Exit the Overvalued Market While You Can

I have to admit that I was wrong in anticipating a market correction in March. The market has rallied strongly off of February lows and the rally has outlasted my expectations. I had warned investors about a market correction in China and in the U.S. towards the end of 2015, however, it is impossible to accurately predict a correction every time.

While the market is slowing heading towards all-time highs, I think investors should be cautious going forward as a correction is highly likely in the foreseeable future. As I have said time and time again, investors can prepare for a correction and profit from it by having about 40% of their portfolio short from companies that would fall even in the most bullish markets.

Earnings are falling

As I had mentioned in one of my previous articles, corporate earnings were expected to fall roughly 8% for the quarter.
While the earnings were expected to fall greatly, I said that most of the companies will beat on earnings estimates, which is what has happened till now. About 25% of the companies have reported their earnings and 75% of these companies have beaten on earnings, which is a lot more than the average of 70%.

Most of the remaining companies have lower expectations to beat and have already revised their guidance downwards. Hence, while the beat may seem impressive, corporate profits are falling at a faster rate than expected.

With tech giants like Visa, Netflix, Microsoft, Alphabet and Sony all reporting disappointing numbers, it is only a matter of time before fundamentals catch up with the overvaluation of the current market. Amid the eroding fundamentals, investors are paying $17.8 for every $1 in expected earnings over the next 12 months. The S&P’s forward price-to-earnings ratio stands at 17.8, the highest since 2004 and way above the average 15 level over the past 30 years.

Also, investors have a misconception that the earnings slowdown has been driven by the energy sector. However, other sectors like technology, consumer staples, and telecom sectors are also witnessing slowdown whereas the energy sector has recovered considerably in the last few weeks.

With earnings falling steeply, corporate America is in a profit recession and I expect the slowdown to continue and it is only a matter of time before the stocks catch up with the reality. Hence, I think investors should prepare for a correction or a recession by either increasing their cash position or by having about 40% of their portfolio short with companies.
Published on Apr 25, 2016
By Ayush Singh

Copyrighted 2020. Content published with author's permission.

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