Storm Clouds Ahead for U.S. Stocks; Major Correction Imminent!

The rally in U.S. stocks over the last 10 weeks has been among the strongest in history. A major reversal in Federal Reserve monetary policy ("patience" now instead of "more rate hikes" ahead and an end in sight for "quantitative tightening"), record corporate share buy backs, and a massive new monetary stimulus program from the PBOC all contributed to the near record advance in U.S. stock prices since the reaction lows were posted on December 26th, 2018. And Bloomberg is now reporting this afternoon (Sunday, March 3rd) that the U.S. and China are very close to announcing a meaningful breakthrough in ongoing trade negotiations. What's not to like!

Given this bullish price action, how could anyone attempt to call a top here?

Trend followers are now 100% invested and loving every trading day!! Short sellers have been killed and most active investment managers are under-performing their benchmarks. How can anyone stay in cash with share prices running like they've run so far this year? Clear sailing ahead, right? Bullish pundits are already predicting new all-time record highs at 30,000 (+15%) for the Dow Jones Industrial Average, 3,000 (+7%) for the S&P 500, and 10,000 (+13%) for the Nasdaq Composite Index for this year. Why not?

For investors who are comfortable that Donald Trump will be re-elected President in 2020, and who are also comfortable that the U.S. Federal Reserve won't hike interest rates and will soon end its balance sheet liquidations, and if you are also an investor who is comfortable that corporations will continue to buy back record amounts of their own shares, then you should be comfortable owning U.S. stocks! (Maybe a bit too much "comfort" and complacency here?)

However, here are just a few obstacles which could upset the apple cart immediately ahead:

1. Year-over-year corporate earnings growth will be nominal in 2019 and may, in fact, actually be negative.

2. Corporate profit margins will be squeezed as upward pressure on wages and downward pressure on prices combine to present the worst possible climate for equities valuations that are already historically stretched.

3. It's not hard to see that the average American voter is now willing to accept a significant move to the political "LEFT" in an attempt to narrow the record wealth gap. Democrats actually won the last mid-term election (Nov 2018) by more than 9 million votes! And with 22 Republican senators up for re-election in 2020, it's not hard to imagine that the Democratic Party could win a majority in the Senate, maintain its current majority in the House of Representatives, and also win the White House with an overwhelming across-the-board mandate for change!

4. If the Democrats manage to win the White House, the Senate, and the House of Representatives in 2020 (which now appears likely to me), all of President Trump's favorable corporate legislation and also his pro-corporate executive actions over the last two years will be quickly reversed!

While the longer term picture for stocks looks increasingly negative, it is my strong view that despite extraordinary investment gains so far this new year, bulls are about to get a major shock.

1. All closely watched U.S. stock market benchmark indices are currently carving out dangerous "head and shoulder" tops (see charts below).

2. Weekly chart sell signals have been triggered by my computer trading program in market leading housing stocks and airline stocks. Technical non-confirmations of this year's bullish trend are already being posted as can be witnessed in the weak recent action within the transportation sector.

3. FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google), once clear leaders of the equity markets over the last 10 years, are now under-performing the broader benchmark indices. A weekly chart sell signal was actually triggered last week by my computer program in Netflix (NFLX).

Bottom line: U.S. stocks are now poised on the precipice of another major correction that will match the size and duration of last year's 4th quarter 20% collapse!

Netflix Weekly Chart with Computer-generated Sell Signal

FAANG Composite Index Weekly Chart

Housing Index Weekly Chart with Computer-generated Sell Signal

Nasdaq 100 Index Daily Chart with possible Head & Shoulders Top Formation

S&P 500 Index Daily Chart with possible Head & Shoulders Top Formation

2019 U.S. Stock Market Outlook

In my last post dated November 3rd, 2018, I forecast a 20% correction from the all-time highs set for most major U.S. stock market indices in early October 2018. 

• The Nasdaq 100 corrected 23.4% from its intra-day high on October 1st at 7,700 to its intra-day low on December 24th at 5,895.
• The Dow Jones Industrial Average corrected 19.4% from its intra-day high at 26,952 on October 3rd to its intra-day low at 21,712 on December 26th.
• The S&P 100 Index (formerly known as the OEX) corrected 20.5% from its intra-day high at 1,310 on October 3rd to its intra-day low at 1,041 on December 26th. 

(Please see charts below)

The rebound in U.S. stock prices from December 26th through December 31st was monumental, but still left December 2018's investment return as the worst  December since 1931.

Despite the fact that U.S. corporations bought more than $1 trillion of their own stock back in 2018, every major U.S. stock market index closed down on the year. Record corporate profits in 2018, not withstanding, failed to inspire investors as historically high valuations and steadily rising short term interest rates weighed heavily on overall share prices.

As promised last year, the Federal Reserve steadily tightened U.S. monetary policy in 2018 by raising its Fed Funds rate three times and by selling $344 billion in Treasury securities and Mortgage-backed securities from its bloated portfolio which now stands at $3.88 Trillion. The Fed is currently projecting three additional 1/4-point hikes in 2019, although the financial markets are only predicting two hikes (as indicated in the Fed Funds futures markets).

My own view is that the Federal Reserve will only raise interest rates one more time (at most) in 2019, as the economy rolls over into recession early in the New Year. Here are some additional thoughts about the New Year:

1. The current rebound in stock prices which began on December 26th will soon peter out, and new reaction lows will then be established early in the 1st quarter of 2019.

2. I strongly believe that U.S. stock investors have underestimated the negative financial impact of the "Blue Wave" which is currently washing over the country in the political arena. It is my prediction that Democratic hopeful Beto O'Rourke will be elected President in the 2020 election. Massive corporate tax cuts that were signed into law last year will be then be scaled back as Democrats win the White House and a majority in the Senate to match their current majority in the House of Representatives.

3. Investigations of the Trump Administration, already meaningful from Robert Mueller's Special Counsel's Office, will pick up speed and momentum as Democrats take control of the House of Representatives on January 2nd, 2019 after picking up 40 seats in the November 2018 election.

3. When Robert Mueller's final report is made public (probably in Q-1, 2019), pressure on President Trump to resign could be overwhelming. From my vantage point, it looks almost inevitable that President Trump will need to "negotiate" a deal involving pardons from Vice President Pence for himself and his family in return for his pledge to resign from office. This assumes, of course, that Vice President Pence is NOT also implicated in "high crimes and misdemeanors" within the Special Counsel's final report. It also assumes that "President" Pence would grant Mr. Trump the pardons he may need to avoid prosecution. While pardons from Mr. Pence are likely, this action may doom any Presidential hopes Mr. Pence may have in the 2020 election (just as Ford's pardon of Nixon in 1974 doomed Mr. Ford's effort in the 1976 Presidential Election).

4. In 2019, I believe that corporate buybacks will be greatly reduced as compared to the record pace of 2018. I believe that corporate profits will significantly under-perform current expectations as profit margins are squeezed coincident with a dramatic slowdown in the U.S. economy.

5. If the economy falls into recession, the Federal Reserve will react too slowly to bail out stock investors. 

Bottom line: When the current bear market rally fades, which I think will happen in early January 2019, I am forecasting another 20% decline in the major stock market averages from the January 2019 peak. Cash will be king for the first half of 2019, at least!

Nasdaq-100 Index Monthly Chart with Computer-generated Buy & Sell Signals

Dow Jones Industrial Average Monthly Chart with Computer-generated Buy & Sell Signals

DJIA Weekly Chart with Computer-generated Buy & Sell Signals plus 200-week MA

S&P 100 Index Monthly Chart with Computer-generated Buy & Sell Signals

S&P 100 Index Weekly Chart with Computer-generated Buy & Sell Signals plus 200-week MA