The one-day slide in the Nasdaq-100 of 2.4% from a record high was a surprise to some. And for good reason: It hints at exhaustion and is a warning sign of more challenging times ahead. In fact, upside momentum is waning as the euphoria surrounding tech companies approaches 1999-2000 levels.
Sure, traditional valuation metrics are not in bubble territory. Plus, there have been some downward revisions to the second-quarter S&P 500 earnings outlook. But the broader-market index is still forecast to grow north of 6.5% on a year-over-year basis.
Still, there are a handful of factors that point to lower stock prices in the nearer term. And I simply can’t ignore them …
Equities are richly valued and leave little room for disappointment. According to FactSet, the forward 12-month P/E ratio for the S&P 500 stands at 17.7. That’s 15.7% above the five-year average, and 26.4% above the 10-year average of 14.0.
There’s been a downshift in economic growth, including paltry job-creation, a downtick in consumer inflation and flatlining manufacturing activity in recent months. There’s also concern that softer economic signals could force a misstep by the Fed. Especially after this week’s plan to begin unwinding its $4.5 trillion balance sheet later this year.
U.S. political uncertainty remains, and the growing partisan divide in Washington presents a significant hurdle for the Trump administration. That includes pushing through their pro-growth agenda like tax reform, repealing the Affordable Care Act and pursuing a bold infrastructure program. This situation is made worse by debt-ceiling negotiations and the latest probe into President Trump for obstruction of justice.
But there’s more.
One of my favorite indicators for market timing is an Artificial Intelligence model developed by my friend and colleague, the late Larry Edelson.
Right now, it shows the uptrend in the Dow Jones Industrial Average is on borrowed time in the nearer term, with a sharp sell-off into the early August time frame …
As you can see, the above chart of the Industrials shows a swift (and large) decline in the coming months. And it’s likely that the selling turns into bouts of panic as the buy-and-hold momentum players rush for the exits at the same time.
I also expect market liquidity to dry up as high-frequency traders dial back risk and adjust their models. That should put even more pressure on prices, just like I experienced while trading bond and currency markets during the 2008 financial crisis.
Take this as a warning call to adjust the risk-profile in your portfolio. Reduce exposure in high-flyer names and free up cash at these lofty market levels. This will help avoid panic and provide fodder for better trades down the road.
In addition, consider taking advantage of historically low equity-market volatility. You can do that by buying downside protection such as September and December put options on the major market indices.
But as was the case in 2008 … and in many market hiccups throughout history … it’s usually darkest before dawn. The stock market will regain traction. And when it does, like the E-Wave Model forecasts, it’ll be time to deploy fresh capital in high-quality blue-chip companies.
The SPDR Dow Jones Industrial Average ETF (NYSE:DIA) closed at $213.56 on Friday, down $0.13 (-0.06%). Year-to-date, DIA has gained 8.13%, versus a 8.55% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of The Edelson Institute.