Today's Selloff: What Does it Mean?

Today U.S. stocks are in the strongest selling mode for over three weeks with the Dow Jones Industrials down over 300 points at one point today and the tech-heavy Nasdaq showing a -1.6% loss into the close of trading. At these levels, the S&P 500 has now seen its YTD returns fall from a robust 4% to only 2.8%.

Should we be concerned?  Not yet, and I'll explain why.  But first, let's see why investors are hitting their sell buttons today. Here are 4 reasons for today's selloff:

FIRST, THE BAD NEWS

1. Corporate earnings for the S&P500 companies that have reported thus far have come in mixed.  77% of reporting companies have beaten earnings estimates -- about par for the course -- but those expectations were so low that the numbers are still a full 4% lower than Q1 last year.  This will mark the first quarterly year-on-year decline in 10 quarters.

2. American Express fell 4.8 percent to its lowest level since 2013 after quarterly revenue missed estimates.  Advanced Micro Devices, a bellwether for PC sales, slumped 13 percent after saying it is hard to see how the second half will be “substantially better” than the first half of the year.

3. The selloff started in the pre-market with a slump in the major index futures after Chinese regulators decided to place restrictions on the use of margin financing to buy equities and expanded the supply of shares available for short sellers. Investors in China had been ramping up wagers on stocks by borrowing through umbrella trusts, which allow for more leverage than brokerage financing. This practice is now banned. Chinese stock-index futures on the Hang Seng Index tumbled more than 2 percent on the news. In the U.S., the Bank of New York Mellon China ADR Index of U.S.-listed Chinese companies slid 2.9 percent.

4. In economic data news, it was reported that the costs of living in the U.S. rose in March for a third month, signaling inflation is starting to firm. A separate report showed consumer confidence improved in April to the second-highest level in more than eight years as Americans held more favorable views of the economic outlook and inflation.  This can only mean one thing: the Fed now has more ammunition to push an interest rate hike through this summer.

NOW FOR SOME GOOD NEWS

So should we all panic here, sell all stocks and buy puts on the S&P?  No, not yet.  There are very compelling reasons why this market still has upside room. Panic if you must, but you may well be missing out on another season (at least) of decent returns.  Here are 3 reasons why.

1. First, the overall P/E ratio for the S&P500 still stands at a relatively undervalued 20.4.  While this is not cheap, that number typically tops out in the low-40's or higher before we see anything like a major market crash.  

2. Earnings projections on the S&P 500 companies are slated to continue to decline into June this year (they have been slumping for the past 6 months) but then take a steady uptick from there.  Decline earnings projections have been largely responsible, along with falling oil, for the market volatility we've seen since October, 2014.  Once they swing back to the upside, we should start to see a more regular ascent begin.  See these stats:

3. Technically, there is nothing wrong with the uptrend here.  All momentum indicators are positive, RSI is only at 50 so neither oversold nor overbought, and the cumulative volume balance is still high and rolling higher.  The chart below shows the uptrend in evidence.  Note the highlighted green area where we see the current consolidation.  We'll likely see a test of that lower dotted trendline in the next few sessions.  From there, it is not certain whether price breaks higher or lower from the wedge, but either way we should continue to see market action contained within the broad solid blue lines:

Posted to Dr. Stoxx Options Letter on Apr 17, 2015 — 3:04 PM
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