The Income Portfolio Letter

April 20th, 2012

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February, March and April brought along with them an interesting situation in the charts of the US stock market, as represented by the S&P 500.

We see that the market has broken into the top quadrant for a third time: the first time was in 1999, then in 2006 and now with sustained action since February 2012.

I always look at three aspects of any market: sentiment, economics and price (SEP).

Although the market in the last few months has been remarkably strong, the question now is:  are sentiment and the economics sufficient to push the S&P past the 1500 highs in the near future?

If the market is not likely to make new highs and is likely to trade in the current range, maybe even fall, then this could give us an opportunity to invest our money more advantageously later on, hopefully in the coming months.


When I study price I focus on trends, support & resistance levels, and extreme prices, three very reliable price patterns.

These three price patterns, combined with a consideration of sentiment and economics, often serve to highlight the main aspects of investment situations.

Let us look at price patterns first.

The monthly trend in the S&P 500 is still up but on a weekly basis the uptrend suffered.  As I write, the daily trend is flat, but it was down most of April.

Looking at support and resistance levels, the S&P 500 is at an index value of 1,379, just 12% below the highest closing of 1,565 in October 2007.  The Dow is even closer to its historical high, just 8% away, at around 13,029 compared to its highest historical closing price of 14,165, again in October 2007.

With the S&P index we are dealing with two peaks, both slightly above the 1,500 levels.  We can see in the diagram that the top quadrant is likely to offer very heavy resistance.

(Chart values approximate.)


The positive sentiment towards the U.S.economy was dented by the news that there were only 120,000 new jobs instead of the expected 203,000 and revised earnings.

The downturn in sentiment was immediately apparent in the dollar which fell nearly 1% against the yen but, of course, by much less, by only 0.2% in fact, against the euro, itself the subject of bad sentiment, as the  symbol of an ailing region.

Given the sharp recent rise in the main US indices, I had expected that the American Association of Individual Investors (AAII) would have reported seeing big herds of romping bulls but its survey as on April 18th is this: Bulls 31%, Neutral 35%, and Bears 34%.  Compared to the survey for April 4th, Bulls decreased and Neutral and Bears increased.

I would say that this denotes a weakly positive sentiment, one unlikely to fuel the indices through the roof but, ironically, with two contrarian implications:  first, if the bulls gain the upper hand then they will have a lot of Neutrals and Bears to feed on, and the market can therefore gain enormous strength; second, that as Standard & Poor’s comment in their latest “Market Attributes” study, “individuals have not yet returned to the market, even as a 24.5% bull run has been dangled in front to them”.

Economic Outlook

For S&P 500 companies, the Operating Earnings and the As Reported Earnings both fell in the last quarter of 2011, the first by 6% and the second by 9% compared to the quarter ending September 2011.

Various earnings and economic estimates for the first quarter of 2012 are coming in on the low side or even flat, but most analysts expect earnings to pick up later on this year and next.

High gasoline prices at the pump are not helping any and the drag will become apparent in the company results and economic data published in the months to come.  There is the usual reluctance to drive the extra mile, less discretionary money in the pocket, and the resulting bad sentiment : all in all less consumption and more blues.

In spite of these setbacks, the U.S.economy is in better shape than most of the other developed countries.


More companies represented in the S&P 500 have recently been declaring dividends and dividends per share have been climbing rather steadily since June 2009, except that they declined by 2.6% in the first quarter of this year.

Following the heavy buyback of shares in the third quarter of 2011, in response to higher earnings and lower stock prices, buybacks in the last quarter of 2011 are estimated to have decreased by 23%.  This may have been due to the higher stock prices we saw in the second half of 2011 but lower expected profits may also have been a factor.

The average dividend yield on the S&P 500 is 2.28% and slightly higher, at 2.72%, on the Dow.  These yields serve to seriously support stock prices only because interest rates have been artificially kept at very low levels.

I would say that, overall, the economic situation in the U.S. is fairly positive but flat to negative in the rest of the world, from which companies in the S&P 500 earn a substantial portion of their income.  (I am here assuming that the situation in Europe does not deteriorate, especially in Spain and Portugal.)

Breaking Resistance?

Is the S&P 500 likely to break the resistance in its top quadrant?  I think that under the present circumstances, the odds are against this happening soon.

A strong penetration of the previous peaks is unlikely and would require something of a miracle, say, an unlikely trifecta of a re-accelerating China, a rapid recovery in Europe and QE3 in the US – but it seems to me it’s more likely that, for now at least, the S&P and the Dow will soon hit a ceiling, if they haven’t already.  Dovish talk from the Fed would help, but on its own it’s unlikely to generate a bull run this time round.

I think the odds now are that we better wait before we invest.  Be patient.

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