By Darrel Whitten
The point & figure chart for the S and ;P 500 still has a bullish upside target of 1,850, meaning the benchmark U.S. index has yet to technically break down even though there is increasing caution about an interim correction. The period from March 2009 to March 2012 was one of the strongest three-year market rallies in history — stronger, in fact, than the 1996-1999 bull market. Further, the index has had an almost uninterrupted run from November 2011 lows.
S&P 500 Point & Figure (Source: StockCharts.com)
The VIX volatility index however has dipped below 15, indicating there is a significant degree of complacency among professional investors, while individual investors, at least in their purchases of mutual funds, continue to take money out of stocks and shift it into bond funds, i.e., exactly where professional investors see the most downside risk.
S&P 500 VIX Volatility Indicator (Source: StockCharts.com)
While we are not Fibonacci chart experts, the S&P 500 looks like it has completed a 5-wave pattern from the March 2009 low. Wave three (the second upleg) is usually the largest and most powerful wave in a trend, as the news now appears positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. In the post March 2009 low bull market, however, the first upleg was the more powerful.
Wave five (the third upleg) is the final leg in the direction of the dominant trend. The news is almost universally perceived positive and everyone is bullish. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences. A bull market, no matter how strong,cannot travel in one direction indefinitely. The larger the advance during the bull market cycle, both in time and magnitude, the larger the correction process will be either is depth or duration. As previously stated, the rally from the March 2009 has been one of the strongest in history, fueled by unprecedented and unconventional monetary easing that has resulted in an explosion of the Fed's balance sheet. Given the historical strength of this 5-wave advance, the correction could also be significant, i.e., another 15%-plus correction that leaves the S&P 500 still in a secular uptrend, but which causes some significant short-term pain.
Source: S&P 500 Fibonacci Waves, Business Insider
Thus the current bull run in the market is in our perception very much driven by expectations of continued liquidity injections, hopes of a European crisis resolution and a U.S.-led economic recovery, while stock prices remain very susceptible to shifts in perceptions about the strength of the underlying fundamental data, as was seen in the 2010 and 2011 corrections, both instigated by investor perceptions that the Fed was about to abandon its extraordinary stimulus and try to "normalize" monetary policy.
The next major correction is coming, the only question is "when". While individual investors remain cautious about stocks, which indicates we are not near a major secular high. Forbes is reporting that three of the best Elliott Wave technical analysts are in general agreement about the price and timing of a stock market top. Tony Caldaro, Charles Nenner and Ramki Ramakrishnan are all focused on the 1,450/1,500 are of the S&P 500 as a potential area of exhaustion for the bull move off of the November 2011 lows, which they see coming sometime in Q2, which is already underway.
Sell in May and Go Away Correction of 10%-Plus is Possible
The last two interim corrections in 2010 and 2011 were classic "sell in May and go away" corrections, of 15.9% and 17.6%, that came close, but did not push, the S and P 500 index into bear market territory. The sectors most susceptible to the next correction are likely to be the sectors that led the market from the November 2011 lows, i.e., the financials, technology and consumer discretionary. While oil prices have been soaring, energy stocks have fallen out of bed since mid-March, leaving the sector with losses for the past three months.
How Hard Will Japanese Stocks Be Hit by Sell in May and Go Away?
Japanese stocks have again become the flavor of the week as, a) Japan's economy is basically a big cyclical bet on a global economic recovery, b) the BOJ's balance sheet expansion policies and 1% inflation target has been noted and positively responded to by foreign investors, c) Japanese corporate profits are expected to see the best cyclical growth of any developed market as well as many developing markets in 2012, aided by a good tailwind of a cheaper JPY versus both USD and its major trading partners.
.Since the Nikkei 225 has only recently broken up out of a downtrend in place since 2007 highs, the recovery rally in Japanese stocks is basically a year behind the S&P 500, and technically is just getting started, whereas the U.S. post March 2009 rally is looking long in the tooth. Were the U.S. stock market seriously fall out of bed, (i.e., ostensibly on a serious deterioration in the Euroland soveriegn crisis or evidence that the U.S. recovery has fizzled and serious additional stimulus is required), Japanese equities would offer no safe haven, while money would knee-jerk flow into JPY as a safe haven, and again begin squeezing exporter profits.
Barring indications that the recovery and financial sector balance sheet repairment has been seriously compromised, global investors could look to Japanese equities even more to hedge an interim correction in U.S. equities, as, assuming the Tohoku earthquake/tsunami/nuclear disaster never happened, Japanese equities like their U.S. peers would already have recovered some 70% of the value lost from the 2007 high, whereas in reality they have only managed to recovery a fraction of the value lost.
Given an interim correction in U.S. equities, the knee-jerk reaction of Japanese equities would be to consolidate as well. But serious foreign investors no longer invest in "Japan" like the do in China or other emerging marekets, but invest in good companies that just happen to be domiciled in Japan. What this implies is that they may continue to be structurally underweight Japanese equities, especially those poorly run, shareholder value-destroying firms that still don't get the joke about adding to shareholder value but nevertheless remain constituents in the major index benchmarks.
By Topix major subsector (there are 33), the sectors that have led the Topix YTD have been the broker/dealers, real estate and insurance. The broker/dealers and real estate are classic high beta "risk on" plays, while the insurers are basically an index (because of their equity portolios) play on Japanese equities. Even the long-suffering Japanese shippers are a cyclical play on a global recovery. However, because these sectors have seen +/- 30% gains YTD versus a 14% return in the Topix, they would be more susceptible to an interim correction.
On the other hand, the domestic-oriented retail and even the banking sector would continue to benefit from the widely expected domestic demand recovery with the rebuilding of the Tohoku region.
Looking at the bets YTD performer constituents of the Nikkei 225, domestic names like Tokyo Dome (9681.T), Sumitomo Realty (8830.T) and Sumitomo Electric (5802.T) shouldn't be too adversely affected by a U.S. market interim correction, while well-run smaller capital companies with little or no exposure to global markets remain largely ignored because both domestic institutions as well as foreign institutions largely ignore them.
Source: Nikkei Astra
The smaller cap indices, notably the JASDAQ and the small-cap value indices have not only outperformed during "risk-on" phases, they are actually also less volatile on the downside because there is less selling pressure from foreign investors. These stocks are however, more high maintenance stocks, i.e., investors have to have access to on-the-ground research on these thinly-covered, no-coverage companies that often do not have adequate English language disclosure. The last thing that foreign investors want to be in is core large cap companies with a high currency and business exposure to the U.S./Europe in any risk-off phase.
Source: Nikkei Astra