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Trade Recommendation: The S&P 500 is on the Verge of a Correction

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The stock market recently celebrated its eighth birthday on March 09, 2017. It is the second longest bull market in history, only second to the 113-month rally from October 1990 to March 2000.

  • The bull market is getting stretched on the upside
  • S&P 500 is overvalued both on a TTM P/E and a forward P/E basis
  • Economic expansion cycle warns of a fall within the next two years
  • Low volatility shows that the traders are not prepared for a fall
  • The chart shows a rising wedge, which is a reversal pattern

Will the bull market see its ninth birthday without seeing a 20% correction and take over the pole position, or do we see cracks developing?

A number of experts have been caught on the wrong foot calling a top of this bull market. Therefore, we will not delve into that territory. We are not interested in making outlandish claims, which are not tradeable. We want to put our money where our mouth is, without risking our house on it.

At the current levels, we see the first signs of weakness in the markets and expect a correction to 2320 levels in the near future. What is the basis for our assumption?

High Price over Earnings Multiple

The markets have developed a myriad of P/E ratios – the trailing 12-month P/E, the forward P/E, the inflation adjusted, the Shiller P/E – that it becomes difficult to correlate all of them to take a decision.

We, for ease of simplicity, will consider both the TTM and forward P/E ratios, as these give a good idea about the pricing of the markets from a medium-term perspective. The charts have been sourced from FactSet.

The chart shows that at the current price the markets are way above the average P/E multiples. There is nothing stopping the markets from getting pricier before a correction sets in. However, with every rise, the multiples will only tick higher and narrow the gap, which started the crash in end-2007.

The stock markets are forward looking, hence, a forward P/E will be a better yardstick for valuation.

However, even if we consider the forward estimates of growth, the market seems to have priced in most of it. Here too, the index is ruling above the 5 and 10-year average forwards 12-month P/E.

With the two charts above we have been able to establish that the S&P 500 at the current levels is pricey – though not in a bubble. Such high valuations leave only a small window for surprises. With any major upheaval, the traders rush to the exit can start a deeper correction.

Economic Expansionary cycle Tells Us to be Careful

Currently, there is very little that can be pointed as being negative for the economy – strong labor markets, high confidence levels, strong earnings projections, low interest rates, etc. However, a study of business cycles done by the National Bureau of Economic Research (NBER), the official arbiter of U.S. shows that we should be careful.

Since 1945, the US economy has witnessed 12 expansionary cycles – including the present one. The average age of those cycles has been 58.4 months, while the current one will complete 96 months. There have been only two cycles that have exceeded the present one – the one from 1991-1969, which lasted 106 months and the other from 1991-2001, which holds the record as the longest one for 120 months.

Though at the first instance one can argue that there is still room for the economy to extend the cycle. Certainly! But let’s see how did those two cycles end.

The S&P 500 peaked in November 1968, a month before the expansion reached its ninth year. The S&P 500, thereafter, dropped 36% by the spring of 1970. Post the fall, the following three-year and five-year returns were an abysmal negative 1.7% and negative 6.1% respectively.

In the 1990s, the economy entered its ninth year of expansion in March 1999 and the S&P 500 celebrated it with a 17.5% return over the next twelve months. However, it was followed by a crash and dismal three-year and five-year returns of negative 10.8% and negative 12.45% respectively.

Hence, the economic expansion cycle is raising a red flag for the next two years.

Low volatility shows that market participants are lax

These days, nothing seems to worry the markets. The market participants are confident that any fall is a good buying opportunity, which has sent the VIX – the US equity fear gauge – to the lowest in a decade, though the global economic policy uncertainty is at elevated levels.

However, this is a dangerous situation when traders concentrate only on the returns, ignoring the risks involved. BofA Merrill Lynch said that the traders are piling on the inverse VIX exchange-traded products (ETPs) linked to the CBOE Volatility Index, which bets volatility to remain low for long.

“A sudden shock to U.S. equities could pressure those invested in such strategies to short cover, thus exacerbating the rise in volatility,” the bank says, as reported by Reuters.

Middle East tensions, North Korean misadventures, Chinese debt problems, central bank withdrawing stimulus – any of these can cause a scare that can increase the volatility and bring the markets down.

Risk to our analysis

The market conditions are benign for the rally to continue further. If the S&P 500 goes on to hit new lifetime highs and sustains above 2453.8 levels for three days, it can continue moving higher till the 2480-2500 levels. A market can remain overvalued for an extended period of time.

Shorting the markets is an advanced technique, which should only be used with proper stop losses. The risk on the upside is theoretically unlimited. Hence, please maintain the stop losses mentioned in the analysis and only enter the trade once the said levels are reached.

What do the Charts Forecast?

The index is rising in a rising wedge pattern, which is a bearish formation. This setup comes into play on a breakdown from the trendline support. Until then, the S&P 500 can continue rising within the wedge. Hence, we shall wait for the price to break and close below the wedge – below 2400 levels – to initiate our short position.

On the daily charts, we find that the index is rising in a channel. The support zone on the index is between 2400-2420. If the index breaks this support zone, it is likely to fall to the channel support line at 2320 levels, which is also a significant support. We expect the index to find a strong support at these levels.

Hence, our short position will be taken at 2395 with a stop loss of 2455 and a target objective of 2320. We risk 60 points for a gain of 75 points. Once we enter our trade, we shall try to lower our stop loss and trail it to reduce our risk.

Traders can use the ProShares UltraPro Short S&P 500 ETF (NYSEARCA: SPXU) to initiate the short positions. As this is an inverse ETF, please buy it at the existing value when S&P 500 hits 2395 levels. We shall sell our position at the existing level when the S&P 500 hits 2320 levels. Once we enter the trade, we shall keep the lows as the stop loss.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.7 stars on average, based on 9 rated postsRakesh Upadhyay is a Technical Analyst and Portfolio Consultant for The Summit Group. He has more than a decade of experience as a private trader. His philosophy is to use technical analysis for momentum trading and fundamental analysis for long-term positions. Rakesh likes to keep himself fit by lifting weights and considers himself to be a spiritual person.




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4 Comments

4 Comments

  1. jedadoo

    June 29, 2017 at 7:43 am

    How will this affect the cryto market? We haven’t seen a stock market downturn since it’s existed. Does it follow the same pattern as the stock markets during past corrections?

    • fkohist123

      June 29, 2017 at 11:30 am

      I would think alot of the small-cap cryptos will suffer from this if their revenue models depend on adoption of their blockchain solutions by industries. Think Civic and the likes: they will need companies to sign up in a recession where cash is scarce.

      Most small-cap crypto issuers are start ups themselves and their growth could be suppressed in a general recession. On the other hand BTC could serve as a hedge seeing as it’s volatility is converging to more stable levels.

    • fkohist123

      June 29, 2017 at 11:30 am

      I would think alot of the small-cap cryptos will suffer from this if their revenue models depend on adoption of their blockchain solutions by industries. Think Civic and the likes: they will need companies to sign up in a recession where cash is scarce.

      Most small-cap crypto issuers are start-ups themselves so their growth is vulnerable to suppression aswell. On the other hand BTC could serve as a hedge seeing as it’s volatility is converging to more stable levels.

  2. Rakesh Upadhyay

    June 29, 2017 at 5:39 pm

    jedadoo,

    A risk-off trade in the S&P 500 will give us a better idea whether traders turn to cryptocurrencies as an alternate asset class? If even a portion of the money that leaves equity markets enters into cryptocurrencies, we should see the uptrend continue.

    On the other hand, if the market perceives cryptocurrency investments as risky and there is a risk aversion across the board, then we might see correction set in.

    Difficult to predict, as there is no precedence and cryptocurrencies are still emerging as a new asset class.

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Analysis

Tesla: A Good Option to Invest

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By Dmitriy Gurkovskiy, Chief Analyst at RoboMarkets

Not so long ago, people only had landline phones that you couldn’t take anywhere, which now looks very inconvenient to modern people. Then, mobile phones appeared, and while you can take them anywhere, you must not forget to charge them regularly. However, charging your mobile has already become as usual as, for example, brushing your teeth.

When it comes to automobiles, modern fuel cars are like landline phones, as you can’t go anywhere without fueling them at a gas station, spending your time and money and planning your day depending on how much fuel you’ve got in your car tank. Electric cars are certainly cars of the future, and charging them would be something modern people are already much used to, as natural as fueling them now. It’s not the question of how much crude oil we still have on Earth; the point is that the progress is moving forward, and combustion engines, which are complex and expensive to maintain, will sooner or later become obsolete. Electric cars, where you don’t have to constantly watch how much engine oil or coolant remains inside, are about to replace the traditional fuel cars.

Tesla, a company founded in 2003, is by far the leader in electric cars production. One of its founders is the famous Elon Musk, an engineer and inventor.

Tesla presented its first electric car concept called Tesla Model S on March 26, 2009, in Hawthorne, CA. On June 22, 2012, after all R&D was completed, it was launched in the market and cost $112,000.

A few months later, the second prototype came in: this time, it was a crossover, Tesla Model X. According to Musk, Model X serial production would start in 2013, and the car would be available in late 2014. These plans proved to be too optimistic, though.

The supply start date was only announced in February 2014, but then postponed to Q2 and Q3 2015, and it fact the first supply was completed In September 2015. By the end of Q3, only 6 Model X cars were sold, each for $80,000.

In 2016, a new car, Tesla Model 3, was announced, and the sales were scheduled for the same year, but then the start date was postponed to 2017. The first Model 3 was actually sold in June 2017, at $35,000.

Since the first model sales start and up to now, the company has been unable to reach any net profit, with all earnings reports showing losses. The company was on the verge of bankruptcy as long ago as in 2008, and only a NASA contract saved it.

Perhaps the famous April 1 joke posted then by Musk was based on this very event.

However, it’s all quite different now.

Looking at the financial indicators of the company over the last 4 years, one can easily see where those losses come from. In 2014, Tesla invested $464M on R&D, while in 2015 they invested $717M, in 2016, $834M, and, finally, in 2017, the R&D cost Tesla $1.378B.

The losses were growing in proportion, but were cut in 2016 thanks to Model X sales. In 2018, the same may occur, as Model 3 is going to be quite popular, so the company may even start receiving profits.

Before 2015, the revenue came from a single model, which was Model S. In 2015, 50,446 cars were sold, with the total gross income of $5.649B.

In 2016, they started to sell Model X, which boosted the total year revenue to $7.728B.

If the company did not invest so much into R&D, perhaps, Tesla Inc. reports would now look far better than they are, but this would not last long, as the competition is also doing something.

When Model S sales started, it cost $112,000, while the average US citizen monthly income was $4,121. While not everyone could afford such a car, the sales went on rising, as Model S targeted mostly the luxury segment.

The next model cost $30,000 less, but was still inaccessible for an average consumer. This is why Tesla decided to release Model 3 at $35,000, much cheaper than the previous models. However, a bad surprise was expecting the company afterwards.

When Model 3 was presented, people could start applying for it with a deposit of just $1,000. By the end of the day, there were already 180,000 applications; three days later, the number already reached 272,000, and by May 2016, it went on rising to reach 373,000.

However, this only led to more expenses, as the company had to upgrade its production infrastructure in order to meet all those applications (the number of those exceeded the total number of cars sold since start).

When Tesla allowed its customers to apply for the new model, its production capacity was just 120 cars per week, while in order to meet all the needs Tesla had to boost it by 60 times, to 7,200 per week. Elon Musk is a go-getter, but this was crazy even for him.

Both investors and customers are already used to Musk not fulfilling his promises on time; this already happened with both Model S and Model X, where the supply date was postponed multiple times. It has not changed much now. By the end of Q1, Musk promised to reach 2,500 cars per week, but in fact was only able to boost it to 1,987. After breaking this promise, Musk said he was going to get 5,000 Model 3 cars per week by the end of Q2, and, curiously enough, this target was reached, according to the report as of July 2.

This news made the stock price go up, but right at the end of the trading session it was again down by 2.3%, as many investors just did not believe the report was true.

With the past experience of Musk’s promises being quite negative, Bloomberg developed an online tool where everyone can track the Model 3 production process by VIN. The news agency sends a request to the National Highway Traffic Safety Administration (NHTSA) website which sends a response on the number of VIN’s registered for Model 3.

However, car manufacturers usually register VIN’s for the whole batch, so the values Bloomberg gets may be a bit higher than they in fact are. Still, according to these stats, the company reached 4,395 cars per week by July 2.

So, in fact, Musk did not fulfill his promise again, and the market reaction was of course negative. However, the key point here is not fulfilling promises but the overall progress that was made over such a short period of time. Just 6 months ago, Tesla produced around 200 Model 3 cars per week, while now this figure is over 4,000. Tesla market cap is already higher than the one of Ford Motor Company and nearly in line with that of General Motors, while those too have over 100 years of experience in car production and sales.

If Tesla is able to maintain the same progress as before, it will produce over 52,000 Model 3 cars by late Q3, which will lead to good Q3 and Q4 reports, while all negative effects of the trade war against China will be void.

Besides, if we also take Model S and Model X sales into account, chances for good reports get even higher.

Reaching 5,000 cars per week is a very difficult task: Tesla even had to place its new assembly line in a tent.

This GA4 (general assembly) allowed the company to boost the production by 20%, and it actually proved to be one of the key decisions.

Meanwhile, Musk says GA3 will be well enough to maintain the production capacity at 5,000 cars per week, while GA4 will help to reach the further target of 6,000 cars. With Tesla products being in demand, investors can be quite optimistic regarding the future of the company and invest more, although they do have some risks.

Tesla is now a leading electric cars producer with relatively accessible prices, but the competition are also looking towards electric car production, which may of course shrink the demand. Other risks include emergencies coming from the autopilot mode Tesla is quite fond of. There is no law regulating the driver responsibility in such cases yet, so the company has to face claims against itself, which lead to Tesla recommending using autopilot only as an additional feature that does not allow the driver to stop watching the road.

Doug Field, a talented engineer, leaving the company after working with it for 5 years is also an important negative factor. Elon Musk says this should not have any influence on the indicators coming in the following quarters, or on the new Tesla cars production.

Technically, there is a clear ascending trend on W1, with the price using the 200-day SMA as a support and constantly bouncing off it. The price has also managed to stay above $300, which may help it go further up, too.

There is no MACD divergence that could stop this growth for now.

Just like before, Tesla looks like a very good option for an investment. Elon Musk may set too ambitious goals, but he achieves them sooner or later. The demand for Model 3 still exceeds the production capacities, with over 400,000 cars pre-ordered, but this will also allow the company to develop new models. As such, the 40-ton truck, Tesla Semi, was already announced to the public in November 2017, and its serial production is scheduled for 2019.

According to some sources, there have already been 1,000 pre-orders, with the deposit increased from $5,000 to $20,000.

Thus, Tesla may become the first company to produce an electric truck in 2019.

 

Disclaimer

Any forecasts contained herein are based on the authors’ particular opinion. This analysis may not be treated as trading advice. RoboMarkets shall not be held liable for trading results based on recommendations and reviews contained herein.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 4 rated postsHaving majored in both Social Psychology and Economics, Dmitry went on to continue his education in post graduate. He then worked as a team lead of a tech and fundamental analysis lab in the Applied System Analysis Research Institute. This helped him to acquire all necessary skills and experience to become a successful trader and analyst, as well as a portfolio manager in an investment company. Dmitry is a pro in the financial field who authors articles for various international media. He also holds the position of Chief Analyst at RoboForex.




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Analysis

Crypto Update: Technical Setup Unchanged Despite Encouraging Rally

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Cryptocurrency bulls could breathe a sigh of relief on Monday as the secular uptrend in the most valuable coin got saved yet again, as BTC rallied above $6500 for the first time in a week after a low-volume consolidation period just above the $6000 level. All of the majors joined the rally as correlations remain very high in the segment, and the market recovered 10% on average with the total market cap of the coins getting back to $275 billion.

Despite the rally, the top coins are still stuck under key resistance levels, as the recent swing highs are still above the current prices and from a short-term standpoint, the downtrend is still intact. Until a move above the crucial levels, traders should still stay away from opening new positions, as odds continue to favor another test of the June lows.

That said, given the still intact long-term bullish setups in the most important digital currencies and the very negative sentiment that developed thanks to the long declining trend, a short-term trend change could be ahead. A bullish leadership is still yet to form, although Bitcoin’s short-term relative strength is a positive sign.

BTC/USD, 4-Hour Chart Analysis

In BTC’s market, all eyes are once again on the $6750-$7000 zone that has capped the really attempts for a month now, and below that zone, the largest coin remains on a short-term sell signal. As the coin didn’t hit a lower low, a bullish pattern could form in the coming weeks, but until it remains in the current trading range, traders shouldn’t enter the market. Support above the long-term $5850 level is found at $6500, $6275, and $6000 while further resistance is ahead at $7350.

Altcoins Slightly Lagging Behind Amid Broad Rally

LTC/USD, 4-Hour Chart Analysis

The major altcoins are in very similar short-term technical setups, thanks to the strong correlation between the coins, and the most bearish coins, like Litecoin, NEO, Monero, and Dash are still below the key support levels that they violated in June. While the previous lows held up this weekend, investors should still remain defensive with regards to the relatively weak currencies.

LTC/USD, 4-Hour Chart Analysis

That still points to a dangerous long-term setup in the segment, and further technical progress is needed to switch the segment-wide trend. Ethereum remains below the key $500 level, although the coin managed to rally above the $475 level yet again, despite being relatively weak from a short-term perspective compared to BTC.

A rally above $500 would be a very positive short-term sign for ETH, and it could trigger a move to the $555-$575 zone. Primary support is at $450, with further levels at $420, $400, $380, and $360, and below $500 the short-term sell signal is intact.

Featured image from Shutterstock

Disclaimer:  The analyst owns cryptocurrencies. He holds investment positions in the coins, but doesn’t engage in short-term or day-trading, nor does he hold short positions on any of the coins.

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 293 rated postsTrader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.




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Analysis

US Opens New Front in Trade War as Oil Plunges

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Financial markets are relatively calm today, with most of the major stock benchmarks being virtually unchanged after the weekend. The energy segment is experiencing the most activity as the volatile correction in crude oil prices continues. Besides that, the Euro’s relative strength is notable, but summer trading conditions remain dominant across the board, with low volumes and choppy intraday price action in most of the asset classes.

Shanghai Composite, 4-Hour Chart Analysis

There seems to be no stopping in the global escalation of trade tensions, as amid the Helsinki meeting between Trump and Putin, the US launched an official probe concerning the retaliatory tariffs of its largest trade partners. The move could deepen the standoff not just between the US and China, but the EU and its other allies as well, and global growth is already weakening, so with further trade troubles growth could grind to a halt.

S&P 500 Futures, 4-Hour Chart Analysis

While global stocks are still well off their highs, and Chinese equities remain in bear market territory, the main US indices are holding on to their recent gains, with the Nasdaq being the by far the strongest benchmark globally. The slightly weaker S&P 500 is also trading at a 4-month high despite trade war fears, and as the first earnings reports of the second quarter were slightly better than expected, with Bank of America beating today before the bell, bulls are still in control on Wall Street.

As for economic news, the much awaited US Retail Sales report delivered a small positive surprise, and last month’s figures were also revised higher. The report helped risk assets during the US session, even as the disappointing Chinese Industrial Production number weighed on investors sentiment earlier on.

Dollar Index, 4-Hour Chart Analysis

Despite the bullish numbers, the Dollar lost a bit of ground against its major peers, although forex markets were less active today than recently and the most traded pairs traded in relatively tight ranges after Friday’s hectic session.

Oil Back Below $70 per Barrel as Commodities Remain Weak

WTI Crude Oil, 4-Hour Chart Analysis

Crude oil prices are sharply lower yet again, with the WTI contract leading the way lower as tight short-term supply conditions got better in Canada, and the general weakness in the global commodity segment infected the market oil. The IMF’s report on weakening global growth, and the chatter about the release of some of the global strategic oil reserves also weighed on oil, and the WTI contract is now at $68 per barrel after trading as high as $75 just one week ago.

Copper, 4-Hour Chart Analysis

Elsewhere in the commodity space, it has been a quiet Monday session, with gold drifting slightly lower after a weak rally in early trading, as selling pressure is still apparent among precious metals. Copper, which also has been suffering in recent weeks as Chinese assets got slammed lower, is still consolidating above the strong long-term support zone that we pointed out last week.

Featured image from Shutterstock

Important: Never invest (trade with) money you can't afford to comfortably lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here. Trade recommendations and analysis are written by our analysts which might have different opinions. Read my 6 Golden Steps to Financial Freedom here. Best regards, Jonas Borchgrevink.

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4.6 stars on average, based on 293 rated postsTrader and financial analyst, with 10 years of experience in the field. An expert in technical analysis and risk management, but also an avid practitioner of value investment and passive strategies, with a passion towards anything that is connected to the market.




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