Heading
into Memorial Day weekend, the S&P 500 closed at its highest level ever,
ending Friday above 1900, breaking through that level for just the second time
ever. But while the market is
sitting just 2 points from all-time highs, all the headlines and all the talk
is how markets are ripe for a correction (10% pullback from the highs). In fact, the higher the market goes,
the stronger the correction talk gets.
Over the last two weeks, analysts across the board were calling for a
correction in the Russell 2000 (RUT), which is the small cap index made up of
mostly tech and biotech stocks.
What those analysts failed to see is that the technical formation is
actually quite bullish. Since last
November, the RUT traded down to 1080 on November 7th, February 5th and most
recently May 15th. Every time the
market traded down to that support level, it rallied higher. 1080 is a very important level to watch
because not only has it been a triple bottom but 1077.49 is the 50% Fibonacci
retracement from the 52-week low to high.
The last two times, a move back to 1080 led to a 9.25% and 12.3%
rally. On February 5th,
the Russell 2000 put in a daily hammer formation (when the market opens, trades
down sharply, only to rally back to end the day near the highs). That technical formation is a bullish
indicator and most traders use the low of that day to buy against. If you look at the price action on
February 5th and May 15th, the open, low, high and close
for each of those days are almost exactly identical. Since May 15th, the Russell 2000 is up 2.7%,
leading both the S&P and Dow during the same time frame. I think the Russell is ready to break
out again for a push back up to 1200.
With that, confidence in the market will come back and investors will
return to those stocks hit the hardest this year like the tech and biotech
sectors.
Perhaps
the most important aspect about the market currently being at all-time highs is
that hedge funds are holding the fewest equity positions since 2008. With most hedge funds underperforming
the broader market last year because of too little exposure to equities or too
many short positions being put on, it’s hard to imagine those same hedge funds
sitting out the next rally higher in this bull market. I expect more money to continue to flow
back into equities, pushing prices even higher.
The
moral of the story is that anytime you hear analysts calling for a correction,
that’s usually a good sign that you should be BUYING and NOT selling. The market isn’t going to drop 10% just
because it’s rallied 35% in the last 18 months. Markets correct themselves because something happens. This stock market has rallied in the
face of oil at $104/barrel, geopolitical problems with Russia and China,
inconsistent housing data, stubbornly high unemployment, “high valuations” for
equities, and lack of global growth.
Since all of this is known, all of this has been priced into the
market. The popular argument for a
market correction is that stock valuations are way to high. But what if they aren’t? Google trades at about 17 times 2015
earnings. But is that really expensive for a company that is expected to grow
earnings by about 20% YoY?
Facebook has a forward P/E of 33 and is expected to grow earnings by
about 28%. Even Amazon can be
considered historically cheap.
Amazon trades at just under a forward P/E of 100, but is expected to
grow YoY earnings by more than 200%.
Then look at a stock like Intel that has rallied in the face of the tech
sell-off. Intel has a forward P/E
of about 13, yet is only expected to grow earnings by 5%. Microsoft is sitting just off its
highest levels since 2000. but the stock trades at a forward P/E of about 14
and is only expected to grow earnings by 6.6%. A lot of money that came out of the momentum names like
Amazon, Facebook and Google, went into these dividend paying stocks that are
actually more expensive when you compare growth rates, and I think the trend will
reverse itself, as it already seems to have begun doing. It’s not too late to buy these stocks,
and I would look to build positions in these names this week.
For
full disclosure, I did take profits in Nike and Southwest Airlines. I had bought Nike based on the chart
and expected a stronger rally but didn’t get it. While I think Nike is a good long-term holding, I don’t see
an immediate catalyst to drive the price higher. I sold Southwest Airlines because I think higher oil prices
are going to hit the airlines this summer. When I look online and see flights to Las Vegas in the dead
of summer are going for almost $500/round trip, I find it hard to believe that
those prices are considered affordable to many households.
My current positions: Long
Ford (F), Toll Brothers (TOL), Gilead Sciences (GILD), SunPower Corporation
(SPWR), Starbucks (SBUX), Macy’s (M), Boeing (BA), Disney (DIS), Google (GOOGL),
long COPPER.
Jeff Lewison
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