4 Reasons You Should NOT Buy This Rally

John DVThe market appears to be bouncing. Last week my inbox was flooded with investment firms recommending I buy this dip in the market and load up on stocks for the rebound. Doing that’s been a great strategy over the past few years, they tell me.

And they’re right.

Without fail, each dip led to a big rebound in stocks, pushing indexes like the S&P 500 and the Dow to higher highs each and every time.

Except, in the last really big dip, it didn’t happen.

And it’s doubtful the market will achieve higher highs this time either. It’s either got to go up or down. It can’t stay in limbo forever.

So, I doubt we’ve seen a bottom. There are plenty of factors working against the market in 2016 that weren’t the case before. Let’s review those headwinds.

For starters…

This market is long in the tooth. The S&P 500 bottomed out nearly seven years ago. With a few hiccups, there hasn’t been a major scare until the start of 2016 when we got off to the worst start to the year ever.

Flash crashes don’t count.

Like I said, stocks quickly rebounded from every dip lower in recent years. Yet, we are about double the amount of time we’d normally expect to have a significant pullback in stocks. After this rebound, the next one might be it.

U.S. stocks are not cheap. It boggles my mind when Wall Street strategists say that stocks are reasonably valued or (gasp)… “cheap.” They clearly need to wipe the smudges off their rose-colored glasses.

Forget about earnings, because we know earnings are heavily manipulated. Before I’ve discussed how 90% of companies are using “adjusted earnings.” It’s bogus. And in my research advisory, Forensic Investor, we delve into companies that are using accounting aggressively to mask deterioration in their business. There’s a lot of them in that 90%.

So if you’re looking at earnings, you’re clueless.

Instead, look at revenue. Revenue can also be manipulated, but it’s less subject to the shenanigans companies can pull on other income statement line items. The median price/sales ratio on the S&P 500 is still 1.96x. That’s more than two standard deviations higher than average since 1965!

Even if you failed math in 11th grade, all you need to know is that two standard deviations outside the norm is pretty rare. It’s nosebleed territory. And, while that is down a little bit in 2016 because the market’s been down, it’s well above 2000 and 2007 levels. We know how that movie ended. It’s a horror story.

We are already in a bear market; you just don’t know it. This also started with the FANG stocks. Companies like Facebook, Amazon, Netflix, and Google (renamed Alphabet but then that ruins the whole FANG thing) drove the indexes higher while the average stock was moving in the opposite direction.

That’s the very definition of a “narrow market,” when fewer and fewer stocks are participating on the way up to new highs. Meanwhile, by summer last year, 25% of the S&P 500 was down 20% or more.

Now, this bearish performance has filtered its way through other sectors of the market, and there’s not much bite left in the FANG stocks, either. That means there’s nowhere to hide. Every sector is overvalued, whereas in the market smashes of 2000 and 2007 it was primarily just technology and financials.

Sentiment is still too bullish. Yeah, it’s been down the past few weeks. People are scared when they lose 10% quickly and $1.3 trillion has evaporated into thin air.

But, it’s not nearly low enough to reach extreme levels. Individual investors have only reduced stock allocations by about 3% and raised only about 2% in cash. They’d have to more than double their cash position and cut equity exposure by another third before getting to extremely bearish levels.

Then there’s the fact that, while the market was imploding, traders were cutting positions in bearish inverse funds.

Again, this is hardly the stuff that bottoms are made of.

We will continue to see a lot of volatility in the markets. That happens when the bear comes out of hibernation. There’s more big “up days” in a bear market than a bull market, like today. Those up moves have a way of faking investors out and picking their pockets of their hard-earned cash.

Don’t fall for it. Take a look at the investment strategy we use in Forensic Investor to see why you have much better opportunity on the downside. We have a strong track record so far and the major indexes are still relatively close to all-time highs. When they confirm a bear market is in, it’ll work even better in our favor.

Quite simply, we have much further to go to clear out the excesses of the last few years. Only then will it be time to load up on stocks for the next multi-year move higher.


John Del Vecchio
Editor, Forensic Investor 

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Categories: Stocks

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.