Why The Trend Is Your Friend In This Market

Amber Hestla's picture

Tuesday, July 2, 2019 - 12:00am

by Amber Hestla

On Saturday, President Trump met with China's President Xi. 

They reached an agreement that seems like it should be important. 

But the top story on CNBC wasn't about that meeting. 

There was news about the meeting further down the page. In terms of page views, it was the fourth-ranked story on Saturday afternoon. 

Instead, it was this...


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CNBC top page

(Don't worry, I won't be discussing the Avengers movie, so you don't have to worry about potential spoilers.) 

The fact that the trade war is less important to CNBC readers than the Avengers movie shows me that the trade war has become routine. 

The specifics of the meeting certainly seemed routine. Both sides agreed not to levy any new tariffs and, according to the Chinese summary, worked "to restart trade consultations between their countries on the basis of equality and mutual respect." Trump noted, "We are right back on track." 

That sounds like both sides are settling in for the long haul; two other pieces of news confirm that. 

1) Trump agreed to allow sales of electronics equipment to Huawei, the Chinese telecommunications company officials described as a security risk to the U.S. and allies. 

2) Trump also said he expects China to buy additional farm products from the United States. 

With no big news from the meeting, it's likely traders in the stock market can continue to ignore the news about tariffs. Instead they can focus on earnings. There, the news might not be good. 

It Looks Like We're In An Earnings Recession
FactSet reported that more companies than usual are issuing guidance ahead of earnings. As of Friday, 113 of the companies in the S&P 500 offered revisions to their outlook for the second quarter. Of those revisions, 87 (77%) were negative. On average, 74 companies provide negative revisions – about 70% of the revisions. 

In effect, companies are warning analysts that they are too optimistic. Yet, analysts are already expecting earnings per share (EPS) to decline 2.6% compared to a year ago. It is likely earnings will be even worse than that. This will be the third consecutive quarter where earnings fell compared to a year ago. 

The S&P 500 struggled during the most recent earnings recession, which lasted from the fourth quarter of 2015 through the first two quarters of 2016. The market action during that time is highlighted with a blue rectangle below. 

SPX earnings recession

The next chart highlights the price action in the current earnings recession. 

current earnings recession

The pattern is similar. There is a selloff as traders realize earnings are contracting. After a recovery, a second wave of selling unfolded in both cases. Then there was a recovery. That brings us to where we are now. From a technical perspective, the stock market is bullish. Breadth is positive and momentum is strong. 

Fundamentals are less bullish. Analysts expect earnings to show growth in the third quarter of 2019. I expect this to change as models are updated with results from the second quarter and the impacts of the status quo in international trade continue to be a drag on the global economy. 

But, as I've noted several times recently, fundamentals don't matter. Sentiment has been bullish in the stock market. As long as that continues, the trend will remain "up." 

In this environment, it could be best to adopt a trend-following strategy to determine when it's best to become defensive. A simple strategy like a 10-month moving average (MA) can work, as the chart below shows. 

QQQ trend chart

I selected a chart of PowerShares QQQ (Nasdaq: QQQ) because that is an ETF that tracks the NASDAQ 100 Index. This was the index that was the focus of the internet bubble in 1999 and 2000. The "sell" signal with the 10-month MA came about 15% below the all-time high. 

Even in a bubble, trend-following works. Given the current state of the stock market, I don't want to ignore the possibility of a bubble developing. Investors, as a group, are irrational. It's hard to think of anything more irrational than buying stocks as earnings decline and a global recession is likely. Yet, here we are. 

The next chart shows the 10-month MA has sidestepped several significant declines in the S&P 500 during the current bull market. 

current SPX trend

This indicator will turn bearish when the next bear market begins. It won't precisely call the top, but it will help limit losses. While other indicators may offer different benefits, this one is easy to find on free websites and takes just a few minutes a month to follow. If you don't follow anything else, this would be an indicator that's worth your time. 

Of course, I will update you every week on other indicators. Below is a chart of my Profit Amplifier momentum (PAM) indicator, which is also bullish. 

SPX PAM

PAM offers signals on shallow pullbacks and helps identify times when it's best to be conservative or aggressive. Right now, PAM is telling us to aggressively invest in large-cap stocks. But it's telling us to avoid small caps as the chart of the iShares Russell 2000 Index (NYSE: IWM) ETF shows. 

Russell 2000 PAM

These two charts tell me the stock market is narrowing and just a few stocks are pushing the S&P 500 to new highs. This is the kind of market we had in 1999, and I really won't be surprised if we see a bubble form soon. 

My Income Trader readers and I will be ready for that, or any other market environment that comes our way.

That's because each week since February 2013, my readers and I have been using a low-risk trading strategy to make thousands of dollars in extra income. In fact, out of 267 official trades,  244 of them have been profitable -- good for a win-rate of 91%. I know it may sound too good to be true... which is why I'm openly sharing my research and results. You can learn all about it right here.

Amber Hestla does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.