The 'bounce' is here... What happens next?... What history says about stocks now... Another reason for caution... The bottom line today...
The market rebound we discussed in Tuesday's Digest could be here...
Regular readers know we've been covering the recent correction in stocks this week. (If you missed our recommendations, you can find them right here.)
Following a 3.6% rally yesterday, U.S. stocks – as measured by the benchmark S&P 500 index – were up another 2.4% today, more than making up for Monday's losses.
Of course, we can't be sure the selling is over for now. It's possible we'll see the major market indexes "test" this week's lows... or even make lower lows – before it ends.
But as we mentioned on Tuesday, the market became extremely "oversold" this week. Many signs were suggesting a strong short-term rally was likely.
Despite the gains of the past couple days, that's still the case today...
On Tuesday, our colleague Steve Sjuggerud explained why history suggested U.S. stocks were likely to move higher, at least in the short term.
Yesterday, he and senior analyst Brett Eversole showed why stocks could move higher over the next year as well. From the latest True Wealth Systems Review of Market Extremes...
The S&P 500 fell 2.1% last Thursday. It fell another 3.2% on Friday. And on Monday, we saw the worst day of all... a 3.9% decline. In total, the S&P 500 crashed 9% in just three days.
A 9% fall in three days isn't a run-of-the-mill fall in prices... it's a serious move. It's the 17th-most-dramatic fall in stocks we've seen since 1970.
The important question is this: What does a fall like this mean going forward?
As you might have guessed, Steve and Brett say history has good news for the bulls. Stocks usually do well after crashes like the one we just saw...
Of the past 16 occurrences of a 9% three-day fall, stocks rose over the next week 75% of the time. And they rose over the next year 81% of the time.
Stocks have risen 4%, on average, one week after these occurrences. And one year later, stocks returned 17.2% on average.
Now, none of this means that stocks can't fall farther from here. But history is clear... The S&P 500 just fell 9% in three days. Since 1970, that kind of decline has been a good thing going forward. We recommend watching your stops closely and staying long.
Our colleague Jeff Clark also expected a short-term rally. As we noted on Tuesday, several of the indicators he follows had hit oversold extremes that often lead to "violent" rallies.
The rallies of the past couple of days have pushed his indicators up from the "extremes" he saw earlier this week. But Jeff says they're still oversold today, and stocks have plenty of room to move higher.
In addition, Jeff says the Volatility Index – known as the "VIX" – gave us a new, broad stock market "buy signal." While the details of this signal are a bit complicated, the important thing to know is these signals are reliable indicators of a short-term market rally.
As you can see in the chart below of the S&P 500, there have been four other buy signals in the past year. In every case, stocks moved higher following them.
Based on the severity of the recent decline, Jeff believes this buy signal could look more like what we saw last October, when stocks rallied more than 10% over the following month...
But like Porter, Jeff believes a more substantial decline could follow this rally. As he explained to his subscribers this morning...
Take a look at this monthly chart of the S&P 500 plotted against its 20-month exponential moving average (EMA)...
I use the 20-month EMA as the defining line between bull and bear markets. If the S&P 500 is trading above the line, stocks are in a bull market. If the index dips below the line, the bears are in charge.
The red circles on the chart show the starts of the bear markets in 2000 and 2007. They both started as the S&P 500 closed below its 20-month EMA, and a few months after the moving average convergence divergence (MACD) momentum indicator turned lower from an extended position.
The red arrows point to the MACD reversals. This indicator gave investors fair warning back in 2000 and 2007. It's giving us a good warning this time as well. The MACD indicator turned lower a few months ago. And the selloff in the stock market over the past week has pushed the S&P 500 below its 20-month EMA.
Now, if you don't understand some of those terms, don't worry. All you really need to know is that the long-term chart of the S&P 500 is showing some of the same warning signs it did prior to the bear markets of 2000 and 2007.
But before you get too bearish, there are a few things you need to keep in mind...
First, as you may know, Jeff is a trader. As editor of the Stansberry Short Report and Stansberry Pro Trader advisories, he focuses mostly on short- to intermediate-term positions – trades lasting several days to several weeks – rather than longer-term investing (the kind Dr. David Eifrig or Dan Ferris specialize in).
By definition, traders are different than investors. They're more "nimble." They often buy and sell more often, use "tighter" stops, and look to make quick profits from small moves.
So while "common sense technical analysis" can be useful, we think it's a mistake for most investors to spend too much time looking at charts. Most folks would be much better off using their time to learn what makes for a great business and how to properly manage risk instead.
Second, as you can see in the chart above, similar signs appeared in 2011. The S&P 500 closed below its 20-month EMA, and the MACD turned lower. But as we discussed yesterday, stocks later reversed and the bull market continued.
Again, this isn't unusual. Traders understand even the most reliable signals don't work all the time. But it's a good example of why it's a bad idea for most investors to put too much weight on chart patterns. More often than not, it leads to little more than frustration and unnecessary transaction fees.
Finally, this signal hasn't "triggered" yet.
This is a "monthly" chart, meaning the end of line on the far right won't be finalized until the market closes on Monday, August 31.
After today's rally, the S&P 500 is slightly above its 20-month EMA. If stocks stay at this level or even move higher over the next two trading days, the signal won't yet be active.
Still, along with several "signs of a top" and Porter's recent warnings, it's one more reason for caution.
So... what should we make of these conflicting signals?
As we've discussed, no one can consistently predict where the market is headed next. But there are some simple things we can do to be prepared for either possibility…
If you were among those who were losing sleep earlier this week, consider this rally a gift.
Use these higher prices to "lighten up" if you had too much money in any particular stocks, or stocks in general. Sell risky or overpriced investments. Consider a "position audit" to ensure you're holding only the best opportunities. And be sure you have an exit strategy for every position you keep.
And if you're finding it difficult to sell now that stocks are moving higher, keep this hard-won advice from Jeff Clark in mind…
Often times, what happens is traders see their stock bounce and then decide to hold onto the trade in anticipation of reversing their losses.
So they lose their chance to exit at a better price.
Inevitably, the market moves lower again and traders end up with an even larger loss than if they had stopped out of the trade right away.
Remember how you felt on Monday. Don't make that mistake again.
Once you're comfortable with your portfolio, we continue to recommend staying long. Keep a close eye on your trailing stops and let them tell you when to sell. Consider holding more cash than usual to pick up bargains down the road, put new money to work only in high-conviction ideas, and think about selling short stocks that are sporting rich valuations.
It's still too soon to be bearish, but there are plenty of reasons for caution.
New 52-week highs (as of 8/26/15): none.
In the mailbag, one subscriber responds to yesterday's question about trailing stops and taxes, and two others write in with their opinions on our recent coverage. Send your e-mails to feedback@stansberryresearch.com.
"Yesterday, Lars was asking for 'approval' to violate his trailing stop on his Berk-B shares. There is an alternative that Doc went through a while back. You could collar your shares using a strike price that takes into account the tax hit on your shares. Use an expiration date of Jan 2016 which pushes the tax liability into next tax year. If done correctly, you could possibly make money on this strategy which is going to increase your tax bill! Thanks." – Paid-up subscriber Mark
Never, never, never stop telling us how to protect our assets from disaster. It is why I am so pleased to see the correction. I know that sounds weird to lots of people. But you all have taught me to take advantage of down turns. For me shopping at Macy's bargain basement. Without that constant reminder many people will pay a foolish price. Oh sure we all know that the thundering bovine herd do this on a regular basis. Thanks to you all we are protected from such foolishness if we so choose. Thanks to all of you for letting me choose to purchase on downturns to make myself and my family wealthier." – Paid-up subscriber Jeff Spranger
Porter et al, having sent a note to you several days ago critical of not discussing the stock market, I now want to send a 'Thank you' for your subsequent analysis. I also want to note that Stansberry puts out a tremendous amount of information on stocks, bonds, commodities, the economy, & politics. I am a happy subscriber to more than a few of your publications & I try my hardest to read thru everything. In the process, I find that I am learning so much more than I ever learned in school. However, while in the process of reading/learning, it is also very easy to overlook/forget some important points that Stansberry has made in previous publications.
"As Stansberry cross-referenced several prior discussions/observations/predictions about the stock market, it did compel me to have several 'head slapping' moments. Of course, I should have remembered those points, but did not as I was focusing on the current issues. And I believe that this leads to a teachable moment: Points that were made previously, may need to be presented again (e.g. capsule 'reminders') for the benefit of those of us who are challenged to have all of this knowledge constantly at our fingertips. Reminders of past points are not only helpful, but important to us readers as is the current topics, discussions, recommendations that you plan on presenting..." – Paid-up subscriber Bob Parker
Regards,
Justin Brill
Baltimore, Maryland
August 27, 2015
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