The big sell-off during the month sets the stock market up for one of its most critical tests since 2002-2003
From Standard & Poor's Equity ResearchWith only one day left in June, the S&P 500 is working on its worst one-month performance since September, 2002 -- which happened to be very close to the bottom of a bear market. The index has cascaded about 9% this month and, as you guessed it, was mostly due to plunging financials and soaring crude oil.
As a child, if June was not your favorite month (the end of school), there was something wrong with you. As an investor or an analyst, however, June, 2008, felt like we were taken back to school, beaten up, and relieved of our lunch money.
This sets the stock market up for one of its most critical tests since 2002 and 2003. More specifically, the question on whether the S&P 500 will retest the March lows seems like a forgone conclusion, and we'll tip our hats to the bears that stayed cautious during the March to May rally.
The key area to watch on the "500" over the near-term is the 1257 to 1273 range, or the intraday and closing lows from March. Needless to say, if we don't get some help from the financials or crude oil, and their ominous trends continue, this range of support may get obliterated.
However, we do expect a bounce in the market once the March lows get tested for a couple of reasons. First, when a key support level is tested, many times the market will rally as long-term investors step in to defend the line, and it is a logical place for shorts to cover positions.
Secondly, we are coming to the end of a quarter, and the pressure to dump losers like financials, as institutions dress up their portfolios ends, and this may give some relief to the beaten down names. Third, the indices are getting pretty oversold once again on both a daily and a weekly basis, and many times you will at least get a counter trend rally when things get this washed out.
We have learned over the years that throwing in the towel near major support levels is usually the worst thing to do, especially after laying out the ground work for a potential rally. Many times, investors give up on equities at exactly the wrong time, and this sometimes leads to dramatic bottoms and reversals. Looking back at horrendous months in the equity markets, like the one we just had, indicates the market is getting close to a bottom. The tendency to rally was high, even though some of the rallies were part of bear markets.
The time periods where we saw about an 8% drop in the S&P 500 in one month include September, 2002, July, 2002, September, 2001, February, 2001, November, 2000, August, 1998, August, 1990, October and November of 1987, September, 1986, March, 1980, October, 1978, July, August and September of 1974 and November, 1973.
Unless we are in the midst of another bear market like the one in 2000 to 2002, or like the one in the 1970s, the June, 2008 drubbing may lead to at least a decent bounce if not more.
The variability of subindustry returns so far this year is something to behold, and we think it is getting exacerbated by the phenomenon known as quarter-end window dressing. This is when institutions clean up their portfolios, dumping the beaten down stocks and accumulating the better performers. It is clear to us that this is part of the reason that some groups have gotten ripped apart, while others have held up well. How much of the weakness in the financials of late can be attributed to this is unknown.
In our view, what is important is what will happen in the early part of the third quarter. If the weakest sectors rally, we think this could stabilize the overall market, leading to at least a decent counter trend rally. If the financials and discretionary stocks continue lower in July, we think it would be a bad omen for stocks.
There are over 40 S&P subindustries that have declined at least 20% this year, a somewhat staggering statistic, and 16 that have plummeted at least 30%. The largest decliners include managed healthcare (-47%), oil & gas refining (-44%), thrifts & mortgages (-44%), multi-line insurance (-41%), auto makers (-39%), regional banks (-39%), and specialized finance (-38%).
On the other end of the spectrum, there were a handful of very good performers in the first half including oil & gas E&P, coal and consumable fuels, fertilizer & agricultural chemicals, steel, railroads, gas utilities, oil & gas equipment & services, environmental services, brewers, and hypermarkets.
We have a hard time believing that the market will right itself, unless we get some relief from surging crude oil prices. In the latest S&P Chart Room video, we went over our updated forecast for oil prices. It appears that the latest pullback was consolidative in nature, and if prices can stay above the $140 per barrel for two days, we think prices could take a stab at $150/barrel. However, during the second half of 2008, we still expect a major correction in crude oil, based on the extreme overbought readings as prices are well extended from their long-term moving averages. In addition, we are also seeing bearish momentum divergences on both a daily and weekly basis.
Finally, looking at a monthly chart of crude using a normal scale as opposed to a semi-log scale, prices have gone asymptotic since the end of January, and look somewhat reminiscent of the Nasdaq during late 1999 and early 2000.
Sentiment continues to move towards the bearish side, a positive as we move into July. The Investor's Intelligence poll is showing 34% bulls and 39% bears, closing in on the extremes we saw in March of 31% bulls and 45% bears. Consensus poll is showing 26% bulls, close to the 22% bulls from March. We had some fairly low ISEE Sentiment Index readings recently, but above the levels we saw in March.
We think the wildcard is put/call ratios. While they are relatively high based on almost 20 years of history, they still have a fair amount of climbing to do to get near the levels we saw in May, 2006, March, 2007, August, 2007, January, 2008, and March, 2008.
We think we are nearing an important juncture for the stock market and the calendar. Hopefully, we won't have to go back and attend summer school.