Daily Gains Letter

Warning Signs Emerging for the Key Indices

By for Daily Gains Letter |

Why Its Time to Reduce Your Exposure in Key Stock IndicesInvestors who have allocated significant portions of their portfolio towards the key stock indices should look into reducing their exposure, as they appear to be heading lower.

While the key stock indices soar and the most prominent stock advisors remain bullish, the Chicago Board Options Exchange (CBOE) Volatility Index (VIX), often referred to as the “fear index,” is indicating that they need to be very careful. The key stock indices may be entering a period of turbulence ahead.

Recently, a technical indicator called the “golden crossover” occurred on the VIX’s chart, indicated by the black circles in the chart above. This happens when the short-term or faster 50-day moving average crosses above the long-term or slower 200-day moving average. This is considered a bullish signal among technical analysts.

Please look at the chart below:

Volatility Index Chart

Chart courtesy of www.StockCharts.com

What’s even more interesting is that this crossover is the first since July 2011 and fourth since key stock indices like the S&P 500 started to tumble in late 2008. Whenever this type of crossover occurred, the S&P 500 declined, as shown by the green line below the chart above.

But the case for a decline in key stock indices goes beyond this one statistical phenomenon.

Consider this: according to FactSet, 87 companies on the S&P 500 have each issued a negative guidance regarding their corporate earnings for the second quarter so far, while only 21 have issued a positive guidance.

If the number of S&P 500 companies issuing a negative corporate earnings guidance remains at 87, then it will be the highest number since FactSet started to track companies’ corporate earnings guidance in 2006. (Source: “Guidance,” FactSet web site, June 28, 2013.)

The warning signs don’t end there. The estimates of earnings growth by analysts continue to descend. For the week ended on June 28, the second-quarter corporate earnings growth rate for S&P 500 companies stood at 0.8%, declining from 4.2% at the end of March. (Source: Ibid.)

Even more troublesome, only four out of the 10 sectors of the S&P 500 are expected to report an increase in corporate earnings for the second quarter. The materials and information technology sectors of the S&P 500 are forecast to post the lowest corporate earnings growth rate.

When I look at this, it reminds me of what Warren Buffett said: “Be fearful when others are greedy, and be greedy when others are fearful.” (Source: Buffett, W.E., “Buy America. I Am.,” New York Times, October 16, 2008.)

Smart investors could profit with exchange-traded funds (ETFs) like the ProShares Short Dow30 (NYSEArca/DOG). Through this ETF, investors can short the Dow Jones Industrial Average and reap the rewards.

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