The stock market’s big swings indicate a top or a bottom — here’s how to decide

I am receiving a large number of complaints about the stock market’s wild swings as the new coronavirus spreads across the U.S.

My suggestion is to not complain. The reason is that there is nothing you can do. Investors ought to accept the swings, focus on making money from them with short-term trades while protecting their portfolios. For example, “Coronavirus brings opportunities in gold — just like in the good, old days.”

Big swings in prices are an indication of a top or a bottom in the stock market. Which one is it? Here is how to decide, with the help of two charts.

Read:These stocks may be your best choice for income as interest rates keep falling

Two charts

Please click here for a long-term chart of the Dow Jones Industrial Average ETF
DIA,
-0.99%
,
which tracks the Dow
DJIA,
-0.98%
.
For the sake of transparency, this chart was previously published, and no changes have been made.

Please click here for an annotated short-term chart of Nasdaq 100 ETF
QQQ,
-1.68%
.

Note the following:

• I chose the chart of Nasdaq 100 ETF instead of a chart of S&P 500 ETF
SPY,
-1.65%
,
which tracks the S&P 500 Index
SPX,
-1.70%
.
Most money is tied to the S&P 500 and not to the Nasdaq 100 or the Dow Jones Industrial Average. However, it seems that most investors’ portfolios are concentrated in five mega-cap stocks: Apple
AAPL,
-1.32%
,
Microsoft
MSFT,
-2.82%
,
Amazon
AMZN,
-1.19%
,
Alphabet
GOOG,
-1.56%

GOOGL,
-1.44%

and Facebook
FB,
-2.20%
.
The Nasdaq 100 ETF has heavier weightings of those five stocks than the S&P 500 does. For example, Apple has a weighting of 4.85% in the S&P 500 and a weighting of 11.67% in the Nasdaq 100.

• The second chart shows six wild stock market swings that have recently happened

• The first chart shows that the stock market is still levitating above the long-term trendline The starting point of the long-term trendline is the Arora buy signal given in 2009 to aggressively buy stocks, which has turned out to be the start of the bull market.

• The stock market was gently trending slightly above the trendline until Donald Trump’s election At the time of the election, most analysts were predicting a big selloff in the stock market. At that time, The Arora Report issued a buy signal followed by several calls for Dow 30,000 points. Please see “Here’s the case for Dow 30,000 in Trump’s first term” The stock market took off and deviated from the long-term trendline. This point is shown in the middle of the first chart.

• The first chart shows that RSI (relative strength index) is not yet oversold on a monthly basis

• The white horizontal line shown on the chart in the RSI pane represents the oversold level

• Note from the first chart how oversold RSI got at the start of this bull market

• On a fundamental basis, the stock market is overvalued compared with its own historical valuations

• On a fundamental basis, the stock market is significantly undervalued when compared to the 1% yield on 10-year Treasury bonds

• Semiconductor stocks have been leading indicators Of special interest is that semiconductor stocks such as AMD
AMD,
+0.99%

and Micron Technology
MU,
-4.18%

as well as semiconductor-equipment makers such as Applied Materials
AMAT,
-2.26%

and Lam Research
LRCX,
-1.57%

have seen less wild swings when compared to their own history relative to the Nasdaq 100.

Ask Arora: Nigam Arora answers your questions about investing in stocks, ETFs, bonds, gold and silver, oil and currencies. Have a question? Send it to Nigam Arora.

What does it all mean?

Start with Arora’s Second Law of Investing and Trading: Nobody knows with certainty what is going to happen next in the markets. Arora’s Second Law is especially applicable to these stock market conditions because not enough is known about coronavirus at this time. Here are the key points:

• Based on the foregoing, if it weren’t for the Fed’s money printing, I could confidently say that the stock market top is in and the prior high will not be seen in a long time. However, think about the 1% yield on 10-year Treasury bonds. That is equivalent to a price-to-earnings (P/E) ratio of 100 on stocks. In comparison, a P/E of 20 for the stock market is relatively inexpensive and perhaps even a bargain. Moreover, the Fed seems to be on track to cut interest rates further and print more money. Such moves will make stocks even more attractive.

• Refrain from thinking there are only two outcomes: Stocks are going to go straight up or they are going to crash. In the emails I get, a vast majority of investors are convinced that they need to go all in buying stocks now or they want to sell all of their stocks now. Please see “Prudent investors should look at these four stock charts as coronavirus spreads.”

• We provide specific levels of cash and hedges to protect long-term portfolios and short-term trades to take advantage of the wild swings. Investors’ focus should shift to how they can make money irrespective of what happens. Please see “As the stock market rallies, put protections on your investing portfolio.”

• To be able to make money under all market conditions, investors may want to pay attention to Arora’s Third Law of Investing and Trading: Making investing and trading decisions based on probabilities is the only realistic and profitable approach.

Consider carefully reading what Warren Buffett said: “Buffett is bullish on stocks but says the market can drop 50% — is he wrong?

Disclosure: Subscribers to The Arora Report may have positions in the securities mentioned in this article or may take positions at any time. Nigam Arora is an investor, engineer and nuclear physicist by background who has founded two Inc. 500 fastest-growing companies. He is the founder of The Arora Report, which publishes four newsletters. Nigam can be reached at Nigam@TheAroraReport.com.

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