What to Watch If the Market Starts Falling Again

The streak is over... These signs point to an imminent correction... The 'Wuhan virus' could be the catalyst... What to watch if the market starts falling again... Your second chance to buy into the world's best-performing sector...

Last Monday, January 27, the benchmark S&P 500 Index fell roughly 1.5%...

The size of the decline was nothing remarkable. But that day's performance was noteworthy for one reason...

You see, prior to last Monday, stocks hadn't closed even 1% lower for 74 days in a row. The market has rarely been so tranquil for so long...

In fact, it was tied for the fourth-longest streak in the past 20 years. And if history is any indication, at least a short-term correction could be just around the corner...

The previous streak of 74 days came to an end on October 9, 2018...

The next day, the S&P 500 fell more than 3%. And it ultimately plunged a total of nearly 20% over the next few months, bottoming on Christmas Eve in 2018 before bouncing back.

Before that, the market racked up an all-time record of 112 straight days without a 1% decline through late January 2018... and then proceeded to plunge nearly 12% in two weeks shortly afterward.

Rounding out the top five longest streaks without at least a 1% decline were December 2006 and March 2017... where the streaks extended to 94 and 109 days, respectively.

Unlike the other two examples we mentioned, these streaks occurred in the middle of strong rallies. Yet even in these two instances, the market experienced short-term pullbacks of roughly 5% over the next month or two before resuming its uptrend.

But this isn't the only sign that the market is due for a 'breather'...

Last month, I (Justin Brill) mentioned that several measures of market sentiment have been hitting rare extremes. One of the most notable is the Chicago Board Options Exchange's ("CBOE") equity put/call ratio...

As regular Digest readers may recall, this ratio compares how many put options individual investors are buying versus how many call options they're buying. And like other sentiment measures, it's contrarian in nature.

When folks are buying many more put options (bearish bets on stocks) than call options (bullish bets), the CBOE's put/call ratio jumps higher. That tends to be a bullish sign for the market. It signals the "crowd" is too bearish... and at least a short-term rally is likely.

On the other hand, when folks are piling into call options relative to put options, the CBOE's put/call ratio drops lower. This is often a bearish signal. It's a sign that the crowd has gone "all in"... and at least a short-term pullback is likely.

Because this indicator can be extremely volatile on a day-to-day basis, you'll often see it presented as a moving average to help smooth out its swings.

Earlier this month, we noted one such moving average had plunged to a rare extreme...

Specifically, the CBOE's 10-day put/call ratio – which, as the name implies, is simply the average of this ratio over a rolling 10-day basis – had just dropped below its January 2018 extreme. As we wrote in the January 10 Digest...

[In November], the 10-day CBOE put/call ratio [fell] to its lowest level since late January 2018 – just days before the S&P 500 plunged more than 10% in that February's "volatility panic."

As you can see in the chart below, this indicator has now fallen below even that previous extreme...

This trend has continued in recent weeks...

The CBOE's 10-day put/call ratio fell to another fresh low in late January. And now, an even more significant measure has joined it...

In the following chart, you can see the S&P 500 tracked against the CBOE's 50-day put/call ratio. Again, as the name implies, this is a rolling average of the put/call ratio over the previous 50 days. As a result, it takes an even greater and more sustained trend in the daily put/call ratio for this measure to hit an extreme.

And as you can see, that's exactly what has happened...

The CBOE's 50-day put/call ratio recently fell below 0.56 for only the ninth time on record. And like the historic streaks we mentioned earlier, previous extremes in this measure have often been a bearish short-term signal for stocks.

In fact, seven of the previous eight extremes were followed by a correction of 5% to 15% over the next few months. The only exception was December 2010, when the S&P 500 rallied another 10% in the five months following this signal.

But even in that case, the market eventually gave up all those gains and more. It lost a total of 22% over the next five months... good for a net decline of about 12% from when the signal was first triggered.

Our friend Jason Goepfert has been following the extremes in the options market as well...

Regular Digest readers know Jason publishes one of our go-to websites, SentimenTrader.com. He tracks hundreds of sentiment readings to figure out what folks love and hate in the markets at any given time.

And today, he's also concerned about stocks. As he explained in a note to subscribers in late January...

Perhaps the most telling measure of speculative excess is when options traders buy an extreme number of speculative call options. These are opening customer transactions on a leveraged, expiring contract that can only profit with one market direction, the very definition of speculation. And it just hit a record high for the [second] week in a row.

[In the week ending January 17], customers bought 22.8 million call options to open, exceeding the record from the prior week of 21.6 million contracts. The only other week in the past 20 years that neared 20 million contracts was 19.8 million during the week of January 26, 2018.

Like us, Jason and his team believe these extremes could lead to a sharp pullback in stocks over the next few months...

Among everything we follow, this kind of behavior is by far the most troublesome and should be a major worry for anyone buying with a medium-term time frame.

These are just a few of the sentiment indicators that suggest folks have become dangerously complacent today...

Meanwhile, as we also noted in the January 10 Digest, the market had become more "stretched" above its 200-day moving average ("DMA") than at any time since its January 2018 peak...

In short, almost everything has lined up for a brief – but potentially violent – sell-off in stocks.

Of course, astute readers will point out that this has been the case for several weeks now. And yet, the market has continued to surge higher.

The one thing that has been missing so far is a good excuse – a "catalyst" – for folks to start selling. And now, it could be here...

Several of our colleagues believe fears about the emerging 'Wuhan virus' may fit the bill...

In last Monday's Digest, we shared the following chart from Stansberry NewsWire editor C. Scott Garliss. It compares the market's recent price action with what happened during another coronavirus-related scare – the severe acute respiratory syndrome ("SARS") outbreak in 2002 and 2003...

The S&P 500 fell more than 10% during that scare, before ultimately ending the year higher. Scott believes we could see something similar this time around. Below is the same chart updated through midday trading today...

DailyWealth Trader editors Ben Morris and Drew McConnell agree...

Like us, they believe the market is overdue for a shakeout. And they think the coronavirus outbreak could be the trigger. As they explained to their subscribers on the same day as Scott's update...

Investors are worried about the spread of the contagious coronavirus in China and around the world... The potential for this to get a lot worse is scary. And it is disrupting China's economy, which is bad for business and stocks.

Back in December, stocks were up a lot in a short amount of time... But there wasn't a major catalyst for a pullback. Now, coronavirus provides that catalyst...

Investors' imaginations are now running wild with a high degree of uncertainty. What will come of coronavirus? How long will it continue? How far will it spread? What will the economic effects be? It's a real catalyst for a drop.

If a significant correction is starting, Ben and Drew believe the 200-DMA should be a strong area of "support." More from the issue...

If we see a deeper pullback, the S&P 500 could fall to its 200-DMA... That would be a 10% drop from the recent peak. If this happens quickly, it wouldn't have much of an effect on the uptrends in the S&P 500...

That level – around 3,000 – is also in the area where stocks topped out in July and September, before they broke out in October.

As always, there are no guarantees that the market will move lower immediately...

The S&P 500 fell nearly 4% from its most recent peak through last Friday's close. But as of midday today, it has since recovered more than half of those losses this week.

It's possible that the market will continue even higher – and the extremes we've cited in today's Digest will become even more extreme – before it finally takes a "breather."

Like us, Ben and Drew recommend holding plenty of cash and "hedging" with some positions in precious metals to protect yourself, just in case. (We'd also suggest adding a few short sales as well.) But make no mistake, they're not turning bearish just yet...

In spite of what's happening with coronavirus, if the S&P 500 drops to its 200-DMA, we would see it as a major buying opportunity...

If stocks drop 8% to 10%, investor sentiment will be bearish. But the long-term trend in stocks will likely still be up. So we'll look to add new bullish positions in our top market sectors.

Speaking of top market sectors...

If you read last Tuesday's Digest from our colleague Bryan Beach, you know one tiny corner of the technology sector has dramatically outperformed other tech stocks over the past 15 years.

In fact, this group has trounced almost every other investment on the planet over that time.

It has returned 11 times more than gold... five times more than the Russell 3000 Index... and nearly double the super-popular "FAANG" stocks (Facebook, Amazon, Apple, Netflix, and Google's parent company Alphabet), just to name a few.

All told, these companies – which operate a special kind of software business known as Software as a Service ("SaaS") – have returned an incredible 56% per year, on average, for more than a decade.

Bryan says the reason for this tremendous outperformance is simple...

SaaS businesses are absurdly "capital efficient."

As longtime Digest readers know, capital-efficient businesses are able to grow rapidly without needing to reinvest large sums of money into things like new buildings, factories, and equipment.

Software has long been one of the most capital-efficient industries out there. But as Bryan noted, the SaaS model has raised the bar even further...

SaaS is the most capital-efficient sector of the already capital-efficient software space.

The secret of the massive success of the SaaS model is that it isn't just capital-efficient for software vendors... It's also the most capital-efficient way for customers to access and use software.

Given this fact, it's no surprise that SaaS stocks have been among the best-performing stocks in this bull market to date.

And if our colleague Steve Sjuggerud is correct about the "Melt Up" – and we see a massive, final rally that pushes stocks to unimaginable new highs – these stocks will likely continue to lead the way higher.

There's just one problem...

Most of these stocks have soared so high and become so expensive that it's difficult to recommend buying them today.

Now, as Bryan noted, SaaS stocks rarely look "cheap" by traditional valuation metrics due to their tremendous growth rates. But even by that lofty standard, many of these stocks look dangerously overpriced. More from last Tuesday's Digest...

[These companies] typically trade for more than 10 times sales – compared with less than four times sales for the S&P 500. (Shopify traded at about 10 times sales when we recommended it... and now, it trades for a whopping 38 times sales.)

Buying into the hottest sector of an 11-year bull market isn't a recipe for success. And at this point, if you blindly buy an SaaS business, you could get burned... Hypergrowth is likely in the rear-view mirror for stocks that have already run up five or 10 times.

Fortunately, Bryan has discovered a 'loophole' of sorts...

He and his team have uncovered a handful of "hidden" SaaS stocks.

These tiny, early stage companies employ the same highly capital-efficient business model as top performers like Salesforce (CRM) and Shopify (SHOP)... whose shares have soared more than 5,000% and 2,000%, respectively, since they began trading.

Yet for various reasons, these companies are still effectively unknown by Wall Street and the general public... which means you still have the chance to get in well before they become household names and their shares take off.

Bryan believes these stocks present the best opportunities among SaaS companies in the market today. He says each of them could easily grow 10-fold over the next few years.

If you missed out on the big rally in SaaS stocks over the past several years, consider this your second chance... These stocks offer a rare opportunity to both speculate on the Melt Up and invest for the long term at the same time.

We've prepared a special presentation with everything you need to know... including how you can get instant access to Bryan's research on "hidden" SaaS companies for more than 65% cheaper than what other folks have paid. Click here for all the details.

New 52-week highs (as of 2/3/20): CBRE Group (CBRE), Dolby Laboratories (DLB), DocuSign (DOCU), Ingersoll Rand (IR), Microsoft (MSFT), Sea Limited (SE), and Essential Utilities (WTRG).

In today's mailbag, we answer a few questions about our annual Report Card and share more feedback for our colleague Dr. David "Doc" Eifrig... Have a question or comment? As always, you can shoot us an e-mail at feedback@stansberryresearch.com.

"Did I miss the report card for the Gold and Silver Advisory?" – Paid-up subscriber Jim B.

Corey McLaughlin comment: Yes, it appears so! We published the grades for John Doody's Gold Stock Analyst and Silver Stock Analyst, as well as Stansberry Gold & Silver Investor, in the second part of our annual Report Card on Friday. (And if you also missed the first part on Thursday, you can read that right here.)

"I want to tell a story about the kind of person Doc is, at least how I see/view him. (Most/all know this already.) We all know about December 2018... Fed Powell causing the market selloff. In January 2019, [the 2018 Stansberry Research Report Card] comes out and Doc gets a ["B+" in Income Intelligence and a "B" in Retirement Millionaire].

"Nobody makes money every month and I understand this. What does Doc do? He sends an e-mail to all, apologizing for his bad results in 2018. This guy has such INTEGRITY... such a class move by him.

"Doc, a bad month is not the whole year, sir. The level of your excellence from your research is amazing. Thank you for your education with options. Thank you for being human with your thoughts. Thank you for your class. Thank you for all your health information, which just adds to your greatness.

"Thank you Porter for hiring Doc and the two of you joking with each other. Investing is boring and we need to poke fun at each other from time to time!" – Paid-up subscriber Jeff R.

Regards,

Justin Brill
Baltimore, Maryland
February 4, 2020