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Commentary -- July 2010

The stock market, as defined by the S&P 500 Index, closed the 2nd Quarter by breaking through the key 1040 technical level. I believe the bull cycle from March 2009 peaked at the intraday high of 1219 on April 26. On an intraday basis, the S&P 500 Index is now down  - 15.67%, excluding dividends, from the April 26 peak to the June 30, 2010 close of 1030. Year-to-date, the S&P 500 Index is down - 7.60%, also excluding dividends.  

Is this the beginning of something worse?  Or, is it just a normal pullback before the stock market moves higher? I agree with Jonathan Tepper of Variant Perception, a research firm in London, when he recently said:                                                                                

“Investors are good at absorbing short-term information, but they are much less successful at absorbing bigger structural trends and understanding when secular breaks have occurred. Perhaps investors are like the proverbial frogs in the frying pan, who do not notice the slow, incremental changes occurring around them.”  

Most investors struggle with hearing the daily market news and trying to make sense of it. As Tepper stated, investors have a hard time “absorbing bigger structural trends” and “understanding when secular breaks have occurred.” The stock market, however, doesn’t have that problem. It has historically shown us clear, long-term trends – both bull trend and bear trends.

How do we know?

Go back ten years to June 30, 2000. The S&P 500 Index closed at 1454. Over 10 years later, as of the June 30, 2010 close of 1030, the stock market is still down - 29%, excluding dividends, on a buy-and-hold basis. In this bear trend, we’ve seen two bull cycles and two bear cycles. I believe we have started the third bear cycle on April 26 which will be the third leg down.  This is why I have positioned our portfolios accordingly. Yes, I was early by five months. It was frustrating, too, as the market kept making new highs in the first quarter of 2010. However, the end of the second quarter has brought all three of our model portfolios into positive territory so far in 2010. The major stock market indexes are all negative year-to-date.

Correction or New Bear Cycle?

Corrections are typically defined as - 10% pullbacks while bear markets are typically defined as - 20% or more pullbacks. While the major stock averages have only reached “correction” territory so far, several indicators are suggesting the bull cycle that started in March 2009 ended on April 26. Of course, the stock market doesn’t always move exactly the way we think it should or exactly when we think it should. There are always issues that either hasten or delay its direction regardless of what the technical and fundamental indicators may be suggesting.  

According to Bespoke Investment Group, there have been 58 corrections of 10% or more in the S&P 500 Index since 1927. In 33 of the 58, the corrections fell short of the - 20% “bear cycle” level. Interestingly, 25 of the 58 did go beyond a - 20% loss into a full-blown bear cycle.

Let’s drill deeper. Of the 33 corrections that fell short of the - 20% “bear cycle” level AND had a pullback as deep as the one we’ve just had (- 14.40% from April 23 to May 25 on the S&P 500 Index) -- 26 of the 33 corrections saw declines extend beyond - 20% into a full blown bear cycle. Bespoke said the average bear cycle decline for those 26 periods was - 35.50%.

It’s my opinion that protecting your money is most important at this juncture. This is why I have positioned our models so defensively. Rest assured there will be an opportunity to fully reinvest in our models – but not right now. We’ve just finished a bull cycle. Now, it’s time for a bear cycle and I have our models currently positioned for it.

Again, thanks for visiting and come back soon.

Matt Montgomery

* The Dow Jones Industrial Average and the S&P 500 Index are un-managed stock indexes. The Dow Jones Industrial Average is a registered trademark of the Dow Jones Company and the S&P 500 Index is registered trademark of the Standard & Poors Company. Investors cannot invest in the Dow Jones Industrial Average or the S&P 500 Index. Past performance is not indicative of future results.

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Matthew Montgomery is a Registered Representative of and offers securities products and services through Royal Alliance Associates Inc. Member FINRA / SIPC, a registered broker-dealer. In this regard, this communication is strictly intended for individuals residing in the states of Alabama, Arkansas, Louisiana, Ohio and Texas. No offers may be made or accepted from any resident outside the specific states referenced.

Matthew Montgomery is also separately registered investment adviser under Montgomery Financial Designs, a registered investment adviser, offering advisory services in the state of Texas. As such, these services are strictly intended for individuals residing in Texas.

Advisory services offered through Royal Alliance Associates, Inc. a Registered Investment Advisor.

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