Hello investors,
Last week, we experienced a significant improvement in the market price action behavior. It seems like the markets started a recovery, but the metrics are still weak. That raises the question: Is this just a bounce, a relief rally before resuming the downtrend, or the end of a correction?

On the one hand, the markets lost 6.4% in this correction so a reversal could be justified. But we still have inflation freaking investors out; we have slowing GDP, which along with the inflation, can signal stagflation like we saw in the 1970s. If we consider worsening metrics (like rising volatility, again), we may expect more market weakness. But no one knows what the future will bring, so we need to wait and find out if this is the end of a correction.

Market sentiment

We had a much smoother ride in the market this week compared to last week. The war in the Middle East cooled, but interest rates in the U.S. continued to heat up. There is an obvious correlation between interest rates and the bond market. Rates go up; bonds go down.

There is also an inverse correlation between equities and interest rates—rising rates cause multiples (PE ratios) to compress. The forward PE ratio of the S&P 500 got up to 22x before this correction began. That is much too high; we should be closer to 19x. We have come down to 20x in the last few weeks of selling. And the selling was mostly caused by overvaluation and rising rates. Yet, the S&P 500 would have to come down to about 4,700 to get that forward PE ratio down to 19x. We closed the week at 5,100.

It was a busy and crazy week of earnings reports. On Thursday, META lost over 12% of its value in one day due to an underwhelming revenue forecast. Then, on Friday, Alphabet (GOOGL) added just over 10.2% to its value in one day with a better-than-expected earnings report.

So far, 50% of the S&P 500 companies have reported earnings. This earnings season aligns with overall expectations. But the street is still looking for record earnings this year and next year for the S&P 500. Earnings have been going up yearly since 2009 (except for the COVID year of 2020). There is no better explanation than why the market has come so far since then. Indexes and stocks follow earnings.

Earnings and expectations must keep growing for this long bull market to continue. I watch those expectations very, very closely daily. When they start to erode, we are in for another bear market.

Fasten your seat belt and put on your helmet because another 175 companies from the S&P 500 will report earnings this week. Like this past week, it should be interesting. We remain amid about a 5% overall correction in the overheated markets. Is there more downside to come?

The S&P 500 is still in a downtrend but is trying to hold and establish a sideways trend around the 5,000 area. Its support level is now 4,950. A break below that would be a continuation of the downtrend. Resistance is now at 5,120 (50-day MA). The forward PE ratio of this index rose from 19.9x to 20.0x this past week. Its five-year average is 19.0x, and its ten-year average is 17.7x. It peaked at 23x in early 2021, when rates were near zero. The S&P 500 would have to pull back to 4,750 to return the forward PE ratio to 19.0x. The golden cross in February of last year is still in place. This chart is still vulnerable and a down move to its 200-day moving average at 4,690 is still possible.
The chart above shows improvement in price action and some oscillator, but the price is approaching resistance level. Will the market have enough strength to break above it?

Market Score

The market score dropped again last week to 57. It is a large drop from 83 just three weeks ago! This indicates significant damage to the trend but also allows us to get large gains. The market participants are afraid and selling. We can see it in this metric as it drops and increases volatility.

This doesn't mean we should jump in and start buying—not at all! We need to see more damage to the sentiment, but most importantly, it has to be accompanied by a drop in volatility. That would indicate that the sentiment is bottoming, and the market would follow—the ideal time to jump in.

However, the primary (secular) trend is still bullish, and this can be just a correction. Nevertheless, be prepared for a potential 10% to 15% drop. It still may happen and it will be perfectly normal.

When the market drops like this, we will be getting ready for the moment when we start buying stocks again. In the previous weeks, we held cash and are now ready to deploy it. But not yet! The volatility is still very high, and we need that to turn around too. But we can see it coming soon.

I still save all proceeds (options premiums and dividends) to cash vehicles in this manner:

  • Dividends > save to SGOV fund.
  • Options premiums > save to ICSH fund.

Volatility Metrics

Volatility spiked again last week by a staggering 42%. The new score is 61.93. It is an improvement from the last two weeks ago trend. But during the last week's trading the volatility metric dropped to 57.77% before it spiked back up to 61.93%. Definitely, there is still a lot of fear out there.

We rotated into defensive positions a week ago and are now waiting for this correction to end so we can rotate back into bullish positions. We will limit our options trading to a minimum (mostly trading call spreads and managing old put spreads only), avoid buying stocks, and buy ETFs performing well in a bear market.

What does this mean?

The chart and trend indicate that volatility spiked hard and is trending up. The market participants are worried and panicking. Some are in denial, which may fuel further selloff in the near future. More of them may be buying protective puts or selling out of their bullish positions. The market trend is reversing.

There are the following potential scenarios:

1) Volatility starts rising, the score rises, and the market rallies.
This will be the most dangerous scenario. It will indicate that the correction is imminent. In this market, we will save cash (parking it into ICSH and SGOV), not buy new stock positions, and keep trading options, but we will not be scaling up our trading.

2) Volatility increases above 55%, the score still rises, and the market still rallies
This indicates that it is time to go bearish and defensive. Let others keep propping the market, but we will reverse our trades into neutral to bearish trades. We will add protective positions. Our options trades will be placed as far away from the market as possible, and we will trade Iron Condors.

3) Volatility keeps increasing above 55%; the score starts dropping, and the markets stall, reverse, or drop.
This will be the time to go full defensive and bearish. We will likely release cash (selling ICSH and SGOV funds to increase cash) to prevent margin calls. Our options trading will be fully bearish (selling calls or call spreads), and we will buy 2x or 3x leveraged bearish ETFs (sell SSO, SPXL, and buy VIXM, XLU, or stay in cash. We will buy protective puts, trade collars, or deep ITM-covered calls to protect our dividend stocks.

4) Volatility crashes, score crashes, and the market crashes.
This will be the time to go aggressively bullish again. We will liquidate all bearish trades and rotate them into bullish ones, such as buying SPXL and SSO and adding stocks to our portfolio again. Our options trades will be bullish again (selling puts, selling put spreads, or trading Iron Condors).

Today, we are still in scenario #3 (highlighted in red above), although there was a small improvement last week. We originally sold our holdings SSO and bought IYR defensive ETF. We also sold QLD funds and bought XLU. However, last week, we rotated back to QLD. If the markets start deteriorating again, we may rotate back to XLU.

We are also saving cash in SGOV and ICSH funds or cash position (depending on margin requirements). Our option trades are now neutral. We are not scaling options trading and replacing old trades; we are just managing the old ones. We are also not buying new stock positions.

Market Outlook

EARNINGS SEASON IS NOW ALMOST HALF OVER! For Q1 2024, with 46% of S&P 500 companies reporting actual results, 77% have beaten their earnings estimates, and 60% have beaten their sales estimates. The estimated (year-over-year) earnings growth rate for the S&P 500 is now 3.5%, a big jump from last week’s 0.5% growth estimate! We were at 3.2% three weeks ago. If 3.5% is the actual growth rate for the quarter, it will mark the third quarter of year-over-year earnings growth for the index.

The S&P 500's estimate for Q1 is now $54.25 per share. Eight weeks ago, it was $55.25 per share. The current revenue growth estimate is 34.0%.

The S&P 500 forward PE ratio goes up to 20.0x this week. This has been ABOVE the upper band of forward PE ratios recently, but it is now coming down from its bloated 22x level. We got as low as 15.5x in October of 2022, and we started 2023 at 17.0x. This forward PE ratio has dropped from 23.5x since the beginning of 2022. The five-year average is 19.1x. The ten-year average is 17.8x. The net profit margin for the quarter is expected to be 11.5%.

175 S&P 500 companies will report this coming week!

The trailing 12-month P/E ratio is 24.9, which is well above the 5-year average of 23.2 and above the 10-year average of 21.3.

For Q1 2024, analysts are projecting earnings growth of 3.5% and revenue growth of 4.0%
For Q2 2024, analysts are projecting earnings growth of 9.7% and revenue growth of 4.4%
For Q3 2024, analysts are projecting earnings growth of 8.6% and revenue growth of 4.9%
For Q4 2024, analysts are projecting earnings growth of 17.3% and revenue growth of 5.6%.

For all of 2024, analysts are projecting earnings growth of 10.8% and revenue growth of 4.9%

For all of 2025, analysts are projecting earnings growth of 13.9% and revenue growth of 5.8%.

The market is now homing in on the 2025 and 2026 estimates. The consensus analyst’s 12-month target price for the S&P 500 is 5,572. The consensus analyst earnings estimate for the next four quarters is now $253. I am keeping my multiple at 19.0x for now.

(2024) $253 X 19.0 = 4,807 S&P 500 Target Price

My current 3-6 month target price for the S&P 500 is 4,807. This gives the S&P 500 an upside potential of -5.80%, which shows the overall market is overvalued. We need a pullback of ~8% for a higher upside potential, more multiple expansion or material earnings expectations increases (unlikely). However, I am still finding individual stocks that have 80-100% upside potential over the next 3-5 years.

(2025) $288 X 19.0 = 5,572 S&P 500 Target Price

The consensus estimate for the next four quarters is $288.00. I am keeping my multiple at 19x this week. My current 6-12 month target Price for the S&P 500 is 5,572. This represents a +9.2% upside potential, which is below average.

Disclaimer: All information, analysis, and articles in this email are provided for educational purposes only. Nothing herein should be interpreted as personalized investment advice, as I do not recommend buying, selling, or holding any securities or positions. This email is available "as is" without warranty or guarantees of its accuracy, completeness, or currentness. You do so at your own risk if you rely on this email or any information. I do not hold myself out as a financial advisor, and nothing herein is a solicitation for any fund or securities mentioned. Although I may answer general questions about the information, I'm not licensed and registered under security laws to address your personal investment situation. Past performance is not indicative of future returns. Any financial decisions are the sole responsibility of you, the individual.
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