Bull Market Charges Ahead

Equities these days are not just bullish, they down right bull-headed. U.S. equity markets just keep pushing up and up and up!

Passing 1,700 for the first time ever, the S&P 500 index is now up 8% in the past 5 weeks, 17% year to date, and 25% in the past 12 months. Since its last major bottom in March 2009, the broader market has climbed 83%.

There have been a few minor corrections along the way, though, every summer almost right on cue. What about this summer? Will all those bears who have been calling for a correction for months finally get their way soon? What has been driving this market so far for so long, anyway? And is it about to end?

Feeding the Equity Bull

These are truly unprecedented times – so much so that historians will look back on these past 5 years since the financial and housing crises of 2008 and will have to give the period its own distinctive name. Maybe something like “The Stimulus Years” or “The Fed’s Bull Run”.

It is almost universally understood and accepted that most of the gains in equities since the spring of 2009 have been induced by the Federal Reserve’s easy-money policies: interest rates near zero almost the whole way through, two massive injections of liquidity in QEs 1 & 2, plus a steady running faucet of cash in monthly bond and mortgage securities purchases.

Whether this is a good plan or not is something that those same future historians will likely still be debating. So we won’t go there now.

Instead, let’s just look at what we have on our hands and compare it to the past to see if some kind of pattern stands out to help us determine if we should be jumping in at this point or jumping out.

What we have here is a relentless bull that is being fed a steady diet of greens by the Federal Reserve: money. And the Fed has told us repeatedly that it will not stop doing so any time soon:

“The Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time,” the Fed’s July 31^st press release repeated. And this “highly accommodative” stance will continue even “after the asset purchase program ends and the economic recovery strengthens”.

Wow! These people mean business. Even after the economic recovery strengthens, the Fed will still be there feeding the bull market. As Chairman Bernanke stressed in an interview back in June, “The key point is that our policies are tied to how the outlook evolves. That should provide some comfort to the markets because they’ll understand that we’ll be providing whatever support is necessary.”

It sure has provided comfort to the equities market – a lot of it. Even as much of the data over the past 5 years has been not so encouraging at times, the bull is hearing and following just one voice. The Fed has spoken. It will support American businesses through easy-money policies, and the markets will continue to climb higher for several more years to come.

Just not in a straight line. It’s August, people. Time for the markets to go on vacation?

Undeniable Patterns

Possibly every trader’s favorite stock market data guide – The Stock Trader’s Almanac – ranks the summertime months as the worst of the year for U.S. major indices.

S&P 500 data from 1950 to 2011 finds the four worst months to be: August in 4th place (netting -2.4%), June in 3rd place (-4.5%), February in 2nd place (-7.4%), and September in 1st place (netting a total -35.4%). The other 8 months are all net positive, with May in 8th place and December in 1st place.

As the following graph of the S&P 500 shows, the past 5 years have upheld that pattern. (click to enlarge)

Source: BigCharts.com

Since 2009, each year has seen springtime pullbacks (yellow) and summertime corrections (red). Usually the spring retreat is smaller than the summer’s, with two recent exceptions:

• 2009, which saw that last desperate capitulation at the end of the severest market correction since the Great Depression, and

• 2013, which didn’t even have a springtime pullback worthy of mention, which is in itself a worrisome sign. This bull is raving mad, as it runs through all the stop signs. Do you really want to jump on his back and ride along now?

As for the summertime periods, 2013 has seen both June and July live up to their reputations as a downer and a relief. Yet July’s relief rallies are usually one last selling opportunity before August and September wreak their havoc, which can sometimes drag into November if they start late, as was the case in 2012.

Is this where we are now? Are we at a point where we might want to trim our positions a little and maybe get defensive? The next graph shows that such may very well be the wise thing to do. (click to enlarge)

Source: BigCharts.com

The graph above uses the MACD (moving average convergence divergence) to help isolate entry and exit points. When the MACD reads +15 and above, it’s a good time to trim (red lines). When the MACD reads -15 and below, that’s a good time to add (green lines).

You will notice that the MACD does not always pick the very tops or the very bottoms. But by-and-large, if you would have bought a little on the greens and sold a little on the reds, you would have beaten the market.

Trading the Latest Signal

So what is the MACD telling us now? This is not a safe entry point. You may wish to continue holding, but you certainly wouldn’t want to add. The risk is to the downside, at least until the MACD dips below zero again.

At times like this, many traders opt to switch into the large caps for a more defensive posturing. Large companies like General Electric (NYSE: GE), WalMart (NYSE: WMT) and Wells-Fargo (NYSE: WFC), tend to fall less than the medium and small caps during a correction, given their greater access to cash.

High dividend payers may also be a good choice here, since companies that pay regular dividends are generally mature companies with a better established presence in their respective markets to help them weather the turbulence. AT&T (NYSE: T), yielding just over 5%, and AstraZeneca PLC (NYSE: AZN), yielding nearly 7.5%, are good examples of large caps paying high dividends.

Still, we mustn’t lose sight of the greatest signal of all, the one coming out of the Fed. Even though monthly purchases may be tapered just a little this autumn or winter – which will set both the equity and bond markets back a little – the Fed’s easy money policy is not going away.

Any pullback in markets from here should be bought, especially when the MACD dips below zero and cries out to you, “Buy me!” But it’s not saying that now.

Joseph Cafariello

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