Over the course of this week, 149 members of the S&P 500 will report earnings. Given that number, this could be a make or break week for the S&P 500 and the ongoing bullish phase.
So far this earnings season hasn’t been able to give the overall market a boost. Companies are meeting or beating estimates at a similar pace as what we saw during the last earnings’ season, but the outlooks have been far more cautious. Another factor that seems to be a concern is corporate profit margins.
With the tax code changes at the end of last year, companies saw a boost to their profit margins, but that was essentially a one-time boost. Now companies are concerned about higher costs of goods from the different tariffs and a higher cost of labor due to the tight labor market. Between those two rising costs, companies are looking at lower profit margins going forward.
The concerns are causing another round of selling and the S&P 500 is in danger of closing below its 52-week moving average for the first time since March ’16. The last time we saw the index move higher for an extended period and then fall below the 52-week was in August ’15.
The blue box shows how the market performed for the six months after the S&P fell below its 52-week moving average. In the article I wrote a few weeks ago about asset allocation, I pointed out different steps investors can take to protect their portfolio from a big bearish move lower. The S&P closing below its 52-week moving average was one of the steps I suggested could be used to lower stock allocations.
“Another adjustment point could come from the S&P dropping below a long-term moving average like the 52-week moving average or the 20-month moving average.”
I also pointed out that another step could be when the 13-week moving average (one quarter of data) crosses bearishly below the 52-week could be another point where investors lower their stock allocations. The S&P hasn’t had this happen yet, but there are a number of individual stocks where this has already happened.
Each month I comb through the universe of stocks that Investor’s Business Daily ranks and build a set of charts with companies that have an EPS rating of 80 or higher from IBD, an SMR rating of an A, and have an average daily trading volume of 500,000. I usually end up with around 175 to 200 stocks on the list and to me, these are some of the most fundamentally sound stocks.
While going through the charts over the weekend, I couldn’t help but notice how some of the top performers had seen their 13-week moving averages cross bearishly below their 52-week moving averages.
Companies like Applied Materials, Caterpillar, Facebook, Intel, Marriott, Micron Technology, Pulte Group, and Charles Schwab have all already had their 13-week moving average move below their 52-week. These are the stocks that were helping lead the indices higher and boosting different sector ETFs. Now they have lost the upside momentum.
I also looked at the 10 main sector SPDR ETFs to see which ones had already experienced the bearish crossover. So far only the Materials Select Sector SPDR (NYSE: XLB) has had the moving averages cross, but it is likely to happen on the Financial Select Sector SPDR (NYSE: XLF) next week.
Is this the start of the next bear market? I don’t know for certain and neither does anyone else. What I do know is that when the 13-week moving average of the S&P crossed bearishly below the 52-week in October 2000, the index fell another 45% over the next two years. When the 13-week crossed below the 52-week in December 2007, the S&P fell another 50% over the next 15 months.
Yes, there have been times when the 13-week moving average has fallen below the 52-week moving average and the market didn’t collapse. There were brief periods in mid-2010 and in late 2012 where the 13-week was below the 52-week and the market bounced back. And there was the period in 2015-2016 that I mentioned before.
Even though there are times when the market doesn’t continue falling after the 13-week crosses below the 52-week, wouldn’t you rather be safe than sorry?
It is going to take a big bounce back for the S&P not to close below its 52-week moving average this week. If investors continue reacting to earnings the way they have so far this earnings season, it won’t take long for the 13-week to drop and potentially make a bearish crossover.
My suggestion to investors is that you pay close attention and start lowering your stock allocations. Move the money to cash, move it to fixed income investments—it doesn’t matter. Just don’t leave all of your money in stocks.
If you are a more aggressive investor, you could move some of your money into an inverse ETF that will gain ground when the indices fall, but be careful of the leveraged inverse ETFs. The ProShares family of ETFs has inverse funds for the S&P, Dow, Nasdaq 100, and Russell 2000. They also have leveraged inverse funds that are designed to move two or three times the move in the underlying index, but the leverage isn’t designed to last for long periods. This causes the correlation between the index and the resulting move in the fund to vary over a long period of time.
The S&P hasn’t closed below the 52-week moving average yet and the 13-week hasn’t crossed below the 52-week yet. But investors should be paying attention and developing a plan. What stocks or funds will you sell? How much do you want to lower your allocation? These are all things you need to think about ahead of time.