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Stock Market Trading Range

Today’s chart shows the S&P 50o Index in a Trading Range with the RSI indicator and Volume by Price overlays for the common stock in the indices.

SPX 2016-06-21Double click on any image for a full sized view

The graph above shows the action in the S&P 500 Index over the past 18 months.

You can see that we have a really well defined trading range with the upper boundary being the all-time high of roughly 2,135 and 2,040 (roughly 4.5% below the high).

There are two very obvious corrections out of the trading range that dropped to a level of 10% below the 200-day moving average (for those of you who are long-time readers of the blog, you know how important the range of 10% above and below the 200-day moving average is for the S&P 500 – 10% above acts as a solid resistance and 10% below is a solid support level – or in other words, when index is trading 10% above the 200-day moving average you consider selling and when its 10% below the 200-day moving average you consider buying).

But our case today is not that cut and dried.  This trading range has become a significant obstacle to investing.  It is clear that investors do not have the confidence in the economy to push the index to new highs.  Who can blame them?  Corporate earnings have been falling for the past 18-months – check out the same graph above except I’ve added GAAP Earnings (the green line) which drops each quarter over the 18-month time frame:

 SPX 2016-06-21 EPS

If a company’s stock price is just the present value of its future earnings, and the index is made up of individual companies, the only way for stock prices to go up at a time when earnings are falling is for investors to place an ever-higher valuation on those earnings.  That can be justified to a certain extent by the low interest rates we have, but given they have been stuck at current levels for seven years that justification eventually runs its course at a certain level of valuation.

Without some catalyst to drive the market higher, like a change in governmental fiscal policy, a change in the tax code, or some macro event that jump starts production, an ever-growing valuation is not likely.  The market will have to correct sometime to fix the over-valued levels we are currently experiencing.  However, this sideways trading within the range can go on for a long time – a lot longer than anyone believes – before the index breaks out of the range.

I am sticking with our defensive asset mix for the present time.  If the market were to fall and correct some of the over-valuation or if something were to cause it to move to a new high and remain above that level for at least three trading days, then I would get more aggressive and put some of the money to work we have reserved for that purpose.  But until we break out of the trading range and the index gives us a buy signal, right here, right now, the current strategy of defensive holdings, cash and fixed income is the right place to be.