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Is the Trump Rally Over?

Written by Briton Ryle
Posted March 22, 2017 at 4:18PM

If you've been sitting on the sidelines of this rally, wondering if you will ever get the chance to buy a stock or two at a reasonable price, well, you're in luck. The optimism bubble that's carried stocks to their highest valuations in 15 years has finally popped. Your chance to buy stocks cheaper than they are now is coming. 

I know, yesterday was just one day. That 29.45-point drop in the S&P 500 was just 1.24%. Not exactly a crash. Volume wasn't as high as it was on Friday. Still, yesterday "felt" different, didn't it?

In part it felt different because we haven't seen a 1% drop for the S&P 500 in months. Even though all streaks must come to an end, we're just not used to seeing stocks sell off like that. But there were a couple aspects of the decline that make me think there's more downside coming. 

First, there are small-cap stocks. While the big indices — S&P 500 and Dow Industrials — were down a little over 1%, the small-cap index got taken to the woodshed...

iwm

That's the Russell 2000 ETF (IWM). It tracks the Russell 2000 small-cap index. It fell 2.74% yesterday, more than double the declines of the S&P 500 and Dow Industrials. That's significant for a couple reasons. One, it represents a lot more stocks — 2,000, to be exact. The selling in small caps was widespread and rampant. 

Two, small caps are generally considered to be more speculative than bigger stocks. Small caps tend to perform best as animal spirits get released during a rally. But when the rally turns, look out. The small caps tend to lead in the downside, too. And that's exactly what happened yesterday. IWM sliced through the 50-day moving average (blue line) like a hot knife through butter. 

The 50-day moving average is a common way to measure the medium-term trend. When the price is above the 50-day MA, the trend is thought to be up. When the price drops below the 50-day MA, the trend is thought to be lower. So that's a pretty strong signal from IWM. 

But perhaps an even stronger signal came from one of my favorite stocks, Bank of America (NYSE: BAC)...

Financials Always Lead

It's one of those stock market mantras: the financials lead the market. There is good reason for this, as banks are excellent gauges of economic health. Basically, when economic activity is increasing, people and companies are borrowing money. And when the economy slows, banks are often the canary in the coalmine. It's no coincidence that the first sign of the financial crisis came in late 2007, when Meredith Whitney made her famous call that Citi was going to have to cut its dividend...

Now, the first thing I did when I took over as editor of The Wealth Advisory income and dividend newsletter in February 2012 was recommend Bank of America. It was just over $9 a share at the time. But its trajectory seemed clear to me. That is, it was going higher. 

But check out the action from yesterday...

bac 3 20 17

As you can see, the stock had been looking kind of weak over the last few days. But wow, Bank of America dropped about 6% yesterday. 259 million shares changed hands, which is a lot. And like the Russell 2000 ETF, Bank of America shares cruised through the 50-day moving average like it wasn't even there. 

Now, about those 259 million shares: If we look back over the last 18 months, we'll see BofA traded that many shares right after the Brexit vote. Volume was heavy like that last January when the sell-off that welcomed in 2016 was reaching a crescendo.

In both cases, Bank of America was very near its lows. In January, the heavy selling started with the shares around $13, and they bottomed out just below $12. In the Brexit case, those two heavy volume days marked the bottom for the stock.

bac 2 year

So, go back and look at those first two charts I shared with you. Notice anything about where the heavy volume selling started? Yeah, the top of the trend, not the bottom. 

Sure, that could be a one-day event...

But somehow I don't think that's going to be the case.

Trump Rally, Trump Correction

I'm not going to talk too much about this, but as we all know, this whole rally was based on Trump policy. Basically the belief that he was going to cut corporate taxes, roll back some regulations like Dodd-Frank that has hindered the banks, and maybe spend a bunch of money on infrastructure.

As I've written here before, the corporate tax cut alone had the potential to add $10 a share to S&P 500 earnings, which is significant. 

You may also recall that I warned that if the Trump administration put off tax reform and easing regulations, and instead focused on Obamacare, the market would sell off

It looks like that's what's happening now. The House is set to vote on the new health care bill tomorrow. Consensus is that it will not pass. That's another defeat for the Trump administration. But worse, it dials back the clock on tax reform. Those corporate tax cuts could have come in 2017. That would have justified the rally. But now that we may not get those tax reforms until 2018, well, just look at those charts again. 

So now the obvious question is: why now? We've all known that Trump was focused on repealing and replacing Obamacare first. Tax reform was clearly on the back burner. So why did it take so long for investors to question the underlying assumptions of this rally? 

I don't know. The stock market is funny that way...

Sometimes things get priced in right away, sometimes it takes a while. Home prices topped out in 2005–2006, but that bull market kept chugging for at least another year. Same thing with the end of the tech bubble in 2000 — the economy had already slowed when Greenspan hiked rates 50 basis points on May 16, 2000. 

So anyway, what now? Well, I'm reminded of a joke from a movie about LA cops called Colors. Robert Duvall has an eager rookie Sean Penn as a partner. Duvall tells him this story about a young bull and an old bull sitting on a hill, watching a bunch of cows grazing in the meadow below. The young bull spies a cow he likes and says to the old bull, "Hey, why don't we run down and [make sweet love] to that cow?"

The old bull shakes his head and says, "Why don't we just walk down and [make sweet love] to them all?"

Until next time,

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Briton Ryle

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An 18-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 also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.

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