(Newswire.net — April 14, 2014) — New York, NY — The Bermuda Triangle Stock Market Indicator jokingly got its name for two reasons. The first is that there are three components that connect to make it the perfect storm, thus the triangle. The second reason is that whenever these factors present themselves investors money magically disappears, never to be found again! Just like the ships and planes that disappeared never to be heard from again, in an area known as The Bermuda Triangle.
Bob Howe, editor of the Value Investors Association explained the indicator to us in its most basic terms. “The first component of the Bermuda Triangle Indicator has to deal with market liquidity and risk in the market place. Every time margin debt in the market has been this high, going all the way back to 1929 it has led to a stock margin correction of at least 20%.” He said, explaining that “Margin debt used by investors reached record highs this March.”
Todays margin debt is currently higher than it was in 1999 and 2007, right before market corrections of more than 40%!
Every time the Fed provides easy money, that money floats into a sector or two and creates a major bubble like those seen with the dot com bubble and real estate bubbles. This time it went into bio-tech stocks, small cap and momentum tech stocks.
When the Central Bank floods the market with cheap money and liquidity, it’s creates a high risk appetite. Because interest rates have been so low for so long, investors have been paying up for growth and reaching for yield with revenues and valuations becoming a secondary factor. “I understand paying more for growth, it makes sense; But when I hear people saying you have to pay up for growth, that’s a warning sign to me” Bob Howe said.
Liquidity is a secondary factor to this first component but almost always comes into play when debt margins reach record highs. While we can debate the theories as to why this happens, so far the results can’t be questioned.
The second component of the Bermuda Triangle deals the economic side of stocks, specifically revenue growth and price to earnings. This is the fundamental side of stocks.
Low interest rates along with record cash reserves have allowed companies to buy back shares to meet EPS estimates even while missing bottom line revenue results. Additionally companies have held back on hiring and are running leaner than ever as real employment rates remain extremely high. This has allowed P/E ratios to be fairly valued overall even with weaker revenue streams.
Revenue growth on the other hand has been more difficult for companies to achieve. Over the last two years companies in the S&P 500 overall have been guiding revenues lower quarter after quarter and it’s starting to accelerate. In 2013, 56% of Fortune 500 companies issued negative EPS guidance with a whopping 88% of Fortune 500 companies issuing negative EPS guidance in the 4th quarter of 2013.
For Q1 of 2014, 104 companies have negatively pre-announced earnings. They’ve already told you that sales and revenue are decreasing. What does that tell you?
While the Federal Reserve did a great job of propping up a failing economy, they forgot the most basic economic principle, supply doesn’t create new jobs, demand creates new jobs.
If demand is higher than supply, companies have to hire to meet the new supply requirements. Seems a little too obvious but it also seems to have been forgotten.
This third component of the triangle is extremely important. Without it, you would have missed the big stock market gains of 2013 as many perma-bear market pundits did.
We on the other hand don’t pretend to know the future and would more often than not look foolish if we tried to predict it. We prepare for what the market offers and then take action based on probabilities. That’s how you make big money investing while minimize risk.
While we can’t predict the future, starting in March all signs were pointing to a stock market correction. Let’s look at two of the most leveraged markets from a technical perspective.
The NASDAQ shows resistance at 4200. If the NASDAQ is not able to go higher than 4200 and goes below 4000, it enters a free fall zone and is susceptible to a big market correction until reaching the next support level which is about the 200 day moving average.
The Russell 2000 shows resistance at 1150 and 1200. If the Russell 2000 isn’t able to go higher than 1200 and goes below 1000, it enters a free fall zone and is susceptible to a big market correction until reaching the next support level which is about the 200 day moving average.
Once it gets to those levels we’ll have to re-evaluate our position.
The signs are all there if you know what to look for.
I would like to add special thanks to Bob Howe of the Value Investors Association for his knowledge and insight into the Stock Market Bermuda Triangle.