When It Makes Sense To Avoid Trades And Wait…
It’s rare, but it happens. This week, over at my premium Income Trader service, I told my subscribers to sit tight. There would be no trade recommendation this week.
If you’ve been following along with my commentary recently, it’s easy to see why. As I said recently, this is a news-driven market right now. And there’s a lot of conflicting news. Then, of course, there’s the 600-lb gorilla in the room: the fast-approaching election.
Here’s what I said in this piece about the dangers posed by the election:
I’ve been expecting volatility before the election, and we are likely to see volatility increase from here. There are still three weeks left, but my forecast is for a week at a time because I believe we could see several price swings during that short time. It’s entirely possible we will see both an upswing and a downswing before the end of the month, with the upswing coming first.
Earnings Season Adds More Risk
Adding to this is the fact that we are in the midst of earnings season. About half of the companies (249) in the S&P 500 are expected to report this week or next.
I purposefully avoid holding open positions in companies that are planning to announce earnings while our trades are still open.
That choice is especially prudent this quarter. Companies that missed earnings have dropped an average of 5% on the news. This is nearly double the five-year average selloff of 2.6% associated with an earnings miss.
Fortunately, few companies are actually missing estimates. Just 14% of companies have missed expectations so far this quarter. That’s about half the average miss rate of 27%.
But even though we’re seeing more companies than average beat expectations, the news below the headlines is still pretty grim.
On a year-over-year (YoY) basis, earnings per share (EPS) for the companies in the S&P 500 are down 18.4%. This is better than the latest quarter when EPS fell 31.6%, but it also marks the sixth time in the past seven quarters that EPS fell on a YoY basis. Only one sector (health care) out of 11 is showing an increase compared to the same period in 2019.
Things aren’t quite as bad when it comes to revenue. Sales are down 3.4% year over year, the second consecutive quarter of declines. Six sectors are reporting gains compared to 2019.
Of course, analysts expect next quarter to be better. Earnings per share are expected to be down just 8% compared to the fourth quarter of 2019. In 2021, Q1 earnings are expected to be about 90% of what they were for the same period in 2020, and analysts are expecting a 50% YoY gain for the second quarter.
Am I being too cautious? I don’t think so. I think preserving capital when risk is high is one of the most underrated traits of a good trader.
So I am more cautious. I believe there is a strong possibility of localized shutdowns because of a new wave of coronavirus. Nationally, this will be the third wave, but, in some areas, it will be the first wave. The epidemic has been hitting different parts of the country harder than others every month. That makes it impossible to predict the economic impact of the shutdowns and the effect this will have on earnings.
The only certainty is that we should remain defensive through the end of the year as the epidemic continues to impact the global economy.
I expect to find a new trade next week after the earnings uncertainty eases. There will still be risks associated with the election, but those risks are more predictable than earnings. The election is likely to drive a trend in the broader stock market rather than lead to declines in just a few stocks as earnings news does.
In the meantime, something you should consider right now is a safe haven like gold…
It’s well-known that during times of uncertainty, money flees to safe haven assets. And gold is the best among them…
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