Investing Advice: S&P May Be Facing Huge Corrections

Posted On December 6, 2017 12:11 pm

The market rotation has gone into overdrive over the past few days. We’ve recently discussed how distribution days might be a sign of a coming market correction, but noted that for now these “rolling corrections” have been healthy. After all, the run-up in many large-cap tech companies was unsustainable. Today’s investing advice will involve analyzing this trend in more detail.

What’s concerning is that the action over the past few days is starting to suggest the market might be losing steam. The shifting between stocks and sectors seems to be defensive re-balancing, rather than aggressive new buying.

As the two images below indicate, on Monday the stocks of the S&P 500 that had been the worst performers posted the best gains. On Tuesday it swung back, as the year’s biggest winners posted the largest gains.

Some profit taking in tech was certainly in order as the end of November. Netflix, Facebook and Amazon are each up 60% in the first 11 months of the year. Apple is up 50%. Google, the laggard, is up just 34%. These five stocks have added over $900 billion in market capitalization in the first eleven months of the year.

The Nasdaq, which these companies represent one third of, is up 33% year-to-date, and is on pace to close higher for the ninth year in a row. With double digit returns in six out of those nine years, the NASDAQ 100 has grown 21.5% per year for over this period.  This was unsustainable.

The other side of profit taking seemed to be short covering.  Last week I noted that many of the retailers rebounding might be opportunities to sell, and the graphic below confirms that much of the retail rally was fueled by short covering.

Now, the question is whether this is just another healthy rotation and rolling correction, or does the increase in volatility near these stretched out valuations indicate a potential change in long term trends?

This very long-term chart suggests we might be at a critical point, and our investing advice may have to change accordingly.

At minimum, it feels like we might finally have a more two-sided market, with more trading opportunities.

Stay Tuned.

Related: Try This Strategy as An Alternative to Covered Calls

About author

Steve Smith

Steve Smith have been involved in all facets of the investment industry in a variety of roles ranging from speculator, educator, manager and advisor. This has taken him from the trading floors of Chicago to hedge funds on Wall Street to the world online. From 1987 to 1996, he served as a market maker at the Chicago Board of Options Exchange (CBOE) and Chicago Board of Trade (CBOT). From 1997 to 2007, he was a Senior Columnist and Managing Editor for TheStreet.com, handling their Option Alert and Short Report newsletters. The Option Alert was awarded the MIN “best business newsletter” in 2006. From 2009 to 2013, Smith was a Senior Columnist and Managing Editor for Minyanville’s OptionSmith newsletter, as well as a Risk Manager Consultant for New Vernon Capital LLC. Smith acted as an advisor to build models and option strategies to reduce portfolio exposure and enhance returns for the four main funds. Since 2015, he has worked for Adam Mesh Trading Group. There, he has managed Options360 and Earning 360, been co-leader of Option Academy, and contributed to The Option Specialist website.

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