Stocks Undergo Sharp Downside Correction After Reaching New All-Time Highs

After both the Dow Jones Industrial Average and the S&P 500 made new all-time highs last Friday morning in response to the ostensibly positive March jobs report, stocks have reversed course to the downside in a vicious manner through Monday’s close.

Before this downside debacle, the market had been helped earlier last week to the upside partly on some positive comments from Fed Chair Janet Yellen, discussed in detail in last week’s column. Last Friday’s non-farm payroll report certainly appeared as if it was going to give the market a new leg up before things went into a sudden and abrupt downside about-face.

The report itself was about as good as one could have hoped for as the U.S. economy finally regained all the private sector jobs it had lost during the Great Recession of 2008-9, even though that took a painfully slow six years to accomplish.

On the other hand, one can argue that because the population has grown since the big downturn, the 8.9 million new jobs created is no big deal.

Non-farm payrolls increased by 192,000 jobs in March after rising by 197,000 in February, and the January number was revised upward as well. The unemployment rate was unchanged at 6.7 percent as the size of the labor force increased as more Americans looked for work. The length of the workweek rose, but average hourly earnings declined by a small amount. Manufacturing payrolls fell by 1,000 after seven straight months of gains, but construction jobs rose by 19,000, the third consecutive month of gains.

Other reports issued last week showed an economy that is trying to regain its footing as February construction spending rose a bit after a decline the prior month and February factory orders increased by the most since last September, but the February trade deficit widened as exports slowed to a five-month low, and this number will subtract from the first-quarter G.D.P. total.

But it was that dramatic downside reversal from an early Dow gain on Friday of 59 points to a best-ever level of 16,631 and the S&P’s advance to a record intraday price of 1897.28 followed by a spectacular downside collapse that sent chills down investors’spines.  Instead of finishing the session with that 59-point early advance, the Dow ended with a closing decline of 160 points, which meant that it made a 219 point intraday downside reversal.

It was the Dow’s worst loss in three weeks and the S&P’s poorest showing in two weeks, but despite this downside shellacking they both ended the week with gains because of strength earlier during the five sessions as mentioned above.

The Nasdaq, on the other hand, ended the week lower and therein lies the story of the recent market malaise, as it is the formerly high-flying components of this index that have really taken a beating lately. This index suffered its worst showing in two months while the Nasdaq 100, which consists of the largest non-financial issues (i.e. technology and biotech), got clobbered in its worst showing in two years after having risen 35 percent last year.

And if one thought that Friday’s session was awful, the market put in a repeat miserable performance on Monday to start the new week as the Dow declined by another 160 points (166 to be exact) as it and the S&P put in their worst three-day performances since early February.

The Nasdaq really took it on the chin with its worst three-day showing since November 2011 and fell to a two-month low as it has now declined by 6 percent from its recent high, as has the Russell 2000 Index of small stocks.

So what is going on here? The answer is that after spectacular gains in individual components of these indexes and the indexes themselves, investors have all of a sudden decided that these stocks are now “overvalued” based on traditional market metrics like price/earnings and price to sale ratios. And there can really be no arguing this fact, as the NBI, or Nasdaq biotechnology index, has now fallen for six straight weeks after having gained an almost unheard of 79 percent during the first two months of the year!

The Nasdaq itself had advanced by 240 percent since the market bottom five years ago, compared to “only” 180 percent for the S&P. What is taking place is some letting the air out of a tremendous upside boom, which has had a long and scary pattern of occurring in the annals of stock market history.

And some of the blame for this overvaluation of high-flying technology stocks that is now being corrected has to lie with the analysts who cover these stocks. Let us look at some of those that have now corrected so sharply and what the analysts who cover them said the price targets were, meaning that investors should hold onto these stocks until this particular objective was attained.

Read them and weep; price targets were never reached and these stocks have declined by the following amounts in the meantime:  BIDU had an upside price target of 250, got as high as 184 and is now 22 percent off its high; FB had a price target of 80 and got as high as 72 and is now 20 percent off its high; LNKD had a 300 price target and got as high as 256 and is now 34 percent off its high; PCLN had a 1500 price target and got as high as 1370 and is now 15 percent off its high; TSLA had a 275 price target and got as high as 254 and is now 20 percent off its high.

What this goes to show is that since no one knows where the top in a stock is until after it is reached, a sophisticated investor should set his profit goals before entering into an investment and sell on the way up instead of having to unload his shares into a panicky selling situation, as we have seen the past several days and weeks with these former high-fliers.

And everyone should remember the old market adage that no one buys at the bottom and sells at the top, and the best one should expect to achieve is to take a nice piece out of the middle, so to speak.