In this week’s Capital Wave Forecast – published Tuesday because Monday was President’s Day – right up top, out front, out loud, and against a very, very long string of very bullish Forecasts, I declared, “This Capital Wave Forecast is your first warning. Markets are overly optimistic, have risen too far too fast, and are prone to a correction in the coming weeks.”
Without hesitation (Wednesday’s dead cat bounce notwithstanding), it’s begun.
Right now, we’re seeing profit-taking.
If there isn’t positive news on the spreading coronavirus, named Covid-19, we’ll see net selling.
In the course of another couple of weeks, if we don’t see actual proof that infection rates are slowing and deaths don’t start declining, we’ll see bouts of panic selling which could, in short order, foster a correction – potentially taking markets down 20%.
From there, it all depends on the virus.
The True Danger of Covid-19
What’s so dangerous about the virus – in market and economic, not just human, terms – is that it is a truly existential threat.
You already understand that. Here are a few comments from Tuesday’s column…
Anonymous wrote: “I’m in UVXY and need a selloff to happen ASAP.”
Good move Anonymous, you made the right play.
Buying the ProShares Ultra VIX Short-Term Futures ETF (UVXY) – especially when it’s plumbing its 52-week lows of $10.40 – to profit from a spike in volatility is a brilliant move.
You’re getting your “ASAP” now; just remember the VIX often corrects quickly after a big run-up. Though I don’t think this volatility spike is done yet, so take your big profits when you get them because they can evaporate quickly when it comes to trading volatility spikes.
Saty commented,”Buy some long puts spreads and sell calls.”
That’s smart Saty. I’m recommending the same path, only I’d go further. Besides buying put spreads, I like buying puts on “overbought” stocks, on market indexes and some of the tech leadership stocks, especially the second tier tech stocks that got bought up along with the FAANGs and Microsoft.
They’ll all yield big gains if the momentum that overly optimistic investors chased stocks higher with reverses course and we see momentum selling. Put spreads and especially outright long put positions will be big winners.
I don’t recommend selling calls, at least not selling naked calls. Selling calls only makes sense if you’re selling calls against long stock positions you have, meaning you’re hedging those positions. Otherwise selling naked calls in what’s still a bull market is far too risky.
Henk Leeuwenburg commented, “You are right, 2nd qtr, earnings will be hit, recovery later to all-time high(s).”
Henk, I agree. I’ve been writing about earnings being good and ammunition for the bulls, but this week I said, “As earnings season winds down, the focus will shift to the global impact of Covid-19.”
That’s already happening. With more than 80% of companies in the S&P 500 having reported already, the “narrative in focus” just changed to the virus.
There have been numerous comments and some significant attention drawn to the coronavirus in earnings calls, but we’ve seen very little impact of the virus in earnings reports from last quarter.
That’s all going to change this quarter; it’s already impacting firms, and the extent of what we don’t see now will be laid bare in next quarter’s earnings reports.
So, look out below!
Linda Weekes commented, “My strategy is to wait till the S&P 500 hits its 200-day simple moving average. When it dips below for 2 days I de-risk taking profits from the quality stocks I don’t sell completely, and selling the higher beta stocks that do not have a dividend. I usually sell the index ETFs at this time as well. I am currently in 55% stocks and 5% REITs 15% gold and 10%cash and ST bonds and 15% in a private REIT. So I move to a 15% cash and10% ST bonds going to 40% stocks approximately. I just “tilt” the portfolio not market time then buy when the trend changes upward. I can get see-sawed but that’s ok.”
Linda, all I have to say about the moves you’ll make is that they’re smart, measured, and what a lot of people should be thinking about doing. In fact, I’m wondering if you have a copy of my trading rules because everything you’re planning is in my playbook for declining markets. Brilliant and thank you for sharing your strategy moves and being a loyal reader for many years!
Friday’s scare me when they come on the heels of an existential threat to markets that have been soaring on almost blind optimism.
Investors often dump stocks on Friday’s, sometimes in panic mode, and as scary as that is, what’s worse is what sometimes happens (not a lot of times, but enough times to warrant extreme caution) on the following Monday.
If we don’t see a big selloff today, especially if we don’t see hard selling into the close, Monday may not be so bad.
That doesn’t mean the profit-taking’s done or there won’t be more selling…there will be.
The narrative focus is the coronavirus now, and until that narrative has a good ending, look out below. I’ll follow up with you on Monday with our next Capital Wave Forecast, but in the meantime, let me know in the comments below what kind of movement you think Monday will bring.