Rally Failure Would Signal 3%-4% Correction

INVESTOR’S first read.com – Daily edge before the open
DJIA: 26,449
S&P 500: 2,900
Nasdaq Comp.:7,996
Russell 2000:1,567
Thursday, April 18
, 2019   9:13  a.m.
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gbifr79@gmail.com
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Summary:
TODAY:
I didn’t like yesterday’s market action. Patient sellers showed up throughout the day after a spike up in early trading. (See “Technical” below).
At any moment, a flash crash can develop taking the market down 12% – 16% in a week or two. Be prepared.
The Street would like to pump prices higher, even to new all-time highs, so the big players can use the news media hoopla to sell big positions at lofty prices.
The minutes from the FOMC March 20 meeting were released yesterday showing most board members resigned to keeping rates at current levels.
I don’t buy that.  Given even a smidgeon of bad news, the Fed will cut rates determined to head off a recession in 2020, a presidential election year.
A heavily redacted Mueller report will hit today, stirring controversary from both sides.
If the market gets hit, it will be because it is overvalued and due to get hit, not due to the Mueller report unless it is so damaging to Trump’s prospects in 2020 he won’t run for re-election or will face certain defeat.
That is all assuming the Street is still bullish on Trump. While they got their massive tax cut, the S&P 500 has appreciated  63% through April 12 under Obama vs. 28% under Trump in the two president’s first term.
TECHNICAL:
Minor Support: DJIA 26,427; S&P 500: 2,897; Nasdaq Comp.: 7,8878.
Minor Resistance: DJIA:26,517; S&P 500: 2,914; Nasdaq Comp.:8,016
A break beyond support or resistance increases the odds that the market will move further in that direction.
        The risk of a flash crash will exist for at least 6 weeks. A smaller correction would take the DJIA down 1,000 points to 25,500; the S&P 500 to 2,786, and the Nasdaq Comp. to 7,787.
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Wednesday (4/17)
About my Headline:
The new normal has been the flash crash, a vertical plunge in prices that happens so fast investors are down 12% – 16% before they can say “sell.”
Under these conditions, it is prudent to maintain a cash reserve in line with one’s tolerance for risk to take the sting out of a flash crash and give an investor some cash to buy-in at lower prices.
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The market averages are notching up, a pattern that reflects automatic buying by institutions, i.e., computers are making decisions to buy and occasionally sell stocks without much human input – kind of an artificial intelligence without the latter.
So, what are these computers programmed to do, other than blindly buy ?
Don’t know.  I still contend, self excluded, that the human brain is the best computer on earth, not the fastest, but generally free to think weigh in on the unexpected.  Put another way, computers can hit a fast ball, but not a sinker.
What is my point ?
Cover your backside, because this will have a bad ending, when reality sets in. We may have to hit new all-time highs to trigger sellers, intent on taking advantage of the hype by the press about new highs, to unload big positions as the public rushes in absolutely sure the bull has a lot further to go.
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TUESDAY (4/17):
      I really don’t trust this market. It cruises along on auto-pilot, as if nothing can interfere with its serenity.
That can change in a heartbeat with a one/two week 12% plunge. This is the new normal, and all it takes is for a piece of unexpected bad news, or for buyers to walk away, looking to return after a correction..
 So far, the Street is not spooked by the prospect of Q1 earnings coming in negative. However, disappointing earnings will punish stocks as with Goldman Sachs (GS), which reported Q1 net of $5.71 vs. $6.98 a year ago on a 13% drop in revenues. GS declined 7.93 points (3.8%) in trading yesterday.
At 31.3, the Shiller price/earnings ratio is more overvalued than at any time in the last 180 years, except during the dot-com bubble in 1999.   At some time earnings will have to catch up with Shiller or valuations will have to adjust downward.
The new normal is the flash crash, where vicious corrections develop out of nowhere. That’s a good reason for investors to have a healthy cash reserve in advance, but that’s hard to do when everyone else is making money.
The Street got a rude awakening in Q4 with a 19.2% 3-month plunge in the DJIA, a 20.2% plunge in the S&P 500, and an even bigger drop in the Nasdaq Comp. (23.9%).
These mini-crashes happened in April/May 2010 with the S&P 500’s  8-day, 12.6% plunge; August 2011 with a 6-day 15.8% plunge; 2015 an 18-day 11.5% plunge; 2016, a 13-day 12.9%; 2018, a 10-day 11.8% plunge.
Fortunately, the market recovered each time, but abrupt plunges like these are scary and the overwhelming tendency is for investors to sell out a good part of their portfolio after the plunge, when it looks like a bear market is under  way, and they don’t get back in until the market has risen substantially.
Bottom line: Don’t get greedy, maintain a decent cash reserve even in steady markets, because the flash crash can happen at any time, and we are now in a place where that can happen.

MONDAY (4/15):

Q1 earnings are underway. They will not compare well with 2018, but the Street expects this, so the impact on the stock market is uncertain.
      Earnings next year are expected to rebound, but no one knows at this time by how much.
The Street may simply ignore earnings reports this year and project valuations out into 2020.
      At 31.3, the Shiller price/earnings ratio is more overvalued than at any time in the last 180 years, except during the dot-com bubble in 1999.   At some time earnings will have to catch up with Shiller or valuations will have to adjust downward.
The Street got a rude awakening in Q4 with a 19.2% 3-month plunge in the DJIA, a 20.2% plunge in the S&P 500, and an even bigger drop in the Nasdaq Comp. (23.9%).
The new normal is the flash crash, where vicious corrections develop out of nowhere. That’s a good reason for investors to have a healthy cash reserve in advance, but that’s hard to do when everyone else is making money.
FRIDAY (4/12):

MarketWatch published an article, “Risk of earnings recession rises, as S&P 500 profits to fall for first time in 3 years.”
This is not news to readers here, I have warned of this for months, but now the Street sees it.  Will they care ?
Yes, the market has been going up, possibly because of expectations of a trade deal or Fed rate cut, or even because they are looking ahead to 2020, but FactSet’s senior earnings analyst, John Butters notes that companies have been cutting guidance more than usual causing leading analysts to make bigger cuts to their forecasts.
He goes on to add, that more important for the outlook for the stock market is that blended EPS growth estimate for the second quarter slipped into negative territory on Wednesday, to minus 0.2% (that is news to me, FactSet had been tracking  a plus 0.1%)
I think the trade deal and expectations of a rate cut to head off a recession before the 2020 elections are mostly built into current market prices, though a brief rally would accompany the news anyhow.
I do think  the Street is ignoring 2019 earnings and focusing on 2020 when it expects  a strong earnings rebound, which may push the market up in coming weeks.  The key will be, will the BIG money use that push to sell ?
If the Street suddenly begins to revise 2020 projections downward, it spells bear market.
As  noted below, the  Shiller price/earnings ratio is calculated by the S&P 500’s price divided by a moving average of 10 years of earnings adjusted for inflation.  At 31.13, it is higher than it was when the market plunged 20% in Q4 last year,  higher than it was before the Great Recession’s 50% plunge, as high as it was in 1929, but not yet as high as the dot-com bubble burst high in 1999, which hit the S&P 500 for 51% (Nasdaq:78%), a time when high priced stocks with near zero earnings dominated the market. It is close to twice as high as its mean of 16.6.
THURSDAY (4/11):
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We are in the late stages of the longest bull market in 155 years and it will be hard to shut off. Speculative frenzy usually drives late stage bulls to absurd  highs.
As noted below, the blue chips are overvalued given the outlook for earnings and a softening economy, worse abroad.
This is the point prudent investors get sucked in by the media headlines and others brag about their newly discovered  genius as stock pickers, but eventually get their clock cleaned.
Most savvy traders know how to play it, quick to bail out before getting picked off second base. Major corrections and bear markets begin with a sharp sell-off that looks like a buying opportunity at first, since bull markets have relentlessly rebounded. Thinking this is a gift (never are in this business), investors jump in only to get ripped by the next down-leg.
One or several more tempting surges may occur – easy does it, one of these will be a “trap door.”
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EARNINGS:
For 2019, FactSet expects a gain of 3.7%. Currently, it tracks  2019 earnings gains/losses at Q1: -4.3%, Q2: -0.4%, Q3: +1.4%, and Q4: +8.3%. For the year, FactSet expects earnings growth to be +3.4%
A Morgan Stanley study shows  a downturn in S&P 500 earnings growth has consistently triggered a plunge in stock prices. Analysts have been slashing 2019 earnings projections, however he Street is betting on a rebound in 2020. If they start slashing projections for 2020, we have the next leg of the bear market.
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What No One on Wall Street Wants to Hear
>We are in the late innings of an economic expansion, so a recession is a good bet. The current expansion started in June 2009, has lasted 116 months, the second longest on record and  twice as long as the average length of 11 cycles since 1945.
> Of the 10 recessions since 1950, the average time between the low point in the unemployment rate and the start of a recession was just 3.8 months.  The unemployment rate hit a low of 3.7 percent in November, jumped to 3.9 percent in December and to 4.0 percent in January. Now, averages include months below and above 3.8. What’s more, we won’t know when the current recession if we have one begins because that conclusion is  reached by the Nat’l Bureau of Economic Research (NBER) long after the fact.
>Bear markets lead the beginning of recessions by 3 to 12 months.  The current bull market at 119 months is four times the average of the last 15 bulls going back to 1957
 >Nine out of the last 10 recessions have occurred with a Republican in the White House.
>The current economic expansion has lasted 123 months. That’s 65 months (2.1x) longer than the average expansion (58.4 months) going back to 1945.
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Of the 10 recessions since 1950,the average time between the low point in the unemployment rate and the start of a recession was 3.8 Months.
> Of the 10 recessions since 1950, the average time between the low point in the unemployment rate and the start of a recession was just 3.8 months.
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George Brooks
Investor’s first read.com
A Game-On Analysis, LLC publication
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Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer.  Neither Game-On Analysis, LLC, nor George  Brooks  is  registered as an investment advisor.  Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed  as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

 

 

 

 

 

 

 

 

 

 

 

 

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