Stocks are in the most precarious position they’ve been in in years.
The fundamental value of the stocks -- that is the earnings they produce -- has been declining steadily for over a year now.
Meanwhile, the overall markets have jumped back to within a few percentage points of their all-time highs.
Something’s gotta give.
And as you’ll see below, what is looking most likely to “give” is going to cost unprepared investors big.
A Sign Of The Top
By most measures, stocks must go down.
Earnings growth stopped at the end of 2014 and so did the steady gains of Dow and S&P 500 stopped.
Since then stocks have been on a volatile road leading back to where they started from.
It can’t and won’t last forever.
The fundamental value of stocks is based on earnings.
Stocks can be driven by all sorts of factors in the short run. Emotions, expectations, Fed comments, etc.
But as any long-term investor will tell you, it always comes back to earnings eventually.
That’s why the chart I’m about to show you should have you exercising caution in the current stage of the market rally.
The chart below from Factset Research shows a massive gap has formed between the earnings of the S&P 500 companies and their market prices:
The gap you see between the solid line (earnings) and the dotted line (the S&P 500 market price) has reached its widest point in over the last decade.
Every time the gap was this wide before, stocks dropped sharply.
Remember that 1,000 point down last fall?
It came when the gap between earnings and prices was as big as it is today.
The sell-off earlier this year?
Same thing. Huge gap between earnings and prices.
Even if you go back to before the credit crisis, the same trend appears.
Stock prices outsripping earnings followed by a sharp drop in stocks.
Beating The Bear
In the end, another correction is justified at current stock price levels.
A correction is even more than justified given the steady deterioration in earnings.
Frankly, the tailwinds which powered stocks from 2009 to 2014 have run out.
I realize that all seems ominous.
For most investors, it is too.
If you own a diversified mutual fund that owns 30, 50, or 100 different stocks, you’re going to be hit hard by the next downswing.
But you don’t have to be in that position.
Next week we’ll get into specific opportunities opening up right now.
For example, I’m working up one of the biggest changes hitting the tech industry.
Think of the VCR switch to DVDs.
That big of a change.
Or the one tiny sector that’s trouncing the market right now.
It’s already delivered multiple triple-digit winners with even more room to run.
You’ll have it all next week. Enjoy the rest of your weekend.