradictory. Among the fast-growing stocks dubbed the Nifty Fifty, those in the cheapest 25 did much better than the more expensive half. I mention that in the third edition of "Stocks for the Long Run."

When people are paying 100 times earnings for big companies, you better watch out.

But right now growth stocks look cheap to me. You shouldn't be afraid to pay for growth. The average P/E ratio of what I call the El Dorados -- the 20 top-performing companies since the inception of the S&P 500 -- was a few points above the market's average.

But none had a P/E over 27. [The S&P 500's average P/E today is 20.]

That links well with my findings on the Nifty Fifty. The most expensive ones -- the tech companies like Polaroid, Digital Equipment, Texas Instruments, IBM -- didn't do well at all.

Among the Nifty Fifty companies, only Johnson & Johnson, in retrospect, deserved a P/E over 50. The key, and it's a theme I talk about again and again, is not wildly overpaying. You almost never want to pay over 30 times earnings.

After this Bubble, I understand perfectly well why Jim Cramer preaches "Buy and Homework" and not "Buy and Hold." Valuation does matter and holding absurdly overvalued stocks is not a good idea over the long term.

While some stocks recovered from the bubble, others, like some of the dotcom companies, are no longer in business, or their stock prices are more than 99% from their all-time highs.

One exception to "Buy and Hold" would be if an investor used very broadbased indexed funds or ETFs instead of individual stocks. More on this in the Diversified section below.

3. Markets can remain irrational for periods of time

Valuations of many tech and large cap companies were very expensive, and for a time, they became even more expensive. Markets can remain irrational for periods of time. And during this time, the largest gains in these stocks were made.

This is a very difficult time for all. Do you invest in a massively overvalued stock that keeps on going up? Or do you invest in value stocks and smaller capitalization stocks that were underperforming the market? During this period, those who were nimble enough to trade momentum, and get out at the top were rewarded, but many who learned "buy and hold" and applied it to overvalued tech stocks were badly burned.

Then there are those who avoided the whole bubble completely (and many were criticized for underperforming the "market" during that time) and invested in value oriented stocks and small and mid capitalization stocks and were greatly rewarded. The period from 2000-2007 favored small and mid cap stocks and value stocks.

4. Diversification is very important.

People learned that diversification is very important. If someone had ridden the dot-com companies from Bubble to Bear market, that person would have lost most of the value in their portfolio. If a person had diversified into small cap, mid cap and value stocks during this time, they would have lost less money and during the recovery, these stocks outperformed the Nasdaq and the S&P 500.

From March 1, 2000 to July 30, 2007 (Adjusted for dividends):

1. Nasdaq: -46% (4784.08 to 2583.28)
   
2. S&P 500: +6.87% (1379.19 to 1473.91)
   
3. S&P Midcap 400: +92.37% (468.71 to 866.31)
   
4. S&P SmallCap 600: +96.67% (219.57 to 413.86)
   

If an investor had an indexed portfolio of ETFs representing the S&P 500, the Midcap 400 and the Smallcap 600 and invested near the Bear Market Peak on March 2000, and held to July 2007, that person would have had a decent return because of the large gains in the Midcap and Smallcap Indices.

5. Diversify from your own company stock

People also learned that they needed to diversify away from their own companies stock. People were very bullish on their own stock. But when the Great Bear Market showed itself, many of those people were laid off at the same time their company stock started plunging. This was a bad combination. People need to diversify away from their own company stock!

6. Many people survived the Great Bear Market of 2000-2002

While many people suffered and lost their jobs during this painful time, many people have recovered from such a brutal Bear market. We are still here and we are the survivors.

What's a correction after you've experienced a very deep and painful Bear Market?

How I'm Staying Calm during this Wild and Volatile Market Correction (Aug. 9, 2007)

I've seen investors go from euphoria as the the Dow passes 14,000 to panic and fear as the Dow has many down 300 days, and later get more excited as we have new rallies. As the market continues its correction (or bear market?), people are experiencing all sorts of emotions including fear. Even Jim Cramer on a "Stop Trading!" segment on CNBC shows his passion during a rant about the Fed.

Yet despite all this and the fact that I've lost some money recently, I've managed to keep my emotions in check. How am I doing this?

1. I believe in the long term power of stocks and the global growth story.

Over a long time period, investing in the stock market is a very good way to grow your money. Over the long term, stocks have returned around 10% per year. According to Schwab Center Research with data from Ibbotson Associates, the longer you hold stocks, the less chance you have of experiencing a negative return.

The table below represents the range of S&P 500 returns from 1926 to 2005. Total returns includes reinvestment of dividends. If you held the S&P 500 index for three years, your annualized return would range between 31.2% gain to a 27% loss. If you held the S&P 500 index for a period of 20 years, your annual return would range from a gain of 3.1% to a gain of 17.9%.

Chart Provided by Charles Schwab.


Stocks, over the long term, will do fine!

James Altucher writes about seven reasons to be bullish in this article, though some people would question if all those points remain true with the recent US credit crunch.

2. I've experienced many corrections before.

Having seen corrections before, I know that this too, will pass. If you look at charts from a longer time period, you'll notice that these corrections are just blips in a stock market whose very long term uptrend is up.

I've also incorrectly sold many of my stocks in my brokerage account during a market correction, only to see the market bounce back again and I had to repurchase a large portion of my portfolio. If I believe in the long term growth of the stock market, and the economy is not heading towards a recession or depression, why sell during a market correction?

3. I've experienced a Bear Market Before

I've experienced a Great Bubble and the Bear Market that followed it, and today's situation doesn't look like it at all. I remember the stock prices of many companies with NO EARNINGS went to the roof. I remember the PE ratios of companies like Yahoo (YHOO) go to astronomical heights during the Bubble.

Jeremy Siegel, in an article in the Wall Street Journal in March 2000 titled "Big-Cap Stocks are a Suckers Bet", says that of the 33 largest firms based on market capitalization (those with values greater than $85 billion), 18 of those were technology stocks, and their market weighted PE equaled 125.9. Mr. Siegel also notes that half of the large cap technology stocks had P/Es over 100.

Even if we look at the trailing PE of the more conservative of S&P 500 during the Bubble, we notice that the PE ratio went up to 35, when historical trailing PE is 14.1 and the trailing PE of the S&P 500 is 17.1 as of May 2007.

I also recently re-read an article about Michael Mauboussin in 1999, the head of value based research as C.S. First Boston. In this article, Louis Corrigan explains Mr. Mauboussin's position:

a. "We disagree with the consensus view that hype and hysteria drive the highflying valuations of Internet stocks," Mauboussin writes in the introduction. "Like all businesses, Internet companies are valued on their ability to generate cash."

b. "Mauboussin's work ultimately instructs investors to focus on FCF, to account for the whole cash economics picture."

c. In Louis Corrigan's introduction to Mr. Mauboussin's work, Mr. Corrigan says:
"Traditional metrics like book value, the price-to-earnings (P/E) ratio, or even the price-to-sales (P/S) ratio are of limited use in valuing start-ups. They are particularly worthless in examining Internet start-ups."


Does today's situation look anywhere close to the last Great Bubble and Bear Market?


4. I learned technical analysis.

If I didn't know technical analysis, I would be dependent on emotions and I would just go for an emotional rollercoaster.

Once I learned technical analysis, I'm able to take emotion out of the equation. I learned about trend lines, support levels, resistance levels, Fibonacci retracement, re-testing lows, and many other technical analysis concepts. Rather than just blindly follow the market and let my emotions contol me, I could analyze the chart and estimate how far a market could bounce and where potential bottoms may occur. When the market gaps down near a resistance area and then stages a late day massive rally, I know what that may mean.

With technical analysis, I could objectively look at the situation and not be a slave to my emotions.

5. I am hedging my portfolio using double short ETFs.

Recent innovations include Exchange Traded Funds (ETFs) that short or double short different market indices. Proshares offers ETFs that short or double short the market. For example, if you buy the ETF SDS, and if the S&P 500 goes down 5%, then SDS will gain 10%.

With this new hedging tool, and with my knowledge of techical analysis, I could implement a hedging strategy without having to use Put Options. This hedging strategy is also good because it prevents me from having to get whipsawed as I try to sell my stocks during wild and volatile corrections, only to have to rebuy my much of my portfolio as the market goes up again.

(Link to article by Roger Nusbaum on TheStreet.com regarding hedging using double short ETFs.)

As an example, in June 2007, the S&P 500 ($SPX) had fallen hard three straight days. There was a possibility that the $SPX could fall even further below the 50 day moving average. So as a hedge, I automatically set an order that if the $SPX goes a certain percentage below the support level (in this case, the 50 day moving average), I would automatically buy SDS.

As it turns out, the $SPX bounced from this level and rallied for almost two months. Then, in late July 2007, the market started to correct. But since my automatic order to buy SDS (remember, this is a double short S&P 500, meaning I profit twice when the S&P 500 index goes down once) was still active, I ended up with a profit.

Near this point, I started seeing the $SPX was getting very oversold. It was time to sell my SDS for a profit.

I then formulated a possible scenario of a bottom, and I expected a Fibonacci retracement bounce ranging from 38.2% to 50% to 61.8%.

Based on the expected Fibonacci retracement oversold rally bounce and expected re-test of lows, I decided to automatically buy SDS if the $SPX reaches 1500 which was triggered at the end of August 8. On August 9, 2007, the $SPX dropped big all the way to 1453. Again, I have SDS for a profit.

That's where we are now. I could sell SDS for a profit, and then, set an automatic buy if the $SPX goes a percentage below the previous low of 1427.


Because of all the factors above, I'm keeping my emotions in check, and looking at the market more objectively despite the wild and volatile nature of this market.