S&P 500 in perspective

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World equities indices have wobbled over the last three to four weeks, sending shivers through the investing world. The financial commentary brigade always looks for a reason whenever equity markets retrace. On this occasion, blame has been pinned on the Fed tapering QE by $10 billion a month to $65 billion.

The bigger picture

The weekly chart below dates back to the end of 2007 and shows the minus 56% 2008 bear market on the left part of the chart. Since the trough in March 2009, the S&P 500 has risen 170% to its recent peak in mid January.

The old cliché that markets don’t rise (or fall) in a straight line, is quite evident in this 6-year chart, however it is amazing that investors forget this whenever even a small retracement occurs in equity indices. As soon as red ink appears on the back of some negative news, fear levels start rising, fueled by the noise from market commentators.

The fact is that negative news is always around, even when markets are rising, but maybe the markets aren’t ready to react negatively at that particular time. And when they do, the noise brigade magnifies the then current negative news, discounting any positive news that may also be around, until the markets start rising again. And so the roller coaster rolls on…

Source: Beyond Charts

The recent high close of 1850 reached on 15 January was just over the 127.2% Fibonacci extension of the 2008 bear market, shown by the top green horizontal line, taking the S&P 500 to 274 points above the 2007 high. The 127.2% Fibonacci extension is a typical area for price action to take a breather, as is 138.2%, 161.8% and 200%, although there is some way to go before these are reached.

Zooming in

The daily S&P 500 chart below zooms in on the last two or so years from October 2011. Four common Fibonacci retracement levels are shown by the blue horizontal lines.

Source: Beyond Charts

Note the retracements that have occurred for the entire run-up shown on the chart. Each of these has been either of a 14.6%, 23.6% or 38.2% Fibonacci retracement. The most recent retracement reached the 14.6% level before jumping over the last two trading days.

Technically this retracement is not over until, in the first instance, the S&P 500 closes above 1798.8 and then above 1850.8. Until then, a deeper retracement is still possible, however becomes less likely as the S&P 500 continues to rise.

If the S&P 500 does falter from here in the short to medium term, then a 23.6% or 38.2% retracement to around the 1660 – 1670 or 1555 – 1565 zones, respectively, will not be that serious, given the run-up that has occurred since October 2011. At some stage, another 38.2% or deeper retracement will occur as markets cannot continue with such shallow retracements.

In this instance, if equity markets fell further from where they are, a retracement in the order of 38.2% would take the S&P 500 back to around its high before the 2008 bear market, shown on the daily chart above by the lower green horizontal line.

In the meanwhile, accept that markets do not rise, or fall, in straight lines and that retracements along the way in a bull market are normal.

Gary Stone is the founder and managing director of Share Wealth Systems.

Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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