How long will this move to the upside on key stock indices last? This question has become the topic of discussion among investors these days. When I hear it, I certainly don’t blame them for asking. The key stock indices have increased significantly without a pullback, especially since the end of 2012, and key stock indices like the S&P 500 have increased roughly 13% in the first quarter of 2013.
Investors are indecisive on what to do; do they buy more, or sell and increase their cash position? Sadly, this is because, as the key stock indices have edged higher, speculation on a significant downturn has also increased.
The bears certainly have a good argument against the rally in key stock indices. They argue that the economy is bleak, there’s job growth in the low-wage-paying sectors, and earnings, the most essential ingredient that cause key stock indices to increase, are dismal. They say that this is not sustainable.
As of August 2, the second-quarter corporate earnings growth rate of S&P 500 companies stood at 1.7%. If this growth rate remains the same, then it would be the third worst earnings growth rate in the last four years. (Source: “S&P 500 at record highs despite cuts to earnings estimates for Q3 2013,” FactSet, August 2, 2013.)
With all this in mind, can we see a significant downturn in the key stock indices?
Certainly, as the key stock indices go higher on anemic fundamentals, they can see a major down tick. Remember that the reality always kicks in when the optimism clears; earnings fall when the consumer is struggling.
The big question still remains: when it will happen? This question is not only tough, but may also be impossible to answer.
Currently, on the key stock indices, it looks like the path of least resistance is to the upside; they are trending higher and there seems to be continuous buying. Consider the monthly chart of the S&P 500 below, paying close attention to the circled area:
After breaking above the long-term resistance (black line), the S&P 500 did come back to test the same level, but from there, it increased once again—in the words of technical analysts, it confirmed the breakout. If it didn’t sustain that level and broke lower, then it could have been a selling point.
When it comes to the stock market, sometimes irrationality can drive it higher. This is nothing new: the tech boom was a prime example, and we saw this during the 2006 and 2007, as well.
Investors who are investing with the long term in mind shouldn’t forget that the fundamentals aren’t strong but, at the same time, should also avoid calling when the key stock indices will top or bottom. They need to be aware that risks are present and then assess them carefully, take some profits off the table if they have any, and adjust their portfolio as the market changes. Taking on a position early can impact one’s portfolio.
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