The gauntlet is formidable. On one side, there’s slowing global growth, the yuan devaluation, and falling commodity prices. On the other, there’s a Fed rate hike, a strengthening dollar, and slowing earnings growth.
Each side is heavily armed with sticks, ax handles, and cudgels.
U.S. stocks are trying to run through that punishing gauntlet without taking too many direct hits. It doesn’t seem to be going very well…
The average stock on the S&P 500 is in bear market territory, down at least 15% from highs. Over half of the S&P 500 is down at least 10%.
Year to date, the S&P 500 is up a measly 1.5%. Sector ETFs for utilities, materials, and industrials are all down between 3.5% and 6%. The energy ETF is down nearly 13%.
Consumer discretionary and health care have done the heavy lifting, up 8.5% and 10%, respectively. The remaining sector ETFs — tech, consumer staples, and financials — are up 2% to 2.5%.
If we look back at just the last month, the picture is bleak. The traditionally defensive sector, utilities, is up 6%. Tech, financials, and consumer discretionary ETFs are up 1% or less. Everything else is in the red.
Slowly but surely, the gauntlet is beating the crap out of stocks.
Bad Breadth
The funny/weird thing is that even though the majority of stocks are in correction territory at best and in bear market territory at worst, the S&P 500 itself is still 40 or so points from its all-time highs. If you simply looked at the index itself, everything would seem copacetic.
You have to look deeper to see that most stocks are not doing well, that it’s a relatively few stocks that are advancing and giving the illusion of overall health for the stock market. This is a breadth problem. For the stock market, breadth refers to the number of stocks that are participating in the primary trend.
When the primary trend is bullish, you expect to see most stocks rallying. And when the primary trend is bearish, you expect to see the majority of stocks selling off.
So changes in breadth are often looked at as a sign that the primary trend is changing. When a primary bull trend is changing, you’ll see more stocks start to sell off, and investment gets concentrated in fewer and fewer stocks.
Right now, just 34 stocks out of the 500 on the S&P 500 are hitting new highs. Adobe (NASDAQ: ADBE), Altria (NYSE: MO), and Home Depot (NYSE: HD) make the list. There’s a bunch of food stocks (consumer staples) on the new highs list: Conagra (NYSE: CAG), Constellation Brands (NYSE: STZ), Campbell Soup (NYSE: CPB), and Hormel (NYSE: HRL).
But if you thought you could just buy any old consumer staples stock, think again. Wal-Mart (NYSE: WMT) is down around 16% this year. Whole Foods (NASDAQ: WFM) is down 28%, and even Procter & Gamble (NYSE: PG) is down over 18%.
The consumer discretionary sector is very well represented with the likes of Starbucks (NASDAQ: SBUX), Amazon (NASDAQ: AMZN), Disney (NYSE: DIS), Priceline (NASDAQ: PCLN), and Nike (NYSE: NKE).
The point here is two-fold: You have to be very careful with the stocks you choose. The discrepancy between the “have” and “have-not” stocks is very wide these days. That’s because economic growth is not supporting revenue and earnings growth for companies in general. Rather, you have to look at revenue and earnings growth on a case-by-case basis, where an individual company must be judged on the market niche the company is in and then how well it is executing.
In other words, this isn’t the “index fund” market we’ve had for the last few years, where it was very difficult to find stocks that would outperform the S&P 500 and you were better off in an index fund.
Now that the gauntlet of negative catalysts has grown stronger, we have a stock-pickers market. There just aren’t that many stocks that can run the gauntlet unscathed. And it may be about to get worse…
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What the Bear Will Do Next
Bear markets are notoriously sneaky. They operate with a ruthless precision. They will begin with the most speculative stocks.
Typically, most investors don’t panic when small-cap tech stocks or biotech stocks get whacked. These stocks are notoriously volatile, and because they often don’t have earnings, their valuation depends on sentiment.
And besides, most investors don’t have speculative stocks in their 401(k) accounts, so they tend not to notice.
The bear will move on and start taking down companies that aren’t executing as well as they might, or companies that are seeing their growth rates slow a bit. Wal-Mart, Intel, Coca-Cola, and even Ford are good examples of this. Investors may see the declines but think, “Well, these are good companies — they’ll make a comeback at some point.”
The final phase is particularly painful. Because that’s the phase where the market leaders get pummeled and investors realize that there are serious economic issue that are going to push earnings lower across the board. Investors that have crowded into the strongest stocks start to bail out, and the rout is on.
This is exactly the pattern we saw heading into the financial crisis. The S&P 500 put in a double top at all-time highs in May and October of 2007. It took until January 2008 for the S&P 500 to put in a solid correction (14%) and test some important support levels. And it took until September 2008 for those support levels to fail and send stock prices into free-fall and investors into a panic.
I can’t tell you that the current market is a replay of 2007, that we’re seeing the first cracks in the primary bull trend, and that we’re entering a bear market…
But I can tell you that if we are indeed heading into a bear market, what happens next is very predictable: The market leaders will take a beating in the gauntlet.
So keep an eye on Starbucks, Amazon, and Disney. Watch the companies that seem to have it all figured out, like Netflix and Under Armour. If they start selling off, there’s trouble ahead.
Until next time,
Until next time,
Briton Ryle
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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.
