S&P 500 (SPX)

The S&P 500 is 410 points (33%) below its 200 day moving average - the most oversold it’s been since 1937.

The 200 day moving average generally serves as an indicator of the markets intermediate term trend. When it is rising, the market is generally thought to be in a bull market. When it is falling, the market is generally thought to be in a bear market.

As you can see from the link, it’s pretty rare for the S&P to get more than 20% above or below its 200 DMA. The 200 DMA tends to act as a magnet, smoothing and rationalizing the markets movement in the direction of the overall trend. When it gets too far away from the 200 DMA, it tends to revert back fairly quickly without necesarily changing the overall trend.

At the same time that the S&P is as oversold as its been in 70 years, volatility is starting to subside. Intraday volatility peaked around 90 on October 24th. 10, 20 and 30 day average volatility have all peaked and 50 day average volatility looks like it might have peaked on Friday.

We are way oversold long term. Now, that does not mean run out and blindly get yourself fully invested. We can also stay this was for a very long time. It does mean for the patient investor the are bargains out there..big ones...

The value to using this is to know that the average ROE for the SP500 is ~14% with about 57% of earnings paid out in Dividends and ~43% being reinvested. This provides for a Book Value growth rate of ~6% which has been remarkably consistent and in line with the SP500 earning’s chart showing the remarkable consistency of our economy. Knowledge of this consistency becomes a tool for the value player.

What you do is to convert the P/BV into a ROE to the investor. On 3/6/2009 the P/BV was 1.2 which converts to 14%/1.2 = ~11.7% return for investors who buy the SP500. Then, what must be done is compare this to the Wicksell Rate which is 5.4% today and falling.

"Wicksell Rate" explained here

You can look at this discrepancy as Buffett would and simply say that you are buying an 11.7% yield in a long term 5%-7% SP500 return range. The current SP500 provides sizable upside if inflation remains low. The lower the inflation the higher the SP500 valuation will be in the future during normal times.

For example:

If inflation is 1.8% the Wicksell Rate will be ~5% and the SP500 will reach about 20 P/E. If inflation drops to 1% then the Wicksell Rate becomes ~4.2% and the SP500 could reach ~25 P/E. You can also have inflation move in the opposite direction and should it move to 3% the Wicksell Rate will be ~ 6.2% and SP500 would price near ~16 P/E.

What permits an investor to enter the market during times of distress such as these is the knowledge of economic history and the trust that the growth of our economy is inherent within the free nature of our society and will continue in the future.

This is one instance in which knowledgeable investors expect history to repeat itself.

The focus is on the S&P 500, which has traded below its November lows and bottomed out at 667 points on March 6.

By trading below 670, the index reached an intermediate-term downside price objective and set up a daily buy signal. Earlier in the week, that buy signal got triggered, meaning that there is now an 82% chance that the S&P 500 will trace out at least a three-wave Elliott move (possibly increasing to five waves) to the upside.

Although the S&P 500 may move higher over the near-term, keep in mind that the index has risen sharply over the past few weeks and is due for a pullback soon. This would be Wave 2 of a three-wave move.

A normal Fibonacci retracement would come in between 38% and 50% of Wave 1. However, in a very bullish market, it may only pullback 25% to 30% before reversing back up.

Either way, when the current rally runs out of steam (which may have been yesterday), look for the index to see at least four days of price action below the Wave 1 high before new highs are possible.

In Elliot wave terms, if we’re only in a three-wave move up, this would be called an A-B-C rally, which is just a corrective move within the the downtrend.

However, if we’re seeing the start a five-wave rally, the S&P would have to close above the January highs. If you want to play a move at least above the highs of Wave 1, you can buy on the first decent pullback.

All companies publicly traded jettisoned higher Tuesday. Regardless of whether this is a bear rally or a bull rally, there is a range of resistance that will prove to be a sweet spot to get out and take a breather, but we aren't there yet.

Take a look at the chart below of the S&P 500 and focus on the bottom on November 20, 2009. When the S&P 500 hit this temporary low it was at a value equal to 60% of its 200 day moving average (DMA). The S&P 500 low on Monday ended similarly at 64% of its 200 DMA.

From The Nov. 20 low the S&P rallied 24% from 752 to a short term peak of 934 on January 6, at which level the index was equal to 75% of the 200 DMA on the day of the bottom (Nov. 20).

Using the 200 DMA and referencing the aforementioned rebound, we can arrive upon a usable level of resistance to which we can ride this rally.

The S&P 500's 200 DMA at the low on Monday was 1058. Using 75% of the 200 DMA at the low as a resistance level, the S&P 500 index at 793 is the level of resistance that would mimic the behavior of the previous rally at the end of 2008. This level will be increasingly difficult to break because it is so near 800, which is an extremely strong psychological level of resistance.

To be more conservative in targeting where to ride the rally, we can use the level on December 16 where the S&P 500 barely surpassed its 50 DMA before finding the peak two weeks later. Here the index was equal to 73% of the 200 DMA at the bottom. If we use this "index level/bottom 200 DMA" fraction as our definition, we could see the resistance level lower at 772.

Finally, it is important to watch the psychologically significant 740 level on the S&P 500. Here the S&P found an intra-day bottom on November 20, and it would be a very bullish sign if the market breaks through. I believe that we can and will break through this level but if you are cautious to put your neck out, this may be where you take some off the table.

Using these three important levels of resistance as a guide, I predict that the S&P 500 will head higher to between 740 and 793. If the S&P 500 reaches 800 in the next 45 days, you should interpret this as a signal to take a substantial share of chips off the table. At this point we will have substantial clarity about the health of banks from the stress tests, and given a strong correction downward we will find new ground to buy.

The price-to-earnings ratio of the S&P 500 was most inflated in the 1990s, at more than 30 times earnings. The recent slump in the markets has dropped the index P/E to 10.7, as of market close Thursday. Looking for blue chip stocks on the cheap? Now's the time to buy.