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Economy, Investing  | September 23, 2020

The "Fall" Ahead

It has been a rough start to the fall season ever since we released our "Correction is Approaching" article on September 2nd. In fact, since the top, the S&P 500/SPX (SP500) futures have corrected by 10.3% from peak to trough.

SPX futures

So, what is going on? I thought the Fed was supporting everything, the economy was going into a V-shaped recovery, economic data was improving, fiscal stimulus was on its way, unemployment was going down, coronavirus vaccines were going to be available soon, etc.

It appears that the market may have gotten a bit ahead of itself

Everything is not quite as optimistic as stock prices were suggesting in late August. To the contrary, there are numerous detrimental fundamental factors facing the economy. A resurgence in coronavirus cases, uncertainty about the upcoming election, worsening economic data, higher than expected probability for a slowdown in corporate profits, the likelihood for higher than anticipated unemployment, less consumer spending, as well as worsening consumer sentiment/confidence, and other negative elements are likely to persist and weigh on economic growth as well as the SPX and stock prices in general going into the November election and beyond.

The Coronavirus Effect


The coronavirus is here to stay, and it continues to multiply at a rapid pace. There are now over 7 million confirmed cases and over 200,000 deaths from the disease in the U.S. alone. Worldwide, the case count is approaching 32 million confirmed cases, and nearly 1 million deaths. 7 million confirmed cases in the U.S. is extremely high as it represents around 2% of the population, implying that at least 1 in 50 people in the U.S. has already been exposed to this virus.

What happens when schools, restaurants, stores, numerous other places of employment and possible other "hot spots" resume to function at less than full capacity or possibly even shut down this fall and winter? Nothing good for the economy in my view, and the Fed cannot fix everything with its magic wand.

Speaking About the Fed,I recently put out an article why I thought the Fed failed at their last FOMC meeting. I truly believe that the Fed should have been more dovish with markets in the fragile state that they are in right now. Hints at negative rates, more support for higher inflation, wider asset buying programs would have been welcomed by the market. Instead, the Fed essentially said "we did all we are willing to do for now, rates will remain at zero for years, and we are handing the ball over to the government for fiscal stimulus."

What fiscal stimulus? The government is so divided right now prior to election time that a fiscal stimulus package seems less and less likely by the hour. What will happen if American citizens stop receiving their bailout checks? What will happen if new jobs cease being created? Nothing good for the economy, for consumer spending, sentiment and confidence, as well as for most corporate profits.

Stocks Far from Cheap

I know, many market participants are saying that stocks are the only game in town, and the market will continue to appreciate no matter what, etc. Sounds a bit like the year 2,000 talk to me, and stocks are far from cheap right now. In fact, most are outright expensive. The SPX is trading at a P/E ratio of around 37 right now, vs. only 23 a year ago. That's about a 60% premium to last year's prices.

Does this make sense? We did not have the coronavirus and all the mayhem along with it a year ago, now we do, and stocks are 60% more expensive. Why? Oh right, it is the forward earnings that count... Well, the forward P/E estimate based on consensus forecasts for the SPX is around 26, and roughly 31 for the Nasdaq.

Does this seem cheap? Not to me. Perhaps a better question is will most companies actually hit their projected EPS targets with all the issues in the economic pipeline? My estimate is no, most corporations will not reach consensus estimates (in 2021) due to the perpetual spread of the coronavirus, a divided government, extremely high unemployment, worse than anticipated consumer spending and other factors.

A Look at the Technicals



Despite the SPX's rebound off around the 3,200 level (10% correction), we can see that the market is not oversold yet. There is no panic selling, the RSI is at around 40, and we can still sense quite a bit of complacency in the air. This implies that there is likely more downside ahead. SPX may get a temporary bounce from here, but if it does not penetrate the 3,300 level decisively, it will very likely fall back down to 3,200, break through that support level, and plausibly head towards key support at 3,000 next. This would be a correction of roughly 16% from peak to trough and this is my base case scenario for now. However, in a worst-case scenario, we could see SPX fall to 2,750 or perhaps lower even if clearer signs of economic deterioration continue to materialize.



Despite the VIX coming off its highs yesterday, it was still up by nearly 8% on the session while the SPX finished down by only about 1%. This implies that market participants are increasingly worried about future months, and are likely stacking up on put option protection before the next leg down occurs.

The Bottom Line

The S&P 500 has corrected by 10% thus far. Unfortunately, due to numerous negative fundamental developments as well as a deteriorating technical image, there is likely more downside ahead for the SPX and for stocks in general in my view. A key level to watch right now is 3,200, and if it fails, down to 3,00, the S&P 500 will go in my view. Furthermore, in a worst-case scenario, SPX could go down to 2,750 or lower even if the economic image continues to deteriorate in the U.S. and around the world.

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