Lessons Learned From the Indy 500 for the S&P 500

As I watched the Indianapolis 500 a week ago Sunday, an interesting thought occurred to me. The winner of the race Dario Franchitti, took several pit stops during the race and was completely stopped with his tires off his car at times. When I listen and read pundits comments about the markets I draw an analogy where one Indy 500 race is like a lifetime of investing. To be the winner it’s not about holding the pedal to the medal the whole time, but rather strategically planning times to get out of the race, refuel, get new tires, and plan your next strategy accordingly.

It is in volatile times like these, that analogy should come in handy for many investors. For the market, the yellow caution flags are up. This should be very apparent to all investors – bulls or bears. This is a great time to reduce exposure, digest all that is going on in the markets and get ready for your next move.

The S&P 500 lost over 8% for the month of May, which was the worst month since February 2009 and the worst May since 1962. Now just a few days into June, the market is already off another 2%, finishing at the lowest week ending close level since October of 2009. We just gave back seven months of gains.

The Euro continues to deteriorate, closing at multiyear lows. Sovereign debt contagion is now spreading. Another analogy is that the sovereign countries saved the private sector banks with their bailouts and acted as lifeguards that save a drowning victim. Unfortunately now some of the lifeguards (Sovereigns) are drowning. Who will save them?

Hungary’s announcement on Friday that their ‘economy is in a very grave situation’ and that it’s not ‘an exaggeration at all’ to talk about default, makes it abundantly clear that the problems in Greece are not going to stay contained. The world is awash with $222.5 trillion of total liabilities across public and private sectors, or the equivalent of 362% of global GDP. If that doesn’t give you pause – I don’t know what will. More debt will not solve a debt crisis. At some point spending cuts must be enacted, which will then slow down economic growth as an unintended consequence.

If you remember heading into the second half of 2002, visions of a “V”-shaped recovery soon turned “W” looking in nature and the real buying opportunity occurred later in the year or into 2003. We could be in for a double dip recession today. We are not seeing real private sector job growth. While the net creation of 41,000 permanent private sector jobs is positive, 150,000 new jobs are needed monthly, just to keep up with population expansion. Gallup publishes its own estimate of the unemployment/underemployment rate, and so far in May it is above 19%.

The S&P/Experian consumer credit default rate index hit a new high of 9.14% in April. This demonstrates that the proportion of credit card debt going bad is rising sharply. I believe this data is not receiving the attention it should but is yet another yellow flag for lenders and businesses.

This past week’s poll by the American Association of Individual Investors was a bit of a surprise. The poll showed bearishness fell to 40.8% this week from 51% last week, while bullishness rose from only 29.8% to 37.1%.

1040 remains the magic threshold for the S&P 500. A break below there on heavy volume could trigger a swoosh down to the 875 – 950 level. The upside is we continue to build a base above 1040 while trying to regroup for another run to new highs. That trading range is 1170 – 1040. The longer the base the better the bullish case becomes.

Volume remains a problem for the bulls. The down days have much more volume than up days. Volume equals conviction. The major indices have now been down four of the last six weeks. Charts are forming a pattern showing a series of lower highs and lower lows. This is called a trend and it is not positive.

We did buy into a natural gas ETF this week and retain our gold and silver positions, but silver is starting to appear weak. The 200 day moving average must hold or we will cover that trade as well. Our cash position is very high.

We are in pit row, the caution flag is out. Investors are not institutions and do not have to always stay invested in the market. If the downtrends that started over a month ago are penetrated to the upside we will buy into the leading sectors. If we break 1040 on volume – we will short the weakest sectors. For now it is time to refuel and get ready for our next move.

Disclosure: I own GLD, SLV, GDX, and GAZ.