It might feel worse than it really is...
Granted, the near daily whipsaws we've witnessed recently could cause motion sickness, but the fact of the matter is, despite all the red splattered across the markets, the S&P 500 is still down less than 10% from its January high.
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Now before I dive into some technical analysis -- and what my premium Maximum Profit system is telling my subscribers and I -- let's look at some macro themes to see if we can glean any information on where we might stand, both from an economic and stock market standpoint.
A historically good indicator of whether the economy is headed for a recession is the yield curve, a measurement of long-term interest rates compared with short-term rates. A normal yield curve is when longer-term rates are higher than short-term interest rates. When the yield curve is inverted -- the short-term rates are above the long-term rates -- that historically indicates that the economy is headed for a recession.
You can see a chart of the yield curve below. Note the shaded areas indicate a recession:
As you can see, the yield curve fell below zero (inverted) prior to each of the last seven recessions. And as you can also see, today it's well above the zero line, telling me that a bear market isn't imminent. By all indications, the volatility that we're seeing in today's markets tells me we're still in correction territory.
Now let's look at what the upcoming earnings season might have in store for us...
Earnings Momentum, But Stocks Are Pricey
According to market data research firm FactSet, the estimated first-quarter earnings growth rate for the S&P 500 is 17.3%. If that mark is hit, it would be the highest earnings growth since the first quarter of 2011. So far, 19 companies in the S&P 500 have reported results for the quarter. Of those, 16 have reported earnings per share numbers that beat estimates, and 15 have reported positive sales surprises.
When looking at the market from a valuation basis, the waters begin to muddy. The forward 12-month price-to-earnings (P/E) ratio for the S&P 500 is 16.1. This P/E ratio is exactly in line with the 5-year average, but it is above the 10-year average of 14.3.
Another popular metric is the Shiller P/E ratio, made famous by Nobel Laureate and economist Robert Shiller. This takes earnings and adjusts them for inflation from the previous 10 years. It's also known as the Cyclically Adjusted P/E Ratio, or CAPE ratio.
According to this metric, the market is wildly overvalued. The 10-year average Shiller PE ratio is 16.84; today it's at 32, nearly double. The only time it was higher was leading up to the dot-com bubble in 2000.
So from a valuation perspective, things are on the pricier side of the equation.Let's move on to some technicals...
The Technical Picture
In a previous issue of Maximum Profit, I talked about two technical indicators to keep an eye on. More specifically I said that to the downside we could see the S&P 500 drop to around 2,585, where it would test its 200-day moving average. As we went to print with the last issue on March 23, the market did exactly that... its low for that day was 2,585 level, and it closed at 2,588.
It tested the 200-day moving average, but we haven't seen a significant break below that mark to indicate further downside. But if it does, let's look at where that puts us in the broader bull market...
As you can see, in order for the long-term bull trend to be tested, the market would need to fall nearly 20% to around the 2,300 mark. The good news is if that scenario unfolds, my Maximum Profit subscribers and I will be watching from the sidelines, as our thoroughly vetted sell signals will have us out before that point.
To emphasize, the 200-day moving average, which is currently around the 2,590 mark, continues to be our support, and a key indicator to watch. But looking at the bigger picture, we could see a near 20% correction, and still be within the confines of the broader bullish trend.
Still In "Safe" Territory
Currently, the market outlook doesn't look as bad as the recent volatility might make it feel. By looking at the 50-day and 200-day moving averages of small-cap stocks, we can see that we're still in "safe" territory. That is, we haven't seen the dreaded "death-cross."
When the 50-day moving average falls below the 200-day moving average, it's considered a bearish development among technical analysts. It means a significant downtrend is in place, and more often than not, continued downward pressure will follow.
A good example of this can be seen in 2015 (the last time we witnessed a death cross):
As you can see, in September 2015 the 50-day moving average (blue line) fell below the 200-day moving average (red line). That bearish indicator signaled more pain ahead and, sure enough, stocks continued to drift lower over the next five months.
Using those same moving averages, here's where we are today:
In short, when looking at the yield curve, we aren't near recession territory. First-quarter earnings season could be the strongest in seven years. The long-term bullish trend is still intact, and we haven't seen the dreaded death cross. However, as noted above, valuations are on the richer side of things.
Again, the situation isn't as dire as the recent volatility might make it out to be. We're still within the confines of a correction, which is normal for a healthy bull market. With that said, the Maximum Profit system is telling me to we remain cautious.
Case in point: In our latest issue, the system gave us six sell signals last week. This trims our equity exposure at a crucial time where we'll either be saved from further downside, or presented with fresh new profit opportunities -- depending on what happens next.
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