Why We Have Seen the End of the S&P 500’s Bear Market Rally

Since the announcement from the Federal Reserve about tapering off quantitative easing, the key stock indices have been showing increased selling pressures. Just take a look at the chart of the S&P 500 below.

Why We Have Seen the End of the S&P 500’s Bear Market Rally image SPC S and P 500 Large Cap ChartWhy We Have Seen the End of the S&P 500’s Bear Market Rally

Chart courtesy of www.StockCharts.com

The S&P 500 started 2013 with momentum to the upside. Investors bought in hopes that the index would continue to go higher, and by no surprise, it did reach its all-time high. As expected, after the Federal Reserve announcement, sellers took hold of the S&P 500, and it broke below its 50-day moving average for the first time this year (indicated by the black circle in the chart above)—a bearish indicator, according to technical analysts.

The last time the S&P 500 reached this far below its 50-day moving average was in October 2012. When that happened, the S&P 500 declined six percent, and it didn’t recover until December (as noted by the green circle in the above chart).

Note: other key stock indices like the Dow Jones Industrial Average and the NASDAQ Composite Index have also fallen below their 50-day moving averages.

Looking at this, I have to ask: is the bear market rally that lured investors into buying over?

The decline in the key stock indices has certainly proved my theory: money printing was a major factor in their flight to their all-time highs. Now, when we have hints that the Federal Reserve will be pulling back on its quantitative easing, the key stock indices are sliding lower.

Corporate earnings, one of the main reasons for the rise in the key stock indices, aren’t improving as expected either. As a matter of fact, 86 companies on the S&P 500 have issued negative guidance for their second-quarter corporate earnings. The expectation for earnings growth has been continuously declining.

At the end of March, analysts expected the corporate earnings of the S&P 500 companies to grow 4.4% in the second quarter, but unfortunately, their estimates came down to 1.3% at the end of May. (Source: FactSet, May 31, 2013.)

On the global macro level, the Chinese economy is sending threats to the key stock indices. Not only is the country expected to grow at a very slow pace compared to its historical average, but the amount of credit has also amassed in the Chinese economy since the financial crisis of 2008 and 2009. Recently, the country experienced a slight cash crunch when the rate banks charge each other rose significantly. (Source: The Globe and Mail, June 21, 2013.)

Dear reader, be careful. When I look at all this, the best investment strategy seems to be capital preservation. The risks of the key stock indices like the S&P 500 sliding even lower are piling up.

What He Said:

“The U.S. lowered interest rates in 2004 to their lowest level in 46 years. And what did Americans do with their access to easy money? They borrowed and borrowed some more, investing the borrowed money into real estate. Looking ahead, perhaps the Fed’s actions (of lowering interest rates so low as to entice consumers to borrow more than they can afford) will one day be regarded as one of the most costly errors committed by it or any other banking system in the last 75 years.” Michael Lombardi in Profit Confidential, July 21, 2005. Long before anyone was thinking of a banking crisis, Michael was warning that the coming real estate bust would wreak havoc with the banking system.

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