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Stocks Will Head Lower in the Short Term

Last week, stocks skidded lower…

The S&P 500 fell as much as 4.1%… the Dow fell as much as 3.5%… and the tech-heavy Nasdaq fell as much as 5%.

And although it may not be what you want to hear, stocks are headed lower over the short term.

That’s according to colleague and former Wall Street trader Jason Bodner.

But before you hit the panic button, you should know Jason loves stocks over the mid- to long-term.

So today, I (Chris Lowe) am shining the spotlight on Jason’s research.

We’ll look at what has investors in a frenzy… and why stocks are still a great place to be for long-term wealth builders.

I’ll also show you two steps you can take right now to make sure you’re prepared for bouts of volatility like the one flaring up now.

First, I want to welcome new readers…

The Daily Cut features the best moneymaking… and wealth-protection… ideas from the team of analysts here at Legacy Research.

Legacy is the publishing alliance behind Jason… as well as Teeka Tiwari, Jeff Brown, Dave Forest, Nick Giambruno, Bill Bonner, and Doug Casey.

If you don’t know him already, Jason is a math whiz who worked for more than a decade on Wall Street. This included jobs at prestigious institutional trading firms Jefferies and Cantor Fitzgerald.

He was one of the few guys authorized to place trades of $1 billion and above. He put together these trades for some of the world’s richest investors.

And the massive trades he’s handled throughout his career taught him how to recognize them before most investors could.

That’s when Jason went from gamekeeper to poacher.

He quit his high-paying Wall Street job. And with the help of some complex math… he developed a proprietary trading system.

It tracks where the big money is flowing… and how it moves stocks… before most investors catch on.

Jason’s system is extremely powerful…

Since he started heading up our Outlier Investor advisory in June 2018, his top five open recommendations are up 104%… 205%… 212%… 278%… and 478%.

And over the five years before coming on board at Legacy… when he shared his recommendations with professional money managers… he averaged about 70% winners.

Jason was so driven to prove his system works, he challenged 10 Ivy League students of quantitative analysis – or “quants” – to test it… and figure out if his success could be down to blind luck.

None of them could conclude that. Talk about tipping the playing field in your favor.

Jason’s system can also pick up major market moves…

That’s thanks to an indicator he developed to spot big-money buy and sell signals.

He calls it the Big Money Index (BMI).

Without getting too in the weeds, it tells him what big, institutional investors are doing.

When the BMI line falls, they’re selling stocks. When it rises, they’re buying.

Take a look at the current BMI chart…

The blue line is the BMI. The purple line is the S&P 500. The horizontal lines show where overbought (red) and underbought (green) levels begin.

When the BMI crosses above the red line, stocks are overbought. The longer stocks are overbought, the more likely they are to fall.

When it crosses below the green line, stocks are oversold. The longer they stay that way, the more likely they are to rise again.

Here’s Jason with more…

The BMI stalled a couple weeks back. Big-money buyers were losing control of the stock market. Since then, the BMI has been trending lower.

That alone should be concerning. But when the BMI so rapidly descends after approaching overbought levels again – as you can see all the way over on the right-hand side of the chart – it’s a warning that stocks are headed lower.

If you own stocks, that does NOT mean you should panic. Jason again…

The near-term outlook may not be pretty. But I love stocks over the mid- to long-term. Corrections are as natural and healthy as a fire to a forest. At first glance, it’s a terrible sight. But over the long term, it lets the underbrush clear out, paving the way for new growth.

That’s not to say investors aren’t worried right now. But Jason believes their fears are overblown.

The first fear factor is extreme valuations…

It’s a mathematical certainty that the less you pay for a stock, the higher your profits will be when you sell.

The opposite is also true: High valuations when you buy mean lower returns.

And that’s front and center on investors’ minds right now.

Take the price-to-earnings (P/E) ratio. It looks at how much investors are willing to pay for reported earnings over the past 12 months.

The P/E ratio for the S&P 500 right now is 44.2.

Going by that measure, the S&P 500 is about as richly valued today as it was at the peak of the dot-com boom in 2000, when the P/E ratio hit 46.5.

And today’s P/E ratio is nearly three times the 150-year average of 15.

But that’s looking in the rearview mirror, says Jason…

The regular P/E looks at today’s share price relative to the last 12 months of reported earnings. The forward P/E ratio measures prices relative to average estimates for earnings over the next 12 months.

The forward P/E ratio is at 21.6. That’s a lot less scary. It implies investors expect earnings to come in line with prices in the next 12 months. Stock prices will rise… but earnings will rise even faster.

Investors are also freaking out about tax hikes…

Right now, soaking the rich is a popular political rallying cry.

President Biden plans to hike taxes on corporations and on folks who make more than $400,000 a year.

He’s also raised the prospect of hiking long-term capital gains taxes. These are the taxes you pay on your long-term investment profits.

And the worry you’ll hear in the mainstream media is that this will end the bull market.

But there’s no evidence that tax hikes are bad for stocks.

Take the Fidelity Investments study Jason recently put on his readers’ radars.

It went back to 1950. And it showed that the S&P 500 rose prior to and during 12 of the 13 periods Washington was hiking taxes on Americans.

And stocks rose 100% of the time corporate taxes rose.

The third fear factor is seasonal volatility…

You may have heard the Wall Street saying, “Sell in May and go away.”

It’s based on the historical underperformance of stocks from May to October compared with the rest of the year.

There’s some truth to it…

In 2017, Forbes looked at seasonal variations in performance of the Dow from 1950 to 2013. It found that the Dow had an average gain of 0.3% during the May-to-October periods. That compared with an average gain of 7.5% during the November-to-April periods.

This isn’t something you can always take to the bank. But it’s imprinted on professional investors’ minds.

That means come October… we’ll have a bullish setup for an end-of-year rally.

Jason is bracing for more turbulence in the short term…

But while you duck for cover, he says it’s important you keep the long-term picture in mind.

So as with all bouts of volatility – whether in stocks, crypto, or any other asset class in your portfolio – our advice remains the same.

Unless something has fundamentally changed about your investments… you should sit and do nothing.

Jumping in and out of your investments based on short-term volatility moves is tempting. Most of us are guilty of that from time to time.

But it’s not a winning strategy. Accurately timing short-term moves is too hard. And you have to time not only when to sell out, but also when to buy back in.

That’s why diversification is key…

It lets you sit comfortably while folks around you panic.

All it means is never being “all in” on stocks… or crypto… or any other asset class.

That way you’re much better equipped to ride out times like these.

Say you have 30% of your portfolio in stocks. If these stocks fall by 20% from their peaks – the standard definition of a bear market – that translates to just a 6% drop in your portfolio.

That’s not good. But it’s manageable. And it’s way easier to ride out than a 20% drop in your portfolio.

So next time you see your stocks take a short-term dive, think about your long-term goals and stay put.

And remember that diversification is what allows you to do that without having to break a sweat. (We wrote more about the importance of following a sensible diversification plan here.)

If you do those two things, you’ll be able to ride out bouts of volatility like we’re seeing right now… and reap the long-term rewards stocks offer.

Regards,

Chris Lowe
May 17, 2021
Barcelona, Spain