THE VIRTUS VIEW

Good afternoon to all.

This communication is intended to add value to your life by helping you separate the real news from the white noise, understand the critical economic events that you read about every day and outlining  alternative investments which might be advantageous to you in these times.  We send this weekly e-mail to both clients as well as individuals we hope become future clients.  Thus, to my valued clients, since we use many alternative investments in your portfolio currently, some of the e-mails might discuss assets that you already understand.  It never hurts to review your knowledge of those investments.

Please feel free to forward these e-mails to any friends you have who you believe will benefit from learning more about finances and investments.

The University of Washington just finished a study that found that the quickest path between two points is not a straight line if one is climbing a mountain.  In fact, what we all do intuitively, zigzagging, when climbing up or down a mountain is the most efficient method to climb terrain with steep slopes, per the study authored by Marcos Llobera.

Unfortunately the market also zigzags but does not usually get to its bottom in a quick and efficient manner.  In any long-term trend, be it a bull or bear market, there are shorter counter trends that extend the pain or gain longer.  This counter trend in a bull market is welcomed because it allows us to buy stocks at lower prices so when the bull market continues we can profit more.  In a bear market we should be doing the opposite, selling into a rally and not buying on dips, because the trend is down and there will be better prices in the future.  Even if there aren’t necessarily better prices, we can make money in a bear market by trading the rallies.

If it was only that easy!  The question becomes when is a bear market rally a long-term bull market?  Or, said differently, when does the long-term trend change from downwards to upwards sloping?  The answer to this major question is usually not exact but there are certain signs that increase the probability one way or another.  As I have said before, technical analysis of the stock market is very important; not only because almost every major money manager uses it to some extent, but because in many times technical analysis is a self-fulfilling prophecy.  And if you have been watching any of the financial news on the television you have probably heard the “experts” mention that the 800 mark on the S&P 500 is a critical point on this current rally.  Let me explain further why 800 is so important.

Chart 1 shows the S&P 500 trend for the past year.  As noted on the chart, we are currently in a long-term bear market that actually started in October of 2007.  The red lines indicate the channel we have been in since April, 2008.  As you can see, we have had lower highs and lower lows since April.  However, as I stated above, there are shorter-term trends (zigzags) within the long-term trend.  In Chart 1, the blue lines indicate the shorter term trend since October.  As you can see the top blue line is going to intersect with the chart at around the 800 level on the S&P 500, which is the upper band in the channel.  That is one reason why many believe that level to be very important.  If we break that upper ceiling with good volume, then we might have an even better rally on our hands (because the short-term down trend has been broken).

Chart 1

 

And I think we might have just that, a better rally on our horizon.  The important key in any rally, either a bear or bull rally, is the volume.  We rallied in December 2009 which had the S&P 500 rise over 20% from the November bottom.  However, the volume was very low (shown in the bars at the bottom of the chart).  Now take a look at the volume over the past week.  The strong volume indicates this rally might actually have some solid legs and it would not surprise me if we rally into late May or to the 900 level for the S&P 500.  The probability is that we start back down at the 800 level, but there is reason to believe this rally goes against the probabilities and lasts longer.

Why is the market rallying?  Two reasons appear to be the catalyst; first is the fact the market was extremely oversold and second the economic news does not appear to be as bad as the market expected.  As I mentioned in the Virtus View on March 2, there is some good news out there.  And we have seen more, including:

• Citigroup actually making a profit in the first two months of the year
• Per the Commerce Department, new housing construction actually grew in February due to apartment building construction
• Retail sales, mainly due to Wal-Mart, beating expectations again in February (source: Bloomberg News)