A market correction is a pullback that is based on the percentage that the market sells off. Analysts generally consider a sell-off of less than 10% a market correction, while a sell-off of more than 10% would constitute a market crash. While the difference is negligible, a market correction is more orderly, whereas a crash is more severe and indicates a structural break of the market trend. Pullbacks are expected in any economy, and many investors view a market correction as positive, allowing them better prices on which to enter new positions.
Yes, we are getting close to that time again; the next earnings season is almost upon us. Many investors will be focusing on the level of earnings growth, not only for the past quarter, but also for the guidance issued by firms for the future.
The stock market is up significantly this year, so any disappointment in guidance regarding corporate earnings could cause a significant market correction.
A recent example of the type of market correction that’s possible is Hertz Global Holdings, Inc. (NYSE/HTZ). The company lowered its guidance for revenues and corporate earnings for the full year, which caused its shares to sell off significantly.
Whenever you have stocks pricing in extremely strong levels of corporate earnings, any marginal disappointment will lead to a market correction. In this instance, Hertz adjusted its corporate earnings range for the full year from $830–$875 million down to $780–$830 million. (Source: Hertz Global Holdings, Inc. web site, last accessed September 27, 2013.)
Chart courtesy of www.StockCharts.com
The company cited weaker-than-expected volume at U.S. airports. The stock did sell off significantly, which goes to show you how vulnerable stocks are to a market correction.
Having said that, we have to put things in perspective. Hertz will still report a record amount of corporate earnings for fiscal 2013, so this isn’t a case of a company losing money; it’s simply making less than what the market expects. Price is always relative, and stocks fluctuate between optimism and pessimism.
When people are too optimistic about corporate earnings growth, it drives valuations extremely high. This also leaves stocks vulnerable to a market correction if corporate earnings even … Read More
As many long-time readers know, over the past couple of months I’ve been raising concerns that a market correction is highly likely to occur fairly soon. One of my concerns is the level of corporate earnings that we are seeing, as much of the low hanging fruit has already been picked.
I believe that much of the good news regarding corporate earnings has already been priced into the market. What this leads us to is a situation in which any marginal disappointment will leave investors rushing to the exits, creating a market correction.
As everyone should be aware, the vast majority of the U.S. economy is led by consumption. While the economy has been showing some signs of improving, we are far from having anything close to an optimal economy. Job creation is still lackluster, especially the stagnant level of wages.
Wages not increasing is a serious problem for companies that generate corporate earnings from selling goods to the average American. I’ve been quite worried that we are going to see disappointing corporate earnings numbers from retailers in this space, which could be a trigger for an overall market correction.
We are now seeing reports that the retailers are indeed struggling, as Wal-Mart Stores, Inc. (NYSE/WMT) lowered guidance for its corporate earnings. The combination of higher taxes and lack of wage growth is certainly hitting the average American. (Source: Wal-Mart Stores, Inc. web site, August 15, 2013, accessed August 15, 2013.)
During the second quarter, Wal-Mart reported that U.S. same-store sales declined 0.3% between April 27, 2013 and July 26, 2013, with its international division increasing sales by 2.9%. Total … Read More
Many friends and readers have been asking me about the overall market and when we will see a market correction occur. For simplicity’s sake, let’s use the S&P 500 as a trading vehicle of choice to represent the overall market.
I believe we are close to a top in the S&P 500 and it could drop at least 150 points during the next market correction.
There are several reasons as to how I calculated the extent of the drop and how we are currently very close to the top. The first is that a market is a multiple of earnings—how much people are willing to pay for every dollar of earned income.
Historically, the average for the S&P 500 price-to-earnings (P/E) ratio has been about 15. A market correction occurs when there is a disconnect between the S&P 500 and the underlying fundamentals of the companies. Remember: the market leads the economy, which is exactly what has occurred over the past couple of years.
However, at this point, we are in a situation in which revenues are not growing, profit margins are close to all-time highs, and earnings appear to be stagnating. With the 12-month forward earnings per share for the S&P 500 estimated to be $117.00, this leaves the forward P/E ratio for the S&P 500 at 14.5. (Source: FactSet, August 2, 2013.)
Is that outrageously expensive? No; however, it isn’t cheap. We need to look at where the risks and the potential rewards are to get a better idea of whether or not a market correction is likely.
In terms of rewards, the historic P/E ratio for the … Read More
The time to act is close at hand. As long-time readers of my pages are aware, one of my primary concerns about the current economy has been the complacency of investor sentiment. If you look back to any period just prior to a significant market correction, what you will usually find is that investor sentiment had grown almost immune to the possibility of a negative event.
As volatility decreases over time, through a steady climb up for stocks, many investors seem to forget that shocks to the system do occur regularly. This complacent level of investor sentiment lulls people to sleep—until they are awoken by the realization that there are extreme risks present. And that leads to sharp market corrections.
At this point in time—at least from the U.S. perspective—things do appear to be getting better. But there are increasingly worrisome signs that much of the rest of the world is actually moving backwards—toward worsening economic conditions.
The latest news from China shows that the country experienced a much worse-than-expected decrease in exports—3.1% in June year-over-year—one of the worst readings since the depths of the recession in 2009. In addition, imports to China dropped 0.7% year-over-year.
China is in the middle of a significant restructuring program, and they are not keen on pumping additional stimulus into their economy unless they see an emergency scenario.
Their approach is significantly different than what we’ve seen over the past decade, and could lead to lower estimates of gross domestic product (GDP) growth. Of course, that news affects more than just investors in Chinese equities.
The drop in exports signifies that Chinese products are … Read More
The Dow Jones Industrial Average (DJIA) is down 2.3% from its record-high on May 28, but just like the S&P 500, the DJIA appears to be flashing some fatigue on the charts, suggesting some stock market risk and possible market correction.
Now, this may only be a temporary pause, or it could be foreshadowing some upcoming selling, stock market risk, or a potential buying opportunity.
The chart featured below of the DJIA (shown in the red candlesticks) and the Dow Jones Transportation Index (in green) shows a decline in both (marked by the larger purple oval). This may indicate that something bigger is coming, or, as the case was in mid-April (as indicated by the smaller purple oval), we may just be seeing a market adjustment prior to another rally.
Chart courtesy of www.StockCharts.com
What will be interesting to monitor is if the transports follow the industrials higher on the chart. If so, it would help to confirm the move in the industrials.
If the transports fail to follow the industrials higher, however, it could suggest a bearish divergence and stock market risk, pointing to some upcoming selling.
The reasoning of Dow theory makes sense: if the country is producing and selling more goods, then we can expect the shipping business to also rise, including rail, truck, and ship, which is something the transports will indicate.
At this point, the industrials and transports are confirming each other. On the industrials, watch the 14,500 to 14,750 area on the above chart. Failure to hold here could drive stock market risk and cause the industrials to retrench to their previous sideways channel … Read More