Is it a Bear Market?

They’re coming out of the woodwork to declare that it is a bear market.

Carl Icahn may be the biggest name yet — on Tuesday, he released a video called “Danger Ahead” that’s getting a lot of attention. Basically, Icahn says that the Fed’s low interest rates have caused companies to focus more on share buybacks than actual investment, and it’s creating a drag.

What’s more, he says the high tax rate on U.S. corporate earnings abroad is another thing keeping growth in check. Interestingly, he doesn’t really talk about China’s slowing economy and the effect it is having on emerging markets very much at all. To me, China is a big concern…

Icahn is a very savvy dude. He has made some ridiculously good investments over the last few years, and he has been warning that stocks were expensive for several months.

But at the same time, he’s offered to serve as Treasury Secretary in the Donald Trump administration, so there is at least a small credibility issue. (That was supposed to be a joke, probably not very funny…)

Ultimately, Icahn is a trader. He’s not a buy-and-hold guy. He takes big positions in companies and then makes a lot of noise about how the company can do better.

You may recall his fight to force Apple into paying a bigger dividend and increasing its share buyback. Icahn wasn’t doing this to help out Apple or its shareholders — he was pressing for a bigger dividend because he thought it would make the share price go up and he would make money. He was right…

My point here is that it’s highly likely that Icahn is “talking his book” when he says “Danger Ahead.” Talking your book means saying things that will help your investments, regardless of whether they are true or not. I bet dollars to doughnuts that Icahn has a big short position, and he wants stocks to go down so he makes more money.

Now, that’s not to say he is the cause of the selling. There are very legitimate reasons that stocks have been selling off for a month. But if you get the kind of media play that Icahn gets, why wouldn’t you use it to your advantage?

Is it a Bear Market?

Corrections are relatively brief ~10% price declines, while bear markets are longer affairs that take indices down at least 20%. What’s more, bear markets are strongly correlated to economic recessions.

The U.S. economy is clearly not in recession, even though the global economy is teetering on the brink. The question remains: Can the U.S. economy avoid recession if the rest of the world succumbs? My answer continues to be that it can for a little while…

Over the last couple of days, a few investment bank strategists have lowered their year-end targets for the S&P 500. A couple have also lowered earnings estimates for the S&P 500 from around $125 a share to $120 a share. Goldman Sachs is really bearish — it’s dropped its 2015 earnings estimates to $109 a share.

Whichever way you slice it, there will be pretty much zero earnings growth for 2015. And if you factor out share buybacks, earnings would show negative growth.

I haven’t seen anyone talking about negative real earnings growth… yet. The bearish talking points remain China, commodities, and interest rates, with some liquidity concerns thrown in. Frankly, that’s more than enough to keep stocks on the defensive.

Current fundamentals seem to demand a lower trading range for the S&P 500. It was 1,900 to 2,100 for the last 18 months. Maybe it needs to drop down to something like 1,800 to 2,000 for the next six months.

While that would put stocks at a more comfortable valuation where some upside is possible, it also doesn’t really take into account the potential for China to get worse.

The bottom line for me is that even if we don’t get a full-fledged bearish slant to this market, the bull argument isn’t likely to come roaring back. Confidence has been shaken, and it will need time to return. 

Now, there is an upside story. Or maybe I should just say that with markets pretty firmly oversold, there is potential for a rally. In fact, 30 to 50 points to the upside seems pretty likely now that the S&P 500 has tested the August lows.

What to Do Now

Now is not the time to get aggressive. I recommend limiting any trades to very specific stocks that have catalysts all their own — stocks like J.C. Penney (NYSE: JCP), which is a compelling turnaround story. It’s around $9 now and has been getting a slew of upgrades and price targets in the $13 to $17 range.

Or maybe Bank of America (NYSE: BAC), which remains a terrific value. The stock trades at a 27% discount to book value. Compare that to Wells Fargo (NYSE: WFC), for instance, which trades at a +50% premium to book value. And BofA will benefit from higher interest rates: a 100 bps rise in rates (from 0% to 1%) will mean $2.2 billion in profits.

You should consider short-term income strategies like selling covered calls on stocks you own when the market puts together multi-day rallies. And you can also sell out-of-the-money put options on stocks you may want to own.

We did this the other day in Real Income Trader and took in $3,300 for simply agreeing to buy Apple at $105.

I suspect the stock market could be weak until Thanksgiving, so don’t feel like you have to rush anything. Patience is always a virtue.

Until next time,

Until next time,

Briton Ryle

@BritonRyle on Twitter

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A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.