My Indicator Is Warning Of A Short-Term Pullback
I have a simple forecast for the S&P 500: we’re about to see a short-term pullback.
Let’s start with what we’re seeing on the charts. The chart below shows the price of the S&P 500 is facing resistance at the February highs. The indicator at the bottom is my Income Trader Volatility (ITV) indicator. (More on that in a moment.)
The reason for resistance seems to be that the outlook for stocks and the economy is not as optimistic as it was in February. In February, based on expected earnings, the price-to-earnings (P/E) ratio was below 20. Now, based on expected earnings, the P/E ratio is almost 24. Simply put, stocks are overvalued now.
At the same time, earnings estimates are more than 20% below the level they were at when the S&P 500 peaked in February.
This explains resistance. ITV helps me understand what is likely to happen next.
For those who aren’t familiar, my ITV indicator for the S&P 500 closely mirrors the VIX (volatility index). Because of the way VIX is calculated, I expect it to rise in the next few weeks. Here’s why…
From the white paper that explains VIX: “The VIX Index measures 30-day expected volatility of the S&P 500 Index. The components of the VIX Index are near- and next-term put and call options with more than 23 days and less than 37 days to expiration.”
Right now, VIX is being calculated with options that expire between September 11 and September 25. That’s about six weeks before the presidential election. Over the next few weeks, the options used to calculate VIX will be expiring even closer to the election.
In other words, VIX will reflect the increased volatility associated with getting closer to the election. That means ITV is likely to rise, and that means the S&P 500 is likely to fall.
The history of ITV says the decline is likely to be a short-term pullback. This means we should be cautious, but ready to buy a dip if the decline follows the historical pattern.
How I’m Trading Right Now
My recent trade recommendation is in a stock we’ve traded successfully before:, Ferrari N.V. (NYSE: RACE).
Yes, that Ferrari.
RACE sells luxury sports cars and there are less 250 dealership locations around the world. That’s enough to deliver the company’s output of about 10,000 cars a year. Obviously, their customers are not ordinary car buyers.
Bloomberg has a great analysis of why high-speed sports cars are actually a low-risk business.
The business of making Ferraris is doing embarrassingly well in the pandemic.
Covid-19 has affected the production and delivery of luxury cars, but not demand from the wealthy to acquire them, as analysts have noted. The financial impact of the virus on Ferrari NV’s performance is, for now, looking like only one quarter of lost earnings. Management has handled the crisis well.
Revenue fell 42% year-on-year in the second quarter, with vehicle shipments dropping 48%, Monday’s results revealed. Production slipped after factories were closed to protect workforces, and the shuttering of dealers hampered deliveries.
The company decided against taking the axe to capital expenditures and costs, choosing instead to continue paying staff and to accelerate bonuses for dealers. Hence earnings per share fell 95%, while free cash flow was negative.
Meanwhile, the order book for new cars is “as strong as ever.” The group says its customers’ morale is high. The pandemic supports private car use at all budgets, and Ferrari believes many see a purchase of one of its vehicles as a reward during a time of difficulty.
This has given Ferrari the confidence to be more precise in its guidance for the year. Underlying Ebitda, a measure of profit, is expected to be down just 13%, at around 1.1 billion euros ($1.3 billion). Second-half Ebitda is expected to be up year-on-year, with the performance weighted toward the end of 2020.
Action To Take
This nicely explains RACE’s recent strength. And bullish investors would probably do just fine buying the stock itself. But that strength also offers an opportunity for a quick income trade.
If all goes according to plan, we’ll be out of the trade in less than a month.
To get the exact details of this trade, however, you need to be a member of my premium Income Trader service.
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