Lessons from the Pros


S&P 500 and the Future of Equity Markets

Happy New Year! A few weeks ago, I published an article where I discussed my view of the equity markets and predicted some of the activity to expect from them in 2019. This week, we will dive deeper into one of those markets for a more in-depth analysis. We will be examining the S&P 500 first, before continuing onto the Nasdaq, Dow and Russell indexes.

The S&P 500 index doesn’t get as much focus from news outlets as the Dow Jones Industrial Average or Dow as it is known. The reason the Dow gets most of the attention is because the number is larger, and reporting on hundreds of points movements is much more exciting than a report on tens of points. However, there are two problems when using the Dow index as a market barometer. The first is the method for calculating the index value, and the second is the composition of the index itself.

How Is the Dow Index Value Calculated vs. Other Indexes?

The Dow Jones Industrial Index is the world’s only price weighted index. This means that the stock within the index with the highest price has the most influence on the index itself. A $1 move in a $100 stock would move the index more than a $5 move in a $30 stock, even though the latter had a more significant percentage move.

In comparison, the S&P 500 and other indexes are market capitalization, (Market Cap) weighted. Market cap multiplies the current price of the stock by the number of shares outstanding. The largest influence this way would not necessarily be the most expensive stock, it would be the one most widely held in people’s portfolios, which provides a more accurate picture of the markets.

The S&P 500’s composition is also a better representation of the stock market and the American Economy as a whole. As you can see below, the Dow is over weighted in the industrial sector and utilities are not even included in that index.

Dow Jones sector allocation vs S&P 500 sector allocation

Market Outlook for the S&P 500

Let’s dive deeper into the S&P 500 index and see what it has to say about its future and the future of the American economy. Remember, people invest in the stock market based on what they expect the future economy to be. Traders and investors will buy stocks in advance of bullish economic data and will sell off or short the markets when they fear a recession.

Unless Santa replaces his sled and reindeer with a rocket ship, it is unlikely for the index to close above the 13-month exponential moving average. In past articles, I highlighted that when there is a monthly close below this line, prices will make a lower low before making a higher high. This is a very bearish omen for the markets.

Chart of the 13 month moving average

The current drop in price is not like anything we have seen before. It is much steeper. Perhaps this is due to electronic trading and the easier access to the markets that we all enjoy now. Looking for the monthly demand zones, we try to answer the question, where will the bear market end? The last two bear markets, (2000 and 2008) both ended when prices hit fresh monthly demand zones after more than a 50% price drop from the highs.

Looking at our chart, you can see that there are two such zones below. The first is 1689 for a 42% decline from the September highs and the second is 1440 or a 51% decline that would be in line with the previous market moves.

Chart showing demand zones in the S&P 500 that could indicated a bear market.

Of course, we shouldn’t move straight down to those targets without some bouncing. Looking to the weekly charts, there are several demand zones that should offer pause points along the way to the monthly targets. The price bounces from those areas are also excellent opportunities to exit losing long positions, add to winning shorts, or even initiate new shorts and hedges.

Stock chart showing possible opportunities to short the markets.

In this time of increased volatility, it is important to work to protect your money. Many financial advisors will tell you to hold fast and ride out the storm. That the markets always recover, and you’ll be fine if you don’t panic. The problem is that even though the price of the indexes and stocks do go back up, you never recover the time lost waiting for them.

S&P chart showing potential gains for active traders and investors compared to buy and hold strategy.

Holding on through the last crash wasted over five years of your investing life. Yes, if you held on from the peak in 2008, your portfolio is currently up nearly 50%. Sounds great, right? Not when you consider that, that equates to only a 5% annual gain for the last ten years! If you used Online Trading Academy’s Core Strategy to time the markets, you could have experienced a 253% gain or over 25% annually instead! Just imagine the difference in your portfolio!

Free Trading WorkshopMarkets run up and also crash. You do not need to expose your money to both. If you want to, at least learn how to profit in the bearish market conditions. The markets can offer you profits in any direction or condition, you simply have to have the right knowledge and skill to navigate them. Come visit your local Online Trading Academy center today and learn how you can secure your financial future today!

DISCLAIMER This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results. Reprints allowed for private reading only, for all else, please obtain permission.

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