Is a Valuation Correction Coming for the Stock Market?

Tuesday recap: Equity markets saw broad based selling Tuesday as demand from beginning of the month reinvestment cash was exhausted after 2 days of buying, and further breakdown in recent market leadership put investors and traders in a defensive posture.

That shift to defense by investors really started the last week in April. This is something you should have noticed when crafting your daily game plan.

Excessive valuations may not be an issue for the broad market averages, but they’ve become a major Red Flag for the high beta momentum stocks that have provided much of the market leadership so far this year.

Valuation Correction or Simply Rotation?

The rotation out of Biotech and Social Medial stocks the beginning of last week coincided with the failure of the Russell 2000 to match the highs from the S&P 500 and NASDAQ the previous Friday.

The flight from Biotech and Social Media names has been most pronounced. Never mind that GEVA is +$125 this morning on a take out. Earnings shortfalls and/or lowered guidance from TWTR, and LNKD were the headline grabbers, but note that FB was touched it’s 200 day MA for the first time in 18 months, and BABA, the “can’t miss” IPO hype of this decade, has broken $80 to the downside.

As Warner Wolf would say: “If you bought BABA in the open market, after the IPO pricing…….You’re a loser!!”

Without getting hung up on Exactly where the trend lines are, or what % decline qualifies a correction, it’s crystal clear we’re in at least a rotational correction as investors began to adopt a more defensive posture 10 days ago:

The Russell 2000 -1.45% at 1215.45 has declined just over 4% since not making a new high on April 24. Clearly the predominance of emerging growth names, very low dividend yield and dangerously high valuation represents 3 big strikes for the Russell with investors shifting to a more defensive posture within their Equity Allocation.

It’s also glaring that the 5 biggest daily price movements by the Russell the last 2 months have all ended in large losses on the day. 3 of these declines have been within the last 7 trading days.

The Russell may be a bit oversold on a very short term basis. In fact, we had a reflex bounce for 2 days after the sharp decline last Thursday, but I think it’s got its sights set on the 200 day MA at just above 1180.

Make no Mistake, The Broad Market Averages Have not been Immune to the selling:

The S&P 500 -1.2% at 2089.46 had closed Monday just over 3 points from a new closing high. Tuesday it never went green, closing just off the lows of the day. The S&P 500 now sits right at its’ 50 day MA of 2090. This is the 5th time in the last 2 months the S&P 500 has hit the 50 day MA after a sharp 1 day decline. Each time it’s regained that marker within a day or two, most recently last Thursday and Friday.

With futures looking 6 to 8 handles higher in very early morning trading it will try to keep that streak of resilience alive. NYMEX crude oil rallying through $62 in very early trading will provide some support if the commodity can hold that move higher.

Topping off our theme of a Valuation Correction, take a quick look at where the over performance was yesterday. The DJIA declined by a meager 0.8%. That’s half the decline from the NASDAQ and Russell 2000. We expect this trend to continue.

Beware of headlines from Greece and China and don’t forget the April NFP and jobs report Friday morning at 8:30 AM.

Twitter: @TJAnderson1


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