Over the week, we moved away from providing broad market analysis and focused more on providing updated target entries for our shopping list of stocks. Please reference the Top Stocks List under the spreadsheet section of the site, as well as the forum for updated charts.
If you are new to the site, a few places to start in regards to the information below:
S&P 500 Levels We Are Targeting
Fundamental Analysis and Convictions
So far, we have updated entries for 16 names and plan to provide the remainder in the week ahead.
As of today, we are still holding onto our long-term positions in Microsoft, Alibaba, Nvidia and Roku. We are also holding our position in Zoom, which we are now holding without a stop, and just began building a small position in Slack when it traded in the $16 range (updated on the forum).
Our shorts, Uber and Lyft, traded above the 8-day EMA on Friday. they both closed the day below the 8-day EMA, so it was an intra-day move. However, as a discipline, I always, without question, follow my exit plan when I set it. Since the exit plan was to sell when the 8-day EMA was breached, I will buy to cover these positions on Monday for 2 really nice gains. As of the close on Friday, we are sitting on a 38% gain in Lyft and a 29% gain in Uber, which have acted as fantastic hedges for our long positions.
I believe the extreme gains we saw in these two positions over the last 2 days were simply short covering. Both these positions have very high short interest, which can make for violent corrective moves up when the shorts cover. We believe there is more downside to be had in both these positions, so we will look to add in any further corrective moves.
With shorts especially, we always follow exit plans as any gain in a short can turn into a loss very quickly.
With a long-term-time frame in mind, we have a very positive outlook. This is the type of market that you build lifetime positions with cost basis we will may not see again. However, our personal opinion and preference is to wait for our target entries and target SP 500 levels because we believe there is more downside in our future. The evidence for this opinion and belief is laid out below. We also discuss the “what if we are wrong” scenario.
Broad Market Valuations
Price-to-Sales (P/S) ratio is a metric we’ve talked about before when referring to market valuations. Using Price-to-Earnings (P/E) ratios to gauge the value of the market, especially in the era of large buy-back programs, is not as accurate as using a metric like sales. Top line revenue, like free cash flow, cannot be distorted. The problem with using free cash flow to gauge the market is that not all promising companies are positive free cash flow, yet the common denominator is they all make sales.
That being said, the Price-to-Sales Ratio (P/S) of the S&P 500 was at an all-time-high in December 2019 at 2.32. For reference, anything over 1.55 has historically been considered expensive while anything below has been considered a value. Last December’s P/S ratio exceeded both the dot.com peak and the 1929 peak when ratios were just above 2.2.
The market is currently 30% from this all-time peak; however, the current P/S ratio is still hovering around 1.66, notably above the 1.55 historical mean. So, even after a 30% drawdown, we are still relatively expensive.
It’s hard to grasp just how overvalued equities were at their recent peak. Looking at the below image by Crescat Capital puts this into perspective.
The U.S. Market Cap/GDP ratio is one of Warren Buffet’s favorite metrics for gauging value in the market. It is calculated by dividing the total stock market by the gross domestic product.
After a 33% drawdown, when we briefly breached the 2018 December low, the market traded around the valuations we saw at the 2007 peak. Today, after a slight corrective bounce, we are trading above this level.
Historically, in bear markets, stock valuations move from overvalued to undervalued. So far, according to two important measurements for market valuations, we have gone from very overvalued to slightly overvalued.
Intermarket Analysis
A few weeks ago, we analyzed the more economically sensitive sectors of the economy to see what they were telling us about the potential severity of the drawdown. At the time, these sectors were completely in a bear market or almost in a bear market, while the S&P 500 was still in correction territory. They were leading the market down a few weeks ago and I believe they continue to lead the markets down today. In other words, these sectors suggest more downside.
Every one of these sectors closed below the 2015 high around 2133. They are above the 2016 low, which is around 1800. These sectors, especially the regional banks and financial sectors, are suggesting an unwinding that has been long overdue.
Prior to the 2020 peak, the global debt was at a record high of $250 Trillion, which is over 3x the level of Global GDP. Like in most cycles, as they age, the quality of the debt deteriorates. The U.S. financial sector’s exposure to this debt is still in question and this why the sector continues to lead the market down.
Technical Damage
The amount of technical damage done to the market is extensive. This chart will be a regular update as we progress in either direction. The chart below also outlines what will need to happen in order to squash this bear market from a technical perspective.
So far, the market has failed to retest 1 of the 2 bear market trend lines in red. There are important moving averages, Fibonacci retrace levels, numerous open gaps, and prior peaks, all of which will act as strong resistance. Until we make a higher high and lower low and begin to take back some of these levels, I will be suspicious of any rally.
The below chart outlines the two scenarios that I am tracking for a likely path.
Scenario 1:
Scenario 1 is outlined in blue. The blue count is the count I am leaning towards as most probable. It suggests that the 3rd wave (within the C-wave) has bottomed or is close to bottoming. This will give way to a corrective 4th wave bounce, and then a final 5th wave down to the 2100 region.
Scenario 2:
Scenario 2 is outlined in red. The red count suggests that the 3rd wave will further extend into the 2200 region. If the economically sensitive sectors we are tracking break through the 2016 level, and this 3rd wave keeps extending, then we could see this market trade down to the 1800 level support level.
Regarding a bottom:
In order for the bulls to convince me that they taking back control of this market, I will want to see them take back the 2750 level on the S&P 500. For me, below this level, and the pressure is down, which puts the above scenarios in play.
Some Good News – Positive Divergences
Beth is covering the speed of the bear market for MarketWatch this week. Since February 20th, the market has gone straight down with minor interruptions. In fact, March of 2020 holds the record for how quickest bear market in history at only 16 days starting on February 19th. The second fastest bear market to occur was the notorious 1929 followed by the escalator drop of 1987.
When calculating how quickly the 2020 market dropped 30%, the juxtaposition of our current situation is even more severe. The bear market of March of 2020 took 19 days to drop 30%, followed by 1987 and 1929, tied for second at 55 days to reach 30% drawdown. The other notorious black swans, the dot-com bust and the 2008 crisis, took almost a full year to retreat 30%.
The good news is that the market structure suggests that we are due for a large degree wave-4 bounce, and the MACD as well as the VIX are supporting this.
Note the MACD in the prior chart regarding the 2 potential scenarios we’re tracking. As the market is making lower lows, the MACD is coiling upwards. This is the type of positive divergence we see when we are approaching a bottom of sorts. This plays into the larger degree wave-4 that I am anticipating.
The VIX refers to the ticker symbol for the CBOE Volatility Index, and has become a popular measure of the stock market’s expectation of volatility based on S&P 500 index options. In other words, it measures the amount of implied or expected volatility in the market.
So, as the market makes new lows, the VIX would typically make new highs because lower prices bring about more fear.
If you look at the above chart, in the final hour of trading, the market began to trend down and closed just above the all-time low for this bear market. However, the VIX also trended down. This is saying that the VIX is seeing a reduction of future volatility, while price is going down. This is a divergence we usually see towards a bottom or the bottom of a bear market.
It’s worth noting, that during the 2008 bear market, the VIX oscillated between the 70 to 50 range four times between October and November of 2008, before finally beginning to slowly trend back down. Basically, the VIX is still in a very elevated state and until it begins to settle down to much lower levels, we will likely not find a meaningful bottom.
What if we are Wrong?
As we stated on the forum to a few readers, this market presents two equal risks to every investor:
-Invest too early and see losses as the market attempts to price in a recession
-Invest too late and miss exceptional pricing (we are already at prices that nobody would have dreamed of a month ago).
Which risk are you most comfortable with? Only you can answer that. We are simply telling you what our plan is based on technical analysis that helps guide the positions we chose from deep-drive research.
I’d like to point out, we are not perma-bears or perma-bulls. We don’t comment a lot on the coronavirus because we are not doctors or health experts. We are sometimes on Twitter but are often too busy with research to tweet frequently.
We believe balanced research is an important strength. We have no desire to be right about calling a market. You won’t hear us pumping our positions during a historic selloff because we feel that it’s irresponsible to say “buy now” when our cost basis is low and we are not buying ourselves.
Instead, once the market broke key support, we worked overtime to find the S&P 500 levels we thought were most probable (and our personal target). We also published technical stops to help protect our readers’ gains. This was based on well over 100 hours of research (closer to 200 hours of research) over the past month on various technical charts and identifying stops and new entries for all of our positions. Our goal is to make money for our readers and to build the best portfolio possible in today’s market.
Where the market decides to bottom is really anyone’s educated guess. Our targets take into account the potential for the blue and red counts I outlined above. These will be the levels that we will begin to build long-term positions. We plan to continue to hedge these long positions in case we are early.
We are not financial advisors. We use technical analysis to help create emotionless game plans, guide potential entries and manage risk. But, ultimately, you are the main arbiter of your investment decisions.
If your time frame is 5+ years and you can weather a potential 20% drawdown from current levels, then you will likely be glad that you bought at current prices.
There are numerous examples of roughly 30% drawdowns in past pandemic scares that showed a quick V-shape recovery. The level of fear in the market is palpable, and we are starting to see divergences amongst the MACD and the VIX, suggesting a bottom of sorts could be forming.
Also, there is not much reference for the amount of liquidity being flooded into the market. On the flip side, this could act as a back stop to further economic deterioration.
However, if you believe this indicates THE bottom, it’s worth comparing today to the 2008 recession. During 2007-2009, we saw a 55% drawdown in stocks. However, during that time frame only the financial sector needed a bailout, now the list of sectors that needs a bailout is growing by the week. Also, airplanes were flying, Vegas was open, small business weren’t forced to close, there was no mandatory stay indoors policy and pro sports were still active as well as schools. No one knows the extent of the economic damage this pandemic will cause to the economy because we have never seen such a widespread halting of economic activity in an economy infused with record levels of debt.
Investors have been trained to buy the dip for 11 years. This strategy paid off handsomely for over a decade, and after 2018’s V-shaped recovery, there’s still a belief that we will see another such recovery. This scenario is possible, but I do not believe it is probable.
The structure of the upcoming bounce will be crucial for providing further clues on the on-going direction of the market. If the correction is overlapping and symmetrical, it will support the 4th wave thesis. I’m expecting this to find resistance around the 2500-2600 before topping out. However, if we see heavy volume and a structure that is impulsive – i.e., 5-wave patterns – then it will support the thesis of a potential bottom.
I want to see the 2750 level taken back before I will believe the bulls are in control. We need resistance to be taken back and an uptrend to form before I’m willing to support the idea that a bottom is in place.
Position Updates
Please reference the Top Stocks List under the spreadsheet section of the site for updates on target entries. Please also reference the forum and the chat rooms for charts. Chat rooms are organized by stock ticker.