What If Inflation Picked Up Out of Nowhere ?

Investor’s first read – Daily edge before the open
DJIA: 18,506
S&P 500: 2,163
Nasdaq Comp.:5,034
Russell 2000: 1,202
Thursday, July 15, 2016 8:23 a.m.
Because I was wrong recently when I expected this market to sell off before the recent surge, is no reason to get caught up in this madness and go all-in.
I don’t err often, but am quick to admit it when I do. However, I still think this is a phony market, propped by the belief that low interest rates are all that count.
The market is ignoring risks that have warrant more respect, namely the fifth straight quarter of declining earnings for the S&P 500, excessive valuations on top of that, and an aging bull market and economic expansion.
Throughout this bull market, the Street has marched to the Fed stimulus drumbeat and little else has mattered,
But, suddenly other factors override the fantasy that ultra low interest rates are the elixir for the economy. It could just be an unexpected event, or the sudden awareness that the market is overvalued and the market adjusts to more realistic levels.
It happened twice in the last twelve months. A 5-day drop 11.7% plunge of the S&P 500 in August 2015 (15.8% drop -Nasdaq) and a 12.9% (15.7%drop Nasdaq) stunned the Street.
The next correction should be every bit as sharp. My message here is BE ALERT that this can happen.
Earnings will be released in coming weeks. Along with that, the Street will have to deal with revisions of future earnings and corporate guidance. Expect those to be lower than projected.
A stronger U.S. dollar stands to adversely impact Q3 and Q4, S&P 500 earnings, which the Street was counting on to justify these prices.
Earnings projections for Q2 call for a drop of 5.3% vs. an estimate of a drop of 2.8% three months ago. While oil and related industries account for much of this decline, nine sectors have lower growth rates now than at Mar.31. This would bring the P/E for the S&P 500 to 16.4 compared to a 5-year average on 14.6 (data FactSet.com). A Q2 decline would be the first time Y/Y earnings have declined five consecutive quarters since Q3 2008 – Q3 2009, the Great Recession.
We are witnessing yet another bubble due to burst. In 1999, it was the dot-com craze. In 2007, it was housing/derivatives. It is now a Fed bubble, where the Fed does everything it can to prop the market. It could persist for many months. But the economy and stock market cannot be artificially propped indefinitely.
Put another way, there are negatives that are not discounted in these record prices, simply because the Street is only focused on Fed stimulus.
All this changes for the better “if” corporate earnings take off more than expected (+ 10%) in Q4, and for the worse if out of nowhere inflation picks up. If it’s the latter, both stock and bond market would plunge.
SUPPORT “today” DJIA:18,447; S&P 500:2,157; Nasdaq Comp.:5,018;
RESISTANCE “today” DJIA:18,635; S&P 500:2,176; Nasdaq Comp.:5,068
On occasion, I technically analyze each of the 30 DJIA stocks for a reasonable risk, a more extreme risk, and an upside potential over the near-term. I add the results of each, then divide by the new DJIA “divisor” (0.14602) to get the DJIA for those levels. This gives me an internal check on the DJIA itself, especially if certain higher priced stocks are distorting the averages.
As of July 11, 2016, a reasonable risk is 16,970 a more extreme risk is 16,812. Near-term upside potential is 18,579.
(I will repeat this regularly to keep readers aware of the potential for an April correction)
The market is tracking a pattern for presidential election years where an administration is in its second term.* The news is bad.
Historically, these markets have declined in Jan./Feb., rallied in March then topped out in early April, plunged in May with brief rallies in June and August and a plunge into October prior to the election.
 STATUS OF MARKET: Neutral – but very, very vulnerable. Expect volatility
 OPPORTUNITY: RISK: Risk high, Profit taking justified.
 CASH RESERVE: 45%. Consider 75% now if tolerance for risk is low.
 KEY FACTORS: Outlook for Q2, and 2016 earnings questionable. Fed has market under its spell.
Note: Source of weekly economic calendar and good recap of indicators: mam.econoday.com.
*Bloomberg.com (Excellent pre-market read)
George Brooks
Investor’s first read
A Game-On Analysis, LLC publication
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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