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Analysis

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.

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  • 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?

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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 money you can't afford to lose. Always do your own research and due diligence before placing a trade. Read our Terms & Conditions here.



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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

Technical Analysis: Litecoin Continues Surge as Bitcoin Tests Highs

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With the crypto world being focused on the historical futures launch, the major coins all enjoyed buying following a hectic weekend, and a volatile week as a whole. BTC itself got another boost from the widespread publicity and the volatile correction of the recent days ended, with the most valuable coin bouncing back towards its all-time high.

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While the long-term picture remains severely overbought, the short-term picture is not stretched and further gains are possible even amid the elevated correction risk. That said, investors should wait for a more favorable entry point to ad dot their holdings, while traders should control position sizes in the light of the long-term setup. Major support levels are now near $13,000, $11,300, and $10,000, with stronger levels still at $8200 and $7700.

BTC/USD, 4-Hour Chart Analysis

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The major altcoins are all up today, but only Monero and Litecoin are still within short-term uptrends, and the segment as a whole is still dangerously overextended, and a deeper correction is very likely in the coming weeks. LTC continued its recent break-out, getting close to the $200 level, and joining the extremely overbought group regarding the long-term momentum, and triggering a long-term sell signal in our trend model. Key support levels are found $100 at $75 and $64, with a weaker primary level at $125.

LTC/USD, 4-Hour Chart Analysis

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Analysis

Long-Term Analysis of the Silver Market

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Silver

The silver market has once again caught investors’ interest as the price is nearing areas not seen since late 2008.

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2017 started at a low point for silver, and it seems it will end the year that way as well, meaning investors who bought at the beginning of the year haven’t suffered nor gained much.

This doesn’t mean, however, that the price hasn’t moved during the year. After the low start of the year, silver quickly tacked on about 18% to a top of $17.50 per ounce.

In terms of fundamentals in the silver market, things look a bit complicated for 2018. There are multiple forces pulling in different directions for the price of silver going forward:

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Positives

  • A sharp stock market correction can be expected to occur some time in 2018. Most likely, this will happen sooner rather than later. Stock market crashes always trigger a flight to safety, meaning gold, silver, and quite possibly bitcoin, can benefit.
  • We are seeing signs that inflation may be starting to rise again, although this is not confirmed yet. Rising inflation is always good for precious metals.
  • If the US federal budget deficit widens as a result of the new tax reform, the US dollar may suffer as a consequence. Goldman Sachs put out a note to investors in November 2017 saying that the US debt is “on track” to reach an “unsustainable” level in coming years. Fed Chair Janet Yellen has also said about the US debt that it is “the type of thing that should keep people awake at night.” Rising debt levels creates uncertainty about the economy, which is generally good for gold and silver.

Negatives

  • Central banks around the world seem committed to raise interest rates in 2018. Rising interest rates are bad for precious metals because it would make it more attractive to put money in the bank.
  • The cryptocurrency bull market is on track to continue, diverting attention and capital away from precious metals as a traditional store of value. However, this one is uncertain, as it may also be considered a positive in the way that the rise of cryptocurrencies brings the inflationary and unsustainable nature of fiat currencies into focus.
  • The US dollar may have hit a bottom in 2017 and trade higher compared to other major fiat currencies going into 2018. A stronger dollar is always bad for precious metals, which are priced in dollars.

Silver chart

When looking at the chart, we can see that silver is back down to were it started the year, which coincides with a major support area where it has turned several times in the past few years.

From a technical perspective, silver has been trading in a triangle pattern on the longer-term weekly chart, with the price now trading very near the lower end of the triangle, adding confluence to our bias that silver will trade up from here.

Silver failed to live up to our prediction from early 2017, and is now even trading well below the level from that time.

A low price by any measure combined with two major technical support levels adds confidence to our trade and makes silver a low risk and potentially high reward trade for 2018.

Depending on your own strategy and investment style, you may want to wait for the price to break out from the current triangle pattern it has been trading in for the past year and a half. You would then give up some of the potential return for an even safer trade. After that, major resistance is found around $17.50 and $18, with lots of upside potential if we can finally break through those levels.

Featured image from Pixabay.

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Analysis

Long-Term Cryptocurrency Analysis: Look Out Below?

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After last week’s observation that a major top is in or near in the segment, the Bitcoin surge continued for almost a week, with Thursday’s wild session taking the coin as high as $19,000 (the article uses Bitstamp prices) on some exchanges. While the currency already pulled back by more than 20% the long-term picture is still extremely overbought and a much deeper correction is likely in the coming weeks.

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BTC spiked below $13,000 today, violating the primary weak support at $13,300, with further levels now at $11,300, $10,000 and $9000, but stronger support only found at $8200 and $7700. Next week’s futures launch could cause another jump in trading activity, and volatility is expected to remain very high amid the likely correction.

BTC/USD, Daily Chart Analysis

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While not all altcoins participated in the, supposedly, last part of the rally, IOTA, Monero, and towards the end of the week Litecoin, also stretched above all conventional targets with IOTA also turning exponential after a deal with Microsoft. The coin exploded by more than 350% before entering an initial sharp correction, breaking the steepest short-term uptrend. Strong support is only found at $3 and $1.5, but potential Fibonacci support is at $2.35.

IOT/USD, Daily Chart Analysis

Let’s see how the long-term charts of the other altcoins look after the crazy week.

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