Which COVID-19 crisis?
The S&P 500 flies high again and sets another record on Wednesday. Since breaking out above its pre-COVID-19 February 19 highs just four trading days ago, the S&P 500 is now more than + 2.5% above its previous peak. It seems that US stocks are unstoppable.
That we do not forget
It is worth remembering that US stocks bottomed out on March 23, just over six months ago, after rising more than -35% in just 23 trading days. Although the S&P 500 has meanwhile been rebounded to new all-time highs, the CBOE Volatility Index (the VIX) remains more than 50% higher from 14.38 on 19 February to 22.03 today. The 10-year Treasury yield is 87 basis points lower, from 1.56% on February 19 to 0.69% today. Unemployment is almost 7 percentage points higher, from 3.5% in February to 10.2% today. And the total output of the U.S. economy today remains measurably below what it was at the beginning of the year.
The S&P 500 trades in rare air again
Consider the fact that the benchmark index now trades at more than 38 times estimated GAAP earnings in 2020, because valuations again do not matter – because they have not been much over the last decade. That is, of course, until they suddenly have a great deal – as they did in February. Not only are stocks now highly overbought with a relative strength index above 76 and Chaikin Money Flow (CMF) showing the pressure of buying is getting more and more volatile, but the S&P 500 is also trading more than + 6% above its 50-day (blue line in the chart above), + 12% above the 200-day (red line) and + 15% above the 400-day moving averages (pink line).
U.S. stocks are now primed for a correction
The S&P 500 has traded at or near this premium over the past seven calendar years on only four previous occasions at its moving averages. The first took place in January 2014, and US equities subsequently corrected by more than -6%. The following happened in early March 2017, and shares fell by more than -3% next month. The third came in January 2018, and shares subsequently fell by -12% in the battle over the next three months. And the fourth took place at the beginning of 2020, and the shares declined by more than -35%.
When should we expect this stock correction to take place?
Not directly. It’s August, and retail and institutional trading volume remains light at a time when the Fed is averaging $ 4 billion in liquidity in capital markets on a daily basis. If history is a guide, investors should reasonably expect no potential correction to begin until mid-September about three weeks from now, as the period from mid-September to mid-November is historically one where tumult occurs, if it is so likely. . This gives stocks time to consolidate recent gains as the S&P 500 trades from here. Conversely, equities also provide the opportunity to reach an even higher perch of which to correct, if the S&P 500 continues to rise.
How much should we expect stocks to fall once a correction occurs?
Investors should be prepared for the possibility that stocks may fall as much as -11% to -15% from current levels over the next 2-3 months at a time. And if stocks continue to rise in the coming weeks, the size of this potential correction could increase to well above -15%. But it should be noted that any such correction in the short term would not only be a garden route in historically normal market conditions, but it would not even break the emerging trend in the ongoing recovery of the stock markets. Instead, such a return would do no more than bring the S&P 500 back to its 200-day to 400-day moving average, leaving the recent uptrend completely intact.
See the opportunity in any future short-term correction
Should the S&P 500 fall into correction over the next few months, investors should not agitate despair. This is true despite the fact that underlying economic and market fundamentals actually support a more sustainable and pronounced stock market share than what is described above, because the forces of monetary and fiscal stimulus are likely to continue such concerns in the long run. Stock returns are normal and healthy, and investors who allocate or add US shares as part of a broad asset allocation strategy can be well served to use such a short-term return after 200-day or 400 -day moving average support as a time to consider adding to U.S. equities.
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Statement: I / we have no positions in named shares, and no plans to take positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I do not receive compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose share is mentioned in this article.
Additional unlock: I have long selected individual stocks as part of a broad asset allocation strategy. I also long SH and RWM as a hedge against these long individual stocks.
Disclosure: This article is for informational purposes only. There are risks involved in investing including loss of principal. Gerring Capital Partners and Global Macro Research do not provide an explicit or implicit guarantee regarding performance as the outcome of investments made as projections. There is no guarantee that the objectives of the strategies discussed by Gerring Capital Partners and Global Macro Research will be met.
