- People ignore valuations until there are no more greater fools, then something makes valuations suddenly matter.
- Coronavirus is the something making valuations suddenly matter.
- With a very likely severe economic slowdown coming, it's appropriate to use the "R" word finally.
- I believe that investors should expect what I have termed a "skip-straight recession" with two down quarters spread across a year or two.
- Investors should sell the rallies in the stock market and not buy back until there's a real panic sell-off.
- This idea was discussed in more depth with members of my private investing community, Margin of Safety Investing. Get started today »
Last week I discussed that Coronavirus Is A Match That Lit The Overvaluation Tinder. That piece went over several stock market valuation measures. All pointed to an extremely high risk of a severe correction - think year-end 2018.
It's clear that suddenly the overvaluation in the stock market, particularly the S&P 500 (SPY) (VOO) matters, at least to some people. As usual, it's the smaller investor who is the slowest to adjust asset allocations. As noted in my 2020 Outlook: Euphoria To Despair, the very wealthy, particularly through family offices, have been dialing back equity exposure for over a year now.
For folks who still refuse to understand the severity of the COVID-19 Coronavirus, let me summarize. It spreads similarly as the flu, but is between 15x and 30x more deadly, depending on what type of healthcare you have available.
The COVID-19 Coronavirus is likely to instigate an economic slowdown which could become a global recession. Consider the massive slowdown in China's economy already that accounts for a quarter of global economic output.
From the current, still overvalued, levels of the S&P 500, another 25% correction is growing in likelihood. It's past time for too many investors to take a very serious look at their risk tolerance and asset allocations. I'm reiterating that investors should completely dump the SPDR S&P 500 ETF (SPY), the Vanguard 500 (VOO) and similar funds.
Do Valuations Matter To You?
I have discussed for six quarters now that stock market valuations were very high. A single-digit percentage stock market correction has not changed that.
An argument is often made that because interest rates are low, the stock market can sustain higher valuations. I would agree that is true, however, to what degree should be asked. Should the stock market be the third most highly valued in history?
The chart above shows that despite low interest rates heading toward zero, corporate profits haven't been growing much the past several years. What we have with low interest rates is a period of diminishing marginal returns.
Given that the stock market is a forward-looking projector, what happens when lower interest rates or monetary stimulus cannot push corporate profits higher? What happens when businesses cannot grow or borrow enough to finance growing share buybacks?
In an article two years ago, I stated that The Buyback Bubble Will End Badly. We are close to seeing how badly. According to Goldman Sach, stock buybacks have been the "dominant" source of stock market demand.
Recessions usually trigger a very steep stock market correction. Here it's necessary to remember, that according to the BLS, a recession is:
A general slowdown in economic activity, a downturn in the business cycle, a. reduction in the amount of goods and services produced and sold — these are all characteristics of a recession.
Folks get married to the two consecutive negative GDP quarters shortcut. With China's economy basically taking a quarter off, there's no doubt that we are seeing an economic slowdown.
According to Goldman Sachs, average coal consumption in China has recently been about 40% lower in recent months, home sales have fallen by a quarter and demand for steel was down nearly by half. (WSJ)
Now consider these already flattish to falling U.S. economic numbers.
U.S. PMI was already floundering:
U.S. Employment numbers have been nearly flat for months already:
Germany has trended essentially sideways for five years, but is now showing a breakdown. Will it get worse?
Let's move away from output numbers. What does consumer confidence say?
The confidence chart reminds me of what was happening in the stock market in December and January.
I have been talking to subscribers and clients for about a year now, telling them to expect something I'm calling a "skip straight recession." Essentially, we will likely see a down quarter or two during the next year or two. With Coronavirus, it could be worse than I anticipated.
The S&P Is On Thin Ice
Last week, I suggested that a rally could manifest in the S&P 500 this week. In general, last Friday's daily technical indicators suggested a day or two rally on Monday and Tuesday. We'll see how Tuesday does after Monday's rally. I late day sell-off makes a lot of sense in my mind.
There's also the knee jerk reaction we are likely to get for Super Tuesday depending on which Democrat is perceived to do well. If Bernie Sanders does very well, then I think we see the stock market correct again.
A look at some longer-term charts makes the case for about another 25% correction sometime soon, even if it's not in a straight line.
Here's what I put together two years ago:
As you can see, the December 2018 correction stopped just above the "strong support" line that I set out.
The bottom support is from the double top of 2000 and 2007. I find it almost incomprehensible that would be breached, though it could be approached.
The level around 220-240 SPY makes a lot of sense to me as those are the levels where major resistance was broken three years ago. That's now a major support zone. If the S&P 500 drops to that region, it would represent a 25%-35% further loss on the index.
As you can see, RSI, money flow and MACD all suggest further downside is likely in the intermediate term, even if we get a small rally. I pay particular attention to money flow indicators. More money flowing into stocks pushes prices up and vice versa. Look at Chaikin Money Flow [CMF] around December 2018.
With as weak as the economy is threatening to become, and the spread nature of the stock market support zone, I'm recommending selling all SPY, VOO and similar ETFs.
Send a direct message through Kirk Spano's profile page with the words "half price" in the subject line to receive your first year with Margin of Safety Investing for 50% off.
Find out how our team and resources can help you beat the markets in up and down cycles. Our approach could prove very valuable in a slowing economy with flat earnings and risks rising.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
I own a Registered Investment Advisor, Bluemound Asset Management, LLC, but publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.