can the bullish us markets continue their impressive run?
TRANSCRIPT
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• Valuations on US Stocks given recent highs
• Next correction will have significant scope
• Identifying sensible risk reward opportunities
This week…
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General Advice & Risk Warning
Please note that any advice given by Invast staff is deemed to be GENERAL advice, as the information or
advice given does not take into account your particular objectives, financial situation or needs.
Therefore at all times you should consider the appropriateness of the advice before you act further.
CFDs and Forex are leveraged products and carry a high level of risk and are not suitable for everyone. You
can lose more than your initial deposit so you should ensure CFD and Forex trading meets your investment
objectives. We recommend you seek independent advice. Strategies and charts used in this presentation are
for example only. You are reminded that past performance is not indicative of future performance.
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Disclosure Statement and Financial Services Guide which contains details of our fees and charges before you
decide whether or not to acquire any financial products. These documents are available at www.invast.com.au
Invast Financial Services Pty Ltd ABN: 48 162 400 035. Australian Financial Services Licence No.438 283
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This week we look at the following topics:
• Valuations on US Stocks given recent highs
• Next correction will have significant scope
• Identifying sensible risk reward opportunities
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Dear Readers,
Throughout the monthly of November we will bepublishing our views and insights on US stockmarkets, following key results and how thisimpacts the Dow, S&P500, NASDAQ and Russel200 index. With quantitative easing nowcomplete and all eyes on the US marketrecovery, we thought it important to explore keythemes coming out of US companies and howthis impacts the largest stock indices in theworld.
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As usual the commentary from the next four weeks will be followed by our monthlywebinar. Invast clients will also have access to a webinar presented by Invast Insightseditor Peter Esho this week on Tuesday 25 November at 6:30PM.
Our focus will be on the key names that drive each index. We will spend the first fewweeks look at individual company results and then the later part of the monthdetermining where the indices are going. Our approach is bottom up, we look atindividual stocks to determine where the broader market is heading. We don’t just lookat financial numbers in isolation, but focus on important comments also, as theyhighlight corporate confidence and signal intentions among traders.
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Our weekly summary will be as follows:
• Week commencing 3 November 2014 – US reporting season highlights – focus onkey Dow stocks• Week commencing 10 November 2014 – US reporting season highlights – focus onkey NASDAQ and technology names• Week commencing 17 November 2014 – US reporting season highlights – focus onthe Russell 2000 and key names within the index
• Week commencing 24 November 2014 – Summary for price and valuation on thekey indices, where they are heading into 2015
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Throughout this month we have introduced you to the characteristics of the key US stockindices and where their sensitivities lie. As we write this note, we make no secret of thefact that US stock markets are scaling all time record highs. Any movement abovecurrent levels is unchartered territories. We need to keep this in context when tradingthe markets. We aren’t now just trading a recovery but trading at levels where therecovery has been completely priced in, based on current market expectations.
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We are always cautious when discussing prices at all-time highs, regardless of whatinstrument we are commenting on. We have been cautious on US markets for most ofthe past year and we haven’t seen a dramatic fall yet. But our caution does not change.History has taught us that complacency is the single largest threat to a successfultrader. Once you start ignoring the fundamentals and start finding excuses, the doorremains open for painful losses. Our main focus is to minimise our loss in our pursuit fortrading profits. We haven’t called the oil price correctly in recent months but we havealways qualified our opinions with tight stop losses – in effect minimising any losses. Thebest way to put this into perspective is to illustrate through charts – the Dow andNASDAQ 100 on a monthly timeframe below.
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This week’s report is on where the markets are heading in 2015. We want to answerthat question through three important points below, given the context of the above.
1. Valuations can always seem justified at the top of the market.2. The next large correction will have significant scope.3. You want to bet pennies to make dollars, not the other way around.
Sure, where US interest rates go is the single most important factor in determiningstock prices but we have already made this point two weeks ago when discussing theNASDAQ. Many factors can influence US rates. We think rates are heading higher but aBlack Swan event can completely change that assumption overnight and drive stockprices lower too.
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The world and global markets are prone to shocks – the tech boom and sub-prime crisisare perfect recent examples. When assessing where markets go in 2015 we want tomake sure you have the right mindset and not just a bunch of numbers which are basedon at best, guesses.
The bottom line of our report this week is that we see overwhelming opportunity tothe downside for major US markets, not necessarily on the upside. We would always beprotecting our position with tight stop losses, it is ok to book many small losses in theaim of securing one very large gain to the downside. As we were writing this note thisweek, your author was typing on his laptop while playing CNBC in the background. Hecouldn’t help but hear the comments of legendary investors Carl Icahn.
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Carl Icahn isn't forecasting a dramatic stock market dropquite yet, but the billionaire investor is still bracing for anequity sell-off in the next three to five years, he told Reuterson Monday.
"I am still concerned that one day you'll see a break like you had a few weeks ago,'' Icahnsaid at the Reuters Investment Outlook Summit in New York on Monday, "but it won'tcome back." Read the full news report here.
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To us Icahn is sounding bearish but wants to protect himself if the market continues torise. This isn’t completely new, many so called legendary investors have been calling alarge fall in the US market for the past few months and have been completely wrong.That doesn’t mean though that the market isn’t vulnerable at current levels. The marketis always vulnerable, particularly the US stock market!
So let’s elaborate on our three points above.
1. Valuations can always seem justified at the top of the market.
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We are have written over the past few weeks, we don’t think valuations are stretched onUS stock indices for the time being. Our underlying assumption here is that earnings arereal and sustainable. What our experience in the market has taught us though is thatcorporate earnings can completely change overnight. Take for example the US oil & gasindustry, six months ago hailing themselves as heroes due to massive exploration andproduction gains but today fighting for survival as the price of energy, particularly crudeoil, falls sharply.
We published a US stock market valuation table in our Invast Insights report publishedon 10 November. If you missed it, you can read the report directly here. On currentmarket estimates, the Russell 2000 and NASDAQ 100 are trading on a price to earningsratio of around 19.3x while the S&P500 trades at around 16.5x which is in line with itslong term average.
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The thing to note here though is that all of these three indices have previously traded onmultiples in line with their historical averages prior to large falls. A price to earnings ratioinvolves two parts – price and earnings. The later can move quite quickly and suddenlybased on shocks in the market and so earnings ratios should be treated with a grain ofsalt.
2. The next large correction will have significant scope.
When the US stock market turns, perhaps sometime in 2015 or earlier, the scope for adownside move is very large. We see this as the single greatest trading opportunity inrecent history. We think on a risk to reward basis, it is much easier for US markets to fallby 20% than it is for them to rally by 20% given their recent rise and all other thingsbeing equal, likely rises in US interest rates. We aren’t completely sure as to when thiswill occur and so most experienced traders and investors, like Icahn, might sit on thefence in terms of timing. The direction though is the most important point.
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Author and former UBS head of trading Nassim Talebhas a famous saying in his book that goes somethingalong the lines of “Do not make pennies to losedollars”. The notion here lies in the protection of parvalue and the pursuit of fat tail risk as a tradingstrategy.
Of course fat tails are very rate events, but when they do occur, the expected payoffcould be very large. This is the core reason we suggest placing stop losses on any shortpositions across the three main US stock indices which we mentioned this month.
3. You want to bet pennies to make dollars, not the other way around.
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We’ve mentioned Taleb’s work in previous publications but if you haven’t read his bookswe would suggest buying The Black Swan and reading it over your Christmas holidayperiod. If you have the appetite for some rock solid academia in this topic, feel free todownload Taleb’s notes on “silent risk” via this link.
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We’ll explain our view on these three points and the preference for SHORTING US STOCKMARKETS IN 2015 in our webinar this week. Our webinar will focus on our strategy, way ofthinking and the whole notion of capturing fat tail risk. The details are below, make sure youregister and present any of your questions to the editor of this publication, Peter Esho.
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US stock market outlook: Join the webinar to discuss these points
Invast Insights editor and contributing author Peter Esho will summarise his Novemberoutlook for US markets, focusing on key indices like the Dow Jones, S&P500, NASDAQ andRussell 2000. Esho will go through recent company results to determine how the US economyis shaping up after the completion of quantitative easing.
Esho is a regular contributor on CNBC, Bloomberg and host of ‘Your Money Your Call’. In hiswebinar he will outline:
How have recent company results fare in the US marketWhat signals are companies suggesting about the economyWhat valuations are implied by the key indices at the momentOutlook for where Wall St will go in 2015
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Peter’s webinar will cover both the fundamental and technical outlook on key US indicesquoted on Invast’s MT4 platform, plus the key drivers to look out for when trading. Thiswebinar is expected to fill fast. Q&A will be open straight after the presentation. Registernow by visiting http://www.invast.com.au/resources/webinars.aspx.
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Go to www.invast.com.au/insights to get a complimentary 4 week trial and receive the latest insights as they are published to our live clients.
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DisclaimerPlease note that you are receiving this report complimentary from Invast Financial Services Pty Ltd(AFSL 438 283). Invast staff members may from time to time purchase securities which areincluded in this or future reports. The authors of this report may or may not be holding a positionin the securities mentioned. Please note that the information contained in this report and Invast'swebsite is of a general nature only, and does not take into account your personal circumstances,financial situation or needs. You are strongly recommended to seek professional advice beforeopening an account with us.
General Disclaimer: This newsletter contains confidential information and is intended only for theperson who downloaded it. You should not disseminate, distribute or copy this newsletter. Invastdoes not accept liability for any errors or omissions in the contents of this newsletter which ariseas a result of downloading this newsletter. This newsletter is provided for informational purposesand should not be construed as a solicitation or offer to buy or sell any financial product. InvastFinancial Services Pty Ltd is regulated by ASIC (AFSL 438 283 | ABN 48 162 400 035).
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Risk Warning: It's important for you to read and consider the relevant Product DisclosureStatement, and any other relevant Invast Financial Services Pty Ltd documents before youdecide whether or not to acquire any financial products listed in this email. Our FinancialServices Guide contains details of our fees and charges. All these documents are available hereon our website, or you can call us on +612 8036 7555. CFDs and Foreign Exchange areleveraged products and carry a high level of risk and you can lose more than your initial depositso you should ensure CFD and Foreign Exchange trading meets your personal circumstances.
General Advice Warning: Being general advice, this newsletter does not take account of yourobjectives, financial situation or needs. Before acting on this general advice you shouldtherefore consider the appropriateness of the advice having regard to your situation. Werecommend you obtain financial, legal and taxation advice before making any financialinvestment decision.
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