Authored by Lance Roberts via RealInvestmentAdvice.com,
Is The Market On The Naughty List?
Two weeks ago, I warned that the “G-20 rally” had exhausted a bulk of the “oversold” condition which had existed at that time. I also recommended remaining cautious until the underlying technical backdrop had improved.
While that turned out to be very good advice, the market is now reversed from where it was then. Markets are back to deeply oversold conditions and are sitting on important support. As shown in the chart below, these conditions have been previously present when markets have bounced.
On Tuesday, we discussed the potential for a “Santa Claus” rally as we head into the end of the year. In case you missed it, here was the important takeaway of that discussion:
“The following graph shows, in orange, aggregate cumulative returns by day count for the 28 Decembers we analyzed plotted alongside daily aggregated average returns by day.”
“IF ‘Santa’ is going to visit ‘Broad & Wall’ this year, it will most likely occur between the 10th through the 17th trading days of the month. Such would equate to Friday, December 14th through Wednesday, December 26th.”
While the current oversold condition is supportive of a rally over the next couple of weeks, that does not mean this is a “stocking” you should stuff everything into. Given the macro-backdrop, any rally may be short-lived going into 2019 unless some of the pressure from weaker economic data, Brexit, Washington politics, “trade wars”, balance sheet reductions, and softer-earnings growth is relieved.
So far, such relief has yet to be the case as economic data both globally and domestically continues to weaken. As noted on Friday, this weakness is occurring at a time where the Federal Reserve continues to extract liquidity from the market. To wit:
“While the Fed’s rate hikes do indeed raise borrowing costs and slow economic growth, it is the extraction of liquidity from the markets which is most important. As shown in the chart below, the Fed is now reducing their flows by $50 billion each month. This is in direct contrast to the billions they were injecting previously which corresponds with the markets decade-long bull market despite weak revenue growth due to a sluggish economic expansion.”
“But it is no longer just the Fed. On Thursday, the European Central Bank made two important announcements.
- They will stop adding to its stock of government and corporate bonds at the end of December, and;
- They are seeing signs of weaker inflation and economic growth.
In other words, as world markets are beginning to struggle as the driver of the decade-long bull market is being removed.”
Last week, as we noted at RIA PRO, we put on a small S&P 500 (IVV) trading position for a potential oversold rally. As I noted on Friday, that trade has left much to be desired as the market simply has not been able to muster a sustainable bounce. On Friday, the market closed right at critical support levels.
Given the Fed meets next week, we are going to give our trade just the smallest margin of movement currently for three reasons:
- The market is deeply oversold which will contribute to a bounce on any bit of good news.
- The index closed lower than where it opened for 4-consecutive days. Such selling is often met with a one or two day bounce.
- Lastly, as noted previously, distributions for mutual funds are now mostly complete and they have to rebalance portfolios before the end of the reporting year. With next week having the highest historical probability for a rally, a more “dovish” than expected Fed could spark a bit of buying frenzy.
While we are expecting an oversold rally, remember after having reduced exposure in portfolios previously, and carrying a much heavier weighting in cash, we are giving the market time to figure out what it wants to do. Given the consolidation range over the last couple of months, it is too risky to be either overly short, or aggressively long, currently. Cash remains the best hedge currently.
But let me repeat the most important point:
“The expected rally IS NOT the next version of the ‘bull market.’ Nor does a rally mean the ‘bear market’ is over. It will be a counter-trend rally to sell into.”
But it is not just the S&P 500 where this is occurring. As shown, every market is now trending negatively.
As I have noted previously, the weakness in the market continues to be a process that has gripped markets over the last several months as the Federal Reserve has steadily increased their extraction of liquidity. As shown in the chart above, the market has continued to build multiple tops as the 50-dma deepens its divergence from the 200-dma. Currently, downside stop losses are holding, but there isn’t much wiggle room here currently before further actions need to be taken.
While we are certainly hoping that Santa Claus will indeed come and visit “Broad & Wall” over the next two weeks, there isn’t much reason to take on an excessive amount of risk currently.
Lack Of Experience
A lot of my articles and newsletters get picked up and republished by great sites like Seeking Alpha, Advisor Perspectives, Equities.com, Investing.com, Zerohedge, and many others. What is interesting to read are the comments that are posted as they show the “lack of experience” most individuals have in the markets today.
But such shouldn’t surprise you. Roughly 70% of Americans have very little or no participation in the financial markets currently. Even more than that have little or no understanding about how markets and investing actually work. Lastly, given that most don’t survive bear markets, most individuals in the markets today started their investing journey after 2008.
My investing journey started prior to 1987 and this note by Carl Swenlin at Decision Point (h/t Mr. Obrien) put a fine point on the single biggest problem which exists currently.
“The chart below shows the entire period during which I have been involved in stock market analysis, and, as you can see, the title of this article definitely does not apply to me. If a decline of -20% or more qualifies as a bear market, then I have experienced seven of them. Additionally, there were three periods which, while not qualifying as bear markets, were sufficiently unpleasant to qualify them for ‘honorable mention.’ I have identified the current decline with a question mark, because we won’t know if it qualifies as a bear market until the benchmark -20% decline is in; however, bear market evidence continues to appear, and I believe we’re in a bear market now.”
“By comparison, anyone with 10 years experience in the market has only seen the 2011 baby bear and a mild correction. A person with such limited experience is at a serious disadvantage.”
“I was going to say that he/she cannot imagine what lies ahead in a real bear market, but that would be wrong. Using technical analysis, a determined individual can study past bear markets and imagine very well what the experience might have been like. In particular, apply favored indicators to bear market periods and observe how they behave.”
Here is the important point, if you have never been through a real “bear market,” it is a lesson which you DO NOT want to learn the “hard way.”
It is always better to err to the side of caution with your hard earned savings than to try and replaced both lost capital and time. As I noted in the “Exit Problem:”
“The markets function much the same way as yelling ‘fire’in a theater filled to capacity with only one exit. Those closest to the exit will likely get out safely, but once the ‘bottleneck’ forms, there is an inability to exit before the damage is done.”
It is likely no longer the time to remain fully invested in the financial markets without a thorough understanding of your “risk exposure.” Most likely, returns over the next decade will be far worse than those in the last.
As I have stated often, my job is to participate in the markets while keeping a measured approach to capital preservation. Since it is considered “bearish” to point out the potential “risks” that could lead to rapid capital destruction; then I guess you can call me a “bear.”
Just make sure you understand I am still in “theater,” I am just sitting much closer to the “exit.”
