Will there be a 20-30% market correction
Market valuations have not mattered for years.
Pundits are no better than three-year-olds.
There must be a better way to analyze the markets.
This past week, I read an article entitled “When Will S&P 500 Valuations Matter Again?,” written by Gary Gordon.
And, in his first bullet point, he said “truth be told, valuations have not mattered for the public markets for three-and-a-half years.” He then goes on to state that “on virtually any methodology one employs, the U.S. stock market is extremely overpriced.”
In coming to this conclusion, he has reviewed price-to-free-cash-flow, price-to-sales, market-cap-to-GDP, and other valuation matrices. Yet, as he noted in his bullet point, these valuations have not mattered for the three and half years where the market added 50% to its price. Yes, that is a 50% return which cannot be supported by traditional valuation methodologies.
So, what would a reasonable person conclude? Well, I concluded that these traditional valuations methodologies matter not when it comes to being able to identify where the market is headed. Yet, Mr. Gordon concluded “regardless, valuations will matter again.” And, yes, I scratched my head.
Isn’t this another way to say that the market is wrong, and when it finally catches up to where the fundamentals suggest it should be, then the market will be right again? Or, as many pundits have stated, “the market is just not trading based upon fundamentals at this time.” And, yes, this is another amazing comment to me.
If one is being intellectually honest about this issue, one must be able to honestly answer the following question: If fundamentals are not controlling the market all the time, then are they really controlling any of the time?
While you ponder that question, I will tell you that I view fundamentals as a coincidental or lagging factor rather than a controlling one. And, I have explained why I have come to this conclusion in this article I wrote quite some time ago.
So, I am not going to beat that dead horse again. Rather, I want to show you a conversation that took place in the comments section of my last article, which I think will be enlightening for those with an open mind:
Vivian: This market is way too expensive and it was made expensive by financial engineering and hype. This can’t be good.
John: That’s been the basic Bear take on things since 2014.
Uncle Hank: If a stock (or an index) is overpriced by whatever metric you’re referring to, but doubles before it tops out, was it really overpriced, or did the investor just not know how to value it appropriately?
As John correctly pointed out, “the market is not trading based upon fundamentals” has been the bear mantra since 2014. Yet, Uncle Hank nailed it on the head with his incredibly insightful comment. So, again, it leads me to question that maybe our traditional methods of valuing the stock market are completely useless when it matters?
To that end, in an article by Caroline Baum in Bloomberg entitled “Rearview Mirror Is Where Economists See Future,” she termed a forecast based upon fundamentals a “Hindcast.” In that same article, Bob Barbera, chief economist at Mt. Lucas Management Co., was quoted as saying “allowing the pace of economic growth in the last three to six months to dictate the next three to six months beats most forecasts – except when it matters.” (emphasis added).
That is an amazing statement if you take the time to think about it and understand what Bob is really saying. It means that using backward-looking information … in other words, using fundamentals to attempt to forecast the future only works in a trend. It will never be able to identify a trend change, which is “when it matters.” So, it seems Bob is saying that fundamentals do not really matter for anyone who wants to know when the market will change direction. The rest of the time, they are simply a coincidental factor.
Moreover, it is clear that these fundamentals have been unable to even maintain many within the current trend as even the fundamentals have failed to do what a simple trend channel would have been able to accomplish.
Yet, as the market continues to break out to new all-time highs, the true insanity of the market pundits is placed on display. As Einstein noted, doing the same thing over and over while expecting a different result is the epitome of insanity. Over the last 3 years, we have had a huge list of factors paraded before us as to why the market rally has come to an end:
Brexit, Frexit, Grexit, rise in interest rates, cessation of QE, terrorist attacks, Crimea, Trump, Syrian missile attack, North Korea, record hurricane damage in Houston, Florida, and Puerto Rico, quantitative tightening, trade wars, etc.
Yet, the market has returned over 50% during that time. You would think that these pundits would learn their lesson that the market simply does not care about these factors, just like it does not care about traditional valuations. Of course, they have not learned. Rather, what they do is simply go searching for other factors that will certainly cause the market to top THIS TIME.
So, when I read this article about 60 events to watch out for in the coming months, it really made me chuckle:
This reminds me of when my children were 3 years old, and we were stopped at a traffic light. They look at the traffic light, and say “now,” as they try to time the light changing back to green. And, if it does not change, they again say “now.” And, this goes on for maybe another 10 to 15 times, depending on how long the light takes to change. Yet, when the light finally changes at one of their “nows,” they proudly assume that they caught that timing ever so perfectly.
This sure sounds like most of the pundits we read and listen to, does it not? So, yes, when I read these pundits providing us reason after reason as to why the market will top, I view it as akin to my 3-year-old child saying “now.” Eventually, the market will turn just like the traffic light will eventually turn and they will react just as proudly as my 3-year-old, assuming they caught that timing ever so perfectly. But, clearly, there is no prescience to their abilities to identify the cause of that turn, just like my 3-year-old.
You see, just like my 3-year-old does not comprehend that there is something internal to the traffic light that causes the light to change, the pundits do not comprehend that there is something internal to the stock market that will eventually make it turn down. This is clearly evidenced by the fact that none of the exogenous events to which they have been pointing for years have been able to cause the turn to the stock market every time they say “now.” My 3-year-old and the market pundit simply do not comprehend the true driver of that which they are attempting to time.
Will the market see a correction? ABSOLUTELY. However, as I have warned over the last several years, we were not yet ripe to see a 20-30% market correction. Rather, we are only beginning to approach that point now. Moreover, the next big drop in the market will likely only be a correction, setting us up for an attempted rally through the 3500SPX region into the early 2020s. So, I still think this bull market has several more years to run, but I do expect a 20-30% correction before that final multi-year rally begins.
Last weekend, I provided you my expectation that the market will likely be heading to the 2920SPX region this past week. Well, we came within 3 points of our target before we turned back down, as we expected. In fact, my Wednesday night update to the members of my Market Pinball Wizard service (sign up for free trial here) was entitled “Time For A Rest For The Holiday Weekend?” And, in summary, this is what I noted to my members:
“So, we have just about hit out target for wave 3 of (3) on the 5-minute chart. That means we should be expecting a wave 4 pullback/consolidation in the coming days. Support has now been moved up to the 2893SPX region, which is the .382 retracement of wave 3 . . .”
On Thursday, the market began to turn down, and on Friday, the market dropped to the 2892SPX level. So, Tuesday of this coming week will be quite important. As long as we hold Friday’s low, my next upside target is the 2950SPX region, and we can strike that region by the end of the coming week. However, should we break Friday’s low early in the coming week, then we can drop back down to the 2845SPX region before we see the next potential rally set up. So, the price action early in the coming week should tell us how the rest of the coming week will take shape.
This leaves me concluding my write-up as I will likely continue to do for the coming weeks. As we continue moving higher, I want to remind you that we are setting up for a 20-30% correction, which can potentially take the SPX back down to the 2100SPX region within the next year or two (with a minimum expectation of the 2400-2500 region). So, even though, as of now, we still retain potential to rally as high as the 3225SPX region (which we set years ago), please keep in mind that risks continue to rise the closer we get to our long-term upside targets, as our minimum target for a topping point is in the 3011 region. And, should a major Fibonacci Pinball support break before we get there, it would make me even more cautious.