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The S&P 500 Is Ready For A Correction – Buy SDS

Summary Historical bull and bear market cycle suggests we are overextended. Earnings are weak, valuations are high. Interest rates are on the way up. This is probably the most hated bull market in history. All along, the bears have been in denial and have been calling for a big crash. To their dismay, the S&P 500 kept moving up and continued making new highs. The bulls have completely demolished the bears. It has reached a point where the bulls don’t give importance to the weak data points; they are happy concentrating on the few positives that still exist. With this backdrop, I want to short the US markets because I believe the markets are ripe for more than a 10% correction with limited upside risk compared to the possible downside. I shall use the historical bull and bear market cycles, the presidential four-year election cycles, the earnings performance and the market valuations to prove my point. As this is a contrarian call, I don’t expect many to agree with me. Previous bull and bear market runs Bull Market data The history of bull market cycles is an important guide, which gives us an idea about the current leg of the bull market. The second half of the 20th century witnessed strong bull runs. I have chosen to study the market cycles from 1942 to the present date; the selected time frame is skewed in favor of the bulls. The first half of the last century wasn’t considered because it had to deal with two world wars and “The Great Depression”. The economical and the geopolitical situation, though fragile, aren’t comparable to that of the early 1900s. Bull Markets with at least a 20% rise, without a 20% drop on a closing basis from 1942 till now SL Start End No of Months % Change 01 28-Apr-42 29-May-46 49.7 157.7% 02 19-May-47 15-Jun-48 13.1 23.89% 03 13-Jun-49 02-Aug-56 86.9 267.08% 04 22-Oct-57 12-Dec-61 50.4 86.35% 05 26-Jun-62 09-Feb-66 44.1 79.78% 06 07-Oct-66 29-Nov-68 26.1 48.05% 07 26-May-70 11-Jan-73 32 73.53% 08 03-Oct-74 28-Nov-80 74.9 125.63% 09 12-Aug-82 25-Aug-87 61.3 228.81% 10 04-Dec-87 24-Mar-00 149.8 582.15% 11 21-Sep-01 04-Jan-02 3.5 21.4% 12 09-Oct-02 09-Oct-07 60.9 101.5% 13 20-Nov-08 06-Jan-09 1.6 24.22% 14 09-Mar-09 ? 82 215.54% Average 52.59 145.40% Maximum 149.8 582.15% Source: BofA Merrill Lynch Global Research, Bloomberg Both in longevity and percentage rise, this market has come a long way and is placed in the third and fourth position respectively. However, the conditions during this bull run are different because the central banks have never printed such massive amounts of money around the world. The excess liquidity was plowed back into the stock markets in search of better returns because gold and a few other base metals peaked in 2011 and have been in a downtrend ever since. Though, this argument holds merit, the current situation is changing. The US Fed has long back stopped its bond purchase, it has gone ahead and raised rates for the first time in a decade. The cushion of the excess liquidity made available every month isn’t there anymore. We shall see higher rates in 2016 and the liquidity situation is likely to tighten further. In the absence of “The Fed Put”, the law of averages should catch up and pull the markets down. Bear Market data Bear markets with at least a 20% drop, without a 20% rise in between on a closing basis since 1942 SL Start End No of Months % Change 01 29-May-46 19-May-47 11.8 -28.47% 02 15-Jun-48 13-Jun-49 12.1 -20.57% 03 02-Aug-56 22-Oct-57 14.9 -21.63% 04 12-Dec-61 26-Jun-62 6.5 -27.97% 05 09-Feb-66 07-Oct-66 8 -22.18% 06 29-Nov-68 26-May-70 18.1 -36.06% 07 11-Jan-73 03-Oct-74 21 -48.2% 08 28-Nov-80 12-Aug-82 20.7 -27.11% 09 25-Aug-87 04-Dec-87 3.4 -33.51% 10 24-Mar-00 21-Sep-01 18.2 -36.77% 11 04-Jan-02 09-Oct-02 9.3 -33.75% 12 09-Oct-07 20-Nov-08 13.6 -51.93% 13 06-Jan-09 09-Mar-09 2.1 -27.62% Average 12.28 -31.98% Maximum 20.7 -51.93% Source: BofA Merrill Lynch Global Research, Bloomberg The average drop during a bear market is 32%; from the all-time high such a fall will take the S&P 500 to 1,452, a level unimaginable now, but that’s what history suggests. I’m not suggesting we will go down to those levels now, even a 20% fall will be highly profitable for us. The risk is, what if this is the mother of all bull markets and the bull run extends by another 70 months with a 300% rise. Anything can happen in the markets; hence, we shall use a stop loss to protect our capital. 2016 is the presidential election year in the US, let’s analyze the stock market performance before and after the new president is elected. Presidential year market performance According to various studies, the stock market gains 9-10% during the first two years of the new president, whereas, the third and the fourth year are comparatively more bullish, yielding higher returns. History suggests a limited upside risk in the next two years; however, since 1952, the last seven months of the election year have yielded positive results but two aberrations have occurred since 2000. The S&P 500 returns from January to March in the election year are mildly positive followed by negative returns in April and May, states a UBS report. I expect the markets to fall during the first five months. Though, the cycles indicate a possibility, stock market returns are closely linked to earnings and valuations. We shall analyze these in the next two sections of this article. There’s a slowdown in earnings Let’s look at a few data points on earnings. According to Bloomberg , the second and third quarter of 2015 have seen negative profit growth for the S&P 500 companies. The expectations for the 4Q 2015 earnings are also negative. A Thomson Reuters report states that compared to 26 positive EPS preannouncements by corporations, there were 86 negative EPS preannouncements by the S&P 500 corporations for Q4 2015. The negative/positive preannouncements ratio in Q4 2014 was 5.1 and in Q4 2015 was 3.3. Both readings are above long-term aggregate ratio of 2.7 taken since 1995. This indicates that the companies are not able to meet their expectations and guidance. Though, Thomson Reuters expects earnings to pick up in Q1 and Q2 of 2016 by 3% and 4% respectively, the current quarter has experienced a downward revision for seven of the ten sectors of the S&P 500. With the current trend, I won’t be surprised if we see negative revisions for the first and second quarters of 2016 going forward. Though 43% of the companies have reported revenue above analyst expectations in Q3 2015, it’s below the long-term average of 60% and lower than the last four quarters’ average of 52%. This shows a declining trend. However, Thomson Reuters states, on the earnings front, 70% has beaten analyst expectations, which is above the long-term average of 63%, and in line with the average of the last four quarters at 70%. In Q3 2015, the share-weighted profits were down 3.3%, the worst figure since 2009, states Bloomberg. Low energy prices and a strengthening dollar are negative for revenues as well as profits. After the first rate hike by the US Fed in almost a decade, the dollar is likely to strengthen further in 2016, with another 0.50-0.75% of rate hike expected by the experts. Some more negative signs for the stock markets In the first nine months of the year, Standard & Poor’s Ratings Services has downgraded US companies 279 times compared to 172 upgrades, this is the worst figure since 2009. Even Moody’s Investors Service has downgraded the credit rating of 108 US non-financial companies against 40 upgrades in the month of August and September. This is the most two-month period downgrades since May and June 2009. According to one metric followed by Morgan Stanley, the ratio of debt to earnings before interest, taxes, depreciation and amortization for investment-grade rated companies was 2.29 in the second quarter. In June 2007, just before the start of the crisis, the same ratio was 1.91. The Wall Street Journal has raised concerns about the balance sheets of the US companies. According to Casey research , the US companies have issued $9.3 trillion in new debt since the financial crisis. The companies have issued record bonds both in 2014 and 2015. Bloomberg business reported that the S&P 500 companies spent 104% of their profits on share buybacks and dividends instead of using it to invest in their business. The last time share payouts crossed 100% was in Q2 2007, just before the end of the bull market. A lot has been written about the junk bond market crash recently. Warning signs are all over the place. What’s the CAPE ratio indicating Are the markets over or undervalued according to the p/e ratio? We use the popular CAPE ratio also known as the Shiller p/e for our study. Shiller p/e Mean: 16.7 This is a popular ratio having both its followers and critics. Though, the reading during the dot-com bubble and Black Tuesday was higher compared to current readings, all other tops have formed at or below the present value. We might not fall just because the ratio is high, but it warrants caution. What does all this indicate We have used multiple studies to arrive at our conclusion about the current state of the bull market. The cyclical study, the drop in revenue and earnings, the red flags in the bond markets, high valuation compared to historical averages all indicate that the average investor should be careful about his holdings. With the US fed tightening interest rates, the trajectory of the rates is on an uptrend. Though, the US economy has displayed strength, the commodity markets, the energy markets, the slowdown in the Chinese economy don’t bode well for the bull run to continue. The markets will likely see a drop in 2016 and we want to go short the S&P via the ETF route. How to take advantage of the drop in S&P 500 Let’s look at a few options one can use to benefit from a drop in the S&P 500. Shorting futures It’s the favorite tool used by professional traders to benefit from a fall. However, it might not be a suitable option for the inexperienced trader, because you have to maintain a margin account to enter the trade. You have to actively manage your positions, you can’t short it and forget it. Buying puts The risk is limited in this trade, however, time value eats into the option premiums. Even if the markets remain at current levels, you will lose all your money if you buy at-the-money or out-of-the money options. Professional traders use complex options strategies to limit their risk and benefit from a fall. To benefit from options, you have to get both the timing, direction and the extent of the fall correctly, which might be difficult. Buying inverse ETFs Leveraged inverse ETFs like the ProShares UltraShort S&P 500 ETF ( SDS) Leveraged inverse ETFs can be bought and sold like stocks. SDS is -2x inversely leveraged against the S&P 500, which means, if the index falls by 1% in a day, the SDS ideally should gain by 2%. In the short term, the correlation is maintained; however, as the calculations are done on a daily basis, over the long term, the correlation is not perfect and can reduce well below 2 times. It’s called as beta-slippage. If the markets rise by 1%, your investment in the SDS will drop by 2%, hence, the risk and reward are maximized. As I expect most of the fall to happen during the first five months, I have advised a buy on SDS to profit from the leverage. In case you are not comfortable with the option of using 2x leverage, you can also buy the ProShares Short S&P 500 ETF (NYSEARCA: SH ), which is -1x inverse correlation to the S&P 500. Here, your risk and reward both are lower compared to SDS. If the markets make a new high and the S&P 500 trades at 2,175 levels (2% more than the current all-time high), we shall close our position and accept our assumption to be wrong. In reference to the current S&P 500 levels, the stop loss is around 5% and the profit objective is more than a 10% fall on the index. Conclusion Calling a top is very difficult, but the indications of a fall are building up. I believe the markets are ripe for a fall and investors should use this opportunity to profit from the fall. I recommend a buy on SDS at the current level of $19.54.

Profit Shortage + Economic Weakness + Stimulus Removal = Less Risk Taking

Since I first began identifying the breakdown in market internals in Q3 2014 equal-weight proxies like EWRI have gone nowhere. Virtually every traditional method suggests stocks are overpriced. I encourage all readers, thinkers and ETF enthusiasts to employ some type of portfolio protection to minimize the potential damage of a potential downtrend in 2016. Healthy bull market uptrends tend to feature similar risk-taking characteristics. Specifically, market-based participants will invest in a wide range of stock sectors (e.g., industrials, telecom, health care, energy, etc.) and asset types (e.g., large, small, foreign, preferreds, REITs, high yield corporate, convertibles, cross-over corporate bonds, etc.). There is little reason to discriminate because across-the-board risk leads to impressive returns. Late-stage bull markets are different. Fewer and fewer individual stocks succeed; fewer and fewer asset types gain ground. There is more reason to become selective because across-the-tape risk leads to discouraging results. I initially identified a “changing of the guard” in the third quarter of 2014 . In fact, it was the first time in the current cycle that I served up questions that challenged unbridled bullishness. (Note: Those who have been reading my commentary for the last decade and/or listened to me on national talk radio circa 1998-2005 know that I am neither a perma-bear nor perm-bull. Those who emotionally deride me as a perma-bear may wish to look at independent reviews of my articles over the years at this web link .) So what hit my radar in the third quarter of 2014? The small-company barometer, the iShares Russell 2000 ETF (NYSEARCA: IWM ), as well as the iShares Micro-Cap ETF (NYSEARCA: IWC ) were both wallowing in technical downtrends. The Vanguard FTSE Europe ETF (NYSEARCA: VGK ) was rapidly deteriorating. The PowerShares DB Commodity Index Tracking ETF (NYSEARCA: DBC ) had revisited 52-week lows. And, history’s favorite risk-off asset, long-term treasuries, had been experiencing a monster rally. In sum, a large percentage of asset types had begun to buckle such that I favored a barbell approach of large-cap stocks and intermediate-to-longer-term treasuries. In the August 2014 commentary, I also highlighted the similarities between monetary and fiscal stimulus removal in 1936/1937 and the QE stimulus removal in 2014 with subsequent anticipation of rate normalization efforts set for Q1 2015. I wrote: Most people are aware of the crash in 1929 as well as the capital depreciation that occurred through 1932. Yet many may not be aware of the government stimulus in 1933 that helped the market soar 200% over the next four years. While the stimulus may have aided in pulling the markets higher in the absence of organic economic growth, stocks eventually tanked nearly 50% in a ferocious 1-year bear (3/10/1937-3/31/1938). Here in December, you can find others who have recently started to talk about historical similarities with 1937 . More noticeably, you can find prominent commentators who are beginning to acknowledge the adverse implications of deteriorating market breadth; that is, the lack of breadth across the individual stock landscape, the ten stock sectors, the stock asset class and/or numerous asset types is a major headwind to a continuation of the bull rally. For instance, Jim Cramer of CNBC warned on 12/30 that six of the 10 key stock sectors are in downtrends. Meanwhile, Josh Brown of the extremely popular Reformed Broker didn’t mince words when he posted his “Chart of the Year” on 12/23. (See the chart below.) To wit, Mr. Brown wrote: You can see that the amount of stocks above this uptrend gauge has been cut in half from the start of the year. At present, just 28% of all NYSE names are in uptrends, or less than 1 in 3 stocks. That’s not a bull market. Since I first began identifying the breakdown in market internals in Q3 2014 – a breakdown that has been accompanied by increasing economic strain, undeniable stock overvaluation , a sales recession and a profit shortage – equal-weight proxies like Guggenheim’s Russell 1000 Equal Weight ETF (NYSEARCA: EWRI ) have gone nowhere. Equally troubling, like the vast majority of index-tracking investments, it has been many months since the fund has notched a new 52-week high. It is not just the deterioration in risk preferences (e.g., widening high yield credit spreads, treasury yield curve flattening, fewer stocks participating in the uptrend, etc.) that investors may wish to heed. As I type my final thoughts for the year (12/31), additional evidence on stock overvaluation as well as economic deceleration provide me with ample reason to reflect. For example, 42.9 on the Chicago Business Barometer is the worst reading since July 2009. The data point is a significant drop from 48.7 in November and it is miles away from the 50.0 reading that economists had expected. (Note: The region’s woes are hardly the only example of national economic headwinds .) As for the overvalued nature of U.S. stocks, virtually every traditional method suggests stocks are overpriced. This includes trailing P/E, forward P/E, price-to-sales (P/S), market-cap-to-GDP, CAPE and Tobin’s Q Ratio . Recently, Ned Davis Research may have come up with a progressive methodology: percentage of household assets. At the end of the 1981-1982 bear market, stocks as a percentage of household assets were a meager 15%. At the end of the 2007-2009 financial collapse, the data point was an exceptionally modest 21%. According to Ned Davis Research, the highest reading came at the height of dot-com euphoria in 2000. A whopping 47%. The third highest level going back to 1951 came before the financial crisis in 2007 (36%). At this moment? Stocks as a percentage of household assets hit 37% in 2015. The first and third highest percentages – 47% in 2000 and 36% in 2007 – occurred at significant market tops. Indeed, it is somewhat unsettling to recognize that 2015 lays claim to the second highest data point. Did we see the market top in the summertime? Perhaps. Bear in mind, the above-described markers line up perfectly with another valuation methodology, “Tobin’s Q.” The ratio at its peak in 2015 is second only to the ratio during “New Economy” insanity (2000). I am going to finish up with a quick anecdote. Although I live in California, I spent the previous week visiting family and clients in Florida. And every time that I go to Florida, I am shocked by the number of motorcycle riders who do not wear helmets. I’ve heard the arguments against their use before – everything from peripheral vision to neck injuries. Studies certainly show that helmets reduce the likelihood of brain injury and/or death. So while I recognize the freedom of choice issue, I still believe it makes sense for car drivers to “buckle up” and motorcycle riders to “helmet up.” In the same vein, I encourage all readers, thinkers and ETF enthusiasts to employ some type of helmet – some type of portfolio protection (e.g., multi-asset stock hedging, put options, limit-loss orders , tactical asset allocation, etc.) – to minimize the potential damage of a potential downtrend in 2016. And on that note, go forward to celebrate your happiness and your health! Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Ride The Coming 4th Wave Of Wealth Creation With This ETF

Summary Rising yields generally mean the economy is improving, which should benefit companies that depend on corporate and consumer spending. Technology is at the edge of another transformative wave. The acceleration of global population aging is going to drive demand across the biotech sector. Ride the coming transformative wave with this unique ETF that targets both technology and biotech and has consistently outperformed the broader market by a wide margin. Michio Kaku is a world-renowned, American futurist and theoretical physicist. He is a Professor of Theoretical Physics at the City College of New York (CUNY). Kaku has written several books about physics and related topics and has made frequent appearances on radio, television, and film. I recently had the pleasure of listening to him speak at an event in Boston. During his talk, he described the past three waves of wealth generation and shared his vision of how technology will shape the future. The question today is: what is the fourth wave? The first wave was steam power, the second wave was electricity, the third wave was high technology – all of it unleashed by physicists. What is the fourth wave of wealth generation? It’s going to be on the molecular level: nanotech, biotech and artificial intelligence . – Michio Kaku. According to Kaku, we’re at the edge of another wave of technological transformation. The world is growing increasingly dependent on technology. Products and services based upon or enhanced by information technology have revolutionized nearly every aspect of human life. The use of IT and its new applications has been extraordinarily rapid across all industries and an IT-Biotech convergence is already well underway. The acceleration of global population aging and technological breakthroughs are going to drive demand across the biotech sector. Longer life spans and increasing rates of chronic conditions will continue to fuel demand for new products and services. Nanotech breakthroughs will spur innovations across a wide range of applications in biotech and healthcare, potentially curing human illness. Multiple platform technologies working in combination – nanotechnology, biotech/genomics, artificial intelligence, robotic and ubiquitous connectivity – are going to lead to increasing profits for the dominant players utilizing these technologies. Many ETF issuers are coming up with innovative concepts targeting these technological transformative areas. The iShares Exponential Technologies ETF (NYSEARCA: XT ), with an annual expense ratio of 0.30%, attempts to track the developed and emerging market companies which create or use exponential technologies such as big data and analytics, nanotechnology, medicine and neuroscience, networks and computer systems, energy and environmental systems, robotics, 3-D printing, bioinformatics, and financial services innovation. (click to enlarge) There are funds targeting cloud computing such as the First Trust ISE Cloud Computing Index Fund (NASDAQ: SKYY ), which has annual expense ratio of 0.60%. The Robo-Stox Global Robotics and Automation Index ETF (NASDAQ: ROBO ), with an annual expense ratio of 0.95%, targets the robotics industry or you could own the Purefunds ISE Cyber Security ETF (NYSEARCA: HACK ), for 0.75% per year, which holds a portfolio of companies in the cyber security space. SKYY and HACK both follow the technology sector solely while ROBO and XT follow multiple sectors. Although many of these ETFs hold a few well-known, large-cap companies, most are fairly expensive and have so far proven to be more volatile than the broader technology sector. Because they have a short history, and until many of the smaller Exponential Technology companies achieve consistent profit growth, I prefer to ride the coming tech-biotech transformative wave with a portfolio of large, high-quality companies – market leaders within their respective industries, with a history of delivering consistent revenue growth. These large-cap market leaders are, no doubt, aware of how emerging technologies might bring them new customers or force them to defend their existing bases or even inspire them to invent new strategic business models. Many successful small-cap companies with disruptive technologies will eventually become dominant large-cap players. In fact, the NASDAQ’s dominant players have changed drastically in the last 15 years and probably will look much different in the future. You can capture this large-cap dynamic dominance with one of our favorite, can’t miss ETFs, the tech-heavy PowerShares QQQ ETF (NASDAQ: QQQ ), a unique fund that targets both technology and biotech and has outperformed the broader market by a wide margin for more than a decade. (click to enlarge) The QQQ is an ETF based on the NASDAQ 100 Index. The Index includes 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization. The fund is rebalanced quarterly and reconstituted annually. Besides being a 5-Star Morningstar-rated ETF with an expense ratio of just 0.20%, QQQ has delivered consistently superior returns during most time periods over the last decade. QQQ Sector Allocation: (click to enlarge) The top 10 holdings of QQQ consist primarily of U.S. technology, and also include Gilead Sciences (NASDAQ: GILD ), a major biotechnology firm, Amazon (NASDAQ: AMZN ), an e-commerce retailer and Comcast (NASDAQ: CMCSA ), a media/entertainment giant. QQQ Top 10 Holdings: (click to enlarge) In addition to the technology names in the above graphic, the QQQ holds another 36 big-tech firms including Qualcomm (NASDAQ: QCOM ), Texas Instruments (NASDAQ: TXN ) and Baidu (NASDAQ: BIDU ) to name a few. Besides Amazon and Comcast , there are 31 additional Consumer Discretionary names including Netflix (NASDAQ: NFLX ), Tesla (NASDAQ: TSLA ) and Priceline (NASDAQ: PCLN ). And besides Gilead, the QQQ’s biotech holdings consist of 15 more companies including Celegene (NASDAQ: CELG ), Amgen (NASDAQ: AMGN ) and Biogen (NASDAQ: BIIB ). Over 55% of the QQQ is tech. Technology is a cyclical industry. When the economy gets stronger, cyclical sectors like technology have tended to generate higher revenues from increased consumer and corporate spending. So its relative performance tends to rise and fall with the strength, or lack thereof, of the economy. However, a number of technological innovations – from nanotech applications to cloud computing to mobile connectivity – are spurring migration to new technologies. This migration may continue regardless of the overall condition of the global economy. Some solid, pure technology funds include the Technology Select Sector SPDR ETF (NYSEARCA: XLK ), the iShares U.S. Technology ETF (NYSEARCA: IYW ), the Vanguard Information Technology ETF (NYSEARCA: VGT ) and the Fidelity Select IT Services Portfolio (MUTF: FBSOX ). However, the aforementioned funds are primarily all tech and not the unique mix of the QQQ. The world’s dependence on technology and the acceleration of global population aging are two megatrends that should drive performance for years to come. Seventy percent of the QQQ’s holdings focus on well-established, high-quality technology and biotech companies. The fund’s consumer discretionary stocks should also benefit from an improving economy while the fund’s consumer staples stocks add a defensive component to the mix. Let’s take a look at how the QQQ has performed over various time frames. The newer Exponential Technology ETFs don’t have a long-term performance record so they cannot be included in this comparison. As you can see in the table below, the QQQ, with its unique structure of one-half tech, one-fifth consumer discretionary and one-seventh biotech, has outperformed the S&P 500 and just about every other large-cap technology fund during most time periods over the past decade, including the iShares S&P 500 Growth ETF (NYSEARCA: IVW ), which holds the fastest growing half of the S&P 500 stocks. QQQ is a kind of quirky fund, but it works. It delivers a unique combination of tech-biotech, growth and large-cap exposure. 10-Year Performance: (click to enlarge) Conclusion Rising yields generally mean that the economy is improving, which should be good for technology and growth companies that depend on corporate and consumer spending. Big tech and biotech companies have the potential to capitalize on two mega-trends for years to come – the increasing global dependence on technology and the acceleration of global population aging. QQQ is in a strong position to benefit from these favorable trends. As Michio Kaku says, “Don’t bet against technology. Be a surfer. Ride the wave of technology, see the wave coming, get on the wave”.