After running up four months straight, the stock market has
fallen into a correction. While profit-taking after such a long
run should come as no surprise to ETF investors, there are
reasons to be cautious about expecting a quick rally.
Here are five warnings that show how the stock market is very
weak and could get weaker:
1. High-volume distribution.
SPDR S&P 500 ETF (
) shot up to a four-year high of 148.11 on Sept. 14 and then
turned tail, closing in the lower half of its intraday range.
Since then trading volume on the red days has outweighed volume
on the up days. SPY has logged seven distribution days in the
past few weeks. This suggests institutions are selling more than
buying and buyers' strength is waning.
"The International Monetary Fund caused the market sentiment
to dip when it indicated that 'risks for a serious global
slowdown are alarmingly high,' in their World Economic Outlook
report, which was released in Tokyo on Tuesday ahead of the
fund's annual fall meeting," said Mark Martiak. He is senior vice
president of Premier Financial Advisors in New York with $300
million in assets under management. "It was its bleakest
assessment of global growth prospects since the 2009
Lee Munson, chief investment officer at Portfolio LLC in
Albuquerque, N.M., recommends traveling to China for bargain
"China, while ugly beyond belief, is selling at a 20% discount
to emerging markets," Munson said. "This is a first. If you want
value, and think a hard landing has already been priced in, then
China and emerging markets should be the place from now until the
end of the year."
IShares FTSE China 25 Index (
),SPDR S&P China (
) andPowerShares Golden Dragon Halter USX China Portfolio (
) offer easy access to the People's Republic.
2. Weak earnings outlook.
Earnings -- the biggest drivers of stock prices -- look ugly.
Throngs of companies have issued negative pre-earnings
announcements owing to slowing demand overseas as the global
economy weakens. The negative-to-positive preannouncement ratio
for the third quarter is 4.3, the weakest since the third quarter
of 2001, according to Pat O'Hare, chief market analyst at
Third-quarter corporate earnings are expected to drop 2.9%
from the year-ago period, marking the first quarterly decline
since 2009, according to Thomson Reuters.
"Q2 was an exercise in accounting. Most of S&P 500 missed
on revenue and hit on earnings. Accountants earned their keep in
Q2," said Andrew Norman, an analyst at BullandBearMash.com in
Plano, Texas. His firm specializes in analyzing the S&P 500,
Dow and Nasdaq 100 indexes.
"The only thing that will save revenues in Q3 will be channel
stuffing. That's where the sales people call their distributors
and play 'let's make a deal.'"
"There is too much unsold product to stuff in an already
stuffed channel," Norman added. "The auto industry has been
stuffing going back to 2010. Channel stuffing is a process, not
an event. The issue arises when channels overflow."
A major Dow industrial component,Alcoa (
), kicked off earnings season Tuesday night on a sour note. Owing
to poor demand and low aluminum prices, the aluminum maker lost
$143 million, or 13 cents a share, vs. a profit of $172 million,
or 15 cents a share, in the year-ago period.
Fellow Dow member,Chevron (CVX) said third-quarter earnings,
due out Nov. 2, would be "substantially lower" than the prior
Engine makerCummins (CMI) lowered its 2012 outlook for a
second time this year.
3. As goes Apple...
Apple (AAPL) has fallen below its key 50-day moving average
and is trading 10% below its 52-week high. It corrected 19% from
April to May this year. It fell 15% peak to trough between
October and November last year. So it could sink considerably
more while staging a normal correction.
The tech giant accounts for nearly 20% ofPowerShares QQQ (QQQ)
and 4.4% of SPY. As a major holding in those indexes, Apple could
take both indexes down with it.
"The tide may be turning for the stock, at least in the short
term," said Vahan Janjigian, chief investment officer at
Greenwich Wealth Management in Greenwich, Conn. "But the Apple
story is not over. The company makes great products and it will
continue to do so."
Janjigian added: "However, I believe there has been too much
enthusiasm for these products. Whether it is a new iPhone, a
smaller iPad, or Apple TV, the stock runs up in anticipation and
in reaction to these products."
"It's normal for investors to take profits on the stock as
analysts cut their sales outlook for iPhone 5 sales because of
supply problems," said Alan Zafran, partner at Luminous Capital
in Menlo Park, Calif. He also cited Normura's report of possible
slower growth in 2014 but the stock trades at cheap
"One can hardly call Apple shares expensive, currently trading
at 12.5 times forward earnings, whereas shares ofGoogle (GOOG),
for instance, trade at 15.3 times forward earnings," said Zafran.
"Meanwhile, you have a product wildly in demand, iPhone 5, two
other products along the way, iPad mini and iTV, and potential
significant growth in China in 2013."
4. The smart money is short.
The so-called "smart money," or commercial traders in S&P
500, S&P 400 and Nasdaq 100 index futures, are overwhelmingly
short the market, or betting it will go down, according to the
Commitment of Traders reports
. Meanwhile, the so-called "dumb money," or noncommercial traders
such as retail investors and speculators, is overwhelmingly long.
More-knowledgeable commercial traders are more likely to be right
than retail traders, who are generally wrong. Of course, that's
not always the case.
5. History suggests caution.
October may be the new September. The market didn't sell off
in September, so it's due for a correction. Historically, the
market dreads September, which has been the worst-performing
month of the year for the Dow and S&P 500 since 1950,
The Stock Trader's Almanac
. It's been the worst month for the Nasdaq since 1971 and for the
Russell 1000 and Russell 2000 since 1979.
"Performance does improve modestly in election years, but it
is still negative nearly across the board," the Almanac stated in
a client note in August. "Only the small caps of the Russell 2000
have been able to escape negative territory and post a modest
0.4% average gain in the last eight election-year
"Measured on a long-term basis, the stock market typically
rallies from it's midyear correction, bottoming out in September
or October, and then rallies again into year end," said Brian
Schreiner of Schreiner Capital Management of Exton, Pa. "But
given all the variables investors are contending with right now,
there are a whole range of outcomes with relatively high
probabilities in play."