Girding Yourself for a Market Pullback

Nicholas Vardy

Nicholas Vardy has a unique background that has proven his knack for making money in different markets around the world.

Global stock markets pulled back over the past week with the Dow Jones down 1.33%, the S&P 500 falling 1.35% and the NASDAQ tumbling 2.56%. The MCSI Emerging Markets Index fared the worst, falling 3.92%.

Despite the poor week, Markel Corp. (MKL) eked out a gain of 1.77% on better-than-expected earnings.

Although it was a down week for the major indexes, the pullback was unusually hard on several of your Alpha Investor Letter positions.

Several of your positions fell below their respective 50-day moving averages and changed to Hold. The list includes AdvisorShares TrimTabs Float Shrink ETF (TTFS), WisdomTree Japan Hedged Equity ETF (DXJ), PayPal Holdings (PYPL), KraneShares CSI China Internet ETF (KWEB), iShares MSCI Philippines (EPHE), Market Vectors Biotech ETF (BBH) and Phillips 66 (PSX).

You also were stopped out of Chipotle Mexican Grill, Inc. (CMG) as the travails of this turnaround play continue. That said, I am still keeping this position on our watch list for potential re-entry in the future.

As I noted last week, the majority of the fundamental, technical, market sentiment and seasonal indicators that I look at suggest that the market is due for at least a short-term pullback.

This week, I’m including a chart that I look at to gauge market sentiment for my short-term trading services, Bull Market Alert and the Alpha Algorithm.  As you can see, the line above the S&P 500 chart — a technical measure named “slow stochastics” — tends to track and predict the performance of the overall market fairly well.

SPY Vardy

Today, it suggests two things to me.

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First, the recent rally in the market went on for a lot longer than it usually does, stretching from mid-February through the end of April with a minor hiccup in between. That, in turn, suggests that the current pullback likely has more to go before the market turns around again. Thus, we will likely have more downside ahead.

Second, I’d add one more very subjective reading, based on my long-time experience. We are coming off a record poor start to the year followed by an almost record recovery since Feb. 11. When the market behaves in such an extreme manner — whether falling or rising — you often you can expect the opposite behavior once the market turns. Since the market failed to break out to a new high, odds are the unpleasant pullback we are in the midst of is likely to continue.

None of that is great news for the coming month or so.

Of course, as Yogi Berra observed, “Prediction is hard, especially about the future.”

Still, a more sustained pullback is something that you should gird yourself for. So keep an eye on those stops.

And with any luck, you’ll be pleasantly surprised if I am wrong…

Portfolio Update

Berkshire Hathaway (BRK-B) dipped 1.49% over the last five trading days. However, BRK-B opened the week moving upwards to within 54 cents of its 52-week high. Berkshire Hathaway announced Monday that it expects its net earnings to rise 8.2% year-over-year to $5.59 billion. It also expects its manufacturing, service and retailing earnings to rise 12.7%. BRK-B is a BUY.

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Markel Corp. (MKL) added 1.77% last week. MKL reported strong earnings on Monday after markets closed. Diluted net income per share was $11.15 vs. an estimated $6.245. This compares to a first-quarter 2015 diluted net income of $13.49. Markel’s executive chairman commented, “2016 is off to a strong start with solid contributions from our underwriting, investing and Markel Ventures operations. Our growth in book value per share for the quarter reflects significant returns from our investment portfolio and our long-term focus on underwriting discipline. We are well-positioned to continue to build shareholder value and to take advantage of profitable growth opportunities as they arise.” MKL is a BUY.

WisdomTree Japan Hedged Equity ETF (DXJ) dropped 9.51%. The Bank of Japan (BOJ) met last Thursday and decided against new economic stimulus measures. This pushed the Nikkei index down more than 3%, causing a strong ripple effect on your DXJ position. Recent appreciation of the Japanese yen against the U.S. dollar is also creating a headwind for this position. DXJ fell below its 50-day moving average (MA) and changed to a HOLD.

PayPal Holdings (PYPL) fell 3.45%. PYPL reported strong earnings on April 27 after markets closed. Earnings per share (EPS) came in at $0.37 vs. an estimate of $0.35. Revenue was $2.54 billion vs. an estimate of $2.5 billion. PayPal also provided future second-quarter earnings guidance of $0.34 – $0.36 on revenue of $2.57 billion-$2.62 billion. PYPL dipped and moved to a HOLD on news of an investigation into its Venmo payment service.

Guggenheim Spin-Off (CSD) gave back 1.83% last week. CSD is your bet on corporate spin-offs and has been a steady gainer since bottoming in mid-February. Now trading sideways and consolidating its gains just above its 200-day MA, this investment appears to be primed to continue its gains. CSD is a BUY.

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Illumina Inc. (ILMN) moved 3.99% lower. ILMN reported earnings on May 3 after markets closed. EPS was $0.71 vs. an estimate of $0.74. Revenue ended the period at $572 million vs. an estimate of $593 million. This was a 6% year over year increase. ILMN is a HOLD.

Phillips 66 (PSX) fell 9.49% due to an April 29 earnings miss. Due to weakness in oil prices, PSX reported a 61% drop in profits. EPS came in at $0.67 vs. an estimate of $0.87. Revenue fell 24% to $17.76 billion. PSX moved below its 50-day MA to become a HOLD.

Sincerely,

Nicholas Vardy

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