Small investors are set up for a fall

Smart money is selling into this rally and buyers who recently transitioned out of bonds will get hurt when the market turns.

By Stock Traders Daily Jul 22, 2013 3:58PM

Photodisc Blue, Getty ImagesBy Thomas H. Kee Jr.


Media coverage of the stock market is often riddled with giddy and blindly bullish sentiment, with guest appearances enticing the small investor. When they get the little guy to chase the market, the smart money watches for the right time and starts selling into the rally. 

 

When IBM (IBM) and General Electric (GE) surge after reporting lower revenues and not increasing forward projections, we have evidence that investors are reacting to the media instead of paying attention to valuation. 


We also have investors who recently got out of bond funds and into stocks -- the Great Rotation. Their brokers told them that they could get growth and income by investing in stocks, and without paying attention to valuation they followed, driving equity prices higher than they should be given growth expectations. Eventually this will change, and the writing is on the wall.

 

Last week I recorded a webinar (stocktradersdaily.com) that identifies the fair value of the S&P given earnings growth expectations. By every measure analysts are extremely optimistic about the next year, but they were forced to bring down their optimistic estimates for the current quarter by 10% from where they were a year ago. Current valuations are lofty, with trailing as-reported P/E for the S&P 500 now over 19.  I expect that to adjust down to 18 after this season.

 

Apple (AAPL) is expected to release earnings after the bell on Tuesday. Roughly 25% of S&P companies will report earnings this week, and that combination will likely give analysts enough information to make the forward adjustments necessary to bring their current estimates in line with fair and reasonable growth, at least for the next quarter.

 

Obviously, given what we currently know, analysts are expecting extraordinary EPS growth next quarter, but these expectations were lofty to begin with, and the headwinds that we know of are only now starting to hit this economy.  Although I have not found any quantifiable relationship between reported GDP growth and earnings, I have found an almost exact relationship between the consumption expenditures component and earnings since 2011.

 

Indeed it was in 2011 that earnings comps began to come down, and in my opinion future comps are much more difficult, but the Street actually believes that future growth rates will show EPS growth equivalent to those that existed when comps were extremely easy (right after the recession).  I am warning everyone that is not reasonable.

 

Smart money is selling into this rally, and soon those weak-handed investors who were chasing performance as they transitioned out of bond funds are likely to be the ones fueling the selling when the tide turns. Smaller investors have a natural attraction to smaller companies, and we all know what has happened to the iShares Russell 2000 Index (ETF) (IWM) since the Great Rotation began.  Right now no one expects any decline from this market -- that is obvious -- but tides turn fast.


Tags: AAPLGMIBM
9Comments
Jul 22, 2013 11:03PM
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The one thing small investors have on their side is time.  If you start young, invest in the total market using low fee index funds, re-invest the dividends, continue putting in new money (especially in bear markets), you'll have a nice nest egg by the time you retire.  One of the hardest things to do, but also the most important, is to completely ignore the financial "experts" who appear on CNBC, FBN, and other financial networks. I've probably made every possible investment mistake over the years, but I did keep a large part of my portfolio invested in diversified low cost funds, which have outperformed my trading accounts by a wide margin.


Jul 22, 2013 9:38PM
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I'm with you, Active RIA.  I finally got the kahones to invest some of 'my' money in the market (as opposed to actively funding my 401k, which I can't touch for about another 15 years), and have gotten around 7%.... in two weeks!  Just wish I had the guts to do this earlier, but I'm glad I waited until after Bernanke made his announcement that QE would end - someday.  The market surging on junk news driven by the comfort of QE and the other crazy things the market would do on reports was driving me nuts!  (not to mention what looked like a whole lot of pump-and-dumps that were happening on good news)  I'm thinking there's about another 5% that can be squeezed out of this run in the next quarter or so, give or take depending on 3rd quarter earnings reports.  I just hope I read the tea leaves right when it comes time to cash out and take the .01% on the money market when all hell breaks loose.
Jul 22, 2013 9:27PM
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Stay invested for the long term in index funds.  Ignore all the people like this.
Jul 22, 2013 11:50PM
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I usually read the tripe on MSN money then do just the opposite. My retirement funds are in three different pots: employer IRA, Scottrade self directed IRA funded by rollovers from prior jobs and a Roth. If you really wants good analytical reports with entry points and price targets, buy an online subscription to Barrons. In both Scottrade accounts, I have "buy and hold" stocks and a lesser percentage of "trade money". That trade money is placed on Barrons advice with sell orders at price target. As the price nears the price target, I look at the charts and decide exactly when to pull the trigger.

This is typical for MSN: Shoot up flares, but give no direction.

Jul 22, 2013 10:53PM
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1700-1730 may be the top. than come back in sept/oct.
Jul 22, 2013 9:42PM
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ibm really didn't surge!! up on the day of results...down much more on the next day. They also announced a better year end outlook...
Jul 23, 2013 6:13AM
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"without paying attention to valuation they followed"

So it's not really us small investors who are set up to fall, it's the IGNORANT investors.  Those who can't be bothered to read a serious investment book.  Those who read a 4-page brochure and think they know all about investing.

I automatically put money each month into the DRIPs of Abbott Labs, Cracker Barrel Old Country Store, Duke Realty, Exxon Mobil, and General Mills.  All of them have P/E's under 20 and as low as 9.7.  The past and projected % earnings plus % dividends make their P/E's justifiable.
Jul 22, 2013 10:14PM
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I saw it, our miner up over 9.5%......wooohoootty!!!!!
Jul 22, 2013 9:57PM
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What happened on GDX....?  Been on long road trip.

And having prob with LTP.

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