Stay with the trend

The overall stock market is unbelievably resilient and strong at the moment and it seems there is nothing that can stop it from challenging its all time high for the S&P around $2135. Will S&P breaks out this time soon? Anything is possible but I highly doubt! Since last May when S&P came off its all time high, it has tried more than 10 times to break out but all failed. In a few times, a 5-10% drop followed. I think a big decline will follow soon as well this time. You see, the stock market is a discounting machine that should ultimately follow the footsteps of the companies’ earnings. However, since the end of 2014, earnings have been in a steady decline, which eventually led the market to turn to the downside (see the chart below, curtsey of Casey Research). When the earnings decline but the stock prices increase, what will happen? The P/E ratio goes up, meaning the stocks become more expensive.  Per Casey Research,  “Measured by the CAPE ratio, stocks are now 58% more expensive than their historic average. They’ve only been more expensive three times in history: before the Great Depression, during the dot-com bubble, and leading up to the 2008 financial crisis.”  I’m convinced it is really a very dangerous time to be long at the moment and a flash crash could also happen without notice in this kind of environment. Again, I’d advise “BE CAUTIOUS” as I have done a few times in the past month.

 

Having said that, the biotech is probably the only sector that has a great risk reward ratio for the time being. As I said a week ago, this is the only sector that I feel comfortable to buy and I did just that. I bought TROV about 2 weeks ago when it was tanking due to the management shake-up. A great timing I must say. It has shot up 50% already since I got in. Then I bought AMAG just a week ago but it has gone up almost 8% already. My options are several times better than the underlying stocks in terms of the short-term paper gains. But I think more gains are ahead for them if the whole sector continues to outperform the overall market, which is what I expect to see. Stay in the course with this trend for the biotech sector!