Be Careful With Highfliers in This Market

by Sam Collins | August 6, 2013 4:00 am

Stocks traded slightly lower on Monday, with eight of the S&P’s 10 sectors falling. But volume was light, and several floor traders attributed the pause to regrouping after an outstanding run higher in July.

Weaker-than-expected jobs numbers on Friday were a disappointment, but yesterday they appeared offset by a strong nonmanufacturing index — the ISM Services number came in at 56 in July, up from 52.2 in June. But the market seemed most affected by a statement from Dallas Fed President Richard Fisher, who said that the current bond-buying program could be a “misallocation of resources and [could] fuel inflation.” He expects a slowdown in bond buying before the end of the year.

At the close the Dow industrials were off 46 points at 15,612, the S&P 500 fell 3 to 1707, but Nasdaq rose 3 points to close at 3693. The NYSE traded 8.5 million shares and Nasdaq crossed 6.4 million shares. Decliners outpaced advancers on the Big Board by 1.5-to-1, but on Nasdaq advancers were ahead by 1.3-to-1.

08062013 collins nasdaq high
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08062013 collins rus 2000 high
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Note that both Nasdaq and the Russell 2000 (which represents small- and mid-cap stocks) have broken above their channel trends. Some technicians refer to this as “going exponential,” which merely means that prices are moving higher and faster each day. But while Nasdaq — the higher-quality index — has a fresh MACD buy signal, the Russell has triggered a MACD sell.

08062013 collins nyse reversion to mean
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Even the more conservative NYSE Composite broke above its channel trend (back in May). The breakout, however, was quickly followed by a selloff that dropped the index to the bottom of a channel just above its 200-day moving average. This is called a “reversion to mean,” and from there it resumed its advance.

Conclusion: According to FactSet, the S&P 500 is now at 14.6 times 12-month forward earnings (over the past 10 years, 14.2 is average). This fact is telling us that the better-quality stocks are slightly overpriced on a price-to-earnings basis, and so they tend — as illustrated by the higher-quality NYSE Composite — to trade within the established bull channel with less volatility than lower-quality stocks.

However, traders and speculators have driven the lower-quality small- and mid-caps — which have less international exposure and higher growth rates, but also higher P/E ratios — above their trend channels. This scenario is dangerous; they are volatile and more subject to a correction than the higher-quality equities.

Those who play the higher-P/E stocks should be vigilant since they, too, could have a “reversion to the mean” and succumb to a round of profit-taking. Be careful out there — chasing high-P/E stocks could be hazardous.

Today’s Trading Landscape

To see a list of the companies reporting earnings today, click here[2].

For a list of this week’s economic reports due out, click here[3].

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