The market can be so cruel sometimes. It invites you in, offering the appearance of discounts, only to pull the rug out from under you just as you say goodbye to your hard-earned capital.
If you’ve ever been a market bear trap victim, then you’ll agree that the current market set-up looks more and more like traps of yore.
Stocks in free-fall lure unsuspecting value investors at just the wrong time. The calendar’s turn to September should be a big warning bell to those thinking the all-clear has been given.
The biggest clue: valuations.
Despite the first correction of this long-in-the-tooth bull market, stocks remain richly priced.
On the day of the big reversal rally for stocks last week, we saw two important retail names, Tiffany (NYSE: TIF) and Williams-Sonoma (NYSE: WSM), lose value as both companies reduced their future profit expectations.
For some time, the Cyclically Adjusted Price Earnings (CAPE) has been well above historical averages. With the rally in stocks, it still sits at 25—a number that suggests a big drop may be right around the corner.
For CAPE followers, the only big issue now is when—not if—stocks will drop.
Layer on the negatives of a China slow-down and collapsing commodity prices increasing the risk of deflation, and you have all the signs of a bear trap.
We have a week of trading before Labor Day. Unsuspecting bulls want to deploy capital while stocks are down. When the holiday ends and traders return from vacation, watch out.
Last week’s revision to second-quarter GDP upward to 3.7% was, economically speaking, the good news that opened the door to the V-shaped rally on Wednesday and Thursday.
The problem is that many economists see most of that upward revision reversing course in the third quarter. The double-edged blade of high stock valuations and an economy at risk for recession will form the ceiling on stocks for some time to come. The best the bulls can hope for is that stocks continue trading in a tight range.
Few catalysts for growth remain, as the Federal Reserve is already in the middle of a tightening mode. Middle? Yes, because the end of quantitative easing should be viewed as the first step in efforts to tighten the purse strings.
Fed policy makers are in a tough position. They desperately want to raise interest rates, but doing so runs the risk of tightening just as the economy is tipping over.
Now, investors are worrying like crazy over the central bank’s next move, wondering what to do.
Here’s what you shouldn’t do: panic. Sure, systematically taking some money off the table as the storm approaches is never a bad idea, but don’t go crazy.
No need to go into complete hibernation, but do avoid buying aggressively. There will be better moments for that down the road.
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