Stocks Aren’t Done Getting Crushed
Opinion

Stocks Aren’t Done Getting Crushed

© Lucas Jackson / Reuters

You know the adage: If you're looking around a room and can't find the sucker, then the sucker is you.

Main Street investors probably feel sucker-punched right about now, encouraged by the Dow's 1,000 point rip in just six days and Wall Street's echo chamber touting the strong seasonality of the "Santa Claus" rally — only to see that washed away in the worst start to a year since 2009.

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The Dow Jones Industrial Average is down more than 730 points from its high set on December 26. The reversal has been neck snapping: For the first time ever, the more than 90 percent of the S&P 500 components are below their 10-day moving averages, after more than 90 percent were above this level within the past week.

^INDU Chart

^INDU data by YCharts

Folks were not prepared: According to Jason Goepfert at SentimenTrader, individual investors have skewed their portfolio allocations toward stocks and away from the safety of cash on the largest scale since the dotcom peak in 2000. The latest data from the American Association of Individual Investors shows that people are holding nearly 54 percent more of their portfolio in stocks than in cash — one of the most extended measures of the past 30 years. The long-term average is 36 percent, for context.

^TNX Chart

^TNX data by YCharts

And yet smart-money traders on Wall Street have been slowly backing away, as indicated by measures such as commercial hedging activity in equity index futures and the current relationship between stocks and bonds. The fixed-income market is sending a very, very different signal than stocks are, with the 10-year Treasury yield collapsing below 2 percent on Tuesday for the first time since early 2013. High-yield corporate bonds are under pressure as well.

Stepping back, stocks have been warning of trouble too, if you knew where to look. Breadth has been disappointing for months as fewer and fewer stocks participated in the rally — a sign that the uptrend has become fatigued. At the market peak in December, just 62 percent of the stocks on the NYSE were in uptrends vs. the near 75 percent seen back in November and the near 85 percent from back in July.

The reasons for this fatigue are clear enough: As I’ve written before, the bulls have stretched cyclically adjusted market valuations to well above their historical norms as a time when worries about the Eurozone have reemerged and plunging oil prices are sending troubling signals about global demand. Here at home, we’ve got the Federal Reserve preparing to pull the trigger on the first interest rate increase in nearly a decade.

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These kinds of pullbacks can ultimately create buying opportunities, but for now I continue to recommend defensive positions. As I’ve told my newsletter subscribers, the selling looks far from over.

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