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By: Costas Bocelli — August 24, 2017

How Trump Can Salvage the Market

It’s shaping up to be a bad month for the market.

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Although the major indices such as the Dow Jones Industrial Average and the S&P 500 are holding up relatively well, what’s going on beneath the surface should have investors concerned.

If it doesn't, it's only because market "breadth" is invisible to most investors.  But not for True Market Insider readers. We already know that the deterioration in breadth that’s occurred since the beginning of August has been pretty glaring.

In fact, in last week’s article, we said that three barometers of internal strength have recently turned negative, which is a warning sign not to be taken lightly.   That's because every day thousands of stocks across many sectors fight with one another in a war over price.  It’s a battle that pits demand versus supply.

And let me tell you, since the beginning of the month, supply has been beating the tar out of demand.

And while it’s true that U.S. Domestic Stocks are still the top-ranked broad asset class with respect to relative strength, supply (at least in the short term) has taken control over many of the segments that make up the U.S. stock market.

In Sector Prophets, our data-driven analytics service, we break the broad market into 41 narrow groups or sub-sectors plus four international groups.  We've found that this particular distribution makes it easy to identify the strongest and weakest segments of the overall market.  What we’re seeing right now is nothing less than shocking.

(To learn more about getting access to The US Industry Bell Curve and becoming a subscriber to Sector Prophets Pro, click here.)

Take a look at the Sector Breadth Bell Curve (below) which plots the status of each group’s bullish percent index (BPI), a key barometer of risk that we track on the sector level.

There’s a lot of valuable information in the graphic, but today, what I want you to pay attention to is the color for each sector.  If the sector is green, it suggests that demand is in control. But if it’s red, it suggests that supply is in control.

(Click to enlarge)

sectorbellcurve

Clearly, the graphic shows a great deal of red.

In other words, at the same time that the major stock market averages are trading just a percent or two from their previous all-time highs...  deep look into the internal market reveals that supply has taken control of most sectors.

This is a sign that large institutional money managers (the guys who run the big hedge funds, mutual funds, and sovereign wealth funds) are more in distribution (sell) mode rather than they are in accumulation (buy) mode.

All of this raises the key question...

Is this the beginning of the end for one of the longest bull markets in history?  Or simply just another in a normal series of pauses that eventually resumes the upward trend?

To help answer that, we can look in an unexpected place -- the White House.  You see, August hasn't just been a bad month for the stock market.  It’s been unkind to the Trump Presidency as well.

After his failed attempt to repeal and replace Obamacare, the president and Senate Majority Leader Mitch McConnell had a major falling out and have ceased communicating.

Many people interpreted Trump’s reaction to events in Charlottesville, Va. as equating nazis with the protestors who rallied against them.  Shortly after his comments, some prominent CEO’s resigned from Trump’s business economic policy board.  This in turn impelled the president to disband the forums.

Then there’s the crisis on the Korean peninsula.  The president’s response to reports of North Korea’s nuclear threat ("It will be met with fire and fury like the world has never seen”) did little to soothe Mr. Market.

Finally, the president earlier this week threatened to shut down the government if Congress doesn’t include funds to build the southern border wall in the 2018 fiscal budget.

Now here’s the thing…

It’s not too late for Trump to turn things around.  To get his approval ratings back up.  And, at the same time, to give the stock market a badly needed “breadth mint”.

You see, the strong rally that immediately followed Election Day in November was no accident.  Many of the things Trump campaigned on are in fact pro-growth policies and are bullish for the stock market.

Take corporate tax reform.  If the president can put the past few weeks behind him and focus on getting tax reform done, it would be more than a yuge win for his Presidency.  It could also be the catalyst that turns the market internals positive.

That's because every 5% reduction in the corporate tax rate translates into an increase of 4% in earnings per share, according to an analysis by S&P Investment.  So if the corporate tax rate from its 35% rate down to 20%, that change could boost S&P 500 earnings from $132 to $148 per share.

Applying the current market P/E multiple of 18 would project the S&P 500 index around 2,750.  And tax reform would likely go hand in hand with some sort of tax holiday on the more than $2 trillion in untaxed profits sitting overseas -- another big boost for U.S. Domestic Stocks.

So Mr. President, Mr. Market is counting on you to make nice and work with your colleagues on Capitol Hill to get it done.

For investors in the meantime, it’s best to continue taking defensive measures, such as weeding out securities demonstrating poor relative strength.  Buying protective puts and selling near-dated covered calls is another effective way to mitigate risk in the current market environment.

And don’t forget to build a shopping list, because if the market internals do turn positive, it’s definitely not going to be a ride you’ll want to miss out on.

Until next week!

Costas

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