Tag Archives: bonds

Major Market Buy/Sell Review: 04-27-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

NOTE: I have added relative performance information to each graph. Most every graph shows relative performance to the S&P 500 index except for the S&P 500 itself which compares value to growth, and oil to the energy sector. 

S&P 500 Index

  • Last week I wrote: “The break of the 50% retracement this past week, is bullish and suggests a run to the 200-dma is likely. However, the risk/reward is not in the favor of longer-term positions, so trading positions only for now.” 
  • This past week, SPY retested, and held above, the 50% retracement keeping a run to the 61.8% retracement still viable. However, the market does appear to be struggling and is overbought short-term. 
  • This analysis still doesn’t negate the risk of more volatility ahead, so be prepared for sharp declines which means keeping trading stops tight.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No core position
    • This Week: Trading “Rentals” Only 
    • Stop-loss moved up to $265
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • DIA is a little different story as it failed at the 50% retracement and closed below it.
  • Also, on a relative basis, SPY continues to smartly outperform DIA. 
  • If DIA fails to gain traction next week, we will likely see a failure of support. Trading “rentals” only for now with a tight stop at $226
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: Trading “Rentals” Only
    • Stop-loss moved up to $226
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • As we have noted previously, QQQ is by far “the best index” to own currently from a technical basis. 
  • QQQ is outperforming the SPY by a wide margin, but not surprising given the top-5 stocks in the SPY are also the top-5 in the QQQ and are most technology related shares. 
  • Last week’s break above the 200-dma and the 61.8% sets up a test of “all-time” highs. (Pretty incredible when you think about the amount of economic devastation that is coming.)
  • But, from a trading perspective, “What is…is.”
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: Trading “Rentals” Only
    • Stop-loss moved up to $200
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • Small caps continue to sorely underperform large caps in the current environment which also suggests the broader market remains at risk as well. 
  • No change to our positioning on Small-caps which are still “no place to be as both small and mid-cap companies are going to be hardest hit by the virus.”
  • Be careful what you own. 
  • Avoid small-caps. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $44 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-caps, we have no holdings. 
  • Relative performance continues to remain exceedingly poor. MDY failed at the 28.2% retracement level and is at risk of a much slower economic environment.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss moved up to $245 for trading positions. 
  • Long-Term Positioning: Bearish

Emerging Markets

  • As with small and mid-cap stocks, emerging and international markets are being hit hard by the virus. Economically, these countries are being destroyed right now. 
  • We previously stated that investors should use counter-trend rallies to sell into. If you haven’t done so, do so Monday. Relative performance remains exceedingly weak. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved up to $33 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Same with EFA as with EEM. 
  • The rally failed at the 28.2% retracement and relative performance remains exceedingly weak. 
  • Remain out of these markets for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $51 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • This past week, saw oil prices collapse and then rally back as futures contracts rolled from May to June. That’s the good news, the bad news is that oil prices are going to go lower again as we head into May and storage remains a problem. 
  • We continue to suggest using any rally to clear positions in your portfolio for now.
  • We have not changed out stance on the sector from a “value” perspective, however, and this past week we nibbled into XOM, CVX, and XLE as oil stocks had exceedingly strong relative performance relative to oil. This suggests most of the risk has been pulled out of the sector. We are still carrying very tight stops though. 
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: XOM, CVX, and XLE
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • We previously added to our positions in IAU and GDX. 
  • This past week Gold broke out to new highs as inflationary concerns continue to persist. 
  • The sectors are VERY overbought short-term so a pullback is likely that can be used to add to current holdings. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions – Positions can now be added at 157.50
    • Stop-loss moved up to $150
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds are back to “crazy” overbought with the Fed buying everything from the banks who are happy to mark-up prices and sell it to them. 
  • As we have been adding equity exposure to portfolios, we needed to increase our “hedge” against equity risk accordingly.  We added a 5% position of TLT on Friday for just this reason. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Added 5% position of TLT
    • Stop-loss is $152.50
    • Long-Term Positioning: Bullish

U.S. Dollar

Major Market Buy/Sell Review: 04-20-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index

  • Last week I wrote: “This past week, the market was able to muster a rally to the 50% retracement level, and on many short-term fronts is extremely overbought. While a retest, and potential break of the March lows is likely, the market does have some lift short-term.”
  • The break of the 50% retracement this past week, is bullish and suggests a run to the 200-dma is likely. However, the risk/reward is not in the favor of longer-term positions, so trading positions only for now. 
  • This still doesn’t negative the risk of more volatility ahead, so be prepared for quick declines, so keep trading stops tight.
  • Remain cautious for now.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No core position
    • This Week: Trading “Rentals” Only 
    • Stop-loss moved up to $278
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA. 
  • The break of the 50% retracement sets up a run to the 200-dma. 
  • Trading “rentals” only for now with a tight stop at $238
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: Trading “Rentals” Only
    • Stop-loss moved up to $238
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • As we have noted previously, QQQ is by far “the best index in town,” technically speaking.
  • Last week’s break above the 200-dma and the 61.8% sets up a test of “all-time” highs. (Pretty incredible when you think about the amount of economic devastation that is coming.)
  • But, from a trading perspective, “What is…is.”
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: Trading “Rentals” Only
    • Stop-loss moved up to $200
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • No change to our positioning on Small-caps which are still “no place to be as both small and mid-cap companies are going to be hardest hit by the virus.”
  • Be careful what you own. 
  • Avoid small-caps. Use last week’s rally to clear positions for now.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $44 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. Use last week’s rally to sell positions.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss moved up to $245 for trading positions. 
  • Long-Term Positioning: Bearish

Emerging Markets

  • As with small and mid-cap stocks, emerging and international markets are being hit hard by the virus. Economically, these countries are being destroyed right now. 
  • We previously stated that investors should use counter-trend rallies to sell into. If you haven’t done so, use last week’s rally to clear positions.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved up to $33 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • As noted previously: “A reflexive rally is likely. Use those levels to sell into.”
  • Use last week’s rally to sell holdings. 
  • Remain out of these markets for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $51 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • The “spike” in oil prices on Friday was due to the change in oil futures contracts from May to June. Oil actually declined on Friday with the May contract at $17/bbl. 
  • Regardless, $25 is the price for June delivery of oil. Without any help on the horizon, look for the June contract to head back towards $20/bbl. 
  • We continue to suggests using any rally to clear positions in your portfolio for now.
  • We have not changed out stance on the sector from a “value” perspective, however, the sector still has work to do, so be patient. 
  • Avoid for now.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • We previously added to our positions in IAU and GDX.
  • The sectors are VERY overbought short-term so a pullback is likely that can be used to add to current holdings. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions – Look at add if support holds at $150
    • Stop-loss moved up to $147.50
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Bonds are back to “crazy” overbought with the Fed buying everything from the banks who are happy to mark-up prices and sell it to them. 
  • Bond prices will correct and provide a better entry point to add exposure. So, be patient for now. Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Take Profits and rebalance holdings as needed.
    • Stop-loss is $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

10 Planning Rules that Drive Financial Success

10-rules-financial-success

Are You A “Basement” Thinker?

Too often, we tend to focus on individual stocks and other investments that will hopefully lead to wealth. 

While that is O.K., it isn’t enough.

The issue is investing without a sound “plan” is the same as building a house without a “blueprint.” Yes, you will get something, but it probably won’t be the result you set out to get.

Be A Rooftop Thinker!

By starting with a proper plan you take into account all assets, liabilities and sources of income. From there it becomes much easier to focus on the investments YOU NEED to meet your financial goals.

Work from rooftop to basement for financial success!

Investment Manager, Lance Roberts and Certified Financial Planner, Richard Rosso we’ll help you understand:

  1. How proper Social Security and Medicare strategies can boost retirement income,
  2. Our concept of financial life benchmarking which is there to help you become more self aware of your financial goals, wants and needs,
  3. How using the wrong, or enthusiastic investment returns can place your retirement in jeopardy,
  4. When housing decisions in retirement can affect your quality of life, and;
  5. The art of talking about your gifting and estate intentions with loved ones.

This 30-minute webinar can keep your from making costly investment mistakes and help bring clarity to your future financial plan.

If you would like to access this recorded webinar please click here.

Major Market Buy/Sell Review: 04-13-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index

  • Previously we wrote: “Well, that bounce finally came and it was as vicious as we expected. While this remains a “bear market” rally, the media was quick to jump on the “Bear market is over” bandwagon. It isn’t, and investors will likely pay a dear price in April.”
  • This past week, the market was able to muster a rally to the 50% retracement level, and on many short-term fronts is extremely overbought. While a retest, and potential break of the March lows is likely, the market does have some lift short-term.
  • Despite the Fed flooding money into the system, we could be set up for some very volatile moves as the economic data is about to become horrific, and earnings estimates will be revised sharply lower. 
  • Remain cautious for now. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No core position
    • This Week: No core position
    • Stop-loss moved up to $245
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • The bounce we discussed previously retraced to the 50% retracement level. We could see some positive action on Monday, but we remain firmly entrenched in a bear market for now. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss moved up to $210
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • We had previously put on a small QQQ trade for a reflexive rally, but we closed that out. 
  • As with SPY and DIA, the QQQ has established a downtrend, but technically is in MUCH better shape than the other markets with the bull-trend still intact.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss moved up to $180
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • Small-caps are no place to be as both small and mid-cap companies are going to be hardest hit by the virus.
  • Be careful what you own, there are going to be quite a few companies that don’t make it. 
  • Avoid small-caps. Use last week’s rally to clear positions for now.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $44 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. Use last week’s rally to sell positions.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss moved up to $245 for trading positions. 
  • Long-Term Positioning: Bearish

Emerging Markets

  • As with small and mid-cap stocks, emerging and international markets are being hit hard by the virus. Economically, these countries are being destroyed right now. 
  • We previously stated that investors should use counter-trend rallies to sell into. If you haven’t done so, use last week’s rally to clear positions.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss moved up to $33 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • As noted previously: “‘A reflexive rally is likely. Use those levels to sell into.”
  • Use last week’s rally to sell holdings. 
  • Remain out of these markets for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss moved up to $51 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • As stated last week, “Saudi and Russia are NOT likely going to cut production meaningfully as they now have shale drillers in a stranglehold. They are going to talk a lot, but they aren’t going to do anything until they extinguish shale to some degree. For the last couple of years, I have warned this outcome would eventually occur.”
  • Shockingly they did come to an agreement, but it may be too little ,too late and whose to say that member OPEC countries adhere to their commitments.
  • We also stated to use the rally last week to clear positions in your portfolio for now stating:
    • “We will very likely retest or set new lows in the coming months as drillers are forced to “shut in” production. At that point we can start picking through the ruble for portfolio positioning.” 
  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. We clearly aren’t at lows yet, so be patient. 
  • Avoid for now.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • We added to our positions in IAU and GDX last week as the Fed’s action are starting to raise the specter of rather serious inflation problems. 
  • Last week, Gold broke out to highs and brought the “buy signal” back online. 
  • Gold is a little overbought short-term so use pullbacks to support to add further holdings.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions.
    • Stop-loss moved up to $142.50
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • We have reduced our overall bond exposure, because we are running a very reduced equity exposure currently. This aligns our “hedge” of fixed income relative to our equity book. 
  • However, bonds are now MORE overbought that at just about any other point in history which suggests we could see a tick up in rates and a fall in bond prices. (Such will provide a good opportunity to add bond exposure to portfolios.)
  • Normally, such a reversion would coincide with a “risk on” trade into equities. However, given the economic devastation coming, we need to look back at 2008. In November of 2008, the Fed hit the markets with QE which caused bonds and stocks to rise in unison. However, shortly thereafter, both declined sharply in price as economic realities came to the fore.

  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Take Profits and rebalance holdings as needed.
    • Stop-loss is $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar fell sharply as we had a reflexive “bear market” rally. However, with concerns over the deteriorating global economy and the demand for dollars from abroad, money is flowing back into the dollar for safety. 
  • The recent volatility of the dollar makes it hard to trade for now, so be patient for the moment and let things calm down. We may look to add a long-dollar trade on a pull back to the $98-99 areas. 
  • The dollar is on a strong “buy signal” and is NOT “overbought,” which suggests dollar strength may be with us for a while longer.

Major Market Buy/Sell Review: 04-06-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index

  • Last week: “Well, that bounce finally came and it was as vicious as we expected. While this remains a “bear market” rally, the media was quick to jump on the “Bear market is over” bandwagon. It isn’t, and investors will likely pay a dear price in April.”
  • After running into the bullish trend line and the initial 38.2% retracement, the market failed and has established a downtrend. A retest, and potential break of the March lows is likely, but we will monitor this carefully. With the Fed flooding money into the system, we could be set up for some very volatile moves, but the economic data is about to become horrific and earnings estimates will be revised sharply lower. 
  • Remain cautious for now. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position
    • Stop-loss set at $220
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • The bounce we discussed previously retraced to the 38.2% retracement level and failed. We could see some positive action on Monday, but we remain firmly entrenched in a bear market for now. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss set at $185
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • We had previously put on a small QQQ trade for a reflexive rally, but we closed that out. 
  • As with SPY and DIA, the QQQ has established a downtrend, but technically is in MUCH better shape than the other markets with the bull-trend still intact.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss set at $170
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • Small-caps have a lot more downside to go as both small and mid-cap companies are going to be hardest hit by the virus.
  • Be careful what you own, there are going to be quite a few companies that don’t make it. 
  • Avoid small-caps. Use any reflexive rally to step-aside for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $42 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • As with small and mid-cap stocks, emerging and international markets are being hit hard by the virus. Economically, these countries are being destroyed right now. 
  • We previously stated that investors should use counter-trend rallies to sell into. If you haven’t done so, use any rally to clear positions.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss set at $30 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • As noted last week: “‘A reflexive rally is likely. Use those levels to sell into. Do so this week.”
  • Remain out of these markets for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $46 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Last week, the President said he talked to Saudi Arabia and they were in talks with Russia to cut $10 million barrels of production. That tweet sparked a vicious rally in oil keeping prices above the critical level of $20.
  • Saudi and Russia are NOT likely going to cut production meaningfully as they now have shale drillers in a stranglehold. They are going to talk a lot, but they aren’t going to do anything until they extinguish shale to some degree. For the last couple of years, I have warned this outcome would eventually occur. 
  • Use this rally in oil to clear positions in your portfolio for now. We will very likely retest or set new lows in the coming months as drillers are forced to “shut in” production. At that point we can start picking through the ruble for portfolio positioning. 
  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. We clearly aren’t at lows yet, so be patient. 
  • Avoid for now.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • We previously added to our position in IAU and continue to have a small holding in GDX, as the previous liquidation left a lot of value in the sector. However, performance remains lazy at this point, so we are looking for pullbacks to support to add to our holdings. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions.
    • Stop-loss set at $137.50.
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • We have reduced our overall bond exposure, because we are running a very reduced equity exposure currently. This aligns our “hedge” of fixed income relative to our equity book. 
  • We remain very cautious on our bond exposure currently, and will look to add to that exposure once the credit markets calm down a bit. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar fell sharply as we had a reflexive “bear market” rally. However, with concerns over global economic strength rising, money is flowing back into the dollar for safety. 
  • The recent volatility of the dollar makes it hard to trade for now, so be patient for the moment and let things calm down. We can look to add a long-dollar trade on a pull back to the $98-99 areas. 
  • The dollar has reversed its sell signal, which suggests dollar strength may be with us for a while longer.

Previous Employment Concerns Becoming An Ugly Reality

Last week, we saw the first glimpse of the employment fallout caused by the shutdown of the economy due to the virus. To wit:

“On Thursday, initial jobless claims jumped by 3.3 million. This was the single largest jump in claims ever on record. The chart below shows the 4-week average to give a better scale.”

This number will be MUCH worse when claims are reported later this morning, as many individuals were slow to file claims, didn’t know how, and states were slow to report them.

The importance is that unemployment rates in the U.S. are about to spike to levels not seen since the “Great Depression.” Based on the number of claims being filed, we can estimate that unemployment will jump to 15-20% over the next quarter as economic growth slides 8%, or more. (I am probably overly optimistic.)

The erosion in employment will lead to a sharp deceleration in economic and consumer confidence, as was seen Tuesday in the release of the Conference Board’s consumer confidence index, which plunged from 132.6 to 120 in March.

This is a critical point. Consumer confidence is the primary factor of consumptive behaviors, which is why the Federal Reserve acted so quickly to inject liquidity into the financial markets. While the Fed’s actions may prop up financial markets in the short-term, it does little to affect the most significant factor weighing on consumers – their jobs.

The chart below is our “composite” confidence index, which combines several confidence surveys into one measure. Notice that during each of the previous two bear market cycles, confidence dropped by an average of 58 points.

With consumer confidence just starting its reversion from high levels, it suggests that as job losses rise, confidence will slide further, putting further pressure on asset prices. Another way to analyze confidence data is to look at the composite consumer expectations index minus the current situation index in the reports.

Similarly, given we have only started the reversion process, bear markets end when deviations reverse. The differential between expectations and the current situation, as you can see below, is worse than the last cycle, and only slightly higher than before the “dot.com” crash.

If you are betting on a fast economic recovery, I wouldn’t.

There is a fairly predictable cycle, starting with CEO’s moving to protect profitability, which gets worked through until exhaustion is reached.

As unemployment rises, we are going to begin to see the faults in the previous employment numbers that I have repeatedly warned about over the last 18-months. To wit:

“There is little argument the streak of employment growth is quite phenomenal and comes amid hopes the economy is beginning to shift into high gear. But while most economists focus at employment data from one month to the next for clues as to the strength of the economy, it is the ‘trend’ of the data, which is far more important to understand.”

That “trend” of employment data has been turning negative since President Trump was elected, which warned the economy was actually substantially weaker than headlines suggested. More than once, we warned that an “unexpected exogenous event” would exposure the soft-underbelly of the economy.

The virus was just such an event.

While many economists and media personalities are expecting a “V”-shaped recovery as soon as the virus passes, the employment data suggests an entirely different outcome.

The chart below shows the peak annual rate of change for employment prior to the onset of a recession. The current cycle peaked at 2.2% in 2015, and has been on a steady decline ever since. At 1.3%, which predated the virus, it was the lowest level ever preceding a recessionary event. All that was needed was an “event” to start the dominoes falling. When we see the first round of unemployment data, we are likely to test the lows seen during the financial crisis confirming a recession has started. 

No Recession In 2020?

It is worth noting that NO mainstream economists, or mainstream media, were predicting a recession in 2020. However, as we noted in 2019, the inversion of the “yield curve,” predicted exactly that outcome.

“To CNBC’s point, based on this lagging, and currently unrevised, economic data, there is ‘NO recession in sight,’ so you should be long equities, right?

Which indicator should you follow? The yield curve is an easy answer.

While everybody is ‘freaking out’ over the ‘inversion,’it is when the yield-curve ‘un-inverts’ that is the most important.

The chart below shows that when the Fed is aggressively cutting rates, the yield curve un-inverts as the short-end of the curve falls faster than the long-end. (This is because money is leaving ‘risk’ to seek the absolute ‘safety’ of money markets, i.e. ‘market crash.’)”

I have dated a few of the key points of the “inversion of the curve.” As of today, the yield-curve is now fully un-inverted, denoting a recession has started.

While recent employment reports were slightly above expectations, the annual rate of growth has been slowing. The 3-month average of the seasonally-adjusted employment report, also confirms that employment was already in a precarious position and too weak to absorb a significant shock. (The 3-month average smooths out some of the volatility.)

What we will see in the next several employment reports are vastly negative numbers as the economy unwinds.

Lastly, while the BLS continually adjusts and fiddles with the data to mathematically adjust for seasonal variations, the purpose of the entire process is to smooth volatile monthly data into a more normalized trend. The problem, of course, with manipulating data through mathematical adjustments, revisions, and tweaks, is the risk of contamination of bias.

We previously proposed a much simpler method to use for smoothing volatile monthly data using a 12-month moving average of the raw data as shown below.

Notice that near peaks of employment cycles the BLS employment data deviates from the 12-month average, or rather “overstates” the reality. However, as we will now see to be the case, the BLS data will rapidly reconnect with 12-month average as reality emerges.

Sometimes, “simpler” gives us a better understanding of the data.

Importantly, there is one aspect to all the charts above which remains constant. No matter how you choose to look at the data, peaks in employment growth occur prior to economic contractions, rather than an acceleration of growth. 

“Okay Boomer”

Just as “baby boomers” were finally getting back to the position of being able to retire following the 2008 crash, the “bear market” has once again put those dreams on hold. Of course, there were already more individuals over the age of 55, as a percentage of that age group, in the workforce than at anytime in the last 50-years. However, we are likely going to see a very sharp drop in those numbers as “forced retirement” will surge.

The group that will to be hit the hardest are those between 25-54 years of age. With more than 15-million restaurant workers being terminated, along with retail, clerical, leisure, and hospitality workers, the damage to this demographic will be the heaviest.

There is a decent correlation between surges in the unemployment rate and the decline in the labor-force participation rate of the 25-54 age group. Given the expectation of a 15%, or greater, unemployment rate, the damage to this particular age group is going to be significant.

Unfortunately, the prime working-age group of labor force participants had only just returned to pre-2008 levels, and the same levels seen previously in 1988. Unfortunately, it may be another decade before we see those employment levels again.

Why This Matters

The employment impact is going to felt for far longer, and will be far deeper, than the majority of the mainstream media and economists expect. This is because they are still viewing this as a “singular” problem of a transitory virus.

It isn’t.

The virus was simply the catalyst which started the unwind of a decade-long period of debt accumulation and speculative excesses. Businesses, both small and large, will now go through a period of “culling the herd,” to lower operating costs and maintain profitability.

There are many businesses that will close, and never reopen. Most others will cut employment down to the bone and will be very slow to rehire as the economy begins to recover. Most importantly, wage growth was already on the decline, and will be cut deeply in the months to come.

Lower wage growth, unemployment, and a collapse in consumer confidence is going to increase the depth and duration of the recession over the months to come. The contraction in consumption will further reduce revenues and earnings for businesses which will require a deeper revaluation of asset prices. 

I just want to leave you with a statement I made previously:

“Every financial crisis, market upheaval, major correction, recession, etc. all came from one thing – an exogenous event that was not forecast or expected.

This is why bear markets are always vicious, brutal, devastating, and fast. It is the exogenous event, usually credit-related, which sucks the liquidity out of the market, causing prices to plunge. As prices fall, investors begin to panic-sell driving prices lower which forces more selling in the market until, ultimately, sellers are exhausted.

It is the same every time.”

Over the last several years, investors have insisted the markets were NOT in a bubble. We reminded them that everyone thought the same in 1999 and 2007.

Throughout history, financial bubbles have only been recognized in hindsight when their existence becomes “apparently obvious” to everyone. Of course, by that point is was far too late to be of any use to investors and the subsequent destruction of invested capital.

It turned out, “this time indeed was not different.” Only the catalyst, magnitude, and duration was.

Pay attention to employment and wages. The data suggests the current “bear market” cycle has only just begun.

Shedlock: Recession Will Be Deeper Than The Great Financial Crisis

Economists at IHS Markit downgraded their economic forecast to a deep recession.

Please consider COVID-19 Recession to be Deeper Than That of 2008-2009

Our interim global forecast is the second prepared in March and is much more pessimistic than our 17 March regularly scheduled outlook. It is based on major downgrades to forecasts of the US economy and oil prices. The risks remain overwhelmingly on the downside and further downgrades are almost assured.

IHS Markit now believes the COVID-19 recession will be deeper than the one following the global financial crisis in 2008-09. Real world GDP should plunge 2.8% in 2020 compared with a drop of 1.7% in 2009. Many key economies will see double-digit declines (at annualized rates) in the second quarter, with the contraction continuing into the third quarter.

It will likely take two to three years for most economies to return to their pre-pandemic levels of output. More troubling is the likelihood that, because of the negative effects of the uncertainty associated with the virus on capital spending, the path of potential GDP will be lower than before. This happened in the wake of the global financial crisis.

Six Key Points

  1. Based on recent data and developments, IHS Markit has slashed the US 2020 forecast to a contraction of 5.4%.
  2. Because of the deep US recession and collapsing oil prices, IHS Markit expects Canada’s economy to contract 3.3% this year, before seeing a modest recovery in 2021.
  3. Europe, where the number of cases continues to grow rapidly and lockdowns are pervasive, will see some of the worst recessions in the developed world, with 2020 real GDP drops of approximately 4.5% in the eurozone and UK economies. Italy faces a decline of 6% or more. The peak GDP contractions expected in the second quarter of 2020 will far exceed those at the height of the global financial crisis.
  4. Japan was already in recession, before the pandemic. The postponement of the summer Tokyo Olympics will make the downturn even deeper. IHS Markit expects a real GDP contraction of 2.5% this year and a very weak recovery next year.
  5. China’s economic activity is expected to have plummeted at a near-double-digit rate in the first quarter. It will then recover sooner than other countries, where the spread of the virus has occurred later. IHS Markit predicts growth of just 2.0% in 2020, followed by a stronger-than-average rebound in 2021, because of its earlier recovery from the pandemic.
  6. Emerging markets growth will also be hammered. Not only are infection rates rising rapidly in key economies, such as India, but the combination of the deepest global recession since the 1930s, plunging commodity prices, and depreciating currencies (compounding already dangerous debt burdens) will push many of these economies to the breaking point.

No V-Shaped Recovery

With that, Markit came around to my point of view all along. Those expecting a V-shaped recovery are sadly mistaken.

I have been amused by Goldman Sachs and Morgan Stanley predictions of a strong rebound in the third quarter.

For example Goldman Projects a Catastrophic GDP Decline Worse than Great Depression followed by a fantasyland recovery.

  • Other GDP Estimates
  • Delusional Forecast
  • Advice Ignored by Trump
  • Fast Rebound Fantasies

I do not get these fast rebound fantasies, and neither does Jim Bianco. He retweeted a Goldman Sachs estimate which is not the same as endorsing it.

I do not know how deep this gets, but the rebound will not be quick, no matter what.

Fictional Reserve Lending

Please note that Fictional Reserve Lending Is the New Official Policy

The Fed officially cut reserve requirements of banks to zero in a desperate attempt to spur lending.

It won’t help. As I explain, bank reserves were effectively zero long ago.

US Output Drops at Fastest Rate in a Decade

Meanwhile US Output Drops at Fastest Rate in a Decade

In Europe, we see Largest Collapse in Eurozone Business Activity Ever.

Lies From China

If you believe the lies (I don’t), China is allegedly recovered.

OK, precisely who will China be delivering the goods to? Demand in the US, Eurozone, and rest of the world has collapse.

We have gone from praying China will soon start delivering goods to not wanting them even if China can produce them.

Nothing is Working Now: What’s Next for America?

On March 23, I wrote Nothing is Working Now: What’s Next for America?

I noted 20 “What’s Next?” things.

It’s a list of projections from an excellent must see video presentation by Jim Bianco. I added my own thoughts on the key points.

The bottom line is don’t expect a v-shaped recovery. We will not return to the old way of doing business.

Globalization is not over, but the rush to globalize everything is. This will impact earnings for years to come.

Finally, stimulus checks are on the way, but there will be no quick return to buying cars, eating out, or traveling as much.

Boomers who felt they finally had enough retirement money just had a quarter of it or more wiped out.

It will take a long time, if ever, for the same sentiment to return. Spending will not recover. Boomers will die first, and they are the ones with the most money.

The COVID19 Tripwire

“You better tuck that in. You’re gonna’ get that caught on a tripwire.Lieutenant Dan, Forrest Gump

There is a popular game called Jenga in which a tower of rectangular blocks is arranged to form a sturdy tower. The objective of the game is to take turns removing blocks without causing the tower to fall. At first, the task is as easy as the structure is stable. However, as more blocks are removed, the structure weakens. At some point, a key block is pulled, and the tower collapses. Yes, the collapse is a direct cause of the last block being removed, but piece by piece the structure became increasingly unstable. The last block was the catalyst, but the turns played leading up to that point had just as much to do with the collapse. It was bound to happen; the only question was, which block would cause the tower to give way?

A Coronavirus

Pneumonia of unknown cause first detected in Wuhan, China, was reported to the World Health Organization (WHO) on December 31, 2019. The risks of it becoming a global pandemic (formally labeled COVID-19) was apparent by late January. Unfortunately, it went mostly unnoticed in the United States as China was slow to disclose the matter and many Americans were distracted by impeachment proceedings, bullish equity markets, and other geopolitical disruptions.

The S&P 500 peaked on February 19, 2020, at 3393, up over 5% in the first two months of the year. Over the following four weeks, the stock market dropped 30% in one of the most vicious corrections of broad asset prices ever seen. The collapse erased all of the gains achieved during the prior 3+ years of the Trump administration. The economy likely entered a recession in March.

There will be much discussion and debate in the coming months and years about the dynamics of this stunning period. There is one point that must be made clear so that history can properly record it; the COVID-19 virus did not cause the stock and bond market carnage we have seen so far and are likely to see in the coming months. The virus was the passive triggering mechanism, the tripwire, for an economy full of a decade of monetary policy-induced misallocations and excesses leaving assets priced well beyond perfection.

Never-Ending Gains

It is safe to say that the record-long economic expansion, to which no one saw an end, ended in February 2020 at 128 months. To suggest otherwise is preposterous given what we know about national economic shutdowns and the early look at record Initial Jobless Claims that surpassed three million. Between the trough in the S&P 500 from the financial crisis in March 2009 and the recent February peak, 3,999 days passed. The 10-year rally scored a total holding-period return of 528% and annualized returns of 18.3%. Although the longest expansion on record, those may be the most remarkable risk-adjusted performance numbers considering it was also the weakest U.S. economic expansion on record, as shown below.

They say “being early is wrong,” but the 30-day destruction of valuations erasing over three years of gains, argues that you could have been conservative for the past three years, kept a large allocation in cash, and are now sitting on small losses and a pile of opportunity with the market down 30%.

As we have documented time and again, the market for financial assets was a walking dead man, especially heading into 2020. Total corporate profits were stagnant for the last six years, and the optics of magnified earnings-per-share growth, thanks to trillions in share buybacks, provided the lipstick on the pig.

Passive investors indiscriminately and in most cases, unknowingly, bought $1.5 trillion in over-valued stocks and bonds, helping further push the market to irrational levels. Even Goldman Sachs’ assessment of equity market valuations at the end of 2019, showed all of their valuation measures resting in the 90-99th percentile of historical levels.

Blind Bond Markets

The fixed income markets were also swarming with indiscriminate buyers. The corporate bond market was remarkably overvalued with tight spreads and low yields that in no way offered an appropriate return for the risk being incurred. Investment-grade bonds held the highest concentration of BBB credit in history, most of which did not qualify for that rating by the rating agencies’ own guidelines. The junk bond sector was full of companies that did not produce profits, many of whom were zombies by definition, meaning the company did not generate enough operating income to cover their debt servicing costs. The same held for leveraged loans and collateralized loan obligations with low to no covenants imposed. And yet, investors showed up to feed at the trough. After all, one must reach for extra yield even if it means forgoing all discipline and prudence.

To say that no lessons were learned from 2008 is an understatement.

Black Swan

Meanwhile, as the markets priced to ridiculous valuations, corporate executives and financial advisors got paid handsomely, encouraging shareholders and clients to throw caution to the wind and chase the market ever higher. Thanks also to imprudent monetary policies aimed explicitly at propping up indefensible valuations, the market was at risk due to any disruption.

What happened, however, was not a slow leaking of the market as occurred leading into the 2008 crisis, but a doozy of a gut punch in the form of a pandemic. Markets do not correct by 30% in 30 days unless they are extremely overvalued, no matter the cause. We admire the optimism of formerly super-intelligent bulls who bought every dip on the way down. Ask your advisor not just to tell you how he is personally invested at this time, ask him to show you. You may find them to be far more conservative in their investment posture than what they recommend for clients. Why? Because they get paid on your imprudently aggressive posture, and they do not typically “eat their own cooking”. The advisor gets paid more to have you chasing returns as opposed to avoiding large losses.

Summary

We are facing a new world order of DE-globalization. Supply chains will be fractured and re-oriented. Products will cost more as a result. Inflation will rise. Interest rates, therefore, also will increase contingent upon Fed intervention. We have become accustomed to accessing many cheap foreign-made goods, the price for which will now be altered higher or altogether beyond our reach. For most people, these events and outcomes remain inconceivable. The widespread expectation is that at some point in the not too distant future, we will return to the relative stability and tranquility of 2019. That assuredly will not be the case.

Society as a whole does not yet grasp what this will mean, but as we are fond of saying, “you cannot predict, but you can prepare.” That said, we need to be good neighbors and good stewards and alert one another to the rapid changes taking place in our communities, states, and nation. Neither investors nor Americans, in general, can afford to be intellectually lazy.

The COVID-19 virus triggered these changes, and they will have an enormous and lasting impact on our lives much as 9-11 did. Over time, as we experience these changes, our brains will think differently, and our decision-making will change. Given a world where resources are scarce and our proclivity to – since it is made in China and “cheap” – be wasteful, this will probably be a good change. Instead of scoffing at the frugality of our grandparents, we just might begin to see their wisdom. As a nation, we may start to understand what it means to “save for a rainy day.”

Save, remember that forgotten word.

As those things transpire – maybe slowly, maybe rapidly – people will also begin to see the folly in the expedience of monetary and fiscal policy of the past 40 years. Expedience such as the Greenspan Put, quantitative easing, and expanding deficits with an economy at full employment. Doing “what works” in the short term often times conflicts with doing what is best for the most people over the long term.

Major Market Buy/Sell Review: 03-30-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index 

  • We previosly wrote: “With the market now 3-standard deviations oversold, a bounce is likely next week as it is expected the Fed will cut rates and restart a substantial QE program. A retracement to the 31.8%, 50%, 62.8% levels are possible and each level should be used to reduce equity risk and hedge.”
  • Well, that bounce finally came and it was a vicious as we expected. While this remains a “bear market” rally, the media was quick to jump on the “Bear market is over” bandwagon. It isn’t, and investors will likely pay a dear price in April.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position
    • Stop-loss set at $220
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • The bounce we discussed previously retraced to the 38.2% retracement level and failed. While Monday and Tuesday could see a push higher for quarter end rebalancing, this is still a bear market to be sold into. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss set at $185
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • Last Monday, in anticipation of a rally, we put on a small QQQ trade. The rally did occur and ran into resistance at the 38.2% retracement level. We closed out the trade Friday afternoon, as we were unwilling to hold over the weekend.
  • We may put on another trade soon, depending on getting the right setup. April promises to be sloppy. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions
    • Stop-loss set at $170
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • As noted last week, small-caps are extremely oversold, and on a very deep “sell signal.”  They did bounce this past week, but underperformed the major indexes substantially. 
  • Avoid small-caps. This particular group of stocks are the most susceptible to an economic slowdown from the virus. Use any reflexive rally to step-aside for the time being.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $42 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. 
  • MDY is oversold, and is on a very deep a “sell signal.” The rally this past week also underperformed the broad market. 
  • As noted last week, “MDY is oversold enough for a counter-trend bounce to sell into. Trading positions only.” That rally is likely done for now.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • As noted last week, EEM was extremely oversold and on a deep sell-signal. A bounce was likely which occurred. 
  • We previously stated that investors should use counter-trend rallies to sell into. Do that now.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss set at $30 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Like EEM, EFA was also sold previously. as we return our focus back to large cap value.
  • As noted last week: “EFA is very sold and on a deep sell signal. A reflexive rally is likely. Use those levels to sell into.”  Do so this week.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $46 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. We clearly aren’t at lows yet, so be patient. 
  • Oil continues to weaken and supplies are building as economic shutdowns are not good for the crude market. Bankruptcies are rising as well. 
  • Avoid for now.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • Last week we noted: “It seems that liquidation event may be passing. If Gold can climb back above the 200-dma we will look to add back our holdings.
  • It did.
  • We added to our position in IAU and continue to have a small holding in GDX, as the previous liquidation left a lot of value in the sector. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Added to position
    • Stop-loss set at $137.50.
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • We have reduced our overall bond exposure, because we are running a very reduced equity exposure currently. This aligns our “hedge” of fixed income relative to our equity book. 
  • We remain very cautious on our bond exposure currently, and will look to add to that exposure once the credit markets calm down a bit. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss is moved up to $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously we stated: “This past week, the dollar surged through that resistance and is now extremely overbought short-term. Looking for a reflexive rally in stocks next week that pulls the dollar back towards the breakout level of last week.”
  • That occurred this past week, and the dollar is now approaching its moving average support. 
  • The credit crisis, and rush to cash, sent the dollar surging to 7-deviations above the mean. As we noted previously, with the credit markets calming down we are starting to see previous relationships between asset classes return to normal. 
  • The dollar has reversed its sell signal, which suggests dollar strength may be with us for a while longer.

#WhatYouMissed On RIA This Week: 03-27-20

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Seth Levine: COVID-19 Is Not The Last War

These are truly remarkable times in the investment markets. The speed, intensity, and ubiquity of this selloff brings just one word to mind: violence. It would be remarkable if it wasn’t so destructive. Sadly, the reactions from our politicians and the public were predictable. The Federal Reserve (Fed) faithfully and forcefully responded. Despite its unprecedented actions, it seems like they’re “fighting the last war.”

Caveat Emptor

My intention here is to discuss some observations from the course of my career as an investor and try to relate them to the current market. I won’t provide charts or data; I’m just spit-balling here. My goal is twofold: 1) to better organize my own thoughts, and; 2) foster constructive discussions as we all try to navigate these turbulent markets. I realize that this approach puts this article squarely into the dime-a-dozen opinion piece category—so be it.

Please note that what you read is only as of the date published. I will be updating my views as the data warrants. Strong views, held loosely.

The Whole Kit and Caboodle

Investment markets are in freefall. U.S stock market declines tripped circuit breakers on multiple days. U.S. Treasuries are gyrating. Credit markets fell sharply. Equity volatility (characterized by the VIX) exploded. The dollar (i.e. the DXY index) is rocketing. We are in full-out crisis mode. No charts required here

With the Great Financial Crisis of 2008 (GFC) still fresh in the minds of many, the calls for a swift Fed action came loud and fast. Boy, the Fed listen. Obediently, it unleashed its full toolkit, dropping the Fed Funds rate to 0% (technically a 0.00% to 0.25% range), reducing interest on excess reserves, lowering pricing on U.S. dollar liquidity swaps arrangements, and kick-starting a $700 billion QE (Quantitative Easing) program. The initiatives are coming so fast and so furious that it’s hard to keep up! The Fed is even extending credit to primary dealers collateralized by “a broad range of investment grade debt securities, including commercial paper and municipal bonds, and a broad range of equity securities.” Really?!

Reflexively, the central bank threw the whole kit and caboodle at markets in hopes of arresting their declines. It’s providing dollar liquidity in every way it can imagine that’s within its power. However, I have an eerie sense that the Fed is (hopelessly) fighting the last war.

The Last War

There are countless explanations for the GFC. The way I see it is that 2008 was quite literally a financial crisis. The financial system (or plumbing) was Ground Zero. A dizzying array of housing-related structured securities (mortgage backed securities, collateralized debt obligations, asset-backed commercial paper, etc.) served as the foundation for the interconnected, global banking system, upon which massive amounts of leverage were employed.

As delinquencies rose, rating agencies downgraded these structured securities. This evaporated the stock of foundational housing collateral. Financial intuitions suddenly found themselves short on liquidity and facing insolvency. It was like playing a giant game of musical chairs whereby a third of the chairs were suddenly removed, unbeknownst to the participants. At once, a mad scramble for liquidity ensued. However, there simply was not enough collateral left to go around. Panic erupted. Institutions failed. The financial system literally collapsed.

This War

In my view, today’s landscape is quite different. The coronavirus’s (COVID-19) impact is a “real economy” issue. People are stuck at home; lots are not working. Economic activity has ground to a halt. It’s a demand shock to nearly every business model and individual’s finances. Few ever planned for such a draconian scenario.

Source: Variant Perception

Thus, this is not a game of musical chairs in the financial system. Rather, businesses will be forced to hold their breaths until life returns to normal. Cash will burn and balance sheets will stretch. The commercial environment is now one of survival, plain and simple (to say nothing of those individuals infected). Businesses of all sizes will be tested, and in particular small and mid-sized ones that lack access to liquidity lines. Not all will make it. To be sure, the financial system will suffer; however, as an effect, not a primary cause. This war is not the GFC.

Decentralized Solutions Needed

Given this dynamic, I’m skeptical that flooding the financial system with liquidity necessarily helps. In the GFC, a relatively small handful of banks (and finance companies) sat at the epicenter. Remember, finance is a levered industry characterized by timing mismatches of cash flows; it borrows “long” and earns “short.” This intermediation is its value proposition. Thus, extending liquidity can help bridge timing gaps to get them through short-term issues, thereby forestalling their deleveraging.

Today, however, the financial system is not the cause of the crisis. True, liquidity shortfalls are the source of stress. However, they are not limited to any one industry or a handful of identifiable actors. Rather, nearly every business may find itself short on cash. Availing currency to banks does not pay your favorite restaurant’s rent or cover its payroll. Quite frankly, I’m skeptical that any mandated measure can. A centralized solution simply cannot solve a decentralized problem.

Fishing With Dynamite

The speed and intensity at which investment markets are reacting is truly dizzying. In many ways they exceed those in the GFC. To be sure, a response to rapidly eroding fundamentals is appropriate. However, this one seems structural.

In my opinion, the wide-scale and indiscriminate carnage is the calling card of one thing: leverage unwinding. It wouldn’t surprise me to learn of a Long Term Capital Management type of event occurring, whereby some large(?), obscure(?), new (?), leveraged investment fund(s) is (are) being forced to liquidate lots of illiquid positions into thinly traded markets. This is purely a guess. Only time will tell.

Daniel Want, the Chief Investment Officer of Prerequisite Capital Management and one of my favorite investment market thinkers, put it best:

“Something is blowing up in the world, we just don’t quite know what. It’s like if you were to go fishing with dynamite. The explosion happens under the water, but it takes a little while for the fish to rise to the surface.”

Daniel Want, 2020 03 14 Prerequisite Update pt 4

What To Do

This logically raises the question of: What to do? From a policy perspective, I have little to offer as I am simply not an expert in the field (ask me in the comment section if you’re interested in my views). That said, the Fed’s response seems silly. Despite the severe investment market stresses, I don’t believe that we’re reliving the GFC. There’s no nail that requires a central banker’s hammer (as if there ever is one). If a financial crisis develops secondarily, then we should seriously question the value that such a fragile system offers.

Markets anticipate developments. I can envision a number of scenarios in which prices reverse course swiftly (such as a decline in the infection rate, a medical breakthrough, etc.). I can see others leading to a protracted economic contraction, as suggested by the intense market moves. Are serious underlying issues at play, even if secondarily? Or are fragile and idiosyncratic market structures to blame? These are the questions I’m trying to grapple with, weighing the unknowns, and allocating capital accordingly.

As an investor, seeing the field more clearly can be an advantage. Remember, it’s never different this time. Nor, however, is it ever the same. This makes for a difficult paradox to navigate. It’s in chaotic times when an investment framework is most valuable. Reflexively fighting the last war seems silly. Rather, let’s assess the current one as it rapidly develops and try to stay one step ahead of the herd.

Good luck out there and stay safe. Strong views, held loosely.

Robertson: When “Stuff” Gets Real

We all can be tempted to follow the path of least resistance and in a competitive world there are always incentives to get the most bang for the buck. Often this means taking shortcuts to gain some advantage. In a forgiving world, the penalties for such transgressions tend to be small but the rewards can be significant. When conditions are extremely forgiving, shortcuts can become so pervasive that failing to take them can be a competitive disadvantage.

In a less forgiving world, however, the deal gets completely flipped around and penalties can be significant for those who take shortcuts. This will be important for investors to keep in mind as rapidly weakening economic fundamentals and increasing stress in financial markets make for far less forgiving conditions. When things get real, competence and merit matter again – and this is a crucial lesson for investors.

Leaders of companies and organizations normally receive a lot of attention and rightly so; their decisions and behaviors affect a lot people. In the best of situations, leaders can distinguish themselves by creatively finding a “third” way to resolve difficult challenges. In other situations, however, leaders can reveal all-too-human weakness by taking shortcuts, cheating, and acting excessively in their own self-interest.

One of the situations in which these weaknesses can be spotted is in whistleblower incidents. For example, the Financial Times reported on the illuminating experiences of one HR director who in successive jobs was requested to break rules by a boss:

“Told by a senior manager at a FTSE 100 business to rig a pay review to favour his allies, she refused. ‘After that, he did everything to make my life absolute hell,’ she says. Then, at the first opportunity, he fired her, claiming that she was underperforming. Warned that the company would use its resources to fight her all the way if she took legal action, she accepted a pay-off and left’.” 

“Her next employer asked her to manipulate the numbers for a statutory reporting requirement to make its performance look better. She refused, signed another non-disclosure agreement and resigned.”

As unfortunate as these experiences were, they were not isolated events. The HR director described such incidents as happening “left, right and centre”. The fact that such cases are extremely hard to prosecute in any meaningful way helps explain why they are so pervasive. Columbia law professor John Coffee describes: “It’s extremely difficult to make a case against the senior executives because they don’t get Involved in operational issues. But they can put extreme pressure on the lower echelons to cut costs or hit targets.”

Company employees aren’t the only ones who risk facing hostility for standing for what they believe is right. Anjana Ahuja reports in the FT that scientists can fall victim to the same abuses. As she points out, “Some are targeted by industry or fringe groups; others, as the Scholars at Risk network points out, by their own governments. The academic freedom to tell inconvenient truths is being eroded even in supposed strong holds of democracy.”

Ahuja noted that the Canadian pharmacist and blogger, Olivier Bernard, was chastised for “interrogating the claim that vitamin C injections can treat cancer.”  As a consequence of his efforts, “He endured death threats” and “opponents demanded his sacking.”

In yet another example, Greece’s former chief statistician Andreas Georgiou “has been repeatedly convicted, and acquitted on appeal, of manipulating data.” The rationale for such a harsh response has nothing to do with merit: “statisticians worldwide insist that Mr Georgiou has been victimised for refusing to massage fiscal numbers.” It is simply a higher profile case of refusing to be complicit in wrongdoing.

The lessons from these anecdotes also play out across the broader population. The FT reports:

“According to the [CIPD human resources survey], 28 per cent of HR personnel perceive a conflict between their professional judgment and what their organisation expects of them; the same proportion feel ‘it’s often necessary to compromise ethical values to succeed in their organisation’.”

Employees are all-too familiar with the reality that such compromises may be required simply to survive in an organization and to continue getting health insurance: “Most HR directors know colleagues who have been fired for standing their ground.”

Yet another arena in which expertise and values get compromised is politics. While political rhetoric nearly always involves exaggerations and simplifications, the cost of such manipulations becomes apparent when important issues of public policy are at stake. Bill Blain highlighted this point on Zerohedge:

“It’s as clear as a bell that Trump had no plan to address the Coronavirus before he was finally forced to say something Monday [March 9, 2020]. Until then it was a ‘fake-news’ distraction. He made a political gamble: that the virus would recede before it became a crisis, making him look smart and a market genius for calling it.”

Blain’s assessment illustrates a point that is common to all these examples: Each involves a calculation as to whether it is worth it or not to do the right thing based on merit or to take a shortcut. Each involves an intentional effort to reject/deny/attack positions that are real and valid. Evidence, expertise and professional judgment are foresworn and replaced by narrative, heuristics, and misinformation. While such tactics undermine the long-term success of organizations and societies, they can yield tremendous personal advantages. The good of the whole is sacrificed for the good of the few.

Another point is that these efforts are absolutely pervasive. They can be found across companies, academia, politics, and beyond. They can also be found in countries all across the world. In an important sense, we have been living in an environment of pervasive tolerance of such decisions.

A third point, and the most important one, is that now it is starting to matter. It appears that the real human impact of the coronavirus has shaken many people out of complacency. The types of narratives and misinformation regarding the market that had been accepted suddenly seem woefully out of place when dealing with a real threat to public health. As Janan Ganesh reports in the FT, “This year provides a far less hospitable atmosphere for such hokum than 2016”. He concludes, “Overnight, competence matters.”

True enough, but Ganesh could have gone further. Suddenly, additional traits such as courage, good judgment, and ethical behavior also matter. Overnight, carelessness and complacency have become much more costly.

All these things will become extremely important for investors as well. For example, information sources are crucial for early identification of potential problems and for proper diagnosis. Most mainstream news outlets were slow to report on the threat of the coronavirus even though it was clearly a problem in China in January. By far the best sources on this issue have been a handful of independent researchers and bloggers who have shared their insights publicly.

One form of news that will be interesting to monitor is upcoming earnings reports and conference calls. These events can provide an opportunity to learn about companies as well as to learn about management’s philosophy and decision-making.

Which companies are busily responding to the crisis by scrutinizing their supply chains and developing HR policies to ensure the safety of their employees? Which companies already had these measures in place and are simply executing on them now? Which companies are withdrawing guidance while they frantically try to figure out what’s going on? These responses will reveal a great deal about management teams and business models.

In addition, a much higher premium on merit will also place much higher premia on security analysis, valuation, and risk management. Alluring stories about stocks and narratives about the market can be fun to follow and even compelling. At the end of the day, however, what really matters is streams of cash flows.

Finally, a higher premium on merit is likely to significantly re-order the ranks of advisors and money managers. Those ridiculed as “overly cautious” and “perma bears” will emerge as valuable protectors of capital. Conversely, those arguing that there is no alternative (TINA) to equities will be spending a lot of time trying to pacify (and retain) angry clients who suffer big losses. Further, things like education, training, and experience will re-emerge as necessary credentials for investment professionals.

As the coronavirus continues to spread across the US, things are starting to get real for many investors. Suddenly, the world is appearing less forgiving as it is becoming clear that economic growth will slow substantially for some period of time. This especially exposes the many companies who have binged on debt while rates have been so low. Further, it is becoming increasingly obvious that there is very little the Fed can do with monetary policy to stimulate demand.

While the coronavirus will eventually dissipate, the increasing premium on merit is likely to hang around. The bad news is that in many cases it will be too late to avoid the harm caused by leaders and managers and advisors who exploited favorable conditions for personal advantage. The good news is that there are very competent people out there to make the best of things going forward.

Why QE Is Not Working

The process by which money is created is so simple that the mind is repelled.” – JK Galbraith

By formally announcing quantitative easing (QE) infinity on March 23, 2020, the Federal Reserve (Fed) is using its entire arsenal of monetary stimulus. Unlimited purchases of Treasury securities and mortgage-backed securities for an indefinite period is far more dramatic than anything they did in 2008. The Fed also revived other financial crisis programs like the Term Asset-Backed Securities Loan Facility (TALF) and created a new special purpose vehicle (SPV), allowing them to buy investment-grade corporate bonds and related ETF’s. The purpose of these unprecedented actions is to unfreeze the credit markets, stem financial market losses, and provide some ballast to the economy.

Most investors seem unable to grasp why the Fed’s actions have been, thus far, ineffective. In this article, we explain why today is different from the past. The Fed’s current predicament is unique as they have never been totally up against the wall of zero-bound interest rates heading into a crisis. Their remaining tools become more controversial and more limited with the Fed Funds rate at zero. Our objective is to assess when the monetary medicine might begin to work and share our thoughts about what is currently impeding it.

All Money is Lent in Existence.

That sentence may be the most crucial concept to understand if you are to make sense of the Fed’s actions and assess their effectiveness.

Under the traditional fractional reserve banking system run by the U.S. and most other countries, money is “created” via loans. Here is a simple example:

  • John deposits a thousand dollars into his bank
  • The bank is allowed to lend 90% of their deposits (keeping 10% in “reserves”)
  • Anne borrows $900 from the same bank and buys a widget from Tommy
  • Tommy then deposits $900 into his checking account at the same bank
  • The bank then lends to someone who needs $810 and they spend that money, etc…

After Tommy’s deposit, there is still only $1,000 of reserves in the banking system, but the two depositors believe they have a total of $1,900 in their bank accounts.  The bank’s accountants would confirm that. To make the bank’s accounting balance, Anne owes the bank $900. The money supply, in this case, is $1,900 despite the amount of real money only being $1,000.

That process continually feeds off the original $1,000 deposit with more loans and more deposits. Taken to its logical conclusion, it eventually creates $9,000 in “new” money through the process from the original $1,000 deposit.

To summarize, we have $1,000 in deposited funds, $10,000 in various bank accounts and $9,000 in new debt. While it may seem “repulsive” and risky, this system is the standard operating procedure for banks and a very effective and powerful tool for generating profits and supporting economic growth. However, if everyone wanted to take their money out at the same time, the bank would not have it to give. They only have the original $1,000 of reserves.

How The Fed Operates

Manipulating the money supply through QE and Fed Funds targeting are the primary tools the Fed uses to conduct monetary policy. As an aside, QE is arguably a controversial blend of monetary and fiscal policy.

When the Fed provides banks with reserves, their intent is to increase the amount of debt and therefore the money supply. As such, more money should result in lower interest rates. Conversely, when they take away reserves, the money supply should decline and interest rates rise. It is important to understand, the Fed does not set the Fed Funds rate by decree, but rather by the aforementioned monetary actions to incentivize banks to increase or reduce the money supply.

The following graph compares the amount of domestic debt outstanding versus the monetary base.

Data Courtesy: St. Louis Federal Reserve

Why is QE not working?

So with an understanding of how money is created through fractional reserve banking and the role the Fed plays in manipulating the money supply, let’s explore why QE helped boost asset prices in the past but is not yet potent this time around.

In our simple banking example, if Anne defaults on her loan, the money supply would decline from $1,900 to $1,000. With a reduced money supply, interest rates would rise as the supply of money is more limited today than yesterday. In this isolated example, the Fed might purchase bonds and, in doing so, conjure reserves onto bank balance sheets through the magic of the digital printing press. Typically the banks would then create money and offset the amount of Anne’s default.  The problem the Fed has today is that Anne is defaulting on some of her debt and, at the same time, John and Tommy need and want to withdraw some of their money.

The money supply is declining due to defaults and falling asset prices, and at the same time, there is a greater demand for cash. This is not just a domestic issue, but a global one, as the U.S. dollar is the world’s reserve currency.

For the Fed to effectively stimulate financial markets and the economy, they first have to replace the money which has been destroyed due to defaults and lower asset prices. Think of this as a hole the Fed is trying to fill. Until the hole is filled, the new money will not be effective in stimulating the broad economy, but instead will only help limit the erosion of the financial system and yes, it is a stealth form of bailout. Again, from our example, if the banks created new money, it would only replace Anne’s default and would not be stimulative.

During the latter part of QE 1, when mortgage defaults slowed, and for all of the QE 2 and QE 3 periods, the Fed was not “filling a hole.” You can think of their actions as piling dirt on top of a filled hole.

These monetary operations enabled banks to create more money, of which a good amount went mainly towards speculative means and resulted in inflated financial asset prices. It certainly could have been lent toward productive endeavors, but banks have been conservative and much more heavily regulated since the crisis and prefer the liquid collateral supplied with market-oriented loans.

QE 4 (Treasury bills) and the new repo facilities introduced in the fall of 2019 also stimulated speculative investing as the Fed once again piled up dirt on top of a filled hold.  The situation changed drastically on February 19, 2020, as the virus started impacting perspectives around supply chains, economic growth, and unemployment in the global economy. Now QE 4, Fed-sponsored Repo, QE infinity, and a smorgasbord of other Fed programs are required measures to fill the hole.

However, there is one critical caveat to the situation.

As stated earlier, the Fed conducts policy by incentivizing the banking system to alter the supply of money. If the banks are concerned with their financial situation or that of others, they will be reluctant to lend and therefore impede the Fed’s efforts. This is clearly occurring, making the hole progressively more challenging to fill. The same thing happened in 2008 as banks became increasingly suspect in terms of potential losses due to their exorbitant leverage. That problem was solved by changing the rules around how banks were required to report mark-to-market losses by the Federal Accounting Standards Board (FASB). Despite the multitude of monetary and fiscal policy stimulus failures over the previous 18 months, that simple re-writing of an accounting rule caused the market to turn on a dime in March 2009. The hole was suddenly over-filled by what amounted to an accounting gimmick.

Summary

Are Fed actions making headway on filling the hole, or is the hole growing faster than the Fed can shovel as a result of a tsunami of liquidity problems? A declining dollar and stability in the short-term credit markets are essential gauges to assess the Fed’s progress.

The Fed will eventually fill the hole, and if the past is repeated, they will heap a lot of extra dirt on top of the hole and leave it there for a long time. The problem with that excess dirt is the consequences of excessive monetary policy. Those same excesses created after the financial crisis led to an unstable financial situation with which we are now dealing.

While we must stay heavily focused on the here and now, we must also consider the future consequences of their actions. We will undoubtedly share more on this in upcoming articles.

Technically Speaking: The One Thing – Playing The “Bear Market” Rally.

Let’s flashback to a time not so long ago, May 2019.

“It was interesting to see Federal Reserve Chairman Jerome Powell, during an address to the Fernandina Beach banking conference, channel Ben Bernanke during his speech on corporate ‘sub-prime’ debt (aka leveraged loans.)

‘Many commentators have observed with a sense of déjà vu the buildup of risky business debt over the past few years. The acronyms have changed a bit—’CLOs’ (collateralized loan obligations) instead of ‘CDOs’ (collateralized debt obligations), for example—but once again, we see a category of debt that is growing faster than the income of the borrowers even as lenders loosen underwriting standards. Likewise, much of the borrowing is financed opaquely, outside the banking system. Many are asking whether these developments pose a new threat to financial stability.

In public discussion of this issue, views seem to range from ‘This is a rerun of the subprime mortgage crisis’ to ‘Nothing to worry about here.’ At the moment, the truth is likely somewhere in the middle. To preview my conclusions, as of now, business debt does not present the kind of elevated risks to the stability of the financial system that would lead to broad harm to households and businesses should conditions deteriorate.’ – Jerome Powell, May 2019

In other words, corporate debt is ‘contained.’”

As we concluded at that time:

“Unfortunately, while Jerome Powell may be currently channeling Ben Bernanke to keep markets stabilized momentarily, the real risk is some unforeseen exogenous event, such as Deutsche Bank going bankrupt, that triggers a global credit contagion.”

While the “exogenous event” was a “virus,” it led to a “credit event” which has crippled markets globally, leading the Federal Reserve to throw everything possible at trying to stem the crisis. With the Fed’s balance sheet set to expand towards $10 Trillion, the Federal deficit to balloon to $4 trillion, it is “all hands on deck” to stop the next “Great Depression” before it takes hold.

However, this is what we have been warning about:

“Pay attention to the market. There action this year is very reminiscent of previous market topping processes. Tops are hard to identify during the process as ‘change happens slowly.’The mainstream media, economists, and Wall Street will dismiss pickup in volatility as simply a corrective process. But when the topping process completes, it will seem as if the change occurred ‘all at once.’

The same media which told you ‘not to worry,’ will now tell you ‘no one could have seen it coming.’”

The only question which remains to be answered is whether the MORE debt and monetary stimulus can fix a debt and monetary stimulus bubble?

In other words, can the Fed inflate the fourth bubble to offset the implosion of the third?

Think about the insanity of that statement, but that is what the markets, and the economy, are banking on.

We do expect that with the flood of fiscal and monetary stimulus, a “bear market rally” becomes a real probability, at least in the short-term.

How big of a rally? What should you do? These are the important points in today’s missive.

The One Thing

The “ONE Thing” you need to do TODAY, right now, is “accept” where you are.

What you had, what was lost, and the mistakes you made, CAN NOT be corrected. They are in the past. However, by hanging on to those “emotions,” we lock ourselves out of the ability to take actions that will begin the corrective process.

Let me dispel some myths:

  • “Hope” is not an investment strategy. Hanging on to some stock you lost money in waiting for it to “get back to even,” costs you opportunity.
  • You aren’t a loser. Whatever happened previously is over, and it doesn’t make you a “loser.” However, staying in losing positions or strategies will continue to cost you. 
  • Selling does NOT lock in losses. The losses have already occurred. Selling, however, gives you the ability to take advantage of “opportunity” to begin the recovery process.  

Okay, now that we have the right “mindset,” let’s take an educated guess on what happens next.

The current bear market is exhibiting many of the same “technical traits” as seen in both the “Dot.com” and “Financial Crisis.” 

In each previous case, the market experienced a parabolic advance to the initial peak. A correction ensued, which was dismissed by the mainstream media, and investors alike, as just a “pause that refreshes.” They were seemingly proved correct as the markets rebounded shortly thereafter and even set all-time highs. Investors, complacent in the belief that “this time was different” (1999 – a new paradigm, 2007 – Goldilocks economy), continued to hold out hopes the bull market was set to continue.

That was a mistake.

Also, in each period, once the monthly “sell signal” was triggered from a high level, the ensuing correction process took months to complete. This not only reset the market, but valuations as well. In both previous periods, reflexive rallies occurred, which eventually failed. While the 2008 plunge following the Lehman crisis was most similar to the current environment, there was a brief rally following the passage of TARP, which sucked investors in before the additional 22% decline in the first two months of 2009.

Most importantly, the market got very oversold early in both previous bear markets, and stayed that way for the entirety of the bear market. Currently, the market has only just now gotten to a similar oversold condition.

What all the indicators currently suggest is that while the current correction has been swift and brutal, bear markets are not resolved in a single month. 

This is going to take some time.

Bear Market Rally

Over the past couple of week’s, we have been talking about a potential reflexive bounce.

From a purely technical basis, the extreme downside extension, and potential selling exhaustion, has set the markets up for a fairly strong reflexive bounce. This is where fun with math comes in.

As shown in the chart below, after a 35% decline in the markets from the previous highs, a rally to the 38.2% Fibonacci retracement would encompass a 20% advance. Such an advance will “lure” investors back into the market, thinking the “bear market” is over.

This is what “bear market rallies” do, and generally inflict the most pain possible on unwitting investors. The reasons for this are many, but primarily investors who were trapped in the recent decline will use the rally to “flee” the markets permanently.

Chart Updated Through Monday

More importantly, as noted above, “bear markets” are not resolved in a single month. Currently, there are too many investors trying to figure out where “the bottom” is, so they can “buy” it.

Bear markets do not end in optimism; they end in despair. 

Looking back at 2008, numerous indicators suggest the “bear market” has only just begun. While this does NOT rule out a fairly strong reflexive rally, it suggests that any rally will ultimately fail as the bear market completes its cycle. 

This can be seen more clearly in the monthly chart below, which looks at both previous bull and bear markets using a Fibonacci retracement. As shown, from the peak of both previous bull market “bubbles,” the market reversed 61.8% of the advance during the “Dot.com” crash, and more than 100% of the advance during the “Financial Crisis.”  

Given the current bull market cycle was longer, more levered, and more extended than both previous bull markets, a 38.2% decline is unlikely to fulfill the requirements of this reversion. Our ultimate target of 1600-1800 on the S&P 500 remains confirmed by the quarterly chart below.

The current correction process has only just triggered a quarterly sell signal combined with a break from an extreme deviation of the long-term bull-trend back to the 1930’s. Both previous bull market peaks coincide with the long-term bull trend at about 1600 on the S&P currently. Given all the stimulus being infused into the markets currently, we broaden our bear market bottom target to 1600-1800, as noted.

The technical signals, which do indeed lag short-term turns in the market, all confirm the “bear market” is only just awakening. While bullish reflexive rallies are very likely, and should be used to your advantage, this is a “traders” market for the time being.

In other words, the new mantra for the market, for the time being, will be to “Sell Rallies” rather than “Buy The Dip.”

As I have noted many times previously:

“This ‘time is not different,’ and there will be few investors that truly have the fortitude to ‘ride out’ the next decline.

Everyone eventually sells. The only difference is ‘selling when you want to,’ versus ‘selling when you have to.’”

Yes, the market will rally, and likely substantially so. Just don’t forget to take action, make changes, and get on the right side of the trade, before the “bear returns.” 

Let me conclude by reminding you of Bob Farrell’s Rule #8 from our recent newsletter:

Bear markets have three stages – sharp down, reflexive rebound and a drawn-out fundamental downtrend

  1. Bear markets often START with a sharp and swift decline.
  2. After this decline, there is an oversold bounce that retraces a portion of that decline.
  3. The longer-term decline then continues, at a slower and more grinding pace, as the fundamentals deteriorate.

Dow Theory also suggests that bear markets consist of three down legs with reflexive rebounds in between.

The chart above shows the stages of the last two primary cyclical bear markets versus today (the 2020 scale has been adjusted to match.)

As would be expected, the “Phase 1” selloff has been brutal.

That selloff sets up a “reflexive bounce.”  For many individuals, they will feel like” they are “safe.” This is how “bear market rallies” lure investors back in just before they are mauled again in “Phase 3.”

Just like in 2000, and 2008, the media/Wall Street will be telling you to just “hold on.” Unfortunately, by the time “Phase 3” was finished, there was no one wanting to “buy” anything.

Major Market Buy/Sell Review: 03-23-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index

  • Last week: “With the market now 3-standard deviations oversold, a bounce is likely next week as it is expected the Fed will cut rates and restart a substantial QE program. A retracement to the 31.8%, 50%, 62.8% levels are possible and each level should be used to reduce equity risk and hedge.”
  • Well, no bounce this week, and markets are even more extended and deviated the previously.
  • Again, we suspect a bounce is likely from such extreme moves, but a retest of lows likely before this over. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: No position
    • Stop-loss set at $250
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • DIA is on a very deep “Sell signal” so rallies will most likely fail in the weeks ahead. All stops have been triggered on trading positions.
  • A bounce is still likely, stops reset at recent lows.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold current positions
    • This Week: No positions.
    • Stop-loss set at $190
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • QQQ tested and violated its bullish trend line, is now on a deep “sell signal.” This suggests that rallies will likely fail for the time being. 
  • The index is very oversold, so a reflexive rally back to $190-195 is possible. which coincides with the 200-dma, 
  • Trading positions only with stops at recent lows.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: No positions
    • Stop-loss set at $170
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

  • As noted in our portfolio commentary, we sold our small-cap positions 5-weeks ago.
  • Small-caps are extremely oversold, and on a very deep “sell signal.”  
  • This particular group of stocks are the most susceptible to an economic slowdown from the virus. Use any reflexive rally to step-aside for the time being.
  • You can deploy a trading position in small-caps for a bounce, but they are underperforming large cap, so I am not sure its worth the risk.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $42 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. 
  • MDY is oversold, and is on a very deep a “sell signal.”
  • MDY has broken all critical supports, and like SLY, there is no reason to “buy” the sector currently. However, MDY is oversold enough for a counter-trend bounce to sell into. Trading positions only. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • Last week: “EEM has completed a “head and shoulders” topping pattern and violated support at the 61.8% retracement level. EEM will eventually test previous lows particularly with a sell signal now registered.” 
  • EEM is very now extremely oversold and on a deep sell-signal.
  • Use counter-trend rallies to sell into. Trading positions only. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss set at $30 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Like EEM, EFA was also sold previously. as we return our focus back to large cap value.
  • EFA is very sold and on a deep sell signal. A reflexive rally is likely back to $58 to 63 which doesn’t even get you back to the 200-dma. Use those levels to sell into.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $46 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • As noted last week: “We just didn’t realize how bad it would get until Saudi Arabia decided to launch a price war, thankfully, we had recommended selling all energy holdings on the Friday before that announcement.”
  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. We clearly aren’t at lows yet, so be patient. 
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • Last week we noted: “Gold had been holding up well as a hedge until this past week where two hedge funds (we suspect Citadel and Millennium) blew up creating margin liquidation across all asset classes included gold, bonds, and even bitcoin.” 
  • It seems that liquidation event may be passing. If Gold can climb back above the 200-dma we will look to add back our holdings.
  • We also added a small position to GDX this past week, as the previous liquidation left a lot of value in the sector. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Look to add above $140.
    • Stop-loss set at $137.50.
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • As noted last week: “We previously sold our small position in TLT, and this past week reduced our IEF position by 50% and increased BIL accordingly to shorten duration. The rest of our bond holdings have done the work of supporting the portfolio.” 
  • The margin liquidation event is now bringing bonds back to a “buyable” range and bonds did hold support at the previous market highs. 
  • We remain very cautious on our bond exposure currently, and will look to add to that exposure once the credit markets calm down a bit. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Sold bond mutual funds, added position of STIP.
    • Stop-loss is moved up to $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Three weeks ago we stated: “This past week, the dollar surged through that resistance and is now extremely overbought short-term. Looking for a reflexive rally in stocks next week that pulls the dollar back towards the breakout level of last week.
  • The credit crisis, and rush to cash, has sent the dollar surging to 7-deviations above the mean. As the credit markets calm down we should see relationship between asset classes return to normal. 
  • The dollar has reversed its sell signal, which suggests dollar strength may be with us for a while longer.

#WhatYouMissed On RIA This Week: 03-20-20

We know you get busy and don’t check our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything you might have missed.

The Week In Blogs

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Our Latest Newsletter

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What You Missed At RIA Pro

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free)

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The Best Of “The Lance Roberts Show

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Video Of The Week A

Michael Lebowitz, CFA and I dig into the financial markets, the Fed’s bailouts, and what potentially happens next and what we are looking for. (Also, our take on corporate bailouts, and why, I can’t believe I am saying this, we mostly agree with Elizabeth Warren.)

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Our Best Tweets Of The Week

See you next week!

Shedlock: Fed Trying To Save The Bond Market As Unemployment Explodes

Bond market volatility remains a sight to behold, even at the low end of the curve.

Bond Market Dislocations Remain

The yield on a 3-month T-Bill fell to 1.3 basis points then surged to 16.8 basis points in a matter of hours. The yield then quickly crashed to 3 basis points and now sits at 5.1 basis points.

The Fed is struggling even with the low end of the Treasury curve.

$IRX 3-Month Yield

Stockcharts shows the 3-month yield ($IRX) dipping below zero but Investing.Com does not show the yield went below zero.

Regardless, these swings are not normal.

Cash Crunch

Bloomberg reports All the Signs a Cash Crunch Is Gripping Markets and the Economy

In a crisis, it is said, all correlations go to one. Threats get so overwhelming that everything reacts in unison. And the common thread running through all facets of financial markets and the real economy right now is simple: a global cash crunch of epic proportions.

Investors piled $137 billion into cash-like assets in the five days ending March 11, according to a Bank of America report citing EPFR Global data. Its monthly fund manager survey showed the fourth-largest monthly jump in allocations to cash ever, from 4% to 5.1%.

“Cash has become the king as the short-term government funds have had massive deposits, with ~$13 billion inflows last week (a 10-standard deviation move),” adds Maneesh Dehspande, head of equity derivatives strategy at Barclays.

4th Largest Jump in History

It’s quite telling that a jump of a mere 1.1 percentage point to 5.1% cash is the 4th largest cash jump in history.

Margin and Short Covering

“In aggregate, the market saw a large outflow, with $9 billion of long liquidation and $6 billion of short covering,” said Michael Haigh, global head of commodity research at Societe Generale. “This general and non-directional closure of money manager positions could be explained by a need for cash to pay margin calls on other derivatives contracts.

The comment is somewhat inaccurate. Sideline cash did not change “in aggregate” although cash balances t various fund managers did.

This is what happens when leveraged longs get a trillion dollar derivatives margin call or whatever the heck it was.

Need a Better Hedge

With the S&P 500 down more than 12% in the five sessions ending March 17, the Japanese yen is weaker against the greenback, the 10-year Treasury future is down, and gold is too.

That’s another sign dollars are top of mind, and investors are selling not only what they want to, but also what they have to.

Dash to Cash

It’s one thing to see exchange-traded products stuffed full of relatively illiquid corporate bonds trade below the purported sum of the value of their holdings. It’s quite another to see such a massive discount develop in a more plain-vanilla product like the Vanguard Total Bond Market ETF (BND) as investors ditched the product to raise cash despite not quite getting their money’s worth.

The fund closed Tuesday at a discount of nearly 2% to its net asset value, which blew out to above 6% last week amid accelerating, record outflows. That exceeded its prior record discount from 2008.

It is impossible for everyone to go to cash at the same time.

Someone must hold every stock, every bond and every dollar.

Fed Opens More Dollar Swap Lines

Moments ago Reuters reported Fed Opens Dollar Swap Lines for Nine Additional Foreign Central Banks.

The Fed said the swaps, in which the Fed accepts other currencies in exchange for dollars, will for at least the next six months allow the central banks of Australia, Brazil, South Korea, Mexico, Singapore, Sweden, Denmark, Norway and New Zealand to tap up to a combined total of $450 billion, money to ensure the world’s dollar-dependent financial system continues to function.

The new swap lines “like those already established between the Federal Reserve and other central banks, are designed to help lessen strains in global U.S. dollar funding markets, thereby mitigating the effects of these strains on the supply of credit to households and businesses, both domestically and abroad,” the Fed said in a statement.

The central banks of South Korea, Singapore, Mexico and Sweden all said in separate statements they intended to use them.

Fed Does Another Emergency Repo and Relaunches Commercial Paper Facility

Yesterday I commented Fed Does Another Emergency Repo and Relaunches Commercial Paper Facility

Very Deflationary Outcome Has Begun: Blame the Fed

The Fed is struggling mightily to alleviate the mess it is largely responsible for.

I previously commented a Very Deflationary Outcome Has Begun: Blame the Fed

The Fed blew three economic bubbles in succession. A deflationary bust has started. They blew bubbles trying to prevent “deflation” defined as falling consumer prices.


BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

For a discussion of the study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

Blowing bubbles in absurd attempts to arrest “price deflation” is crazy. The bigger the bubbles the bigger the resultant “asset bubble deflation”. Falling consumer prices do not have severe negative repercussions. Asset bubble deflations are another matter.

Assessing the Blame

Central banks are not responsible for the coronavirus. But they are responsible for blowing economic bubbles prone to crash.

The equities bubbles before the coronavirus hit were the largest on record.

Dollar Irony

The irony in this madness is the US will be printing the most currency and have the biggest budget deficits as a result. Yet central banks can’t seem to get enough dollars. In that aspect, the dollar ought to be sinking.

But given the US 10-year Treasury yield at 1.126% is among the highest in the world, why not exchange everything one can for dollars earning positive yield.

This is all such circular madness, it’s hard to say when or how it ends.

Unemployment Set To Explode

A SurveyUSA poll reveals 9% of the US is out of a job due to the coronavirus.

Please consider the Results of SurveyUSA Coronavirus News Poll.

Key Findings

  1. 9% of Working Americans (14 Million) So Far Have Been Laid Off As Result of Coronavirus; 1 in 4 Workers Have Had Their Hours Reduced;
  2. 2% Have Been Fired; 20% Have Postponed a Business Trip; Shock Waves Just Now Beginning to Ripple Through Once-Roaring US Economy:
  3. Early markers on the road from recession to depression as the Coronavirus threatens to stop the world from spinning on its axis show that 1 in 4 working Americans have had their hours reduced as a result of COVID-19, according to SurveyUSA’s latest time-series tracking poll conducted 03/18/20 and 03/19/20.
  4. Approximately 160 million Americans were employed in the robust Trump economy 2 months ago. If 26% have had their hours reduced, that translates to 41 million Americans who this week will take home less money than last, twice as many as SurveyUSA found in an identical poll 1 week ago. Time-series tracking graphs available here.
  5. 9% of working Americans, or 14 million of your friends and neighbors, will take home no paycheck this week, because they were laid off, up from 1% in an identical SurveyUSA poll 1 week ago. Time-series tracking graphs available here.
  6. Unlike those laid-off workers who have some hope of being recalled once the worst of the virus has past, 2% of Americans say they have lost their jobs altogether as a result of the virus, up from 1% last week.
  7. Of working Americans, 26% are working from home either some days or every day, up from 17% last week. A majority, 56%, no longer go to their place of employment, which means they are not spending money on gasoline or transit tokens.

About: SurveyUSA interviewed 1,000 USA adults nationwide 03/18/20 through 03/19/20. Of the adults, approximately 60% were, before the virus, employed full-time or part-time outside of the home and were asked the layoff and reduced-hours questions. Approximately half of the interviews for this survey were completed before the Big 3 Detroit automakers announced they were shutting down their Michigan assembly lines. For most Americans, events continue to unfold faster than a human mind is able to process the consequences.

Grim Survey of Reduced Hours

Current Unemployment Stats

Data from latest BLS Jobs Report.

If we assume the SurveyUSA numbers are accurate and will not get worse, we can arrive at some U3 and U6 unemployment estimates.

Baseline Unemployment Estimate (U3)

  • Unemployed: 5.787 million + 14 million = 19.787 million unemployed
  • Civilian Labor Force: 164.546 million (unchanged)
  • Unemployment Rate: 19.787 / 164.546 = 12.0%

That puts my off the top of the head 15.0% estimate a few days in the ballpark.

Underemployment Estimate (U6)

  • Employed: 158.759 million.
  • 26% have hours reduced = 41.277 million
  • Part Time for Economic Reasons: 4.318 million + 41.277 million = 45.595 million underemployed
  • 45.595 million underemployed + 19.787 million unemployed = 65.382 million
  • Civilian Labor Force: 164.546 million (unchanged)
  • U6 Unemployment Rate: 65.382 / 164.546 = 39.7%

Whoa Nellie

Wow, that’s not a recession. A depression is the only word.

Note that economists coined a new word “recession” after the 1929 crash and stopped using the word depression assuming it would never happen again.

Prior to 1929 every economic slowdown was called a depression. So if you give credit to the Fed for halting depressions, they haven’t. Ity’s just a matter of semantics.

Depression is a very fitting word if those numbers are even close to what’s going to happen.

Meanwhile, It’s no wonder the Fed Still Struggles to Get a Grip on the Bond Market and there is a struggled “Dash to Cash”.

Very Deflationary Outcome Has Begun: Blame the Fed

The Fed is struggling mightily to alleviate the mess it is largely responsible for.

I previously commented a Very Deflationary Outcome Has Begun: Blame the Fed

The Fed blew three economic bubbles in succession. A deflationary bust has started. They blew bubbles trying to prevent “deflation” defined as falling consumer prices.

BIS Deflation Study

The BIS did a historical study and found routine price deflation was not any problem at all.

“Deflation may actually boost output. Lower prices increase real incomes and wealth. And they may also make export goods more competitive,” stated the BIS study.

For a discussion of the study, please see Historical Perspective on CPI Deflations: How Damaging are They?

Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

Blowing bubbles in absurd attempts to arrest “price deflation” is crazy. The bigger the bubbles the bigger the resultant “asset bubble deflation”. Falling consumer prices do not have severe negative repercussions. Asset bubble deflations are another matter.

Assessing the Blame

Central banks are not responsible for the coronavirus. But they are responsible for blowing economic bubbles prone to crash.

The equities bubbles before the coronavirus hit were the largest on record.

Dollar Irony

The irony in this madness is the US will be printing the most currency and have the biggest budget deficits as a result. Yet central banks can’t seem to get enough dollars. In that aspect, the dollar ought to be sinking.

But given the US 10-year Treasury yield at 1.126% is among the highest in the world, why not exchange everything one can for dollars earning positive yield.

This is all such circular madness, it’s hard to say when or how it ends.

Margin Call: You Were Warned Of The Risk

I have been slammed with emails over the last couple of days asking the following questions:

“What just happened to my bonds?”

“What happened to my gold position, shouldn’t it be going up?”

“Why are all my stocks being flushed at the same time?”

As noted by Zerohedge:

“Stocks down, Bonds down, credit down, gold down, oil down, copper down, crypto down, global systemically important banks down, and liquidity down

Today was the worst day for a combined equity/bond portfolio… ever…”

This Is What A “Margin Call,” Looks Like.

In December 2018, we warned of the risk. At that time, the market was dropping sharply, and Mark Hulbert wrote an article dismissing the risk of margin debt. To wit:

“Plunging margin debt may not doom the bull market after all, reports to the contrary notwithstanding.

According to research conducted in the 1970s by Norman Fosback, then the president of the Institute for Econometric Research, there is an 85% probability that a bull market is in progress when margin debt is above its 12-month moving average, in contrast to just a 41% probability when it’s below.

Why, then, do I suggest not becoming overly pessimistic? For several reasons:

1) The margin debt indicator issues many false signals

2) There is insufficient data

3) Margin debt is a strong coincident indicator.”

I disagreed with Mark on several points at the time. But fortunately the Federal Reserve’s reversal on monetary policy kept the stock market from sinking to levels that would trigger “margin calls.”

As I noted then, margin debt is not a technical indicator that can be used to trade markets. Margin debt is the “gasoline,” which drives markets higher as the leverage provides for the additional purchasing power of assets. However, that “leverage” also works in reverse as it provides the accelerant for larger declines as lenders “force” the sale of assets to cover credit lines without regard to the borrower’s position.

That last sentence is the most important and is what is currently happening in the market.

The issue with margin debt, in terms of the biggest risk, is the unwinding of leverage is NOT at the investor’s discretion.

It is at the discretion of the broker-dealers that extended that leverage in the first place. (In other words, if you don’t sell to cover, the broker-dealer will do it for you.) 

When lenders fear they may not be able to recoup their credit-lines, they force the borrower to either put in more cash or sell assets to cover the debt. The problem is that “margin calls” generally happen all at once as falling asset prices impact all lenders simultaneously.

Margin debt is NOT an issue – until it is.

When an “event” occurs that causes lenders to “panic” and call in margin loans, things progress very quickly as the “math” becomes a problem. Here is a simple example.

“If you buy $100,000 of stock on margin, you only need to pay $50,000. Seems like a great deal, especially if the stock price goes up. But what if your stock drops to $60,000? Suddenly, you’ve lost $40,000, leaving you with only $10,000 in your margin account. The rules state that you need to have at least 25 percent of the $60,000 stock value in your account, which is $15,000. So not only do you lose $40,000, but you have to deposit an additional $5,000 in your margin account to stay in business.

However, when margin calls occur, and equity is sold to meet the call, the equity in the portfolio is reduced further. Any subsequent price decline requires additional coverage leading to a “death spiral” until the margin line is covered.

Example:

  • $100,000 portfolio declines to $60,000. Requiring a margin call of $5000.
  • You have to deposit $5000, or sell to cover. 
  • However, if you don’t have the cash, then a problem arises. The sell of equity reduces the collateral requirement requiring a larger transaction: $5000/.25% requirement = $20,000
  • With the margin requirement met, a balance of $40,000 remains in the account with a $10,000 margin requirement. 
  • The next morning, the market declines again, triggering another margin call. 
  • Wash, rinse, repeat until broke.

This is why you should NEVER invest on margin unless you always have the cash to cover.

Just 20% 

As I discussed previously, the level we suspected would trigger a margin event was roughly a 20% decline from the peak.

“If such a decline triggers a 20% fall from the peak, which is around 2340 currently, broker-dealers are likely going to start tightening up margin requirements and requiring coverage of outstanding margin lines.

This is just a guess…it could be at any point at which “credit-risk” becomes a concern. The important point is that ‘when’ it occurs, it will start a ‘liquidation cycle’ as ‘margin calls’ trigger more selling which leads to more margin calls. This cycle will continue until the liquidation process is complete.

The Dow Jones provided the clearest picture of the acceleration in selling as “margin calls” kicked in.

The last time we saw such an event was in 2008.

How Much More Is There To Go?

Unfortunately, FINRA only updates margin debt with about a 2-month lag.

Mark’s second point was a lack of data. This isn’t actually the case as margin debt has been tracked back to 1959. However, for clarity, let’s just start with data back to 1980. The chart below tracks two things:

  1. The actual level of margin debt, and;
  2. The level of “free cash” balances which is the difference between cash and borrowed funds (net cash).

As I stated above, since the data has not been updated since January, the current level of margin, and negative cash balances, has obviously been reduced, and likely sharply so.

However, previous “market bottoms,” have occurred when those negative cash balances are reverted. Given the extreme magnitude of the leverage that was outstanding, I highly suspect the “reversion” is yet complete. 

The relationship between cash balances and the market is better illustrated in the next chart. I have inverted free cash balances, to show the relationship between reversals in margin debt and the market. Given the market has only declined by roughly 30% to date, there is likely more to go. This doesn’t mean a fairly sharp reflexive bounce can’t occur before a further liquidation ensues.

If we invert margin debt to the S&P 500, you can see the magnitude of both previous market declines and margin liquidation cycles. As stated, this data is as of January, and margin balances will be substantially lower following the recent rout. I am just not sure we have “squeezed” the last bit of blood out of investors just yet. 

You Were Warned

I warned previously, the idea that margin debt levels are simply a function of market activity, and have no bearing on the outcome of the market, was heavily flawed.

“By itself, margin debt is inert.

Investors can leverage their existing portfolios and increase buying power to participate in rising markets. While ‘this time could certainly be different,’ the reality is that leverage of this magnitude is ‘gasoline waiting on a match.’

When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point that triggers an initial round of margin calls. Since margin debt is a function of the value of the underlying ‘collateral,’ the forced sale of assets will reduce the value of the collateral, triggering further margin calls. Those margin calls will trigger more selling, forcing more margin calls, so forth and so on.

That event was the double-whammy of collapsing oil prices and the economic shutdown in response to the coronavirus.

While it is certainly hoped by many that we are closer to the end of the liquidation cycle, than the beginning, the dollar funding crisis, a blowout in debt yields, and forced selling of assets, suggests there is likely more pain to come before we are done.

It’s not too late to take actions to preserve capital now, so you have capital to invest later.

As I wrote in Tuesday’s missive “When Too Little Is Too Much:”

“With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

The good news is that a great ‘buying’ opportunity is coming. Just don’t be in a ‘rush’ to try and buy the bottom. 

I can assure you, when we ultimately see a clear ‘risk/reward’ set up to start taking on equity risk again, we will do so ‘with both hands.’ 

And we are sitting on a lot of cash just for that reason.”

You can’t “buy low,” if you don’t have anything to “buy with.”

The Problem With Pragmatism… and Inflation

Pragmatism is seeking immediate solutions with little to no consideration for the longer-term benefits and consequences. An excellent example of this is the Social Security system in the United States. In the Depression-era, a government-sponsored savings plan was established to “solve” for lack of retirement savings by requiring contributions to a government-sponsored savings plan.  At the time, the idea made sense as the population was greatly skewed towards younger people.  No one seriously considered whether there would always be enough workers to support benefits for retired people in the future. Now, long after those policies were enacted and those that pushed the legislation are long gone, the time is fast approaching when Social Security will be unable to pay out what the government has promised.

Pragmatism is the common path of governments, led by politicians seeking re-election and the retention of power. Instead of considering the long-term implications of their policies, they focus on satisfying an immediate desire of their constituents.

In his book Economics in One Lesson, Henry Hazlitt made this point very clear by elaborating on the problems that eventually transpire from imprudent monetary and fiscal policy.

“The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.

Nine-tenths of the economic fallacies that are working such dreadful harm in the world today are the result of ignoring this lesson.”

Inflation

One of the most pernicious of these issues in our “modern and sophisticated” intellectual age is that of inflation. When asked to define inflation, most people say “rising prices,” with no appreciation for the fact that price movements are an effect, not a cause. They are a symptom of monetary circumstances. Inflation is a disequilibrium between the amounts of currency entering an economic system relative to the productive output of that same system.

In today’s world, there is only fiat (“by decree”) currencies. In other words, the value of currencies are not backed by some physical commodity such as gold, silver, or oil. Currencies are only backed by the perceived productive capacity of the nation and the stability of the issuing government. If a government takes unreasonable measures in managing its fiscal and monetary affairs, then the standard of living in that society will deteriorate, and confidence in it erodes.

Put another way, when the people of a nation or its global counterparts lose confidence in the fiscal and monetary policy-makers, the result is a loss of confidence in the medium of exchange, and a devaluation of the currency ensues. The influence of those in power will ultimately prove to be unsustainable.

Inflation is an indicator of confidence in the currency as a surrogate of confidence in the policies of a government. It is a mirror. This is why James Grant is often quoted as saying, “The gold price is the reciprocal of the world’s faith in central banking.”

Confidence in a currency may be lost in a variety of ways. The one most apparent today is creating too many dollars as a means of subsidizing the spending habits of politicians and the borrowing demands of corporations and citizens.

Precedent

There is plenty of modern-day historical precedent for a loss of confidence from excessive debt creation and the inevitable excessive currency creation. Weimar Germany in the 1920s remains the modern era poster child, but Zimbabwe, Argentina, and Venezuela also offer recent examples.

Following the 2008 financial crisis, many believed that the actions of the Federal Reserve were “heroic.” Despite failing to see the warning signs of a housing bubble in the months and even years leading up to the crisis, the Fed’s perspective was that it exists to provide liquidity. As the chart below illustrates, that is precisely what they did.

Data Courtesy Bloomberg

That pragmatic response failed to heed Hazlitt’s warning. What are the longer-term effects for the economy, the bailed-out banking system, and all of us? How would these policies affect the economy, markets, society, and the wealth of the nation’s citizens in five, ten, or twenty years?

Keeping interest rates at a low level for many years following the financial crisis while the economy generally appears to have recovered raises other questions. The Fed continues to argue that inflation remains subdued. That argument goes largely undisputed despite credible evidence to the contrary. Further, it provides the Fed a rationalization for keeping rates well below normal.

Politicians who oversee the Fed and want to retain power, consent to low-rate policies believing it will foster economic growth. While that may make sense to some, it is short-sighted and, therefore, pragmatic. The assessment does not account for a variety of other complicating factors, namely, what may transpire in the future as a result? Are seeds of excess being sown as was the case in the dot-com bubble and the housing bubble? If so, can we gauge the magnitude?

Policy Imposition

In the mid-1960s, President Lyndon Johnson sought to escalate U.S. involvement in the Vietnam War. In doing so, he knew he would need the help of the Fed to hold interest rates down to run the budget deficits required to fund that war. Although then-Fed Chairman William McChesney Martin was reluctant to ease monetary policy, he endured various forms of abuse from the Oval Office and finally acquiesced.

The bullying these days comes from President Trump. Although his arguments for easier policy contradict what he said on the campaign trail in 2016, Jerome Powell is compliant. Until recently, the economy appeared to be running at full employment and all primary fundamental metrics were well above the prior peaks set in 2007.

Additionally, Congress, at Trump’s behest and as the chart below illustrates, has deployed massive fiscal stimulus that created a yawning gap (highlighted) between fiscal deficits and the unemployment picture. This is a divergence not seen since the Johnson administration in the 1960s (also highlighted) and one of magnitude never seen. As is very quickly becoming clear, those actions both monetary and fiscal, were irresponsible to the point of negligence. Now, when we need it most as the economy shuts down, there is little or no “dry powder”.

Data Courtesy Bloomberg

President Johnson got his way and was able to fund the war with abnormally low interest rates. However, what ensued over the next 15 years was a wave of inflation that destroyed the productive capacity of the economy well into the early 1980s. Interest rates eventually rose to 18%, and economic dynamism withered as did the spirits of the average American.

The springboard for that scenario was a pragmatic policy designed to solve an immediate problem with no regard for the future. Monetary policy that suppressed interest rates and fiscal policy that took advantage of artificially low interest rates to accumulate debt at a relatively low cost went against the American public best interests. The public could not conceive that government “of, by and for the people” would act in such a short-sighted and self-serving manner.

Data Courtesy Bloomberg

The Sequel

Before the COVID-19 pandemic, the Congressional Budget Office (CBO) projections for U.S. budget deficits exceeded $1 trillion per year for the next 10-years. According to the CBO, the U.S. Treasury’s $22.5 trillion cumulative debt outstanding was set to reach $34.5 trillion by 2029, and that scenario assumed a very optimistic GDP growth of 3% per year. Further, it laughably assumed no recession will occur in the next decade, even though we are already in the longest economic expansion since the Civil War. In the event of a recession, a $1.8 trillion-dollar annual deficit would align with average historical experience. Given the severity of what is evident from the early stages of the pandemic, that forecast may be very much on the low end of reality.

The 1960s taught us that monetary and fiscal policy is always better erring on the side of conservatism to avoid losing confidence in the currency. Members of the Fed repeatedly tell the public they know this. Yet, if that is the case, why would they be so influenced by a President focused on marketing for re-election purposes? Alternatively, maybe the policy table has been set over the past ten years in a way that prevents them from taking proper measures? Do they assume they would be rejected despite the principled nature of their actions?

Summary

Inflation currently seems to be the very least of our worries. Impeachment, Iran, North Korea and climate change were all crisis head fakes.

The Fed was also distracted by what amounted to financial dumpster fires in the fall of 2019. After a brief respite, the Fed’s balance sheet began surging higher again and they cut the Fed Funds rate well before there was any known threat of a global pandemic. What is unclear is whether imprudent fiscal policies were forcing the Fed into imprudent monetary policy or whether the Fed’s policies, historical and current, are the enabler of fiscal imprudence. Now that the world has changed, as it has a habit of doing sometimes even radically, policymakers and the collective public are in something of a fine mess to understate the situation.

Now we are contending with a real global financial, economic, and humanitarian threat and one that demands principled action as opposed to short-sighted pragmatism.

The COVID-19 pandemic is clearly not a head fake nor is it a random dumpster fire. Neither is it going away any time soon. Unlike heads of state or corporate CEOs, biological threats do not have a political agenda and they do not care about the value of their stock options. There is nothing to negotiate other than the effectiveness of efforts required to protect society.

Given the potential harm caused by the divergence between stimulus and economic fundamentals, it would be short-sighted and irresponsibly pragmatic to count out the prospect of inflation. Given the actions of the central bankers, it could also be the understatement of this new and very unusual decade.

Technically Speaking: Risk Limits Hit, When Too Little Is Too Much

For the last several months, we have been issuing repeated warnings about the market. While such comments are often mistaken for “being bearish,” we have often stated it is our process of managing “risk” which is most important.

Beginning in mid-January, we began taking profits out of our portfolios and reducing risk. To wit:

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels.”

Importantly, we did not “sell everything” and go to cash.

Since then, we took profits and rebalanced risk again in late January and early February as well.

Our clients, their families, their financial and emotional “well being,” rest in our hands. We take that responsibility very seriously, and work closely with our clients to ensure that not only are they financially successful, but they are emotionally stable in the process.

This is, and has been, our biggest argument against “buy and hold,” and “passive investing.” While there are plenty of case studies showing why individuals will eventually get back to even, the vast majority of individuals have a “pain point,” where they will sell.

So, we approach portfolio management from a perspective of “risk management,” but not just in terms of “portfolio risk,” but “emotional risk” as well. By reducing our holdings to raise cash to protect capital, we can reduce the risk of our clients hitting that “threashold” where they potentially make very poor decisions.

In investing, the worst decisions are always made at the moment of the most pain. Either at the bottom of the market or near the peaks. 

Investing is not always easy. Our portfolios are designed to have longer-term holding periods, but we also understand that things do not always go as planned.

This is why we have limits, and when things go wrong, we sell.

So, why do I tell you this?

On Friday/Monday, our “limits” were breached, which required us to sell more.

Two Things

Two things have now happened, which signaled us to reduce risk further in portfolios.

On Sunday, the Federal Reserve dropped a monetary “nuclear bomb,” on the markets. My colleague Caroline Baum noted the details:

“After an emergency 50-basis-point rate cut on March 3, the Federal Reserve doubled down Sunday evening, lowering its benchmark rate by an additional 100 basis points to a range of 0%-0.25% following another emergency meeting.

After ramping up its $60 billion of monthly Treasury bill purchases to include Treasuries of all maturities and offering $1.5 trillion of liquidity to the market via repurchase agreements on March 3, the Fed doubled down Sunday evening with announced purchases of at least $500 billion of Treasuries and at least $200 billion of agency mortgage-backed securities.

In addition, the Fed reduced reserve requirements to zero, encouraged banks to borrow from its discount window at a rate of 0.25%, and, in coordination with five other central banks, lowered the price of U.S. dollar swap arrangements to facilitate dollar liquidity abroad”

We had been anticipating the Federal Reserve to try and rescue the markets, which is why we didn’t sell even more aggressively previously. The lesson investors have been taught repeatedly over the last decade was “Don’t Fight The Fed.”

One of the reasons we reduced our exposure in the prior days was out of concern the Fed’s actions wouldn’t be successful. 

On Monday, we found out the answer. The Fed may be fighting a battle it can’t win as markets not only failed to respond to the Fed’s monetary interventions but also broke the “bullish trend line” from the 2009 lows.  (While the markets are oversold short-term, the long-term “sell signals” in the bottom panels are just being triggered from fairly high levels. This suggests more difficulty near-term for stocks. 

This was the “Red Line” we laid out in our Special Report for our RIAPro Subscribers (Risk-Free 30-Day Trial) last week:

“As you can see in the chart below, this is a massive surge of liquidity, hitting the market at a time the market is testing important long-term trend support.”

It is now, or never, for the markets.

With our portfolios already at very reduced equity levels, the break of this trendline will take our portfolios to our lowest levels of exposure.

What happened today was an event we have been worried about, but didn’t expect to see until after a break of the trendline – “margin calls.” This is why we saw outsized selling in “safe assets” such as REITs, utilities, bonds, and gold.

Cash was the only safe place to hide.

We aren’t anxious to “fight the Fed,” but the markets may have a different view this time.

Use rallies to raise cash, and rebalance portfolio risk accordingly.

We are looking to be heavy buyers of equities when the market forms a bottom, we just aren’t there as of yet.”

On Monday morning, with that important trendline broken, we took some action.

  • Did we sell everything? No. We still own 10% equity, bonds, and a short S&P 500 hedge. 
  • Did we sell the bottom? Maybe.

We will only know in hindsight for certain, and we are not willing to risk more of our client’s capital currently. 

There are too many non-quantifiable risks with a global recession looming, as noted by David Rosenberg:

“The pandemic is a clear ‘black swan’ event. There will be a whole range of knock-on effects. Fully 40 million American workers, or one-third of the private-sector labor force, are directly affected ─ retail, entertainment, events, sports, theme parks, conferences, travel, tourism, restaurants and, of course, energy.

This doesn’t include all the multiplier effects on other industries. It would not surprise me at all if real GDP in Q2 contracts at something close to an 8% annual rate (matching what happened in the fourth quarter of 2008, which was a financial event alone).

The hit to GDP can be expected to be anywhere from $400 billion to $600 billion for the year. But the market was in trouble even before COVID-19 began to spread, with valuations and complacency at cycle highs and equity portfolio managers sitting with record-low cash buffers. Hence the forced selling in other asset classes.

If you haven’t made recession a base-case scenario, you probably should. All four pandemics of the past century coincided with recession. This won’t be any different. It’s tough to generate growth when we’re busy “social distancing.” I am amazed that the latest WSJ poll of economists conducted between March 6-10th showed only 49% seeing a recession coming”.

The importance of his commentary is that from an “investment standpoint,” we can not quantify whether this “economic shock” has been priced into equities as of yet. However, we can do some math based on currently available data:

The chart below is the annual change in nominal GDP, and S&P 500 GAAP earnings.

I am sure you will not be shocked to learn that during “recessions,” corporate “earnings’ tend to fall. Historically, the average drawdown of earnings is about 20%; however, since the 1990’s, those drawdowns have risen to about 30%.

As of March 13th, Standard & Poors has earnings estimates for the first quarter of 2020 at $139.20 / share. This is down just $0.20 from the fourth quarter of 2019 estimates of $139.53.

In other words, Wall Street estimates are still in “fantasy land.” 

If our, and Mr. Rosenberg’s, estimates are correct of a 5-8% recessionary drag in the second quarter of 2020, then an average reduction in earnings of 30% is most likely overly optimistic. 

However, here is the math:

  • Current Earnings = 132.90
  • 30% Reduction = $100 (rounding down for easier math)

At various P/E multiples, we can predict where “fair value” for the market is based on historical assumptions:

  • 20x earnings:  Historically high but markets have traded at high valuations for the last decade. 
  • 18x earnings: Still historically high.
  • 15x earnings: Long-Term Average
  • 13x earnings: Undervalued 
  • 10x earnings: Extremely undervalued but aligned with secular bear market bottoms.

You can pick your own level where you think P/E’s will account for the global recession but the chart below prices it into the market.

With the S&P 500 closing yesterday at 2386, this equates to downside risk of:

  • 20x Earnings = -16% (Total decline from peak = – 40%)
  • 18x Earnings = 24.5% (Total decline from peak = – 46%)
  • 15x Earnings = -37.1% (Total decline from peak = – 55%)
  • 13x Earnings = 45.5% (Total decline from peak = – 61%)
  • 10x Earnings = 58.0% (Total decline from peak = – 70%)

NOTE: I am not suggesting the market is about to decline 60-70% from the recent peak. I am simply laying out various multiples based on assumed risk to earnings. However, 15-18x earnings is extremely reasonable and possible. 

When Too Little Is Too Much

With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

One concern, which weighed heavily into our decision process, was the rising talk of the “closing the markets” entirely for a week or two to allow the panic to pass. We have clients that depend on liquidity from their accounts to sustain their retirement lifestyle. In our view, a closure of the markets would lead to two outcomes which pose a real risk to our clients:

  1. They need access to liquidity, and with markets closed are unable to “sell” and raise cash; and,
  2. When you trap investors in markets, when they do open again, there is a potential “rush” of sellers to get of the market to protect themselves. 

That risk, combined with the issue that major moves in markets are happening outside of transaction hours, are outside of our ability to hedge, or control.

This is what we consider to be an unacceptable risk for the time being.

We will likely miss the ultimate “bottom” of the market.

Probably.

But that’s okay, we have done our job of protecting our client’s second most precious asset behind their family, the capital they have to support them.

The good news is that a great “buying” opportunity is coming. Just don’t be in a “rush” to try and buy the bottom.

I can assure you, when we see ultimately see a clear “risk/reward” set up to start taking on equity risk again, we will do so “with both hands.” 

And we are sitting on a lot of cash just for that reason.Save

RIA PRO: Risk Limits Hit

For the last several months we have been issuing repeated warnings about the market. While such comments are often mistaken for “being bearish,” we have often stated it is our process of managing “risk” which is most important.

Beginning in mid-January, we began taking profits out of our portfolios and reducing risk. To wit:

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels.”

Since then, as you know, we have taken profits, and rebalanced risk several times within the portfolios.

Importantly, we approach portfolio management from a perspective of “risk management,” but not just in terms of “portfolio risk,” but “emotional risk” as well. By reducing our holdings to raise cash to protect capital, we can reduce the risk of our clients hitting that “threshold” where they potentially make very poor decisions.

In investing, the worst decisions are always made at the moment of the most pain. Either at the bottom of the market or near the peaks. 

Investing is not always easy. Our portfolios are designed to have longer-term holding periods, but we also understand that things do not always go as planned.

This is why we have limits, and when things go wrong, we sell.

So, why do I tell you this?

On Friday/Monday, our “limits” were breached, which required us to sell more.

Two Things

Two things have now happened which signaled us to reduce risk further in portfolios.

On Sunday, the Federal Reserve dropped a monetary “nuclear bomb,” on the markets. My colleague Caroline Baum noted the details:

“After an emergency 50-basis-point rate cut on March 3, the Federal Reserve doubled down Sunday evening, lowering its benchmark rate by an additional 100 basis points to a range of 0%-0.25% following another emergency meeting.

After ramping up its $60 billion of monthly Treasury bill purchases to include Treasuries of all maturities and offering $1.5 trillion of liquidity to the market via repurchase agreements on March 3, the Fed doubled down Sunday evening with announced purchases of at least $500 billion of Treasuries and at least $200 billion of agency mortgage-backed securities.

In addition, the Fed reduced reserve requirements to zero, encouraged banks to borrow from its discount window at a rate of 0.25%, and, in coordination with five other central banks, lowered the price of U.S. dollar swap arrangements to facilitate dollar liquidity abroad”

We had been anticipating the Federal Reserve to try and rescue the markets, which is why we didn’t sell even more aggressively previously. The lesson investors have been taught repeatedly over the last decade was “Don’t Fight The Fed.”

One of the reasons we reduced our exposure in the prior days was out of concern we didn’t know if the Fed’s actions would be successful. 

On Monday, we found out the answer. The Fed may be fighting a battle it can’t win as markets not only failed to respond to the Fed’s monetary interventions, but also broke the “bullish trend line” from the 2009 lows.  (While the markets are oversold short-term, the long-term “sell signals” in the bottom panels are just being triggered from fairly high levels. This suggests more difficulty near-term for stocks. 

This was the “Red Line” we laid out in our last week, in the Special Report Red Line In The Sand:

“As you can see in the chart below, this is a massive surge of liquidity hitting the market at a time the market is hitting important long-term trend support.”

It is now, or never, for the markets.

With our portfolios already at very reduced equity levels, the break of this trendline will take our portfolios to our lowest levels of exposure. However, given the extreme oversold condition, noted above, it is likely we are going to see a bounce, which we will use to reduce risk into.

What happened today was an event we have been worried about, but didn’t expect to see until after a break of the trendline – “margin calls.”

This is why we saw outsized selling in “safe assets” such as REITs, utilities, bonds, and gold.

Cash was the only safe place to hide.

This also explains why the market “failed to rally” when the Fed announced $500 billion today. There is another $500 billion coming tomorrow. We will see what happens.

We aren’t anxious to “fight the Fed,” but the markets may have a different view this time.

Use rallies to raise cash, and rebalance portfolio risk accordingly.

We are looking to be heavy buyers of equities when the market forms a bottom, we just aren’t there as of yet.”

On Monday morning, we took some action.

  • Did we sell everything? No. We still own 10% equity, bonds, and a short S&P 500 hedge. 
  • Did we sell the bottom? Maybe.

We will only know in hindsight for certain, and we are not willing to risk more of our client’s capital currently. 

There are too many non-quantifiable risks with a global recession looming, as noted by David Rosenberg:

“The pandemic is a clear ‘black swan’ event. There will be a whole range of knock-on effects. Fully 40 million American workers, or one-third of the private sector labor force, are directly affected ─ retail, entertainment, events, sports, theme parks, conferences, travel, tourism, restaurants and, of course, energy.

This doesn’t include all the multiplier effects on other industries. It would not surprise me at all if real GDP in Q2 contracts at something close to an 8% annual rate (matching what happened in the fourth quarter of 2008 which was a financial event alone).

The hit to GDP can be expected to be anywhere from $400 billion to $600 billion for the year. But the market was in trouble even before COVID-19 began to spread, with valuations and complacency at cycle highs and equity portfolio managers sitting with record-low cash buffers. Hence the forced selling in other asset classes.

If you haven’t made recession a base-case scenario, you probably should. All four pandemics of the past century coincided with recession. This won’t be any different. It’s tough to generate growth when we’re busy “social distancing.” I am amazed that the latest WSJ poll of economists conducted between March 6-10th showed only 49% seeing a recession coming”.

The importance of his commentary is that from an “investment standpoint,” we can not quantify whether this “economic shock” has been priced into equities as of yet. However, we can do some math based on currently available data:

The chart below is annual nominal GDP, and S&P 500 GAAP earnings.

I am sure you will not be shocked to learn that during “recessions,” corporate “earnings’ tend to fall. Historically, the average drawdown of earnings is about 20%, however, since the 1990’s, those drawdowns have risen to about 30%.

As of March 13th, Standard & Poors has earnings estimates for the first quarter of 2020 at $139.20/share. This is down just $0.20 from the fourth quarter of 2019 estimates of $139.53.

If our, and Mr. Rosenberg’s, estimates are correct of a 5-8% recessionary drag in the second quarter of 2020, then an average reduction in earnings of 30% is most likely overly optimistic. 

However, here is the math:

  • Current Earnings = 132.90
  • 30% Reduction = $100 (rounding down for easier math)

At various P/E multiples we can predict where “fair value” for the market is based on historical assumptions:

  • 20x earnings:  Historically high but markets have traded at high valuations for the last decade. 
  • 18x earnings: Still historically high.
  • 15x earnings: Long-Term Average
  • 13x earnings: Undervalued 
  • 10x earnings: Extremely undervalued but aligned with secular bear market bottoms.

You can pick your own level where you think P/E’s will account for the global recession but the chart below prices it into the market.

With the S&P 500 closing yesterday at 2386, this equates to downside risk of:

  • 20x Earnings = -16% (Total decline from peak = – 40%)
  • 18x Earnings = 24.5% (Total decline from peak = – 46%)
  • 15x Earnings = -37.1% (Total decline from peak = – 55%)
  • 13x Earnings = 45.5% (Total decline from peak = – 61%)
  • 10x Earnings = 58.0% (Total decline from peak = – 70%)

NOTE: I am not suggesting the market is about to decline 60-70% from the recent peak. I am simply laying out various multiples based on assumed risk to earnings. However, 15-18x earnings is extremely reasonable and possible. 

When Too Little Is Too Much

With our risk limits hit, and in order to protect our clients from both financial and emotional duress, we made the decision that even the reduced risk we were carrying was still too much.

One concern, which weighed heavily into our decision process, was the rising talk of the “closing the markets” entirely for a week or two to allow the panic to pass. We have clients that depend on liquidity from their accounts to sustain their retirement lifestyle. In our view, a closure of the markets would lead to two outcomes which pose a real risk to our clients:

  1. They need access to liquidity, and with markets closed are unable to “sell” and raise cash; and,
  2. When you trap investors in markets, when they do open again there is a potential “rush” of sellers to get of the market to protect themselves. 

That risk, combined with the issue that major moves in markets are happening outside of transaction hours, are outside of our ability to hedge, or control.

This is what we consider to be unacceptable risk for the time being.

We will likely miss the ultimate “bottom” of the market?

Probably.

But that’s okay, we have done our job of protecting our client’s second most precious asset behind their family, the capital they have to support them.

The good news is that a great “buying” opportunity is coming. Just don’t be in a “rush” to try and buy the bottom.

I can assure you that when we see ultimately see a clear “risk/reward” set up to start taking on equity risk again, we will do so “with both hands.” 

And we are sitting on a lot of cash just for that reason.Save

Major Market Buy/Sell Review: 03-16-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

This commentary was written over the weekend prior to the Fed’s Sunday action.

This week I am leaving LAST WEEK’S charts ABOVE this week’s charts so you can realize the magnitude of the moves last week. This is important to keep “perspective” on current allocations and expectations.

S&P 500 Index

  • Last week: “Warning: SPY has triggered a longer-term “sell” signal which historically coincides with deeper declines. We highly suspect that any rally will ultimately fail and we will test the 62.8% retracement level.
  • With the market now 3-standard deviations oversold, a bounce is likely next week as it is expected the Fed will cut rates and restart a substantial QE program. A retracement to the 31.8%, 50%, 62.8% levels are possible and each level should be used to reduce equity risk and hedge. 
  • We are going to have a retest of lows before this over. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: Hold positions
    • Stop-loss set at $250
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • Now back to extreme oversold, trading positions can be added for a counter-trend bounce back to resistance at $240-265.
  • DIA is on a very deep “Sell signal” so rallies will most likely fail in the weeks ahead.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold current positions
    • This Week: Trading positions for rally only.
    • Stop-loss set at $210
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • Despite the correction last week, the QQQ is the best looking index from a trading perspective. QQQ tested and held its bullish trend line, but has now registered a “sell signal.” This suggests that rallies will likely fail for the time being. 
  • The the index is very oversold, so look for a reflexive rallies back to $200, which coincides with the 200-dma, or $207 to $215 (which is optimistic.) to reduce exposure and take profits on trading positions. 
  • Trading position in QQQ for a reflexive rally back to the 200-dma which resides at $200
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss set at $175
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

 

  • As noted in our portfolio commentary, we sold our small-cap positions 4-weeks ago.
  • Small-caps are extremely oversold, and on a very deep “sell signal.”  
  • This particular group of stocks are the most susceptible to an economic slowdown from the virus. Use any reflexive rally to step-aside for the time being.
  • You can deploy a trading position in small-caps for a bounce, but they are underperforming large cap, so I am not sure its worth the risk.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop loss adjusted to $48 on trading positions.
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • As with Small-cap, we have no holdings. 
  • MDY is oversold, and is on a very deep a “sell signal.”
  • MDY has broken all critical supports, and like SLY, there is no reason to “buy” the sector currently. However, MDY is oversold enough for a counter-trend bounce to sell into. Trading positions only. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • Three weeks ago, we stated that “EEM failed at resistance and we sold our exposures to international holdings and return our focus on large cap value for now. EEM has completed a “head and shoulders” topping pattern and violated support at the 61.8% retracement level. EEM will eventually test previous lows particularly with a sell signal now registered.” 
  • EEM is very now extremely oversold and on a deep sell-signal.
  • Use counter-trend rallies to sell into. Trading positions only. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position
    • This Week: No position.
    • Stop-loss set at $32 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • Like EEM, EFA was also sold previously. as we return our focus back to large cap value.
  • EFA is very sold and on a deep sell signal. A reflexive rally is likely back to $58 to 63 which doesn’t even get you back to the 200-dma. Use those levels to sell into.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No position.
    • This Week: No position.
    • Stop-loss set at $50 for trading positions.
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Wow. After Russia failed to join OPEC+ in cutting production, and US drillers are producing more than current demand can offset, we said: “Drillers have to drill to make revenue to meet their debt obligations, so ultimately this is going to end very badly.”
  • We just didn’t realize how bad it would get until Saudi Arabia decided to launch a price war, thankfully, we had recommended selling all energy holdings on the Friday before that announcement.
  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. However, we were early, so we are going to step back and look for a better bottom to buy into. We aren’t there yet.
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: No positions.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • Two weeks ago we stated: “Gold rallied sharply and broke out to new highs, suggesting there was something amiss with the stock market exuberance. The correction came this past week, confirming Gold’s message was correct.”
  • Gold had been holding up well as a hedge until this past week where two hedge funds (we suspect Citadel and Millennium) blew up creating margin liquidation across all asset classes included gold, bonds, and even bitcoin. 
  • Fortunately, we previously sold our GDX position (people intensive) and with the liquidation event over we think Gold will return to its ability to hedge. 
  • We will look to add to our position this week if Gold can hold the $200 dma and our stop level at $137.50
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Look to add at support of $140.
    • Stop-loss set at $137.50.
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • As noted last week: “Carl Swenlin at Decision Point agrees with our view: ‘Price has accelerated into a parabolic advance, so we should be alert for a breakdown very soon. That doesn’t mean that we’ll see a complete collapse, but it is not likely that this vertical ascent will be maintained.’”
  • We previously sold our small position in TLT, and this past week reduced our IEF position by 50% and increased BIL accordingly to shorten duration. The rest of our bond holdings have done the work of supporting the portfolio. 
  • The margin liquidation event is now bringing bonds back to a “buyable” range.
  • As we noted last week: “We agree. Bonds are getting ‘stupid’ overbought which suggests there is plenty of ‘fuel’ for a pretty vicious ‘reflex rally’ in stocks. At 5-standard deviations you are going to see a reversal in rates back to $150-152 on TLT. This is will be your next entry point to buy bonds and sell stocks.”
  • That positioning remains the same this week.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Sold 1/2 of IEF, Added to BIL, looking to add TLT back to portfolios for trading.
    • Stop-loss is moved up to $147.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • It’s been a roller coaster for the US Dollar this past two weeks.
  • Two weeks ago we stated: “This past week, the dollar surged through that resistance and is now extremely overbought short-term. Looking for a reflexive rally in stocks next week that pulls the dollar back towards the breakout level of last week..
  • The dollar rallied last week as the collapse in assets across the board from the margin liquidation event left the “dollar” as the only “safe haven.”
  • The dollar is trying to reverse its sell signal, and with the dollar back to 2-standard deviations, the rally may slow here a bit into next week. 

#WhatYouMissed On RIA This Week: 03-13-20

We know you get busy and don’t check our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything you might have missed.

The Week In Blogs


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Our Latest Newsletter

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What You Missed At RIA Pro

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free)

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The Best Of “The Lance Roberts Show

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Video Of The Week A

Danny Ratliff, CFP and Lance Roberts, CIO discuss the importance of having a process during a market decline, and the importance of financial advisor to ensure you don’t make emotionally driven mistakes.

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Our Best Tweets Of The Week

See you next week!

Special Report: Fed Launches A Bazooka As Markets Hit Our Line In The Sand

The severity of the recent market rout has been quite astonishing. As shown below, in just three very short weeks, the market has reversed almost the entirety of the “Trump Stock Market” gains.

The decline has been unrelenting, and despite the Fed cutting rates last week, and President Trump discussing fiscal stimulus, the markets haven’t responded. In mid-February we were discussing the markets being 3-standard deviations above their 200-dma which is a rarity. Three short weeks later, the markets are now 4-standard deviations below which is even a rarer event. 

On Wednesday, the Federal Reserve increased “Repo operations” to $175 Billion.

Still no response from the market

Then on Thursday, the Fed brought out their “big gun.”

The Fed Bazooka

Yesterday, the Federal Reserve stepped into financial markets for the second day in a row, this time dramatically ramping up asset purchases amid the turmoil created by the combination of the spreading coronavirus and the collapse in oil prices. 

In a statement from the New York Fed:

The Federal Reserve said it would inject more than $1.5 trillion of temporary liquidity into Wall Street on Thursday and Friday to prevent ominous trading conditions from creating a sharper economic contraction.

‘These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak.’

The New York Fed said it would conduct three additional repo offerings worth an additional $1.5 trillion this week, with two separate $500 billion offerings that will last for three months and a third that will mature in one month.

If the transactions are fully subscribed, they would swell the central bank’s $4.2 trillion asset portfolio by more than 35%.” – WSJ

As Mish Shedlock noted,

“The Fed can label this however they want, but it’s another round of QE.”

As you can see in the chart below, this is a massive surge of liquidity hitting the market at a time the market is hitting important long-term trend support.

Of course, this is what the market has been hoping for:

  • Rate cuts? Check
  • Liquidity? Check

It is now, or never, for the markets.

With our portfolios already at very reduced equity levels, the break of this trendline will take our portfolios to our lowest levels of exposure. However, given the extreme oversold condition, noted above, it is likely we are going to see a bounce, which we will use to reduce risk into.

What happened today was an event we have been worried about, but didn’t expect to see until after a break of the trendline – “margin calls.”

This is why we saw outsized selling in “safe assets” such as REITs, utilities, bonds, and gold.

Cash was the only safe place to hide.

This also explains why the market “failed to rally” when the Fed announced $500 billion today. There is another $500 billion coming tomorrow. We will see what happens.

We aren’t anxious to “fight the Fed,” but the markets may have a different view this time.

Use rallies to raise cash, and rebalance portfolio risk accordingly.

We are looking to be heavy buyers of equities when the market forms a bottom, we just aren’t there as of yet.

Special Report: Panic Sets In As “Everything Must Go”

Note: All charts now updated for this mornings open.

The following is a report we generate regularly for our RIAPRO Subscribers. You can try our service RISK-FREE for 30-Days.

Headlines from the past four-days:

Dow sinks 2,000 points in worst day since 2008, S&P 500 drops more than 7%

Dow rallies more than 1,100 points in a wild session, halves losses from Monday’s sell-off

Dow drops 1,400 points and tumbles into a bear market, down 20% from last month’s record close

Stocks extend losses following 15-minute ‘circuit breaker’ halt, S&P 500 drops 8%

It has, been a heck of a couple of weeks for the market with daily point swings running 1000, or more, points in either direction.

However, given Tuesday’s huge rally, it seemed as if the market’s recent rout might be over with the bulls set to take charge? Unfortunately, as with the two-previous 1000+ point rallies, the bulls couldn’t maintain their stand.

But with the markets having now triggered a 20% decline, ending the “bull market,” according to the media, is all “hope” now lost? Is the market now like an “Oriental Rug Factory” where “Everything Must Go?”

It certainly feels that way at the moment.

“Virus fears” have run amok with major sporting events playing to empty crowds, the Houston Live Stock Show & Rodeo was canceled, along with Coachella, and numerous conferences and conventions from Las Vegas to New York. If that wasn’t bad enough, Saudi Arabia thought they would start an “oil price” war just to make things interesting.

What is happening now, and what we have warned about for some time, is that markets needed to reprice valuations for a reduction in economic growth and earnings.

It has just been a much quicker, and brutal, event than even we anticipated.

The questions to answer now are:

  1. Are we going to get a bounce to sell into?
  2. Is the bear market officially started – from a change in trend basis; and,
  3. Just how bad could this get?

A Bounce Is Likely

In January, when we discussed taking profits out of our portfolios, we noted the markets were trading at 3-standard deviations above their 200-dma, which suggested a pullback, or correction, was likely.

Now, it is the same comment in reverse. The correction over the last couple of weeks has completely reversed the previous bullish exuberance into extreme pessimism. On a daily basis, the market is back to oversold. Historically, this condition has been sufficient for a bounce. Given that the oversold condition (top panel) is combined with a very deep “sell signal” in the bottom panel, it suggests a fairly vicious reflexive rally is likely. The question, of course, is how far could this rally go.

Looking at the chart above, it is possible we could see a rally back to the 38.2%, or the 50% retracement level is the most probable. However, with the severity of the break below the 200-dma, that level will be very formidable resistance going forward. A rally to that level will likely reverse much of the current oversold condition, and set the market up for a retest of the lows.

The deep deviation from the 200-dma also supports this idea of a stronger reflexive rally. If we rework the analysis a bit, the 3-standard deviation discussed previously has now reverted to 4-standard deviation move below the 200-dma. The market may find support there, and with the deeply oversold condition, it again suggests a rally is likely.

Given that rally could be sharp, it will be a good opportunity to reduce risk as the impact from the collapse in oil prices, and the shutdown of the global supply chain, has not been fully factored in as of yet.

The following chart is a longer-term analysis of the market and is the format we use for “onboarding” our clients into their allocation models. (Vertical black lines are buy periods)

The triggering of the “sell signals” suggests we are likely in a larger correction process. With the “bull trend” line now broken, a rally toward the 200-dma, which is coincident with the bull trend line, will likely be an area to take additional profits, and reduce risk accordingly.

The analysis becomes more concerning as we view other time frames.

Has A Bear Market Started?

On a weekly basis, the rising trend from the 2016 lows is clear. The market has NOW VIOLATED that trend, which suggests a “bear market” has indeed started. This means investors should consider maintaining increased cash allocations in portfolios currently. With the two longer-term sell signals, bottom panels, now triggered, it suggests that whatever rally may ensue short-term will likely most likely fail. (Also a classic sign of a bear market.)

With the market oversold on a weekly basis, a counter-trend, or “bear market” rally is likely. However, as stated, short-term rallies should be sold into, and portfolios hedged, until the correction process is complete.

With all of our longer-term weekly “sell signals” now triggered from fairly high levels, it suggests the current selloff is much like what we saw in 2015-2016. (Noted in the chart above as well.) In other words, we will see a rally, followed by a secondary failure to lower lows, before the ultimate bottom is put in. If the market fails to hold current levels, the 2018 lows are the next most likely target.

Just How Bad Can It Get?

The idea of a lower bottom is also supported by the monthly data.

NOTE: Monthly Signals Are ONLY Valid At The End Of The Month.

On a monthly basis, sell signals have also been triggered, but we will have to wait until the end of the month for confirmation. However, given the depth of the decline, it would likely take a rally back to all-time highs to reverse those signals. This is a very high improbability.

Assuming the signals remain, there is an important message being sent, as noted in the top panel. The “negative divergence” of relative strength has only been seen prior to the start of the previous two bear markets, and the 2015-2016 slog. While the current sell-off resembles what we saw in late 2015, there is a risk of this developing into a recessionary bear market later this summer. The market is very close to violating the 4-year moving average, which is a “make or break” for the bull market trend from the 2009 lows.

How bad can the “bear market” get? If the 4-year moving average is violated, the 2018 lows become an initial target, which is roughly a 30% decline from the peak. However, the 2016 lows also become a reasonable probability if a “credit event” develops in the energy market which spreads across the financial complex. Such a decline would push markets down by almost 50% from the recent peak, and not unlike what we saw during the previous two recessions.

Caution is advised.

What We Are Thinking

Since January, we have been regularly discussing taking profits in positions, rebalancing portfolio risks, and, most recently, moving out of areas subject to slower economic growth, supply-chain shutdowns, and the collapse in energy prices. This led us to eliminate all holdings in international, emerging markets, small-cap, mid-cap, financials, transportation, industrials, materials, and energy markets. (RIAPRO Subscribers were notified real-time of changes to our portfolios.)

While there is “some truth” to the statement “that no one” could have seen the fallout of the “coronavirus” being escalated by an “oil price” war, there has been mounting risks for quite some time from valuations, to price deviations, and a complete disregard of risk by investors. While we have been discussing these issues with you, and making you aware of the risks, it was often deemed as “just being bearish” in the midst of a “bullish rally.” However, it is managing these types of risks, which is ultimately what clients pay advisors for.

It isn’t a perfect science. In times like these, it gets downright messy. But this is where working to preserve capital and limit drawdowns becomes most important. Not just from reducing the recovery time back to breakeven, but in also reducing the “psychological stress” which leads individuals to make poor investment decisions over time.

Given the extreme oversold and deviated measures of current market prices, we are looking for a reflexive rally that we can further reduce risk into, add hedges, and stabilize portfolios for the duration of the correction. When it is clear, the correction, or worse a bear market, is complete, we will reallocate capital back to equities at better risk/reward measures.

We highly suspect that we have seen the highs for the year. Most likely,,we are moving into an environment where portfolio management will be more tactical in nature, versus buying and holding. In other words, it is quite probable that “passive investing” will give way to “active management.”

Given we are longer-term investors, we like the companies we own from a fundamental perspective and will continue to take profits and resize positions as we adjust market exposure accordingly. The biggest challenge coming is what to do with our bond exposures now that rates have gotten so low OUTSIDE of a recession.

But that is an article for another day.

As we have often stated, “risk happens fast.”

Special Report: S&P 500 – Bounce Or Bull Market

Headlines from the past two days:

Dow sinks 2,000 points in worst day since 2008, S&P 500 drops more than 7%

Dow rallies more than 1,100 points in a wild session, halves losses from Monday’s sell-off

Actually its been a heck of a couple of weeks for the market with daily point swings running 1000, or more, points in either direction.

However, given Tuesday’s huge rally, is the market’s recent rout over with the bulls set to take charge? Or is this just a reflexive rally, with a retest of lows set to come?

Let’s take a look at charts to see what we can determine.

Daily

On a daily basis, the market is back to oversold. Historically, this condition has been sufficient for a bounce. Given that the oversold condition (top panel) is combined with a very deep “sell signal” in the bottom panel, it suggested a fairly vicious reflexive rally was likely. The question, of course is how far could this rally go.

Looking at the chart above, it is quite possible we could well see a rally back to the 32.8%, or even the 50% retracement level which is where the 200-dma currently resides. A rally to that level will likely reverse much of the current oversold condition and set the market up for a retest of the lows.

This idea of a stronger reflexive rally is also supported by the deep deviation from the 200-dma. If we rework the analysis a bit, the 3-standard deviation discussed previously has now reverted to 2-standard deviations below the 200-dma. The market found support there, and with the deep oversold condition it again suggests a rally to the 200-dma is likely.

Given that rally could be sharp, it will likely be a good opportunity to reduce risk as the impact from the collapse in oil prices and the shutdown of the global supply chain has not been fully factored in as of yet.

The following chart is a longer-term analysis of the market and is the format we use for “onboarding” our clients into their allocation models. (Vertical black lines are buy periods)

The triggering of the “sell signals” suggests we are likely in a larger correction process. With the “bull trend” line now broken, a rally back to toward the 200-dma, which is coincident with the bull trend line, will likely be an area to take profits and reduce risk accordingly.

The analysis becomes more concerning as we view other time frames.

Weekly

On a weekly basis, the rising trend from the 2016 lows is clear. The market has NOW VIOLATED that trend, which suggests maintaining some allocation to cash in portfolios currently. With the two longer-term sell signals, bottom panels, now triggered, it suggests that whatever rally may ensue short-term will likely fail.

The market is getting oversold on a weekly basis which does suggest a counter-trend rally is likely. However, as stated, short-term rallies should likely be sold into, and portfolios hedged, until the correction process is complete.

With all of our longer-term weekly “sell signals” now triggered from fairly high levels, it suggests the current selloff is much like what we saw in 2015-2016. (Noted in chart above as well.) In other words, we will see a rally, a failure to lower lows, before the ultimate bottom is put in.

Monthly

The idea of a lower bottom is also supported by the monthly data.

On a monthly basis, sell signals have also been triggered. HOWEVER, these signals must remain through the end of the month to be valid. These monthly signals are “important,” and one of the biggest concerns, as noted in the top panel, is the “negative divergence” of relative strength which was only seen prior to the start of the previous two bear markets, and the 2015-2016 slog. Again, the current sell-off resembles what we saw in late 2015, but there is a risk of this developing into a recessionary bear market later this summer. Caution is advised.

What We Are Thinking

Since January we have been taking profits in positions, rebalancing portfolio risks, and recently moving out of areas subject to slower economic growth, a supply-chain shut down, and the collapse in energy prices. (We have no holdings in international, emerging markets, small-cap, mid-cap, financial or energy currently.)

We are looking for a rally that can hold for more than one day to add some trading exposure for a move back to initial resistance levels where we will once again remove those trades and add short-hedges to the portfolio.

We highly suspect that we have seen the highs for the year, so we will likely move more into a trading environment in portfolios to add some returns while we maintain our longer-term holdings and hedges.

Given we are longer-term investors, we like the companies we own from a fundamental perspective and will continue to take profits and resize positions as we adjust market exposure accordingly. The biggest challenge coming is what to do with our bond exposures now that rates have gotten so low OUTSIDE of a recession.

We will keep you updated accordingly.

March Madness: Having A Process For A Winning Outcome

We are coming upon that time of year when the markets play second fiddle to debates about which twelve seed could be this year’s Cinderella in the NCAA basketball tournament. For college basketball fans, this particular time of year is dubbed March Madness. The widespread popularity of the NCAA tournament is not just about the games, the schools, and the players, but just as importantly, it is about the brackets. Brackets refer to the office pools based upon correctly predicting the 67 tournament games. Having the most points in a pool garners bragging rights and, in many cases, your colleague’s cash.

Interestingly the art, science, and guessing involved in filling out a tournament bracket provides insight into how investors select assets, structure portfolios, and react during volatile market periods. Before we explain answer the following question:

When filling out a tournament bracket, do you:

A) Start by picking the expected national champion and then go backwards and fill out the individual games and rounds to meet that expectation?

B) Analyze each opening round matchup, picking winners, and then repeat the process with your second round matchups until you make your best guess at who the champion will be?

If you chose answer A, you fill out your pool based on a fixed notion for which team is the best in the country. In doing so, you disregard the potential path, no matter how hard, that team must take to become champions.

If you went with the second answer, B, you compare each potential matchup, analyze each team’s respective records, strengths of schedule, demonstrated strengths and weaknesses, record against common opponents and even how travel and geography might affect performance. While we may have exaggerated the amount of research you conduct, such a methodical game by game evaluation is repeated over and over again until a conclusion is reached about which team can win six consecutive games and become the national champion.

Outcome-Based Strategies

Outcome-based investment strategies start with an expected result, typically based on recent trends or historical averages. Investors following this strategy presume that such trends or averages, be they economic, earnings, prices, or a host of other factors, will continue to occur as they have in the past. How many times have you heard Wall Street “gurus” preach that stocks historically return 7%, and therefore a well-diversified portfolio should expect the same return this year? Rarely do they mention corporate and economic fundamentals or valuations. Many investors blindly take the bait and fail to question the assumptions that drive the investment selection process.

Buy and hold and constant dollar cost averaging along with a host of passive strategies, all of which are largely agnostic to valuation, are outcome based strategies. These strategies can appear full proof for years on end as we have been witnessing. However, as seen twice in the last 20 years, when these strategies are followed blindly without appreciating a portfolio’s risk/return profile, dramatic losses will eventually occur. Outcome-based strategies break a cardinal rule of building wealth; avoid as much of the downside as possible in bear markets.

“The past is no guarantee of future results” is a typical investment disclaimer. However, it is this same outcome-based methodology and logic that many investors rely upon to allocate their assets.

Process-Based Strategies

Process-based investment strategies, on the other hand, have methods that establish expectations for the factors that drive asset prices in the future. Such analysis normally includes economic forecasts, technical analysis, and a bottom-up assessment of an asset’s ability to generate cash flow. Process-based investors do not just assume that yesterday’s winners will be tomorrow’s winners, nor do they diversify just for the sake of diversification. These investors have a method that helps them forecast the assets that are likely to provide the best risk/reward prospects and they deploy capital opportunistically.

Well managed process-based strategies, at times, hold significant amounts of cash. To wit, Warren Buffett is currently sitting on $128 billion in cash. This may have cost him over the last few years, but he has a reason for being so risk averse and is sticking to his process.

Buffett and others are certainly not enamored with historically low cash yields on their cash per se, but they have done significant research and cannot find enough assets offering a suitable value/risk proposition in their opinion. These managers are not compelled to buy an asset because it “promises” a historical return.

What Are We?

At RIA Advisors, we follow a process. We use a combination of technical and fundamental analysis, along with a strong assessment of macroeconomic factors to develop an investing framework and investment guidelines. This process allows us to:

  • Properly choose assets for the short term as well as the longer term (trading vs. investing).
  • Determine the proper allocations to various asset classes and sub-asset classes.
  • Measure and monitor risk which helps limit downside by forcing us to exit positions when we are wrong, and take profits to rebalance asset weightings when we are right.

Investing can be easy at times as it was for most of 2019. It can also be very difficult as we are currently witnessing. Having a process and adhering to it does not eliminate risk, but it helps manage risks and limit mistakes. It also helps us sleep at night and avoids letting our emotions dictate our trading activity.

A or B?

Most NCAA basketball pool participants fill out tournament brackets, starting with the opening round games and progress towards the championship match. Sure, they have biases and opinions that favor teams throughout the bracket, but at the end of the day, they have done some analysis to consider each potential matchup.  So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets?

Starting at the final game and selecting a national champion is similar to identifying a return goal of 10%, for example, and buying assets that are forecast to achieve that return. How that goal is achieved is subordinated to the pleasant but speculative idea that one will achieve it. In such an outcome-based approach, decision-making is predicated on an expected result.

Considering each matchup in the NCAA tournament to ultimately determine the winner applies a process-oriented approach. Each of the 67 selections is based on the evaluation of the comparative strengths and weaknesses of teams. The expected outcome is a result of the analysis of the many factors required to achieve the outcome.

Summary

Winning a bracket has its benefits, while the costs are minimal. Managing wealth, however, can provide great rewards but is fraught with severe risks at times. Accordingly, wealth management deserves considerably more thoughtfulness than filling out a bracket.

Over the long run, those that follow a well-thought out, time-tested, process-oriented approach will raise the odds of success in compounding wealth by limiting damaging losses during major market setbacks and by being afforded generational opportunities when others are fearfully selling.

Technically Speaking: On The Cusp Of A Bear Market

“Tops are a process, and bottoms are an event”

Over the last couple of years, we have discussed the ongoing litany of issues that plagued the underbelly of the financial markets.

  1. The “corporate credit” markets are at risk of a wave of defaults.
  2. Earnings estimates for 2019 fell sharply, and 2020 estimates are now on the decline.
  3. Stock market targets for 2020 are still too high, along with 2021.
  4. Rising geopolitical tensions between Russia, Saudi Arabia, China, Iran, etc. 
  5. The effect of the tax cut legislation has disappeared as year-over-year comparisons are reverting back to normalized growth rates.
  6. Economic growth is slowing.
  7. Chinese economic data has weakened further.
  8. The impact of the “coronavirus,” and the shutdown of the global supply chain, will impact exports (which make up 40-50% of corporate profits) and economic growth.
  9. The collapse in oil prices is deflationary and can spark a wave of credit defaults in the energy complex.
  10. European growth, already weak, continues to weaken, and most of the EU will likely be in recession in the next 2-quarters.
  11. Valuations remain at expensive levels.
  12. Long-term technical signals have become negative. 
  13. The collapse in equity prices, and coronavirus fears, will weigh on consumer confidence.
  14. Rising loan delinquency rates.
  15. Auto sales are signaling economic stress.
  16. The yield curve is sending a clear message that something is wrong with the economy.
  17. Rising stress on the consumption side of the equation from retail sales and personal consumption.

I could go on, but you get the idea.

In that time, these issues have gone unaddressed, and worse dismissed, because of the ongoing interventions of Central Banks.

However, as we have stated many times in the past, there would eventually be an unexpected, exogenous event, or rather a “Black Swan,” which would “light the fuse” of a bear market reversion.

Over the last few weeks, the market was hit with not one, but two, “black swans” as the “coronavirus” shutdown the global supply chain, and Saudi Arabia pulled the plug on oil price support. Amazingly, we went from “no recession in sight”, to full-blown “recession fears,” in less than month.

“Given that U.S. exporters have already been under pressure from the impact of the “trade war,” the current outbreak could lead to further deterioration of exports to and from China, South Korea, and Japan. This is not inconsequential as exports make up about 40% of corporate profits in the U.S. With economic growth already struggling to maintain 2% growth currently, the virus could shave between 1-1.5% off that number. 

With our Economic Output Composite Indicator (EOCI) already at levels which has previously denoted recessions, the “timing” of the virus could have more serious consequences than currently expected by overzealous market investors.”

On The Cusp Of A Bear Market

Let me start by making a point.

“Bull and bear markets are NOT defined by a 20% move. They are defined by a change of direction in the trend of prices.” 

There was a point in history where a 20% move was significant enough to achieve that change in overall price trends. However, today that is no longer the case.

Bull and bear markets today are better defined as:

“During a bull market, prices trade above the long-term moving average. However, when the trend changes to a bear market prices trade below that moving average.”

This is shown in the chart below, which compares the market to the 75-week moving average. During “bullish trends,” the market tends to trade above the long-term moving average and below it during “bearish trends.”

In the last decade, there have been three previous occasions where the long-term moving average was violated but did not lead to a longer-term change in the trend.

  • The first was in 2011, as the U.S. was dealing with a potential debt-ceiling and threat of a downgrade of the U.S. debt rating. Then Fed Chairman Ben Bernanke came to the rescue with the second round of quantitative easing (QE), which flooded the financial markets with liquidity.
  • The second came in late-2015 and early-2016 as the market dealt with a Federal Reserve, which had started lifting interest rates combined with the threat of the economic fallout from Britain leaving the European Union (Brexit). Given the U.S. Federal Reserve had already committed to hiking interest rates, and a process to begin unwinding their $4-Trillion balance sheet, the ECB stepped in with their own version of QE to pick up the slack.
  • The latest event was in December 2018 as the markets fell due to the Fed’s hiking of interest rates and reduction of their balance sheet. Of course, the decline was cut short by the Fed reversal of policy and subsequently, a reduction in interest rates and a re-expansion of their balance sheet.

Had it not been for these artificial influences, it is highly likely the markets would have experienced deeper corrections than what occurred.

On Monday, we have once again violated that long-term moving average. However, Central Banks globally have been mostly quiet. Yes, there have been promises of support, but as of yet, there have not been any substantive actions.

However, the good news is that the bullish trend support of the 3-Year moving average (orange line) remains intact for now. That line is the “last line of defense” of the bull market. The only two periods where that moving average was breached was during the “Dot.com Crash” and the “Financial Crisis.”

(One important note is that the “monthly sell trigger,” (lower panel) was initiated at the end of February which suggested there was more downside risk at the time.)

None of this should have been surprising, as I have written previously, prices can only move so far in one direction before the laws of physics take over. To wit”

Like a rubber band that has been stretched too far – it must be relaxed before it can be stretched again. This is exactly the same for stock prices that are anchored to their moving averages. Trends that get overextended in one direction, or another, always return to their long-term average. Even during a strong uptrend or strong downtrend, prices often move back (revert) to a long-term moving average.”

With the markets previously more than 20% of their long-term mean, the correction was inevitable, it just lacked the right catalyst.

The difference between a “bull market” and a “bear market” is when the deviations begin to occur BELOW the long-term moving average on a consistent basis. With the market already trading below the 75-week moving average, a failure to recover in a fairly short period, will most likely facilitate a break below the 3-year average.

If that occurs, the “bear market” will be official and will require substantially lower levels of equity risk exposure in portfolios until a reversal occurs.

Currently, it is still too early to know for sure whether this is just a “correction” or a “change in the trend” of the market. As I noted previously, there are substantial differences, which suggest a more cautious outlook. To wit:

  • Downside Risk Dwarfs Upside Reward. 
  • Global Growth Is Less Synchronized
  • Market Structure Is One-Sided and Worrisome. 
  • COVID-19 Impacts To The Global Supply Chain Are Intensifying
  • Any Semblance of Fiscal Responsibility Has Been Thrown Out the Window
  • Peak Buybacks
  • China, Europe, and the Emerging Market Economic Data All Signal a Slowdown
  • The Democrats Control The House Which Effectively Nullifies Fiscal Policy Agenda.
  • The Leadership Of The Market (FAANG) Has Faltered.

Most importantly, the collapse in interest rates, as well as the annual rate of change in rates, is screaming that something “has broken,” economically speaking.

Here is the important point.

Understanding that a change is occurring, and reacting to it, is what is important. The reason so many investors “get trapped” in bear markets is that by the time they realize what is happening, it has been far too late to do anything about it.

Let me leave you with some important points from the legendary Marty Zweig: (h/t Doug Kass.)

  • Patience is one of the most valuable attributes in investing.
  • Big money is made in the stock market by being on the right side of the major moves. The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not.
  • Success means making profits and avoiding losses.
  • Monetary conditions exert an enormous influence on stock prices. Indeed, the monetary climate – primarily the trend in interest rates and Federal Reserve policy – is the dominant factor in determining the stock market’s major decision.
  • The trend is your friend.
  • The problem with most people who play the market is that they are not flexible.
  • Near the top of the market, investors are extraordinarily optimistic because they’ve seen mostly higher prices for a year or two. The sell-offs witnessed during that span were usually brief. Even when they were severe, the market bounced back quickly and always rose to loftier levels. At the top, optimism is king; speculation is running wild, stocks carry high price/earnings ratios, and liquidity has evaporated. 
  • I measure what’s going on, and I adapt to it. I try to get my ego out of the way. The market is smarter than I am, so I bend.
  • To me, the “tape” is the final arbiter of any investment decision. I have a cardinal rule: Never fight the tape!
  • The idea is to buy when the probability is greatest that the market is going to advance.

Most importantly, and something that is most applicable to the current market:

“It’s okay to be wrong; it’s just unforgivable to stay wrong.” – Marty Zweig

There action this year is very reminiscent of previous market topping processes. Tops are hard to identify during the process as “change happens slowly.” The mainstream media, economists, and Wall Street will dismiss pickup in volatility as simply a corrective process. But when the topping process completes, it will seem as if the change occurred “all at once.”

The same media which told you “not to worry,” will now tell you, “no one could have seen it coming.”

The market may be telling you something important, if you will only listen.

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Major Market Buy/Sell Review: 03-09-20

HOW TO READ THE CHARTS

There are three primary components to each chart:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

With this basic tutorial let’s review the major markets.

S&P 500 Index

  • As noted previously, “extensions to this degree rarely last long without a correction.” Now the markets are extremely oversold to the downside so a reflexive rally is likely. However, SPY will trigger a sell signal in the lower panel suggesting that any initial rally will fail and retest of support is likely.”
  • Last week, we did see a reflexive rally but it was short-lived and didn’t reverse the oversold condition. We are still long our “rental trade” in VOOG as the market ended up just slightly above where we ended last week. 
  • On Friday, there was a good bit of last hour buying which suggests institutions have likely gotten exhausted on selling. As such, there should be another reflexive rally again this next week in which we will remove the rental trade.
  • Warning: SPY has triggered a longer-term “sell” signal which historically coincides with deeper declines. We highly suspect that any rally will ultimately fail and we will test the 62.8% retracement level.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: Hold positions
    • Stop-loss adjusted to $290
    • Long-Term Positioning: Bearish

Dow Jones Industrial Average

  • The same situation exists with DIA.
  • Now back to extreme oversold, trading positions can be added for a counter-trend bounce back to resistance at $265-270.
  • DIA has triggered a “Sell signal” so rallies will most likely fail in the weeks ahead.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold current positions
    • This Week: Hold current positions
    • Stop-loss moved up to $250
  • Long-Term Positioning: Bearish

Nasdaq Composite

  • Despite the correction last week, the QQQ is the best looking index from a trading perspective.
  • The correction this past week took the index back to oversold, and the buy signal has now reversed but has NOT yet triggered a “Sell” signal like SPY and DIA. 
  • Trading position in QQQ for a reflexive rally back to the 50-dma which resides at $221
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Hold position
    • This Week: Hold position
    • Stop-loss moved up to $207
  • Long-Term Positioning: Bearish due to valuations

S&P 600 Index (Small-Cap)

 
  • As noted in our portfolio commentary, we sold our small-cap positions the week before last. 
  • Small-caps are oversold, and on a “sell signal.”  
  • This particular group of stocks are the most susceptible to an economic slowdown from the virus. Use any reflexive rally to step-aside for the time being.
  • In our portfolio we own KGGIX which is “technically” a “small-cap value fund.” However, we don’t classify it that way as it holds a significant chunk of Gold Miners which fits with our hedge theme.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Sold all positions.
    • This Week: No positions.
    • Stop loss adjusted to $62
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • Previous, we said: “MDY remains extremely extended above the 200-dma, so more corrective action is likely. MDY is still on a buy-signal but is pushing rather extreme deviations from long-term means.”
  • Over the last two weeks, that changed. Now MDY is oversold, and has triggered a “sell signal.”
  • Since Mid-caps are more impacted by supply chain impacts we are centering our portfolio strategy on domestic large caps until the “virus crisis” is resolved. We will then start picking through other areas for value.
  • MDY has broken all critical supports and is holding one of its last two “lines of defense.” It will ultimately fail and likely set lower lows. However, MDY is oversold enough for a counter-trend bounce to sell into. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No holding
    • This Week: No holding
  • Long-Term Positioning: Bearish

Emerging Markets

  • Previously: “EEM failed at resistance and we sold our exposures to international holdings and return our focus on large cap value for now.”
  • EEM has completed a “head and shoulders” topping pattern and violated support at the 61.8% retracement level. EEM will eventually test previous lows particularly with a sell signal now registered. 
  • EEM is very oversold short-term so use counter-trend rallies to sell into. 
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Sold positions
    • This Week: No position.
    • Stop-loss set at $40
  • Long-Term Positioning: Bearish

International Markets

  • Like EEM, EFA was also sold previously. as we return our focus back to large cap value.
  • EFA is very sold and on a deep sell signal. A reflexive rally is likely back to $65. Use that level to sell into.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: Sold positions
    • This Week: No position.
    • Stop-loss set at $61
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Last week, Russia failed to join OPEC+ in cutting production, and US drillers are producing more than current demand can offset. Drillers have to drill to make revenue to meet their debt obligations, so ultimately this is going to end very badly.
  • We nibbled around the energy sector previously, but with the break of the 2018 lows in oil prices, suggesting we are going to see sub-$40/bbl oil, we were stopped out of our trades.
  • On Friday we sold all energy related assets (AMLP, XOM, RDS.A).
  • We still like the sector from a “value” perspective and expect that we will wind up making a lot of money here. However, we were early, so we are going to step back and look for a better bottom to buy into. 
  • Short-Term Positioning: Bearish
    • Last Week: No positions
    • This Week: Sold All Holdings.
    • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Gold

  • As noted last week: “Gold rallied sharply and broke out to new highs, suggesting there was something amiss with the stock market exuberance. The correction came this past week, confirming Gold’s message was correct.”
  • We previously sold our GDX position (people intensive) but are maintaining our gold position as a hedge to the overall portfolio.
  • We missed our entry on gold last week, as we never worked off the overbought condition enough. But support at $147.50 held.
  • Our positioning looks good, and if we get some follow through next week on a “reflexive rally,” it should allow us another opportunity to add to our positions. 
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss for profits adjusted to $142.50, Look to buy at $147.50
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Previously we stated: “As with Gold, Bonds were also suggesting something was amiss with the market. Bonds broke out to new highs this past week, and after adding exposure previously, the rally was a welcome hedge against stock market volatility.
  • While we sold our small position in TLT previously, the rest of our bond holdings have done the work of supporting the portfolio. 
  • Carl Swenlin at Decision Point agrees with our view: ““Price has accelerated into a parabolic advance, so we should be alert for a breakdown very soon. That doesn’t mean that we’ll see a complete collapse, but it is not likely that this vertical ascent will be maintained.”
  • We agree. Bonds are getting “stupid” overbought which suggests there is plenty of “fuel” for a pretty vicious “reflex rally” in stocks. At 5-standard deviations you are going to see a reversal in rates back to $150-152 on TLT. This is will be your next entry point to buy bonds and sell stocks.
  • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Holding positions.
    • Stop-loss is moved up to $142.50
    • Long-Term Positioning: Bullish

U.S. Dollar

  • As noted previously: “This past week, the dollar surged through that resistance and is now extremely overbought short-term. Looking for a reflexive rally in stocks next week that pulls the dollar back towards the breakout level of last week.”
  • The early week rally in stocks pulled the dollar sharply lower and has now corrected a large chunk of the 3-standard-deviation extension to the upside. With the dollar back to oversold, it should find support near current levels to help support a reflexive rally in equities.
  • The dollar is close to triggering a sell signal, so be cautious with positioning, there is risk down to the 38.2% retracement level.

Shedlock: Supply And Demand Shocks Coming Up

Dual economic shocks are underway simultaneously. There are shortages of some things and lack of demand for others.

Rare Supply-Demand Shocks

Bloomberg has an excellent article on how the Global Economy Is Gripped by Rare Twin Supply-Demand Shock.

The coronavirus is delivering a one-two punch to the world economy, laying it low for months to come and forcing investors to reprice equities and bonds to account for lower company earnings.

From one side, the epidemic is hammering the capacity to produce goods as swathes of Chinese factories remain shuttered and workers housebound. That’s stopping production of goods there and depriving companies elsewhere of the materials they need for their own businesses.

With the virus no longer contained to China, increasingly worried consumers everywhere are reluctant to shop, travel or eat out. As a result, companies are likely not only to send workers home, but to cease hiring or investing — worsening the hit to spending.

How the two shocks will reverberate has sparked some debate among economists, with Harvard University Professor Kenneth Rogoff writing this week that a 1970s style supply-shortage-induced inflation jolt can’t be ruled out. Others contend another round of weakening inflation is pending.

Some economists argue that what’s happened is mostly a supply side shock, others have highlighted the wallop to demand as well, to the degree that the distinction matters.

Slowest Since the Financial Crisis


Inflationary or Deflationary?

In terms of prices, it’s a bit of both, but mostly the latter.

There’s a run on sanitizers, face masks, toilet paper ect. Prices on face masks, if you can find them, have gone up.

But that is dwarfed by the demand shock coming from lack of wages for not working, not traveling, not eating out etc.

The lost wages for 60 million people in China locked in will be a staggering hit alone.

That has also hit Italy. It will soon hit the US.

Next add in the fear from falling markets. People, especially boomers proud of their accounts (and buying cars like mad) will stop doing so.

It will be sudden.

Bad Timing

Stockpiling

Deflation Risk Rising

Another Reason to Avoid Stores – Deflationary

Hugely Deflationary – Weak Demand

This was the subject of a Twitter thread last week. I agreed with Robin Brooks’ take and did so in advance but I cannot find the thread.

I did find this.

Deflation is not really about prices. It’s about the value of debt on the books of banks that cannot be paid back by zombie corporations and individuals.

That is what the Fed fears. It takes lower and lower yields to prevent a debt crash. But it is entirely counterproductive and it does not help the consumer, only the asset holders. Fed (global central bank) policy is to blame.

These are the important point all the inflationistas miss.