Avoid Bursting Bubbles

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The stock market is growing narrower … how to position your portfolio in strength … an example of a bubble stock waiting to get pricked

We’re going to go into the bumpy summer months, and it’s going to get narrow, and it’s going to be every stock for itself … boy, there are some bubbles out there to be pricked.

That quote comes from famed investor, Louis Navellier. It’s the takeaway from his Special Market Podcast on Wednesday.

For newer Digest readers, Louis is one of the early pioneers of using predictive algorithms to scour the markets for quantitatively-strong stocks. Forbes actually named him the “King of Quants.”

This numbers-approach has helped Louis produce decades of triple-digit winners for his private clients and subscribers. Given this, when Louis provides a market forecast, we pay attention.

So, in today’s Digest, let’s find out how he’s viewing the markets right now, and how to prevent your own portfolio from “getting pricked.”


***What is the recent market weakness telling us?

 

Louis begins his podcast by contextualizing the weakness in the market from earlier this week.

He notes how stocks need to consolidate their gains. And given that volume was light when the markets were rising several days ago, this suggested that stocks were about to roll over.

Volume is big for Louis. It’s one thing for the markets to pull back. But what we want to avoid is a sustained, declining market with heavy volume.

Fortunately, Louis doesn’t see this happening in our immediate future. There are three bullish reasons why, and they all boil down to one thing — institutional buying pressure.

From Louis’ Accelerated Profits update on Wednesday:

The first is the annual Russell realignment, which takes place after the market close on June 26. The new indices will begin trading on Monday, June 29, so I expect to see a lot of our stocks pop on institutional buying pressure as they’re added to the Russell indices.

The second factor is quarter-end window dressing. This is when investment managers try to make their portfolios “pretty” with the best-performing stocks from the quarter. So, they buy our stocks, as these are the creme de la creme.

And third, we’re benefitting from the 90-day ETF realignment. As the ETFs rebalance and adjust their weightings, the weightings of our stocks are also increased, which gives them an extra boost.

Now, let’s digress a moment …

Above, Louis references “our stocks.” This makes sense as he’s speaking to subscribers.

But for non-subscribers reading this Digest, it’s important to understand the type of stock Louis targets. This will provide greater context for Louis’ added market views we’ll discuss in a moment.


***Louis’ numbers-based market approach

 

As noted earlier, Louis is a quant investor. In other words, he bases his market activity on cold, impartial numbers instead of hunches or guesses.

In doing this, Louis analyzes eight key fundamental factors:

  • sales growth
  • operating margin growth
  • earnings growth
  • earnings momentum
  • earnings surprises
  • analyst earnings revisions
  • cash flow
  • return on equity

So, when Louis references “our” stocks, he’s referring to a specific mix of variables that generally reduce to one thing — earnings strength.

Fortunately, Louis offers a free tool which you can use as a diagnostic for the earnings strength of your own stocks — his Portfolio Grader. It evaluates a stock according to the same variables just identified.

Now, returning to Louis’ podcast, he’s comfortable with his portfolio-positioning. And that’s especially important right now, since we’re just a few weeks away from what is likely to be a highly-divisive second-quarter earnings season.

As Louis notes in his podcast …

… there are bubbles out there to be pricked.


***A second-quarter earnings preview by the numbers

 

FactSet is the go-to data analytics company used by the pros. As we look ahead to second-quarter earnings, FactSet reveals a steep drop in estimated earnings despite the market’s recent run-up in price.

This sets the stage for some bubble investors to get nailed.

From FactSet:

Earnings Growth: For Q2 2020, the estimated earnings decline for the S&P 500 is -43.8%.

If -43.8% is the actual decline for the quarter, it will mark the largest year-over-year decline in earnings reported by the index since Q4 2008 (-69.1%).

Valuation: The forward 12-month P/E ratio for the S&P 500 is 21.9.

This P/E ratio is above the 5-year average (16.9) and above the 10-year average (15.2).

So, we have a huge expected earnings decline coupled with a valuation that towers above five and ten-year averages.

This relationship isn’t stable.

Either earnings will need to come in stronger than expected to support today’s market prices. Or, conversely, market pries will need to drop to better reflect a subdued earnings environment.

This means that in the upcoming earnings season, fundamentally strong stocks with solid earnings that are worthy of their market prices will hold up well.

However, the herd-trade stocks without strong earnings that have zoomed higher are going to face headwinds.

Back to Louis’ podcast:

There are a lot of stocks that don’t have earnings and just have hope or hype that have gone up …

The Nasdaq 100 is definitely driving a lot of stocks. And there’s a lot of quality stuff in the Nasdaq that I like … but there are a few stocks that might have a problem.

Louis goes on to point toward upstart electric truck maker, Nikola, as an example. This has been one of the most popular stocks traded by the Robinhood crowd in recent weeks.

Below, you can see Nikola exploding 496% higher in the last two months. And notice gains of about 550% earlier this month …

 

Keep in mind, not only has Nikola not made a dime of profit, it hasn’t yet generated a dime of revenue (though it will begin taking preorders on its hydrogen-electric truck, the Badger, this coming Monday).

Louis notes in his podcast how Nikola’s founder has been a net seller of his stock as the price has been surging.

Louis also suggests it will be years before the hydrogen infrastructure that Nikola’s trucks require will be built out.

All this suggests one thing …

From Louis:

Nikola is an example of a bubble stock that needs to be pricked.


***A reminder to focus on fundamentals

 

At the top of this Digest, we quoted Louis, highlighting the “narrow” market dynamic he sees us entering.

Here’s how he put it in his update:

… the stock market will grow more narrow in the upcoming weeks, as investors focus on quality. That means it’ll be every stock for itself. The high-quality stocks, like the ones we own, will emerge as the market leaders.

Remember, if you’re not sure whether your own portfolio is rooted in quality, use Louis’ free Portfolio Grader to give you a quick-yet-powerful analysis.

As we wrap up, this is going to be a painful earnings season for undeserving stocks — the imposters that don’t have the earnings strength to support recent, lofty market gains.

But, as Louis writes to his subscribers, “as long as we remain focused on the fundamentally superior stocks and avoid the bubbles, we’ll be just fine.”

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2020/06/avoid-bursting-bubbles/.

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