A New Warning Sign for Stocks

A rough day for tech... Amazon's 'Prime Day' hiccups... Bezos sets a record... Netflix plunges on 'strong' earnings... Just six stocks are leading the market... A new warning sign for stocks... What Doc Eifrig's favorite indicator is saying today...

Yesterday was a rough day for the market's leading tech companies...

Online-retail behemoth Amazon (AMZN) kicked it off with the start of its widely anticipated "Prime Day," its annual one-day shopping event for the company's 100 million paid members.

This year's event was expected to bring in more than $3.4 billion in sales, which would be a new U.S. retail record. (China's Alibaba would still hold the global record, and it's not even close... During its annual "Single's Day" event last November, the company hauled in an incredible $25.3 billion in sales.) However, Prime Day did not begin as planned.

Many customers reported problems accessing the site when the event officially began at 3 p.m. Eastern time, and Amazon's homepage continued to display occasional error messages well into the evening.

While the news was certainly a disappointment for the company, the market's reaction was relatively mild.

Amazon shares reversed sharply lower from a fresh all-time high of more than $1,840, but still closed up about 0.5% for the day. In addition, the rally pushed Amazon founder and CEO Jeff Bezos' net worth above $150 billion for the first time. This officially made him the richest man of the modern era, and the second only to John D. Rockefeller – worth an inflation-adjusted $350 billion at his peak – in all of U.S. history.

The market was not so kind to content-streaming giant Netflix (NFLX)...

Shares plunged as much as 15% in after-hours trading after the firm reported a rare "miss" during its second-quarter earnings announcement last night. As financial-news network CNBC reported...

In addition to a slight miss on revenue compared to estimates, Netflix posted a huge miss on subscriber additions. The company only added 5.15 million subscribers, about one million less than forecast. Domestic additions were only a little more than half of its projections, while it just added 4.5 million subscribers internationally...

Netflix also issued a weaker guidance for the third quarter than expected, saying it is expecting to add 5 million subscribers total compared to an analyst estimate of more than 6 million. It is projecting 650,000 new subscribers in the U.S. and 4.35 million internationally.

Now, to be fair, the report was far from a disaster...

Rather, as the company itself noted in its official statement, it was a "strong but not stellar" quarter. The problem is that the stock was priced for perfection...

Netflix has grown revenues by roughly 1,000% since 2008. That sounds impressive... until you realize its shares have soared more than 10,000% – 10 times faster – over the same time, including more than 100% in the last year alone.

When a company is trading at nearly 15 times sales and more than 250 times earnings, "strong" often isn't good enough.

The recent performance of these high-flying tech stocks is notable for another reason...

They've been responsible for a huge portion of the broad market's gains this year.

According to CNBC data, just three of these stocks – Amazon, Netflix, and Microsoft (MSFT) – account for 71% of the S&P 500 Index's returns and a huge 78% of the Nasdaq 100 Index's returns.

If you expand the list to the six top-performing stocks – adding in Apple (AAPL), Alphabet (GOOGL), and Facebook (FB) – these stocks account for 98% and 105% of this year's returns, respectively.

This extreme narrowing of market leadership is concerning...

It's a classic sign that we're likely nearing the end of this long bull market. But it's not yet a reason to panic...

You see, market "breadth" – as measured by the advance/decline line, one of our colleague Steve Sjuggerud's five market "vital signs" – continues to mirror the overall market. Since February's "volatility panic" bottom, more stocks have been rising higher along with the major indexes than have been

Of course, simple math tells us most stocks aren't up anywhere near as much as the market leaders we just mentioned. But they are still up... And as regular readers know, history shows breadth typically begins to "diverge" – where fewer and fewer stocks are moving higher with the market – well in advance of major market tops.

But we do have another warning sign to report...

In short, while the advance/decline line remains healthy, another of Steve's five indicators has just flipped to "yellow." As he explained in the July issue of True Wealth Systems...

Our major concern is when all five indicators move to "red light" mode. We're not there yet. Still, this month, we have another warning sign for U.S. stocks.

In June, we had a lone "yellow light" – in the financial sector. We have a second this month. Transportation stocks recently fell into a downtrend... That's our signal to shift this indicator into "yellow light" mode.

Again, Steve says this isn't a reason to panic...

As he explained, two yellow lights are not sell signals. History says there's no need to worry until one or more of these indicators are in red-light mode. And that is not yet the case today...

We will keep a close eye on these indicators in the coming months. We could see multiple red lights pop up quickly. But these yellow lights could move back to green just as easily...

We can't know for certain how long it will take the market to shake off today's uncertainty. But overall, our indicators show that the bull market in U.S. stocks is healthy.

Don't let today's market uncertainty cause you to panic and sell. Stay long.

Our colleague Dr. David 'Doc' Eifrig generally agrees...

He's also watching closely for signs of danger, but like Steve, he isn't too worried yet. As he explained to subscribers of his elite Retirement Trader advisory last month...

Markets can turn down for all sorts of reasons. Some are unpredictable events – so-called "Black Swans" – like an oil crisis or a war. Others grow from the popping of a frenzied bubble, like the overleveraged real estate market a decade ago.

We think the next bear market will be a plain old downturn in the business cycle. The economy will slow and dip into recession. In turn, that will kill the optimism gripping stocks and bring the market down 20%-30%.

I see that point creeping up... The economy is booming – but "boom," to me, always implies a bust.

You can find a thousand economic indicators out there to watch. Today, you only need to focus on one. In short, we won't see the economy or market get rough until the employment picture changes.

As Doc explained, history shows that bottoms in the unemployment rate typically go hand-in-hand with stock market tops...

Unemployment has dropped to 3.8% in May... a historically low level. Prior to this, economists thought unemployment couldn't really get below 5% to account for the natural "frictions" of folks quitting and finding jobs. But they don't talk about that lower bound anymore.

It also turns out that when unemployment starts to tick up, it's a great sign for marking the peak in the market...

Of course, as Doc noted, calling a bottom in real-time is difficult...

Just because unemployment is low, doesn't mean it can't go lower. And as you can see in the previous chart, there are often plenty of "head fakes" before it turns up for good. So Doc prefers to add another measure to this indicator to make it more useful...

If you want to predict recessions, you can overlay the unemployment rate with its 12-month moving average. When unemployment crosses above its moving average, it's a great sign for predicting recessions – no PhD required.

You can see, though, that the current unemployment rates would need a good spike to get to a worrisome level.

Earlier this month, the U.S. Department of Labor reported that the unemployment rate jumped to 4% in June. This was a significant move, but for now, unemployment still remains below its 12-month average. It would take another month or two of similar moves at least to confirm a breakout.

In short, like Steve's five indicators – as well as several other reliable measures we're following, such the U.S. Treasury yield curve and corporate-bond market spreads – Doc's favorite indicator says the time for "full-fledged worry" is approaching... But it's not here yet.

New 52-week highs (as of 7/16/18): Amazon (AMZN), VF Corporation (VFC), and Verisign (VRSN).

A busy day in the mailbag: The responses to Porter's Friday Digest request continue to roll in... and several subscribers share their thoughts on yesterday's Digest from our colleague Austin Root... As always, send your notes to feedback@stansberryresearch.com.

"Porter, I find your Digest writing to be well timed. I've been an Alliance member for a couple years now. During that time, I've slowly been transitioning to appreciate the Magic Stock and P&C data. I've recently been using the Magic Stock list to poach some ideas. I'm okay if the Beta is a little above 0.8, so I recently picked up some DIS. I also liked the way [the latest Stansberry's Investment Advisory recommendation] looked on the Insurance monitor and picked up some of that (both a little before the recent recommendations). Position sizing is found using TradeStops. I'm also selling out of the money calls on these to pick up a little extra return. And I really like the thought process behind the Golden Triangle work and the bond analysis. I'm a little selective on the bonds, using a minimum ROI criteria that some don't exceed. I've picked up small positions in the Golden Triangle stocks presented.

"Now that's not to say I'm ready to go 'all in' on the stability approach. I've got a number of Steve's China reco's, a number of [Stansberry] Gold & Silver, some Venture positions (which I keep very small), and some of Doc's Income reco's. And I love the 'trick' you've taught me from [Stansberry] Alpha option investing. But I'd like to think I'm warming to the idea of an above average return with lower portfolio volatility. Please continue the exceptionally high quality work – and feel free to continue trying to drown this horse in the water. LOL." – Paid-up Stansberry Alliance member Mike T.

"Porter, the temptation to offer some feedback this week was simply overwhelming... As you know, I have been learning from you for over 20 years. I started reading when you started writing. What a journey. I think what is important to understand is that Stansberry Research truly does offer something for everyone. First, ask yourself what type of Investor you are...

• Lazy? Go with the Portfolio Solutions. Let them do all the heavy lifting, you spend 30 mins a month balancing the Portfolio.
• Passive? Go with [Stansberry's] Credit Opportunities. Sleep easy knowing you will most likely get paid Par Value when your bonds mature, and collect paychecks along the way
• Passive-Aggressive? Credit Opportunities with Golden Triangle stocks. Sit tight but still feel like you have a little action on the side.
• Aggressive? Build your own Portfolio with any or all of the editors (Extreme Value, True Wealth, PSIA, Retirement Millionaire, etc)
• Speculator? Venture into the biotech with Dave and the Venture Series or try to catch the trends with Commodities.

"Before everyone starts debating my buckets, these are metaphorical, not specific groupings. In fact, I would argue that the single most important lesson I have learned over 20 year of engaging with you is not what I buy, or which newsletter I follow, the most important lesson I learned was this: Understand the risk you are taking. By that I mean, learn position sizing. Learn trailing stops (or even better, understand VQ Trailing Stops). Learn Asset Allocation. Master those and you will be far superior to most who engage in the stock market.

"The purpose of this email is to offer somewhat of a confession. You have spent a great deal of time on explaining how to find great businesses. How to find capital efficient opportunities. How to understand Return on Assets, Free Cash Flow, P/E, EBITDA, etc. Honestly, it's too much. It's not that I couldn't learn to do all of that. But why would I? You already cover every sector and you have already hired the smartest people in each sector. Do I really think after Dan Ferris has vetted a stock, I could possibly find something he missed? Not likely. Is it possible I could uncover something that Dave Lashmet missed in Biotech? Or the best opportunity of a trend going from bad to less bad than Steve Sjuggerud? Me finding a better P&C insurance company than you? Seriously? At least I am smart enough to know what I don't know.

"The real question I ask myself is whether the companies they are recommending 'fit' into my Asset Allocation model. Am I taking too much risk adding this stock to my portfolio? How heavily weighted am I currently in this sector? How much should I buy based upon the volatility of that stock? How much of my capital am I willing to risk? Finally, what is my exit strategy if I choose to buy it. This is where I focus my efforts, and where I have 'learned' more than I could ever repay you.

"I will most likely never find a stock on my own. And, I am ok with that. But because of what I have learned, I will almost never have a catastrophic loss, or limit my upside, thanks to you. As an investor, that is MY number one goal. I am willing to bet there are more subscribers like me. Subscribers who leave the stock picking to the professionals, but still take total ownership of the decision on whether to own it. On behalf of them and me, thank you. Lesson learned." – Paid-up Stansberry Alliance member Mark T.

"I want to compliment Austin Root for [last] evening's article in the Stansberry Digest. This article should be a 'must read' for all levels of investors. For older investors who sometimes lose sight of the fundamentals to less experienced investors who need a much needed explanation of the importance of financial statements. Kudos to Austin for a job well done." – Paid-up subscriber Frank A.

"As an average investor, Austin Root's explanations regarding reading a company's Balance Sheet, Income Statement and understanding Free Cash Flow are the best I have ever read in all the years I have been studying investing. Adding the information regarding applying the Three Tools to your personal finances was 'the cherry on top of the cake.' Three cheers to you Austin. I'll be looking forward to reading more of your Digest articles. Thank you!" – Paid-up subscriber Christine C.

"Dear Mr. Root, the Digest you wrote is one of the best ever. I have been wanting to ask Mr. Stansberry to do just what you did, only I thought I would sound dumb. Thank you for the Investing for Dummies short course. I especially like the way you gave the example of Xerox and Nvidia. Now I want to go see if I can get the financial statements, look at them, and see where your numbers come from. I suspect there are actual courses on stuff like this. Obviously, I'm not taking them, but what I *am* doing is reading Stansberry newsletters. A friend once told me that if they put real education on the back of cereal boxes then we could all be MBA's by now, one bowl of cereal at a time. That's what you just did. Thanks." – Paid-up subscriber Phil J.

Regards,

Justin Brill
Baltimore, Maryland
July 17, 2018