U.S. stocks have lost ground three out of the past four trading sessions. The S&P 500 is now at its lowest point since September 5 and the Dow Jones Industrial Average (DJIA) just had a -1.8% decline - its biggest drop since June. Is the worst over?
Bad Breadth and Warning Signs
As we've consistently warned, the lack of confirmation from market internals such as breadth (Dow Theory) and sentiment (bullish survey extremes) still continues.
Equity trading volume throughout much of this bull market rally has been thin and Q3 recorded the lowest volume since 2008. This occurred just as the S&P (SNP: ^GSPC), Dow Jones (DJI: ^DJI) and Nasdaq (Nasdaq: ^IXIC) were jumping at yearly highs with the help of Bernanke & Co.'s canon launcher.
Since then, reality has begun to set in.
The Nasdaq and small cap stocks (IWM) are underperforming the S&P and DJIA. And our list of other warning signs that winter is ahead keeps growing:
• Luster of central banker stimulus is fading
• Corporate profit margins is in mean reversion cycle
• Bellwethers like Apple (Nasdaq:AAPL) are posting meaningful weakness
• Disintegration of European Union is still intact
• Lagging emerging markets ETFs are screaming "global economic slowdown"
• Deterioration in technical action for major stock benchmarks
Two Broken Streaks
The 25-year anniversary of the 1987 stock market crash ended the DJIA's streak of 81 consecutive days without a 1%+ decline. A stock market without volatility over long-periods isn't just rare - it's abnormal. (The period from July-November 2006 experienced a 94-day trading streak without a 1% or greater decline.)
A few months ago, corporate earnings were at record highs, but the elation was short lived. Because of poor Q3 earnings, the S&P 500's incredible streak of 11 consecutive quarters of earnings growth is kaput.
What about the longer term prospects for higher stock prices?
The November issue of the ETF Profit Strategy update said, "Regardless of how Q3 earnings turn out, the market's trend over the past 12 years is a compressing P/E ratio. A look at historical equity valuations going back to 2000 illustrates this. From peak to trough, P/E ratios fell from 28 to 13, which is a hallmark of bear markets."
Interestingly, precious metals have not bucked the selloff, but rather have followed stock prices down. Gold is down over 3% and silver (SLV) is down almost 7% over the past month.
Ahead of this decline, the ETF Profit Strategy update warned on 9/23 that lower prices were coming. "A break below channel support would likely target a larger pullback to the 200 day MA also where the Fibonacci support zone lies," we wrote. At the time, SLV was at $33.48 and bullish sentiment was extreme. Since then, SLV has made a 10% move lower and our shorts (ZSL) have been huge gainers.
We continue to focus on the stock market's price action, a habit that's served us well. A break above resistance will mean higher prices (new highs) while a failure to overcome resistance will point towards another leg down.