Why to Sell When Wall Street Says 'Buy' and Vice Versa

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The chicken is clueless about the egg's fate. Will it hatch or become an omelet?

Wall Street is clueless about their forecasts, will they 'hatch' or become egg on their face? Who cares; as long as it sounds good at the time, Wall Street's opinions are promoted by the media. Is this a haphazard approach? Judge for yourself.

The most recent Wall Street blunder was the over emphasis on positive earnings in April. Here are some of the headlines Wall Street and the financial media featured late April 2011:

Morgan Stanley shares rise as earnings beat estimates
Stocks, commodities rise as earnings top estimates
Leading U.S. indicators, consumer confidence gain as fuel costs discounted
World revs up U.S. profits
The Global economy is improving
The S&P breaks out
The Dow's going to 20,000
Sales growth the big surprise on Wall Street
Buffett says odds of another U.S. banking crisis low
Equities finally seeing light on the economy
Stocks find sea of tranquility

Flawed Reasoning

The chart below, featured in the September 2010 ETF Profit Strategy Newsletter, reveals the flawed reasoning behind Wall Street's expectations. It plots Earnings per Share ( EPS ) against GDP and U-6 unemployment numbers.

                

Notice how earnings for Q1, Q2, and Q3 2011 were supposed to reach a new all-time high. There were at least four reasons why record high EPS estimates were not long-term bullish:

1) GDP was contracting, U-6 (and every other measure of unemployment) did not signal a recovery. Every spike in EPS would be temporary and unsustainable.
2) EPS estimates are just a projection and are about as valuable as an un-hatched egg.
3) The last time EPS reached an all-time high was in Q2 2007. We all know what happened thereafter.
4) EPS or P/E ratios can be distorted via financial trickery. Financials (NYSEArca: XLF) and banks (NYSEArca: KBE) took advantage of this when accounting rule FASB 157 was changed on April 2, 2009. This allowed banks to hide trillions of dollars of unrealized mortgage losses in an accounting loophole that doesn't affect the income statement and earnings. Thus some of bank's losses were included in earnings numbers.

The ETF Profit Strategy Newsletter's conclusion was simple and straight to the point: 'Buying at current prices with the expectation of long-term gains is almost certain to deliver despair and tears.'

Proceed With Caution

P/E ratios or EPS aren't a short-term timing tool and didn't prevent stocks from rallying since the above analysis was featured in the September ETF Profit Strategy Newsletter.

Nevertheless, a major market top was expected. The April 3 ETF Profit Strategy update put it succinctly this way: 'In terms of resistance levels, the 1,369 - 1,382 range is a strong candidate for a reversal of potentially historic proportions. Bullish bets should be watched very carefully, especially once stocks move above 1,356.'

The Summer 2011 meltdown erased all gains going back as far as December 2009. Yes, over 18 months of gains were eliminated within a matter of weeks.

Financial Serial Offender

If Wall Street was subject to the 'three strikes you're out' rule, there wouldn't be any financial offices in New York. By now it's common knowledge that Wall Street was overly optimistic in 2007 - right before the financial collapse - and overly pessimistic at the March 2009 lows - the beginning of a 100% + rally for the major indexes a la S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC).

More recent financial offenses include Wall Street's ill-advised fascination with silver in late April. On April 27 the Wall Street Journal ran a front-page article entitled 'Silver rush spreads to stock market.' The commentary read as follows: 'The metals are increasingly considered attractive as a permanent store of value that doesn't diminish like paper currencies.'

The ETF Profit Strategy Newsletter didn't call the exact top in silver, but it did recommend to short silver (NYSEArca: SLV) once it comes back down below 44.64 and covered short positions at 32 for a 23% gain.

The Third Strike

Probably freshest in our memory is Wall Streets indiscriminate endorsement for gold (NYSEArca: GLD) as the only safe haven. Below are just a few headlines from August 22:

'Gold at $1,870 is being seen as a haven' - Forbes
'Is $5,000/ounce the new target in gold's run?' - Barron's
'Gold in portfolio is mandatory' - MoneyControl.com
'Gold prices poised to go parabolic to $2,100'  - Beacon Equity Research

On the night of Sunday, August 28, I warned subscribers via the ETF Profit Strategy Newsletter: 'I don't know how much higher gold will spike but I'm pretty sure it will melt down faster than it's melting up. This week's resistance is at 1915 and 1,975.'

Gold briefly squirted to 1,915 and fell more than $150 thereafter.

What's on the Menu Today?

Every investor should wonder what Wall Street is trying to 'sell' us today.  Following the summer meltdown, a unanimous consent (or sales pitch) is harder to find that it was a few months ago.

Wall Street's bias seems to be a 'buy the dip' kind of strategy, which means we should be very selective in buying the dips.

When the S&P 'dipped' below the 200-day MA on August 2, buying the dip didn't work. The July 28 ETF Profit Strategy update warned that: 'A break below the 200-day SMA and the trend line may trigger panic selling. '

Stocks have staged a weak rally over the past two weeks but the S&P is still more than 100 points below the 200-day SMA. The ETF Profit Strategy Newsletter has conducted various studies to formulate a short-term forecast and the results are nearly unanimous (and the opposite of Wall Street's guidance).

This short-term forecast is available via the ETF Profit Strategy Newsletter , which uses fundamental, technical and sentiment analysis to compose semi-weekly forecasts along with actionable trading recommendations.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: EPS

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