The Not-So-Contrarian Path to a Quick 250% Gain

It’s not possible for me to sit still, so to speak. So when it comes to my work – I’m a forensic accountant by trade – I’m constantly looking for more data and more context for both the micro and the macro views.

I prefer to stay in the weeds of quantitative research from which I can draw my own conclusions. Research that’s presented with a clear angle gets the side eye from me.

Why? Well, there’s so much ideology and so little methodology these days. It can be difficult to tell if a writer had a conclusion and worked backward to support it. Data can be interpreted in almost any way you want, with the right spin.

So, the more quantitative the research, the more likely I am to trust it.

The top-sheet numbers and the general consensus of the mainstream media will tell you that the markets continue to climb and find new highs. But there are signs that point to something rotten in the state of the markets, something deep in the foundation.

Let’s run through some of my recent findings.

First, fund flow into passive investment strategies has been massive. The money pouring into index-based ETFs dwarfs anything seen over the last 10 years. This has been a huge factor driving virtually all stocks higher because index funds are indiscriminate.

In other words, they have to buy whatever is in the index. There is no judgement call. So, all stocks go up.

Second, as such flows have topped, the correlations among stocks in the S&P 500 are breaking down. Those correlations are now the lowest at any time since 2006.

What that means to me is that while a few stocks may drive the indexes higher, including Facebook (Nasdaq: FB) and Apple (Nasdaq: AAPL), a lot of stocks under the surface are starting to diverge from the broader indexes.

Third, the number of U.S. stocks trading below their 200-day moving averages has dropped below 50% in the last week – despite indexes sitting near their all-time highs. That means more than 50% of stocks are in negative trends, belying the strength in the indexes.

How can that be?

Well, the big indexes are weighted by market capitalization, so a few stocks contribute a disproportionate amount of performance to the index. But, viewed from each stock being equal-weighted, we’re starting to see bearish trends forming below the surface.

Despite all this data, you don’t need to be a total doom-and-gloom bear right now. But it helps to keep one cynical eye on the big picture, because there are serious profit opportunities when you do so. My Earnings Insider Alert readers just booked a quick 250% gain on a stock that, despite a strong earnings report, still fell short of Wall Street expectations.

There’s bound to be more of these plays in the months ahead.

Looking back at my recent research, if you slice the price-to-sales ratios of each company in the S&P 500 into deciles, nine out of 10 deciles are at 30-year highs. That’s another nitty-gritty way of showing how overvalued the market is.

The only ones not reaching a new high are the most richly valued stocks because the bar’s simply too high: In 2000 this was dominated by internet companies with insane valuations. But even 2017’s level is close.

So even if a company is doing well, it still might disappoint Wall Street, just like our recent winner did.

Many market sectors are valued at 50% or more above their 30-year peaks. That’s a cause for concern, because if selling pressure really starts on the indexes, there’s more room to fall than in prior market cycles across all stocks. There’s going to be virtually nowhere to hide, unlike in 2002 when technology stocks took most of the pain.

My Earnings Insider Alert readers hear my take on the markets on a regular basis, but I’ll also dig into and present my research at our upcoming Irrational Economic Summit in October. I hope to see you there!

Good investing,

John Del Vecchio
Editor, Hidden Profits

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About Author

In 2007, John Del Vecchio managed a short only portfolio for Ranger Alternatives, L.P. which was later converted into the AdvisorShares Ranger Equity Bear ETF in 2011. Mr. Del Vecchio also launched an earnings quality index used for the Forensic Accounting ETF. He is the co-author of What's Behind the Numbers? A Guide to Exposing Financial Chicanery and Avoiding Huge Losses in Your Portfolio. Previously, he worked for renowned forensic accountant Dr. Howard Schilit, as well as short seller David Tice.