That was fun while it lasted.
Last week, the Dow Jones Industrial Average topped 20,000 for the first time ever.
Naturally, people got excited. After all, 20,000 is a nice, big number. And investors love big numbers.
But Donald Trump wasn’t satisfied. He wanted stocks to keep climbing. He told ABC in a recent interview:
The Dow… just hit 20,000. First time in history. I’m very proud of that. Now we have to go up, up, up. We don’t want it to stay there.
Maybe next time Trump will be more careful what he wishes for…
On Monday, the S&P 500 and Dow both fell 0.6%. The Nasdaq slid 0.8%. It was the U.S. stock market’s worst day since the start of the year.
The selloff carried over into Tuesday, too. All three major indices ended yesterday in the red. The Dow closed at 19,864, 1.1% below Friday’s high-water mark.
Trump may not have seen this coming. But we’re not surprised…
• On January 17, we told you to “buckle your seatbelt”…
At the time, U.S. stocks were treading water.
The S&P 500 had been trading between 2,258 and 2,282 all year. The Dow was also abnormally quiet. According to investment advisory firm Pension Partners, it was having its calmest 30-day run since the 1970s.
The Volatility Index (aka the VIX) was at record lows, too. The VIX measures how volatile traders expect the markets to be over the next 30 days.
A low VIX reading is usually a good thing. But an extremely low VIX reading can be a warning sign.
• Like most things in the investing world, the VIX always “reverts to the mean”…
If you’ve never heard of this concept, don’t worry. It’s simple.
Pretend the VIX is a rubber band.
When the VIX is extremely high, that band is stretched out. Sooner or later, it will revert to its mean. It will snap back to normal.
It works the same way when the VIX is extremely low, which has been the case lately.
On Friday, the VIX hit 10.30. That’s one of its lowest readings ever.
It’s also 54% lower than where it hit the Friday before the election. According to Pension Partners, that’s the VIX’s steepest decline over a 12-week period ever.
• This tells us that investors became extremely complacent…
Trump had a lot to do with this.
You see, Trump brings a wealth of business experience to the White House. He’s run a giant global enterprise. He’s managed tens of thousands of employees. We’re not sure if Obama ever even ran a lemonade stand.
But let’s not forget that Trump’s also a wild card. He has no filter. That pisses many people off.
We knew this heading into the election. And it’s been on full display since he took office.
In short, investors have reasons to be cautiously optimistic. But they shouldn’t be complacent.
After all, volatility always spikes when you least expect it. If you put your guard down, it can knock your teeth out.
• The VIX jumped 12% on Monday…
Yesterday, it spiked another 16% before retreating in the afternoon. It ultimately closed the day slightly up.
Today, the VIX is down a little. Stocks are basically flat.
The panic appears to be over. But that doesn’t mean you should get greedy.
Remember, U.S. stocks are coming off their calmest stretch in decades. The VIX is still near record lows.
That’s not the only reason you should prepare for more volatility, either.
• U.S. stocks are incredibly expensive…
Right now, companies in the S&P 500 trade at a cyclically adjusted price-to-earnings (CAPE) ratio of 28.1.
The CAPE ratio is the cousin of the popular P/E ratio. The only difference is that it uses 10 years’ worth of earnings instead of just the previous year’s earnings. In other words, it gives us a long-term view of stocks.
According to the CAPE ratio, U.S. stocks are now 68% more expensive than normal. They’re also more expensive than they were just before the 2008–2009 financial crisis. And we all know how that ended.
Even if U.S. stocks don’t crash, you’re probably not going to make much money in them.
Since 1928, the S&P 500 has returned an average of just 3% (over the next twelve months) when its CAPE ratio exceeds 26.4. That’s according to a recent study by Pension Partners.
In other words, you’d be risking a lot for the chance to make a little by buying stocks right now.
These aren’t the kinds of opportunities we like at Casey Research. We prefer situations where the odds are stacked in our favor. We’ll let you know when we see the next great opportunity. Until then, stay disciplined.
Chart of the Day
Steer clear of Mexican stocks…for now.
Regular readers know we’re contrarians at heart. We like to buy stuff that mainstream investors ignore or even hate. Sometimes, this gives us the chance to buy a dollar’s worth of assets for pennies.
That’s why we’ve been stalking Mexican stocks lately.
You see, Mexican stocks took a dirt nap after the election. The iShares MSCI Mexico Capped ETF (EWW), which tracks about 60 Mexican stocks, plunged 16% in the two days after the election. Two weeks ago, it hit an eight-year low.
This wasn’t exactly surprising.
Long before Trump became president, we knew he would be tough on immigration. We knew he wanted to build a wall along the U.S.-Mexico border and “make Mexico pay for it.” And we knew he wanted to rip up our current trade deal with Mexico.
When Trump unexpectedly won, Mexican stocks tanked.
Since Inauguration Day, relations between the U.S. and Mexico have only worsened. But Mexican stocks have hung in there. EWW has actually done slightly better than the S&P 500 so far this year.
It’s usually a good sign when a stock, index, or ETF does well in the face of bad news…but it’s still not time to buy Mexican stocks. Here are a couple reasons why:
Mexican stocks aren’t cheap. According to iShares, EWW trades at 24 times trailing earnings. That’s only slightly less than the S&P 500, which trades at 25.5 times trailing earnings.
Mexican stocks are still in a downtrend. If you pull up a five-year chart of EWW, you’ll see that it’s been falling since the summer of 2014. We don’t like to buy stocks in downtrends. We’d rather wait for an asset to stop falling, “carve” a bottom, and begin a new trend.
In closing, we could see Mexican stocks rebounding in the near term. We just don’t like them as a long-term investment right now.
Delray Beach, Florida
February 1, 2017
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