What No Longer Works on Wall Street

This year’s trading-range market has frustrated many investors and time-honored investment strategies. While the major stock market index moves placidly sideways in the tightest trading range in history, many individual stocks have plunged in value, masking the real correction that’s well underway.

Consider that over the past six months, the S&P 500 Index has traded in a narrow range of just 4.4% from high to low. That’s the tightest trading range in the history of the index. The S&P is down just 2.4% from its May high.

But this apparent tranquility masks the real carnage beneath the surface of the stock market. In fact, 13 blue-chip Dow stocks are already down 10% or more from their 52-week highs. That’s over 40% of the 30-stock Dow Jones Industrial Average that are already suffering a correction.

And there are some big, household names on this list of the biggest Dow losers  …

Retail giant Walmart (WMT) is down 22% from its high and fell further yesterday after disappointing earnings. This is especially unsettling since consumer discretionary stocks have been among the biggest winners over the past year, and WMT is the biggest of the bunch.

Perhaps it’s better to hide out in defensive consumer staples? Wrong.

While the S&P 500 moves placidly sideways in this year’s frustrating trading range, many individual stocks have plunged in value, masking the real correction that’s well underway.

Procter & Gamble (PG) may be the ultimate defensive stock to own in times of trouble, but the shares have tumbled 18% from the high, in spite of solid earnings that beat expectations in July.

How about technology stocks? They’ve been performing well — just look at Google (GOOG).

But take a look at International Business Machines (IBM) down 17.6%, or Intel (INTC), which has tumbled 22.1% from its 52-week high. Both stocks are trending below their respective 200-day moving averages, which for many technical analysts means that IBM and INTC are already in their own private bear markets.

But of all the stocks on the Dow’s biggest losers list, Apple (AAPL) is the most troubling. That’s because, for the past several years, AAPL has been an absolute darling of momentum investors. But not anymore.

Momentum is an investment strategy that has stood the test of time, paying off for investors over the years in superior returns. Essentially momentum boils down to physics … an object (or a stock) in motion tends to stay in motion.

Buying stocks with the best six- or 12-month price momentum, for example, shows superior results over time. Plenty of academic studies and real-world investment strategies tell us that momentum works as an indicator. That is, until it doesn’t.

You see momentum has a kind of Jekyll-and-Hyde personality. It works well for markets, sectors and individual stocks over long periods, but when it stops working, momentum can reverse with a vengeance, leading to quick and steep draw-downs. Here are two examples:

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#1: Momentum in markets — China: China’s domestic Shanghai Index showed the best upside price momentum of any stock market on the planet last year. The DB X Trackers CSI China ETF (ASHR) closely tracks Shanghai. And from January 2014 to June 2015, this ETF gained an eye-popping 126.8%. That’s terrific upside momentum.

But in less than one month, this ETF plunged 38.6% in value during June and early July. Momentum turned down on investors with a vengeance.

#2: Momentum in stocks — AAPL: This brings us back to Apple, which represents the quintessential momentum stock. AAPL has outperformed by a very wide margin during this bull market, surging more than 10-fold in price since 2009.

But now, AAPL is underperforming with the stock down 12.2% from its peak … Momentum cuts both ways.

The reason why this observation is so relevant right now to investors is that momentum has accounted for the lion’s share of the stock market’s recent gains, but it’s not working anymore.

AAPL and a handful of other high-flying momentum stocks, including Google, Amazon (AMZN) and Netflix (NFLX) among others, have accounted for virtually ALL of the Nasdaq’s gains this year, while hundreds of other stocks have already endured their own steep corrections (down 10% or more), or worse, bear markets (down 20% or more).

Momentum stocks have been leading the market higher, but that leadership is faltering. One by one, stocks like AAPL are falling from grace. Price momentum is turning to the downside.

If you are holding high-momentum stocks or ETFs in your portfolio, beware. Momentum cuts both ways, so be sure to keep your stops tight.

Good investing,

Mike Burnick

Mike Burnick, with 30 years of professional investment experience, is the Executive Director for The Edelson Institute, where he is the editor of Real Wealth Report, Gold Mining Millionaire, and E-Wave Trader. Mike has been a Registered Investment Adviser and portfolio manager responsible for the day-to-day operations of a mutual fund. He also served as Director of Research for Weiss Capital Management, where he assisted with trading and asset-allocation responsibilities for a $5 million ETF portfolio.