While my stock market indicators are giving bullish readings, my outlook remains bearish over the longer term. According to a survey conducted by Bank of America Merrill Lynch, roughly 60% of fund managers surveyed also share the belief that we are in final innings of the market cycle, or at least pretty close to its end, at which point equities will begin to spill over again.
Over the last three quarters, we’ve seen a continued decline in earnings across the board, but a high volume of share buybacks has hidden the true earnings picture. I think one of the big questions on investors’ minds is how the stock market can continue to hang up here at current price levels. One of the reasons it has been able to do so for so long is that companies are buying back a lot of their own stock, and they are using cheap corporate debt to do it. Naturally, this shrinks the amount of available stock and cleverly elevates prices in the process.
However, ahead of first-quarter earnings season, a buyback-blackout period is set to begin, and that is a bearish development we have to consider as well. So, if equities prices are to stay afloat, either the deployment of sideline capital into mutual funds or some other bullish factor will need to be triggered for the stock market to keep its head above water.
Moving from the fundamentals to the technical picture, the stock market appears to be in a long distribution pattern, which I believe is eventually going to lead to a breakdown. The small-caps are feeling the pinch too. In fact, they are starting to pull back more than the overall market, which is evidenced by the underperformance of the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) compared to other equity benchmarks.
And it’s in this opportunity that I find today’s trade.
Buy to open the IWM May 101 Puts (IWM160520P00101000) at $1.38 or lower.
After entry, take profits if the IWM hits $103.00 or the option price hits $3.10. Exit if the IWM closes above $111.50.
These are just a few reasons why I’m still very defensive and, while I remain bearish, my guess is that it may take a little while before we see another downward move with conviction. However, when as we approach the month of May, I think the old Wall Street adage will come into play, and that is: “Sell in May and go away.”
This past Wednesday, the Federal Open Market Committee (FOMC) left interest rates unchanged — which is what I expected the central bank would do. The Fed had forecasted four rate hikes in 2016 at a previous meeting, but now that number has been cut back to only two. This was a dovish move, but, of course, it makes sense given the Fed’s political lean and support of the current administration.
On the commodities side, gold has consolidated somewhat this past week, which I alluded to last Friday. However, I believe that gold will ultimately rise following the Fed’s rate announcement as a result of the decline in the U.S. dollar, which is actually starting to give all commodities a little push. This may turn out to be a good opportunity to begin taking new positions in the precious metal, but wait for my potential signal before taking any action.
Over the long term, though, I still believe the U.S. dollar will appreciate in value. Comparatively, the international markets look poor and offer little incentive for investors in search of a safe-haven currency.
Turning to oil, there’s still a lot of available supply out there, so it’s going to be difficult for oil to really sustain any kind of meaningful rally at this point in time. Also, Iran is simply going to continue pumping more oil until it gets to about four million barrels per day or so.
Again, I would say that oil is in the process of creating a complex bottom. It’ll move up and down, and there could be some severe selloffs still ahead. But, even this week, data from the Energy Information Administration showed that the latest inventory build wasn’t as large as analysts were expecting. To be clear, however, inventories did increase, which tells me there’s still a lot of oil out there. So the recent slide in oil prices is really the result of a renewed focus on supply inventory data — even though the increase was not as large as expected.
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