Why My Bearish Outlook Is Right (So Far)

Amber Hestla's picture

Friday, December 14, 2018 - 12:00am

by Amber Hestla

Last weekend, while many market analysts were starting to feel optimistic, I was apprehensive. There wasn't anything decisive in the agreement between President Trump and the Chinese president besides an agreement to talk.

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Rather than buying into the hype, I told my Profit Amplifier readers I would be watching the market for proof that the bear market in stocks had ended. Specifically, I said...

...I will be watching interest rates, soybean prices, and the stock market. For now, the weight of the evidence remains bearish. But gains in soybeans and interest rates would indicate stocks could delay a bear market for now.

Well, soybeans didn't move much. Prices are up 0.4% since December 3 and recorded most of the week's gains at the open last Monday. Traders in grain markets seem to be taking my approach of waiting for proof that China will be buying beans.

Interest rates did make a big move -- just not in the direction that would justify any kind of optimism. Instead, rates fell, indicating traders had lowered their expectations for economic growth. The chart below shows rates on 10-year Treasury notes fell below their 200-day moving average (MA), and my Profit Amplifier Momentum (PAM) indicator suggests even lower rates are likely.

Markets Confirm My Bearish Outlook For Stocks
The S&P 500 index dropped about 4.5% last week, a large move that shows traders were anxious to get out of stocks. The chart below shows the panic came after the index briefly moved above its 200-day MA.

PAM is now at levels associated with recent lows. The blue rectangle highlights those lows and the trading range that has formed over the past two months. A downside break of this range points to a price target of about 2,460, about 6.6% below Friday's close. That is a reasonable short-term target and implies a significant selloff is likely before the end of the year.

The S&P 500 is now down about 1% since the beginning of the year. That's important to consider.

Investment managers will be sending annual reports to their investors soon, and they'll want to show themselves in the most favorable light possible. That means they may sell stocks with losses. And with about 59% of stocks in the S&P 500 down since the start of the year, there may be a lot of stocks to sell.

By selling those stocks, managers might create the impression they didn't hold the losers the year since the annual report will only show the stocks in the portfolio on December 31. Selling losers can also reduce tax bills. With prices where they are right now, there are a lot of reasons to expect selling pressure in large-cap stocks.

Small-Cap Index Testing Recent Lows
It's a similar picture in small-cap stocks. The chart of iShares Russell 2000 Index Fund (NYSE: IWM) is shown below. This is a weekly chart and shows prices are testing recent lows after a large down move this week.

There is some good news we can take from this chart, or at least what passes for good news this week. The downside target in IWM is just 6.25% lower. That's marginally better than the expected decline in the S&P 500.

Technicals Set Up +50% Trade In GLD
I do have some actual good news -- a trading edge I spotted in SPDR Gold Trust (NYSE: GLD), shown in the chart below. On Friday, GLD closed above its 200-week MA. In the past, there has almost always been some follow through after a break above or below that key level.

PAM remains bearish, so I am still cautious on GLD. But I do see a potential short-term trade in the ETF.

Aggressive traders could consider buying call options on GLD, which will go up in price as GLD's price rises. When buying a call, the trader can only lose the amount paid for the call. The loss is limited and can never be more than that.

One option I saw, the GLD Dec-31 $118 Call, had the potential to gain at least 50%. (That's a call option on GLD with a strike price of $118 that expires on December 31, 2018.) This call closed at about $1 on Monday and was trading slightly below that level Tuesday morning. (Note: Prices could be different by the time you read this.)

Since a contract covers 100 shares, the trade would cost $100 to open. That is also the maximum possible loss.

Based on the breakout above its 200-week MA, I have a short-term price target on GLD of about $119.70. At that level, the call would be worth at least $1.70, a potential gain of about 70%.

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Final Thoughts
I should note, however, that this is not an official Profit Amplifier trade. My premium readers get access to all of my official recommendations -- this is just a trade you might want to look into. If you decide to enter this trade, remember to manage your risk and consider selling if GLD's price breaks below $117.

In the next week, I would like to see the pace of the decline slow. I expect a bear market to continue into next year, but I do not expect the S&P 500 to continue posting big losses week after week.

If, like many investment managers, you have losses to offset gains, you should consider selling into any strength that does develop.

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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.