MW Be cautious about the market now -- and buy these 3 stocks on weakness
By Michael Brush, MarketWatch
Investor sentiment has ramped up and the markets are overbought
It's time to get a bit more cautious about stocks now for two reasons: Investor sentiment has ramped up and the markets are overbought. Consider:
-- Sentiment: U.S. markets finished the first two months of 2019 with their best gains in over a decade. So investors were giddy again (http://www.marketwatch.com/story/heres-why-recent-stock-gains-could-be-just-a-bear-market-rally-2019-03-05). That's the bad news, in a contrarian sense. When the crowd forms a strong point of view, contrarians like to tilt the other way. Virtually all of the dozen or so sentiment indicators I track were recently either neutral or bearish. That's bearish -- meaning these indicators show too much bullishness. (http://www.marketwatch.com/articles/dow-drops-200-points-ecb-weak-forecast-spook-market-slowdown-51551997293)
For example, a reading below 16 for the CBOE Volatility Index is bearish, since this signals investor complacency. The VIX was just flirting with these levels. Various Ned Davis sentiment polls recently showed excessive optimism, also bearish. Put buying, a bearish bet, has dried up relative to call-buying, which is a bullish bet. So put/call ratios are now in neutral territory.
One saving grace for the bulls is that the Investors Intelligence Bull/Bear ratio, a key indicator I track, has recently hovered around 2.57. For me the warning path sell signal is when this measure is at 4.0 or higher. Currently it is firmly in the neutral zone.
-- Technical: More than 90% of S&P 500 stocks were recently trading above their 50-day moving averages, points out Bruce Bittles, the chief investment strategist at Baird. This is not a good sign (http://www.marketwatch.com/story/boeing-could-bring-the-dow-to-a-hard-landing-2019-03-04). It's important to see broad participation in a trend (broad breadth) to confirm that the trend is real. But too much participation signals over-exuberance for a trend (either up or down), which can foreshadow its demise. (http://www.marketwatch.com/story/the-evidence-is-in-stocks-are-in-a-bull-trap-2019-02-02)
-- The 'special friend' indicator: This one's totally anecdotal. But it works. If you're lucky, you have a special market friend who's a great contrarian indicator. I have one who invariably beats his chest about gains and how smart he is right around market tops. At bottoms he sends dire emails proclaiming that world is coming to an end, or worse, and knocking me for every stock I suggested that is down. The boasting typically marks near-term market peaks and vice versa. Last weekend he was in full boast mode about his year-to-date gains.
This is not scientific, but it's a useful sentiment read. If you don't have such a friend, try to cultivate one. Just don't tell them. This will spoil it.
Otherwise, consider tracking your own emotions. Many of us get distraught by portfolio losses, and giddy from the gains. So you, yourself, may be a good contrarian indicator. The best buys are the hardest to make. The best traders feel no emotion at all when moving in and out of the market. This helps them take money from people who are overly emotional and therefore prone to do the wrong thing.
What might cause more stock-market weakness? That's always tough to predict. But here is a top candidate: A lot of bulls are pinning their hopes on a China trade deal to push stocks higher. They will be disappointed. True, there will be a deal, but there is no way it will be comprehensive enough (http://www.marketwatch.com/story/trump-today-president-says-trade-talks-going-well-as-china-reported-to-be-wary-of-quick-deal-2019-03-07).
President Donald Trump and his team are pushing for too many structural changes in China on how the government manages the economy. Their wish list includes things like a rollback in Chinese subsidies for domestic companies and government favoritism towards Chinese suppliers. Trump also wants an end to restrictions on foreign investments -- like the requirement that foreign companies have a Chinese partner -- and an end to forced technology transfers.
This may be all well and good, but it will be tough for Chinese leaders to swallow. When investors see that Trump only got a half a deal (mostly tariff concessions) they'll realize trade battles probably are not over -- and sell. (http://www.marketwatch.com/articles/managing-risk-and-opportunity-ahead-of-a-china-trade-deal-51551956401)
If the U.S. market's current weakness leads to continued consolidation, here's what to do:
-- Hold cash: This is a good time to trim positions, get completely off margin, and raise some buying power.
Cyclical areas including industrials and housing-related stocks were favored in my stock newsletter Brush Up on Stocks (http://www.uponstocks.com) in December because company insiders liked them so much and sentiment was so bad. These might be places to trim because cyclical names like these can do the worst in any sell off. The bottom-line here is that if the pullback continues you don't want to be extended on margin, to avoid margin calls. And you'll want to have some buying power to pick up quality names.
A few companies I've recently suggested in my stock letter are Continental Resources (CLR) , where founder and energy expert Harold Hamm has been a big buyer; Kinder Morgan (KMI) , where chairman Rich Kinder has been a big buyer; and BeiGene (BGNE) , a quality Chinese biotech company developing cancer therapies, which has a partnership with Celgene (CELG) . BeiGene is well above the buy limits I've set in my stock letter ($25 when introduced, then $101). But it is still a buy on weakness, and it may rally on China trade-deal news.
-- Get defensive: If you want to actively trade into any further weakness, tilt towards defensive areas like utilities and real estate investment trusts (REITs). You can do this with exchange-traded funds (ETFs) such as Utilities Select Sector SPDR (XLU) , Fidelity MSCI Utilities (FUTY) , Vanguard Utilities ETF (VPU) , iShares US Utilities (IDU) , iShares Residential Real Estate (REZ) , Vanguard Real Estate (VNQ) , Fidelity MSCI Real Estate Index (FREL) , and Schwab U.S. REIT (SCHH) .
-- Short-beta trades: Beta refers to how much more a stock moves compared to the market (in the same direction). In a downturn high-beta stocks will decline more. Technology is a typical high-beta sector. So consider owning Direxion Daily Technology Bear 3X Shares (TECS) or Direxion Daily Semiconductor Bear 3X Shares x(SOXS) .
For broader market exposure consider ProShares UltraShort S&P500 (SDS) which goes up when the S&P 500 falls.
Remember these are trades, and not buy and holds. That's because they are so volatile. You'll want to take profits or cut losses fast. And these types of ETFs are typically constructed via positions in futures contracts. They must be continually rolled over, which erodes value over the long term.
-- Do nothing: If you are truly a long-term investor, do nothing and ride out the weakness, since it does not seem like a recession and a sustained bear market are right around the corner. Buy and hold makes sense in the stock market because over-trading your account can lead to underperformance. Just make sure you really are "buy and hold." A lot of people think they are until the losses start. Then they panic and make the wrong move at the wrong time.
-- Be clear about the message -- and the messenger: Keep in mind the limits of what sentiment and technical indicators can tell you. They are not saying the market will fall significantly tomorrow or later this week. They are telling us the market is more vulnerable to a pullback now. So further weakness is more likely and you should prepare for it. And if you come across someone saying he or she knows for certain what the market will do tomorrow or next week, run the other way. (Financial news shows are full of these types.) That person is a charlatan who can do real damage to your portfolio.
At the time of publication, Michael Brush had no positions in any stocks mentioned in this column. Brush has suggested CLR, KMI, BGNE, CELG, TECS, SOXS and SDS in his stock newsletter Brush Up on Stocks (http://www.uponstocks.com).
More: Dow is on the verge of a bullish golden cross, but stock-market analysts aren't exactly cheering (http://www.marketwatch.com/story/the-dow-is-the-verge-of-a-bullish-golden-cross-but-stock-market-analysts-arent-exactly-cheering-2019-03-07)
-Michael Brush; 415-439-6400; AskNewswires@dowjones.com
(END) Dow Jones Newswires
March 07, 2019 17:59 ET (22:59 GMT)
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