Three Months of Hell In the Books

Tough Quarter- Tough Crowd

It’s become a life-and-death struggle for the market that has been the scorn of bears and shorts, and any number of assorted curmudgeons. It may be a bit of hyperbole to say that this is a life and death situation, but those that want to see this market lower are salivating and ready to pounce while there are a few defenders on the other side. Markets are cyclical and were due for a pullback. In fact, it is long overdue after 1,400 days without a correction.

So, here we are. It’s not the end of the world, but the chorus of doom is loud, making each down session feel that much worse and hopeless.

This was the third down quarter for the Dow; the S&P 500 was off 6.9%.

Over the past three months (the only sector in the green) investors flocked to utilities as a flight to safety.

However, a look at the actual performance of individual sectors clearly underscores a headline-driven quarter. The global economy took a bigger bite out of U.S. stocks, marked with domestic uncertainty. For the quarter, energy and materials took it on the chin from the oil war and China's woes. Then, there's healthcare, which was hammered from high valuations that made it a sitting duck when Hillary attacked it with criticism and a call for price caps.

• Utilities +4.4
• Consumer staples -0.8
• Consumer discretionary -2.9
• Information technology -4.1
• Financials -7.2
• Industrial -7.4
• Telecom -8.0
• Healthcare -11/7
• Materials -17.4
• Energy -18.1

So, what’s the deal from here?

Testing the recent lows is still in play, but the last two days has seen the kind of resolve needed to turn this ship around. However, there has to be a spark as well. In the meantime, in addition to global economic concerns and our own uneven recovery, there’s a debate over the valuation of domestic stocks. I think this is very much overblown. Price-to-earnings (P/E ratios), down from a year ago, is nowhere near levels normally associated with massive stock market bubbles.

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Valuation Debate

I prefer to use forward price-to-earnings ratios when modeling for future value propositions. Even if you’re a purist, who believes in using trailing earnings, the Dow Jones is reasonable; the S&P could come in more, although dividend yields are attractive enough to lure buyers on further weakness. That said, I am most concerned about transportation, which has long been a key for the market to sustain a rally. Using forward price-earnings ratios, transportation looks very much oversold.

There’s no doubt blue chips could come in because of widespread panic selling, but not because of wildly exuberant valuations. Then, there’s yield, which is actually more attractive or equal to 10-year Treasury yields.

Technical View

Key Support Points:

• S&P 1,867
• Dow 15,666
• NASDAQ 4,500 then 4,214

Of course, using a five-year chart, the Dow Jones Transportation (DJT) is still up 72%, which points to another issue for the market. The rally has been long and powerful and a correction was overdue (I think only two bull markets have lasted longer before a ten-percent pullback).

Dow Jones Transportation

Conclusion

The market is vulnerable and everyone is calling for more pain, but it doesn’t have to be that way because it’s the current conventional wisdom. We’ll know more in the next 24-hours. The key is that we need much better economic data.