October 14, 2013

| Rodrigo C. Serrano, CFA | SIPA | Columbia University Master of International Affairs 14 Candidate | New York City, NY | 01-305-510-0181 | rcs2164@columbia.edu

SPX: Short-term: Neutral Medium-Term: Cautious

Resistance/Support Bands o Short-Term Support: 1,655-1,665; o Short-Term Resistance: 1,725-1,730 o Medium-Term Support: 1,630; 1,600; 1,550-1,560 o Medium-Term Resistance: 1,725-1,730 Principal reasons for view: o Weak Fundamentals and Washington battles o Sentiment + Flying Blind = negative surprise? Principal risks to view: o Medium to Long-term solution to deficit and debt ceiling. o Strengthening global growth.

Analysis Earnings trends for the S&P 500 have become increasingly bearish. YoY growth of quarterly earnings has generally flat-lined since mid-2012. This means that index gains have come mostly on the back of PE multiple expansion (improving investor sentiment). Indeed this improved belief has translated into forwardlooking estimates that imply a strong resumption of YoY earnings growth from the low single-digits (on a 3 quarter average basis) to low double-digits by the end of the year. On the sales front, revenues have declined from an average YoY growth of near 8% from 6/30/10 to 3/31/2012 to 2.6% since then. Furthermore margins remain at very high levels compared to historical standards, which suggests that earnings growth highly depends on growing revenues (ie a strengthening economy). According to a Goldman Sachs report (pictured below) U.S. sales made up 66% of total S&P 500 revenues in 2012. It's important to note that continued political battles in Washington have quickly and rather unexpectedly developed into a powerful headwind for earnings growth due to increased uncertainty. Have investors priced in a potential slowing of economic growth due to continued irresolution? There is a significant probability they have not when analyzing sentiment.

From a sentiment standpoint, there is substantial evidence that investors have grown quite confident of continued gains in equities. To an extent, improvement in economic data since mid-year has been tasty meat to chew on for the bulls. However, there are reasons to believe that investors have become overextended in their positive outlook and their exposure to risk assets. In point of fact, margin balances as reported by NYSE member firms are near highs last achieved when markets topped out in 2007. What make this particular situation more risky is the fact that there has been a myriad of economic data that has not been published due to the government shutdown. Therefore, markets have not priced in potential negative surprises from these releases. Indeed, other non-government data indicates economic conditions have slowed recently, the most prominent being poor retailers sales reports for September. Moreover, it would be great to know if the labor market improved in September after a tepid August payrolls report. Valuation provides the largest tailwind for bullish investors but is not indicative of a market that should be bought with both hands. On a trailing basis, the S&P 500's PE ratio is only near the average level when looking at data since 1960. This indicator suggests that the market is not overbought. However, when looking at valuation using the Cyclically Adjusted Price to Earnings Ratio or CAPE for short. One can see that the index is overbought at these levels. A more detailed discussion of valuation can be found in Doug Short's Advisor Perspective site. o http://www.advisorperspectives.com/dshort/updates/PE-Ratios-and-Market-Valuation.php

Disclaimer: Please first consult your financial advisor for all important investment related decisions


Technically speaking, the SPX is trading in a less bullish manner. While the index remains in an uptrend, the bears are increasingly making their presence felt. A recent violation of the 50 and 100-day moving averages suggests that the political battles in Washington are having a negative effect on sentiment and economic growth. Thursday's powerful reversal represented relief that there seemed to be some movement towards a compromise. It led to the index retaking both moving averages and coincidently occurred at a major support area (upward trend line in place since the beginning of the year). While this price action suggests that the bulls remain in control over the short-term, a large assumption is that progress continues on resolving the political disputes. Reports this weekend of stalled negotiations will likely give bears renewed vigor to start the week.

The market's breadth has become a flashing yellow light for the rally and deserves continuous inspection. The percentage of stocks above their 200-day moving average is currently at 51%, a bearish development when considering that this indicator has been falling throughout the entire rally since the beginning of the year. Furthermore, the Advance / Decline line has been rather sluggish over the past 4 months. Each higher high in the SPX has been accompanied by a weakening pace of growth from this important metric. Taken together, while these barometers do not suggest a prolonged market decline is in the books, they deserve greater attention. The 2013 rally has seen declining participation and is not indicative of a healthy bull market.

Short-Term Medium-Term

Short-Term Support: 1,655-1,665 Short-Term Resistance: 1,725-1,730

Medium-Term Support: 1,630; 1,600; 1,550-1,560 Medium-Term Resistance: 1,725-1,730

Disclaimer: Please first consult your financial advisor for all important investment related decisions