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Market Sentiment (Stocks on NYSE, NASDAQ, AMEX)

May 5, 2016, 12:07 p.m. EDT

Potential for a further drop for stocks grows

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About Adam Koos

Adam D. Koos, CFP® is an award-winning, nationally recognized portfolio manager and financial adviser. He is founder and president of Libertas Wealth Management Group Inc., a fee-only registered investment advisory firm. He appears regularly on Marketwatch, Forbes, Yahoo! Finance, U.S. News & World Report, and many others.

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By Adam D. Koos, CFP®

Dean Treml/Red Bull via Getty Images

I don't like to predict the markets. It's pointless, really. Anything can happen on any given day, so when I'm asked what the market is going to do between now and the end of the year, or "why" the next stock market crash will occur, I try to avoid falling into the trap of attempting to be a fortune teller.

However, today's risk-to-reward ratio as it pertains to investing in stocks is outrageously out of favor for the investor on the long side of the trade. It's like asking your fat uncle to sign up for the Tough Mudder. He might limp and wheeze through the first mile or so, but eventually, he's going to come to rest in some sink hole along the way.

Let's pretend for a second that the market's valuation and internals appear safe and sound. I assume you would agree that anything can happen on any day of the week to send stocks into a black hole.

If you remember two crashes ago, the market had peaked in March of 2000, and by summer of 2001, all the buzz was about the end of the bear market, and then the worst happened: The worst terrorist attack in history on American soil. The market closed for a few days, and when it opened, the bell on the NYSE didn't ring to the beginning of a new bull market. Quite the opposite. The point is, markets can cruise along at 65 MPH, but fall asleep at the wheel, speeding right off a cliff.

The problem we face today is that the market doesn't look safe and sound if you analyze the correct information . So with that said, if everything about the market smells of rancid roadkill, you probably don't want to eat it, but there's always the off-chance that Janet Yellen could drive up in her monetary ambulance and create the image that the dead skunk can be saved by the Fed. At least, she can make it seem that way, temporarily.

Let's briefly review where we've been this last six months:

  • Pre-election years are typically the best year of the 4-year election cycle, but 2015 was the first negative pre-election year since Hitler invaded Poland in 1939

  • The last two days of the year and first two trading days of the new year are considered the "Santa Claus Rally," when the market typically does well. This year, the market went down instead.

  • January was the worst month for the S&P500 since 1923 and the worst for the Dow since 1900.

Now that we've scratched the surface, click on the chart below and notice the following:

For a larger chart, please click here .

  • Look at the long-term trendline that starts roughly a year ago.

  • Notice the highlighted upper portion of the chart where price increases , but compare it to the momentum indicator highlighted in the middle of the chart, which is going down . It is not a good thing when momentum diverges southward, away from price movement.

  • Finally, at the bottom right, notice how volume has fallen when the market went up , but has recently started to pick up steam , now that the market is starting to struggle again.

Observing the state of the market today, it's going to take an ambulance with Janet Yellen behind the wheel to transport stocks to new highs, and if in fact we do see new highs, the probability for a violent, blow-off top increases exponentially.

It takes preparation, time, and financial surgery to stop the bleeding we're seeing today. I don't always buy stocks, but when I do, it's most certainly not during times like this. Continued low interest rates and even another QE Band-Aid can't permanently fix a financial coronary hemorrhage.

So whether the market falls over the course of the next 12 months — or if the Federal Reserve continues to inflate another bubble through financial meddling, the probability is high that investors will be given the opportunity to buy stocks at a cheaper price than you'd pay today. Stay patient, my friends.

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