Ultraviolence in the Stock Market

Harry Dent |

Large-cap stocks opened this morning in the green, seeming to offer a little reprieve from an ultra-violent start to 2016. Small- and mid-caps weren’t so lucky. They’re continuing to rip through fresh new lows.

This has been the toughest bull market and bubble to call, as many leading indicators that we have used in the past simply don’t work since central banks hijacked the markets after 2008. But with these major divergences continuing to build, and after many years of the Fed’s zero-percent interest rates, it seems we’re finally coming close to the end.

You just can’t have a recovery that’s driven entirely by government stimulus. It only works when consumers start spending again and businesses expand to meet the demand. Otherwise, you prevent the economy from rebalancing naturally, and only encourage greater speculation and bubbles… and that’s exactly what these bogus policies have done.

I’ve been warning more and more strongly from late 2014 forward that this bubble finally looked like it was peaking after going much longer than anyone could have imagined. But into May of 2015 it continued to edge up to slight new highs. Since then we have continued to make lower highs on each rally – what I call a “rounded top pattern.”

But there’s a classic indicator that tells when a major bull market or bubble is finally peaking. I was suspicious that this indicator would not work this time in such an artificial market and economy. But it’s working like a charm.

That indicator occurs when small-cap stocks greatly underperform large-cap stocks. This is a sign that the dumb money is piling in and the smarter money is exiting. It’s like the generals advancing without the troops.

Analysts use the advance/decline line to measure this phenomenon. But since it can get confusing, here’s a simpler take on it: the value line geometric index (the blue line in the chart below). This is an equal-weighted and broad index of stocks. Instead of Amazon.com (AMZN) and Google (GOOG) counting for god-knows-how-much of the S&P 500 and skewing our sense of the broader market, this index weights them all equally.

That way, you get a sense for how the broader market is doing. So look at how it’s doing compared to the S&P 500:

Value Line Index Shows Broader Stock Market Already in Bear Market

It shows that the “typical” stock is already in a bear market – down 21% as of yesterday.

The Dow and S&P 500 and the Nasdaq are all weighted by market value and that makes the largest stocks dominant in such indices. At the end of a bull market, the least sophisticated investors pile in and they buy the big-name stocks that they know – Apple (AAPL), Coca-Cola (KO), Facebook (FB), Nike (NKE), Google, Amazon.

Those stocks get super overvalued. Do you realize that Amazon is up 120% in the last year and that its price/earnings ratio is currently at 870 times a 12-month trailing earnings of $0.70? That’s insane!

This is a time to sell on rallies, not buy on dips.

Stocks appear to be coming back after a rough start to the year, but I ultimately project they’ll be down to 5,500 to 6,000 by early- to mid-2017, and possibly sooner. My strongest warnings were at a Dow of 17,300. We’re about 1,000 points below that now, so if we get a sustainable bounce in the weeks ahead, sell any holdings you don’t have allocated to a specific, active investing strategy.

It’s better to get out of a bubble a little early than a little late, as bubbles burst at least twice as fast as they build…

It’s still not too late to get out of this one.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

Companies

Symbol Name Price Change % Volume
FB Facebook Inc. 115.40 0.30 0.26 25,070,364
AAPL Apple Inc. 109.90 0.41 0.37 26,527,997
AMZN Amazon.com Inc. 740.34 -3.31 -0.45 3,561,307
KONE Kingtone Wirelessinfo Solution Holding Ltd 5.11 0.16 3.23 41,722
NKE Nike Inc. 50.46 -0.19 -0.38 6,933,279
GOOG Alphabet Inc. 750.50 2.58 0.34 1,452,484

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