Making Sense of Three Market Risks

How expecting volatility can help you remain invested … three storm clouds over the market … how John Jagerson and Wade Hansen see their potential impact on stocks

 

Investors face numerous market risks today — the kind that often result in fear-based selling.

But we don’t want anxiety about short-term volatility to derail our long-term investment goals.

After all, many retirement portfolios have been bruised by a mistimed “sell,” after which the market resumes its long-term upward climb.

So, how do we remain invested during times of fear and volatility?

One of the best ways is simple … Shine a light on the risks.

We bring them out of the shadows to better understand them — as well as their potential impact on the market.

By doing this, we gain perspective and can plot a wiser course of action. If we don’t do this, we risk letting fear trip us up, potentially resulting in emotion-based, kneejerk buying and selling.

In their latest issue of Strategic Trader, John Jagerson and Wade Hansen directly addressed three major uncertainties hanging over the market today. They also looked at the potential impact of those risks on stocks.

In today’s Digest, let’s see how they’re measuring up these market uncertainties.

By taking the mystery out of what lies in the shadows a few feet away, we can do a better job of keeping our focus where it should be — our investment goals off in the distance.

Let’s jump in.


***The three unknowns John and Wade are watching today

 

For newer Digest readers, John and Wade are the editors behind Strategic Trader.

In their service, they combine options, insightful fundamental and technical analysis, and market history to trade the markets, whether they’re up, down, or sideways.

Let’s begin with John’s and Wade’s 30,000-foot view of the situation:

As expected, volatility is ramping up this month as traders deal with uncertainty around stimulus, the election, and rising COVID-19 infection rates.

… we should expect a rough channel and maybe another short-term correction if investors don’t see some of these questions resolved soon.

While that seems like a sort of dour prediction, we are still reasonably confident that most of these issues will improve in the short term.

Let’s now dive into the risks John and Wade identify to better understand their potential impact on the market.

They begin with the impasse on a new stimulus bill:

We were concerned that the stimulus negotiations would be stretched out past the election, and now we think it could take until January before we see something significant come through from Congress and the White House.

This is clearly not great for the market. But John and Wade tell us that stocks haven’t been overly punished because Wall Street has been willing to look past the impasse, assuming a deal will get done.

They write “if investors believed that there was no pathway to a deal, the market would be falling much faster.”

So, where is market support and resistance in light of a delayed stimulus bill?

Back to John and Wade:

At this point, we think stalled stimulus talks will put a short-term cap on market gains, but support on the S&P 500 at 3,220 is the lowest we expect the market to fall.


***Pricing in election uncertainty

 

A huge portion of the country is going to be disappointed next week with the outcome of the presidential election outcome.

Our personal politics aside, the best thing for the market in the short-term would be a decisive victory for either candidate. What we want to avoid is a contested election, which would mean uncertainty — something Wall Street hates.

But given our desire to bring this potential into the light, let’s look at what happened the last time there was a contested election.

Back to John and Wade:

The last time we had an uncertain outcome was the Nov. 7, 2000 presidential election between Al Gore and George W. Bush.

The recounts in Florida counties were finally ended by the U.S. Supreme Court on Dec. 12. The initial reaction to the uncertainty was a decline of about 8% in the S&P 500, which is close to what we would expect if there were a few days’ worth of a delay this time around as well.

 


Daily Chart of the S&P 500 (SPX) During the 2000 Election — Chart Source: TradingView

It goes without saying that if something extraordinary takes place, the market would drop severely.

In past updates, John and Wade have pointed out that elections tend to be highly emotional events, with significant market swings … but the initial market swing is often wrong.

One way to potentially capture shorter-term profits is to bet against an overreaction, regardless of whether it’s up or down.


***How to address COVID fears

 

This is the big one, and it’s all-but-impossible to predict.

On one hand, if we find an effective vaccine that is rapidly disseminated throughout the world, the biggest threat to the global economy is removed.

In the meantime, coronavirus cases are surging globally. Here in the U.S. states are tightening restrictions again. But the global economy can only endure so much economic starvation.

Back to John and Wade:

… if the U.S. and European economies enter a more severe lockdown this winter, it could be a problem.

Stock valuations are extremely high, so a shock to the economic system could have an outsized effect.

For example, according to Yardeni Research, the S&P 500’s forward P/E ratio (based on estimated earnings for the next 12 months) is 21.1 which is the highest that it has been since the dot-com crisis.

John and Wade write that they’re watching the Italian and Spanish stock indexes for clues:

These two major European economies never recovered from the European debt crisis and so we expect weakness in markets like these to provide some warning for stronger markets like the U.S.

For example, as you can see in the following chart, the iShares MSCI Italy ETF (EWI), which tracks the Italian stock market, was positioned at support near $23 per share (Wednesday) morning.

If support breaks, we may want to increase our protective strategies.

 


Daily Chart of the iShares MSCI Italy ETF (EWI) — Chart Source: TradingView

 

As I write Friday morning, EWI has fallen to $22.68.

We’ll continue to monitor and report back as John and Wade give us updates.


***The final takeaway — cautiously bullish

 

As John and Wade wrap up, they point toward a positive in the market — earnings.

Though it’s still early, the drop in earnings has been less than feared, with an actual decline of 13.5% compared to a consensus estimated decline of 14.4% in July.

They believe that it’s unlikely the earnings situation would significantly deteriorate at this point.

So, when we put it all together, John and Wade remain cautiously bullish.

Yes, the potential for shorter-term volatility is in front of us, but as noted below, as long as the issues John and Wade have outlined don’t materially worsen, look for markets to weather this stretch without too many bumps.

I’ll give John and Wade the last word:

Investors tend to focus on where the fundamentals are heading rather than where they currently are, so this is a vote in favor of stocks.

As long as the uncertainties we have discussed in this week’s update don’t worsen, we should still maintain our bullish — if cautious — outlook.

Have a good evening,

Jeff Remsburg


Article printed from InvestorPlace Media, https://investorplace.com/2020/10/making-sense-of-three-market-risks/.

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