Inflection point on the S&P 500

The technical picture looks troubling. Moving averages are rolling over, the 200-day moving average appears to be in the early stages of topping, and the 50-day moving average will break through the 200-day moving average in the next day or so. The latter points to major inflection points in market sentiment and often are indicative of the beginning of new "bear" and "bull" markets. In this case, it looks like the former, a bear market. A break of the 50 through the 200 could trigger further selling. It is generally accepted that a bear market occurs when stocks fall more than 20% from their previous highs. Credit Suisse reported that there is a high probability of a bear market if the market corrects over 15%. Our portfolio advisory group at ScotiaMcLeod argues there may be a bounce back in the short term. “The S&P 500 has fallen more than 10% in the last 10 days. The market is due for a bounce in the next few days, but any lift is likely to be brief and largely not worth the trouble of trading as the trend is now moving to the downside.”

From a fundamental perspective, the U.S. equity market looks cheap. The S&P 500 is trading at 12.6 times consensus 2010 earnings estimates and only 10.7 times 2011 consensus. Corporate balance sheets in the U.S. are strong as is cash flow; so there is no debt crisis here. Financing costs are cheap by historical standards. With stocks this cheap, why shouldn't we be aggressively buying stocks? The collective opinion and foresight of the market is telling us that trouble may lie ahead. The broader equity market is a discounting mechanism, often predicting turns in the economy by six to nine months. This is the problem investors’ face. Valuations look attractive from a P/E perspective, but the market is showing that the "E" or earnings are wrong and valuations aren't as low as they appear. It doesn't make sense that "blue chip" stocks in the US trade at less than 13 times earnings with a recovering economy and historically low interest rates. What we will probably find is that they don't; earnings expectations are too high and valuations are in fact richer than current estimates would have you believe. Conversely, this same idea holds true when we look at valuations on growth stocks. Price-to-earnings multiples always look rich on forward earnings. A year down the road we find that we are paying considerably less for a growth stock than initially thought as expectations were too low.

We think a good way to play this type of environment, if you want to be in stocks, is to buy high yielding dividend paying stocks. While our outlook for the U.S. market remains somewhat bearish, investors should be using weakness to selectively buy the shares of higher yielding "blue chip" companies offering must have products and services. The Portfolio Advisory Group at ScotiaMcLeod has put out a report for stocks in the US that pay high, sustainable and growing dividends.