Stocks Hit IBSS-Predicted Lows
Please allow us to pat ourselves on the back for predicting that the S&P 500 Index would hit the low 1800s before a significant rebound would occur. In fact, on February 12, 2016, the S&P 500’s diversified stock index hit an intraday low of 1810 amidst some severe selling pressure. Fear of another stock market meltdown dominated the headlines. Many market mavens predicted another 2008-like stock market crash that drove stocks down 38% for that year. After all, the S&P 500 was already down over 10% for 2016 in the first 33 days of trading, and there was no sound economic data on the horizon to support a rebound. With the February 12th intraday low of 1810, this major U.S. index re-tested the 1812 intraday low of January 20, 2016.
Like Siamese twins, U.S. stocks and oil prices have been stuck to each other since the middle of 2015. When oil prices crashed in 2015, due to oversupply and lower global economic growth, stocks started their downward trend too. We had shared our caution then that U.S. stocks could dip to the low 1800s. In mid-February, oil hit its low of $26.00 per barrel, and the S&P 500 reached our predicted low 1800’s (1810).
Soon after, rumors about a Saudi/OPEC and Russian agreement to freeze oil production levels infused the markets with hope that oil prices would rebound if production was limited and stronger consumption resumed. These rumors persisted, and oil reversed its downtrend to reach a recent high of $35.00 a barrel. This change in perception plus several switches in investor hopes (1-China will institute more stimulus; 2-U.S. Fed will slow rate hikes; 3-U.S. GDP will be better later in 2016) drove a “relief rally” to 1932 points for the S&P 500 to end February 2016 on a positive note.
Cautions on “Relief Rally”
While a strong stock market rebound in the last two weeks of February was welcome, we are concerned that this quick rally may not be sustainable for the following 3 major reasons:
- During the early-in-year meltdown between January and mid-February, there was never a period of “capitulation,” where stock sellers were in panic mode and stock values reached major lows. Panic selling is an excellent contrarian signal for a sustainable rally.
- The projected S&P 500 earnings for 2016 is $115, which gives us a Price/Earnings (PE) Ratio of 15.7 X at 1810, 16.9 X at 1950, and 17.4 X at 2000. Barring any major economic stimulus, any S&P PE multiple over 16 X is historically high, and stocks will eventually correct back to this multiple (16 X). We project strong resistance for the S&P 500 at 2000 points due to earning uncertainty. Unless corporate earnings improve significantly in the coming months, the U.S. stock market may have a difficult time rallying past an S&P 500 of 2000. An S&P 500 that is over 2000 will be over-valued and subject to a correction.
- The notion that OPEC, Saudi Arabia, Russia, Iran, and other oil producing nations can artificially and cooperatively hold production at levels that are detrimental to their self-interest is a very risky bet. Making investment decisions on this weak proposition alone can cause significant harm to your portfolio.
What To Do
We believe that during these periods of extreme stock market volatility, long-term investors should implement the following strategies and actions:
- With your taxable accounts and IRA rollover accounts, take the opportunity that this “relief rally” gives to sell the stocks of companies with weak earnings to raise cash levels to 20-25%
- Take the cash and buy stocks of select “strong earnings” companies at better prices if the markets correct again and cause the stocks of these strong businesses to meet your target buying prices. Focus on the consumer-oriented stocks with excellent earnings in our Fun Stocks Watchlist™, such as CCL, NCLH, RCL, WYNN, PCLN, DIS, PLAY, SNI, and FB.
- Regardless of market direction, continue your automatic monthly contributions to your 401(k), 403(b), and IRA retirement accounts based on our TSOA Retirement Model Portfolios, derived from our MOAAA tool. And remain fully invested in your employer-sponsored retirement accounts!