A special report brought to you by the PRS Stock Report

The Breakout Ahead 7/11/2007

Once the S&P 500 pushes through the 2000 highs we expect a powerful surge higher.
Target for the S&P 500: above 1625

In early June long-term interest rates snapped sharply higher reaching levels not seen in over a year. The sudden surge in long rates tripped up the stock market sending the Dow and S&P 500 into a sharp and rapid 3% decline. The correction was powerful enough to awaken a few hibernating bears and suddenly the headlines were full of doom and gloom. Don’t buy into the doom or the gloom.

While the decline was sharp, it was brief. On June 8^th the lows were in place and within a few days the indices were just off their recent highs. For the Dow that means it was just off its all time highs while the S&P 500 remains just below its all time high of 1552, which was set in 2000, over seven years ago.

When people see that the S&P 500 is back near its 2000 all time highs, for some reason that seems to make investors nervous. It is kind of like pushing through the sound barrier. On October 14, 1947, as Chuck Yeager accelerated the X-1 past Mach 0.9, he had his hands full. The plane was bucking and shaking all over the place. Apparently that’s what happens as an airplane approaches Mach 1.0, the speed of sound. Going that fast isn’t a big deal today, but on October 14, 1947 before the sound barrier has been broken, all that turbulence had to have been a bit unsettling to say the lease.

On that day it didn’t really matter. If it was possible, Chuck Yeager was going to ride the X-1 into history and push past the resistance barrier known as Mach 1.0. It was a bumpy ride and he made it. Today fighter jets routinely push through the resistance barrier. There is always some shaking and rattling along the way, but they get through it without worry because pilots know what to expect.

When it comes to the stock market, pushing through major resistance barriers, like important old highs, is often like pushing through the sound barrier for the first time. In a sense, we don’t really know if it can be done. Because of this uncertainty, folks tend to get a bit paranoid and the price action often gets a little bumpy along the way to new high ground. You can see in the chart above how this happened with the Dow in 2006 when it worked through its 2000 high. Once clear of the old high the Dow sailed higher, surprising many with each new high.

The Dow’s recent action is an excellent example of what we expect with the S&P 500. Fortunately, we have a lot of history on which to compare our expectations. When using history as a guide, I always hear someone say, it is different this time. Are things different this time around? Yes and No. The details of current concerns will always be different than way back whenever. However, as long as people remain determined to overcome challenges, the common thread of the solution will remain remarkably similar too.

Today we are concerned about War, energy prices, inflation, and political unrest (at home and abroad.) The details are always different but over the course of time, these are often the major concerns of the day, only with different details.

Fortunately, Capitalism is still capitalism. The problems may be different, but American determination to solve the problems and create a better life for ourselves and those around us remains constant. The events at hand can discourage people for a brief time, but we don’t give up. We find new voice and foundations on which to build. In the end we come up with new ideas and ways to improve and move forward. This has been happening for seven long years and the S&P 500 is ready to push on to new high ground.

American resolve and determination remain the universal constant through out history. While the details of the concerns are often quite different from crisis to crisis, the determination to succeed has remained a constant anchor through out history. And it is because of this anchor point that history provides us with an excellent guide as we look forward.

The S&P 500 reached its high in 2000 and has been in place for an important seven long years. During that time companies have been working hard to improve. Companies have grown their sales and their earnings significantly over the past seven years yet the value of it all is only now nearing its valuation in 2000. It is time to put a higher valuation on them and history says that is going to happen.

Here is why. For the past 100 years, with only one exception, every time a major index approached a previous high, more than five years old, it pushed right on though to measurably higher levels. We can see this in the chart above which shows the Dow from 1915 to present. In 1919 the Dow slightly exceeded the 1917 high, but that only 2 years after the high was reached. Notice that in 1924, seven years after the 1917 high, the Dow easily worked to significantly higher levels.

The 1929 high was easily surpassed in 1955.
The highs reached in 1937 were surpassed in 1946 while lower highs reached in 1939 were easily surpassed in 1945. The 1987 high was cleared with ease in 1990, but the first gulf war stalled the advance for a year. In 1982 the Dow finally smashed through the highs reached in 1976 and 1981.

There is one lone exception. In 1966 the Dow peaked just below 1,000. Three years later it attempted to push higher in 1969 and failed, but that was only three years later. In early 1973, seven years later, the stage was set for prices to breakout to the upside. Everything was set for a push higher; however, the World was stifled by the Arab Oil Embargo, which brought the US economy and a good portion of the world economies to a screeching halt. With that tectonic event, the Dow failed to follow the historical precedent. While it took another seven years, it is worth mentioning that the delayed upside move was followed by one of the largest bull moves on record.

The S&P 500 follows a similar pattern. However, in 1973, the S&P 500 did push to a minor higher high before the global economic conditions pulled it back in.

The lessons of history paint a bullish picture despite the news headlines. Today’s stories are filled with reasons to worry and uncertainty. In short, the media is doing a great job of drawing in more viewers. At the same time, the S&P 500 churning just below its seven year old high. Baring a major world event, similar in scope as the 1973 Arab Oil Embargo, the S&P 500 should push through the seven year old high in the weeks ahead. Like pushing through the sound barrier, the closer the S&P 500 gets to its all time high, the bumpier the ride is likely to become. Once clear of the barrier, the ride should smooth out rather quickly as prices coast higher.

I wish you all the best in your trading and investing endeavors

Jim Patterson