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Michael Markowski: Stock Market Relief Rally High Extended

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The date range for the SCPA’s forecasted relief rally highs for stock markets of the US, Japan, Germany, France, South Korea, and Canada to occur has been adjusted. Based on the adjustment the SCPA’s new 100% statistical probability is that the relief rally highs from the March 2020 lows have been reached or will be reached by April 14, 2020.  Prior to the adjustment, the probability was 100% that relief rally high had been reached on or prior to Friday, April 3, 2020.

The adjustments were required when it was discovered that the empirical data for the Dow Jones Industrial’s index included Saturday trading sessions. From 1871 to 1952 the US market was open for trading on Saturdays. The inclusion of the Saturdays’ data distorted the SCPA’s date-of-event-to-occur forecasts since they increased the empirical data points for the researched periods by 20%. 

All of the event forecast dates by the SCPA (Statistical Crash Probability Analysis) which have been published are in the process of being revised. The only exception is that the final bottom for the Crash of 2020 will occur in Q4 2022 with a decline of 79% to 89% below 2020 highs. None of the previously published interim lows, highs, and final bottom percentages or price targets have changed.

As of Friday, April 3, 2020, all eight of the indices of the six countries had increased by a minimum of 18% from their March 2020 lows.  The SCPA had forecasted on March 24th that the probability for each of the eight indices to increase by 18% was 100% and that the probability of a 23% increase was 50%.  As of today’s April 6, 2020, close the Dow Jones Industrials composite became the first index to reach the 23% threshold with a gain of 24.5%.

My prediction is that the S&P 500’s secular bull market which began in March 2009 ended on February 19, 2020.  The ninth secular bear since 1802 began on February 20th.   Based on the peaks of the last three secular bull markets as compared to the troughs of the three most recent secular bears, the S&P 500 could decline by an additional 47% to 80% from its March 6, 2020 close.

Read my March 31, 2020, article entitled “Embrace the Bear” to learn about:

  • investing strategies that are best utilized during bear markets
  • investing in ETFs which go up when the market goes down
  • algorithms including the Bull & Bear Tracker and SCPA ’s which are being utilized by investors

Michael Markowski: Markets Now At Tipping Point, Ride Will Be Epic.

 Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The market indices of the US, Japan, South Korea, Canada, France and Germany and the share prices for many of the world’s largest companies including Apple and Microsoft are at the tipping point.  Stocks and indices reached their post-crash and relief rally closing highs from March 25th through March 27th.

None of the indices for the six countries has since closed above their highs.  Since making their relief rally highs all eight of the indices have declined by 4.2% to 7.4%.

With each new passing day that the indices are unable to get new post-crash highs, the probability increases that they will careen back to and through their March 2020 lows.

Investors now need to make a decision; stay in the roller coaster or get out?

From my empirical research on the prior notable market crashes in early March 2020, I discovered that the 1929 crash and the bursting of the NASDAQ dotcom bubble in 2000 share the same genealogy as the crashes of the markets of the six countries which have been underway.  The discovery was significant. It enabled the events chronology throughout the lives of the 1929 and 2000 crashes to be utilized to forecast the events for the crashes of six countries which are now underway and future crashes. For more about the genealogy read 03/23/20 “Probability 87% that market is at interim bottom” article.

The table below contains the first four precisely accurate forecasts that were made from the statistical crash probability analysis’ (SCPA).  The SCPA was developed from the findings from my empirical research of the most notable market crashes since 1929.

The charts below depict the almost identical chronology for the post-crash events that occurred after the Dow Jones crashed in 1929 and the NASDAQ dotcom bubble burst in 2000.  The journey to the final bottom took the Dow 32 months and the NASDAQ 31 months. The NASDAQ declined by 78% and the Dow by 89% from their highs.

The “2020”, year to date charts of the US’ Dow Jones, S&P 500 and NASDAQ indices below depict their crash chronologies from February 20th through March 27th.  Again, the chronologies of the 2020 crashes and the 1929 Dow and 2000 NASDAQ crashes though their initial correction and relief rally periods are very similar.

It was no surprise that the chart patterns for Microsoft and Apple mimic the three US indices.  The two companies are the largest members of all three. Since they have significant index weightings, wherever the indices go, they will follow.

The above charts and tables provide the rationale as to why the eight indices of the six countries will soon begin their marches to the following in sequence:

  • new lows 
  • interim bottoms 
  • interim highs 
  • final bottoms in Q4 2022 with declines ranging from 78% to 89% below 2020 highs

According the Statistical Crash Probability Analysis’ (SCPA) forecasts the probability is 100% that:

  • The relief rally highs for markets of the six countries have either already occurred or will occur by Friday, April 3, 2020.  
  • The eight indices will reach new 2020 lows by April 30, 2020.

To be clear.  Those who are still invested in stocks, mutual funds, and ETFs need to give serious consideration as to whether or not they want to stay on the wild roller coaster.  The ride will take everyone to the interim bottoms which will be within 41% to 44% of the eight indices’ 2020 highs.

After reaching the bottom the indices will then ricochet back to and through the recent relief rally highs and to the post-crash highs according to the SCPA’s forecast.  What will likely power the heart-pounding ride to the top is news about a cure or vaccine for the Coronavirus. This is will enable those who choose to stay on the rollercoaster to be able to liquidate at higher prices.  After the post-crash high has occurred the SCPA’s probability is 100% that the indices will then reverse to begin their descents to the final bottom which will 79% below their 2020 highs. The probability is 50% for the bottom to be within 89%

The virus did not cause the crash.   It caused the correction for markets which were ripe for an epic market crash.  Therefore, the probability is extremely low that good news about the virus will be enough to drive the markets back to new all-time highs.  See my March 5, 2020 article “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!”.

The SCPA is also forecasting a 100% probability for the key on the horizon events of the crash of 2020 below to occur in the sequence below.  The events and their probabilities are applicable to the eight indices of the six countries and for their largest members including Microsoft and Apple, etc.

  • Interim bottom by or before May 4, 2020
  • At interim bottom market will be 41% to 44% below 2020 highs
  • Post-crash high before the journey begins to final Q 4 2022 bottom will occur by as early as June 24, 2020 and by as late as September 18, 2020.
  • Post-crash highs to get market to within 17% of 2020 highs.

My only argument with the SCPA’s statistical probability analyses is can the markets get back to above or even to their March/April 2020 post-crash relief rally highs?  The simultaneous crashes in multiple markets for more than one country, let alone six countries, is historically unprecedented.

My hunch is that the damage to the markets and economies of the world’s leading developed countries will be much more severe than the damage caused by the 1929 crash.  The relief rally highs could prove to be the post-crash highs.

Should the recent highs be the post-crash highs, according to the SCPA the probability is 100% that it will take the markets a minimum of 15 years to get back above the highs reached during the week ended March 27, 2020.  Additionally, the findings from my extensive research on all of the secular bear markets since 1929 further support the SCPA’s forecast.

In addition to my empirical research of notable crashes, I also have been conducting empirical research on the Dow’s biggest one day gains from 1901 to 2020.  Based on my findings the probability is 94.4% that the Dow’s media sensationalized gains for the week ended March 27, 2020 were bear market rallies. See, “The TRUTH about Dow’s ‘… one day jump since 1933”.

Everyone should take advantage of markets being in close proximity of their post correction highs to exit the markets.  All mutual funds and stocks over $5.00 per share should be liquidated. I will provide my rationale for holding and also for buying low priced and penny shares in a future article.  My suggestion is to utilize a methodical approach by liquidating 20% of all holdings per day from April 1st to April 8th.

There are only three reasons why anyone would want to hold on to their stocks and mutual funds:

  1. Waiting to get back to break even.  It’s against human nature to take losses.  I knew investors in the 1970s who had been waiting for 10 to 20 years for a blue chip to get back to their purchase price.  Bite the bullet.
  2. Not wanting to pay capital gains.  Securities with gains can be “sold short against the box” to delay a taxable capital gain.   Capital gains taxes will only go up from here.
  3. Financial advisor advising otherwise.  Beware of the following:

a) An advisor’s largest percentage fee that can be charged is for the amount that an investor has in stocks.  If the investor is in cash the advisor can-not charge the fee.

b) The majority of financial advisors are affiliated with big brand name firms including Merrill Lynch, Morgan Stanley, Goldman Sachs and UBS, etc.  These advisors have to follow the party line. They do not have the independence to get their clients out of the market even if they wanted to.

c) The financial services industry utilizes propaganda to keep clients in the market during volatile periods.  Read “No One Saw It Coming’ – Should You Worry About The 10-Best Days” by Lance Roberts. He is among a few of the independent advisors who I know which had his clients’ 90% out of the market.

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.

Michael Markowski: Embrace The Bear – Next Leg Down Is Coming

 Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


Investors must embrace the bear. A savvy investor or advisor can generate significantly more profits from a secular bear, than a secular bull.  It’s also much easier to predict the behavior of a wild and vicious bear than a domesticated bull.

The new 2020 secular bear is the first for which an investor can utilize an inverse ETF (Exchange Traded Fund) to invest in a bear market from start to finish. The share price of an inverse ETF increases when a market goes down. The first inverse ETFs were invented in 2007. The new ETFs enabled investors to make significant profits at the end of the 2000 to 2009 secular bear market.  The chart below depicts the gains for the Dow’s inverse ETF before and after Lehman went bankrupt in 2008.

The increased volatility caused by the secular bear can be leveraged by algorithms which had not been utilized in prior bear markets.   Two of my algorithms have the potential to produce substantial gains:

  • Bull & Bear Tracker (BBT) 

From April 9, 2018, and through February 29, 2020, the Bull & Bear Tracker (BBT) trend trading algorithm which trades both long and inverse ETFs produced a gain of 77.3% vs. the S&P 500’s 14.9%.   March of 2020 will be the BBT’s 9th consecutive profitable month.

The Bull & Bear Tracker thrives on market volatility.  The algorithm’s best performance days since the inception of the signals have been when the markets are most volatile.

  • SCPA (Statistical Crash Probability Analysis)

The SCPA is a crash event forecasting algorithm. The algorithm has been very accurate at forecasting the crash of 2020’s events.  The SCPA’s forecast that the market had reached a bottom on March 23rd was precisely accurate.   From 03/23/20 to 0/3/26/20, the Dow had its biggest one-day gain (11.4%) and three-day percentage gain (21.3%) since 1929 and 1931, respectively.  Those investors who purchased the Dow’s long ETF (symbol: DIA) by close of the market on March 23, 2020, after reading “Probability is 87% that market is at interim bottom”  which was published during market hours, had a one day gain of 11% at the close of the market on March 24, 2020.

The SCPA’s future event forecasts throughout the life of the crash of 2020 are being utilized to trade long and inverse ETFs until the US markets reach their final bottoms in the fourth quarter of 2022.  Had the SCPA and inverse ETFs been available to trade the SCPA’s forecasts in 1929, savvy investors would have made more than 572% from December of 1929 through July of 1932. There were 14 Bear market rallies with average gains of 17%.  The rallies were followed by 14 declines which averaged 23%. could have produced average gains of 23% for inverse ETF investors.

Both the Bull & Bear Tracker (BBT) and SCPA complement each other. The BBT predicts market volatility before it increases. The SCPA forecasts the percentage increases for the bear market rallies and the percentage declines from the bear rally highs. My prediction is that the utilization of both of the algorithms will reduce the failed signals ratio for the Bull & Bear Tracker.

Based on the findings from my recently completed empirical research of the Dow’s best rallies from 1901 to 2020, the markets will remain extremely volatile for the foreseeable future.

The Truth About The Biggest One Day Jump Since 1933

The Wall Street Journal’s “Dow Soars More Than 11% in Biggest One-Day Jump Since 1933” was inaccurate.  It should have read since “1929”.  The article should have been about the Dow Jones industrials composite index having its best one day and three-day percentage gains since 1929 and 1931 respectively.

The gain of 21.3% for the Dow’s three-day rally that ended on March 26th was the index’s second best since 1901.  The one-day gain of 11.4% on March 24th ranks as the Dow’s fourth best day since 1901.  To understand the significance of the error read on.

Nine of the top ten three-day percentage gainers occurred during the first four years of the 1929 to 1949 secular bear market.  The Five rallies which occurred before the 1929 crash reached its final bottom on July 8, 1932 all failed. Their post rally declines ranged from 19% to 82%.

Six of the 10 biggest daily percentage increases in the table below for the Dow over the last 120 years occurred from 1929 to 1933.  There were two 2008 secular bear market rallies, October 13 and 28, 2008 among the top ten one day wonders. The losses for both of the one-day 2008 rallies at the March 2009 were 31.1% and 28.7% respectively.

Of the 100 best percentage gain days for the Dow since 1901, 29 of them occurred between the post 1929 crash and the final July 1932 bottom.  From the 1932 bottom to the end of 1933 accounted for an additional 23 of the 100 best days. All of those rallies were profitable. From the low to the end of 1933, the Dow increased by more than 100%.  The only other period or year which had concentrated representation in the top 100 was 2008 which had seven.

The Wall Street Journal’s error is significant since 100% of the top 100 best one day rallies from:

  • October 1929 to July 1932 resulted in significant losses
  • July 1932 bottom to end of 1933 resulted in significant gains

The error has created a false sense of security for investors and especially for investment professionals, who are aware that after the 1929 crash, the Dow bottomed in 1932.   Had the performance for the Dow’s performance cited in the headline been compared to 1929, the context of the article would have been very bearish instead of somewhat bullish.

From my preliminary empirical research findings there were only seven bull market rallies within the top 100 one day percentage gainers. Three of seven  in the table below were represented by 1987 and two by 2009.

The three post 1987 “Black Monday’ crash rallies enabled the secular bull which began in 2002 to resume. To understand why it’s not possible for the secular bull which began in 2009 to resume read my two March 2020 articles below.  The 1987 crash does not share the genealogy of the Dow 1929, NASDAQ 2000 and the 2020 crashes for the markets of the US, Japan, Germany, Canada, France and South Korea which are now underway.

Based on the findings from my empirical research the probability is 94.4% (17/18) that the Dow 2020’s one day and three-day top ten percentage gainers last week were bear market rallies.         

Many are hopeful that the crash which has been underway since February 20, 2020, is just a correction for the continuation of the secular bull market which began in 2009.  Based on my just concluded empirical research of the Dow’s best daily and three-day gains and my previous findings from my prior statistical crash probability analysis, the rationale is in place for the markets to continue to crash.   My deep fear is that the world is on the verge of a 1930’s style economic depression.

Everyone should take advantage of the Bear market rally that is currently underway to exit the market as soon as possible.

  • According to the Statistical Crash Probability Analysis (SCPA) forecast the probability is 100% that the relief rally high has either already occurred or will occur by April 8, 2020.
  • The probability is the same for the markets of the six countries to make new lows by April 30, 2020.

For more about the SCPA click here for access to all of my 2020 crash related articles.  To view the SCPA’s very accurate track record for March 2020 click here.

All mutual funds and stocks over $5.00 per share should be liquidated by April 8th. My suggestion is to utilize a methodical approach by liquidating 20% of all holdings per day from April 1st to April 8th.

The SCPA is also forecasting the probability is 100% for the coming attractions from the crash of 2020:

  • Interim bottom by or before May 4, 2020
  • At interim bottom market will be 41% to 44% below 2020 highs
  • Post-crash high before the journey begins to final Q 4 2022 bottom will occur from June 24, 2020 to September 18, 2020.
  • Post-crash highs to get market to within 17% of 2020 highs.

My only argument against the SCPA’s statistical probability analyses is can the markets get back to above, or even to their March/April 2020 post-crash relief rally highs?  The simultaneous crashes in multiple markets for more than one country, let alone six countries, is historically unprecedented.

My hunch is that the damage to the markets and economies of the world’s leading developed countries will be much more severe than the damage caused by the 1929 crash.  The relief rally highs could prove to be the post-crash highs.

If that proves to be the case, according to the SCPA the probability is 100% that it will take the markets a minimum of 15 years to get back above the highs already made by the relief rally and longer to get back to their post-crash highs. Additionally, the findings from my extensive research on all of the secular bear markets since 1929 further support the SCPA’s forecast.

There are only three reasons why anyone who is reading my articles would not to sell:

  1. Waiting to get back to break even.  It’s against human nature to take losses.  
  2. Not wanting to pay capital gains.  Securities with gains can be “sold short against the box” to delay a taxable capital gain,
  3. Financial advisor advising otherwise.  Beware of the following:

a) An advisor’s largest percentage fee that can be charged is for the amount that an investor has in stocks.  If the investor is in cash the advisor can-not charge the fee.

b) The majority of financial advisors are affiliated with big brand name firms including Merrill Lynch, Morgan Stanley, Goldman Sachs and UBS, etc.  These advisors have to follow the party line. They do not have the independence to get their clients out of the market even if they wanted to.

c) The financial advisor industry utilizes propaganda to get clients to remain invested during volatile periods. Read “No One Saw It Coming’ – Should You Worry About The 10-Best Days” by Lance Roberts. He is among a few of the independent advisors who I know which had his clients’ 90% out of the market.

TPA Analytics: Death Cross On Russell 3000 Signals More Pain To Come

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


TPA Analytics: Time To Buy CLX, KR, & MRK

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


The market has had a great 2-day rally, but the Coronavirus will be with us for a while. It is time to go back to stocks that outperformed when the market sank in February and March. The 3 stocks below (CLX, KR, and MRK) have declined recently, but were huge outperformers as the S&P500 dropped over 33%.

CLX – broke out above 15-month resistance in late February as the crisis began in earnest. CLX was the 8th best performer in the S&P1500 between 2/19/20 and 3/23/20. During that period CLX was up 5.25%, while the S&P500 was down 33.92% (see table below). CLX is down 23% in the past 5 days and is right back to the February breakout level, which should be support. TPA’s target is +20%.

CLX CLOROX CO 165.6600 Stop = 156.5487 Target = 198.7920

KR – rose above its 3 ½ year downtrend line in December. KR was the 10th best performer in the S&P1500 between 2/19/20 and 3/23/20. During that period KR was up 3.2%, while the S&P500 was down 33.92% (see table below). KR is down 18% in the past 4 days and is right back the breakout level, which should be support. TPA notes that the ratio of KR/S&P500 also broke out long term and short term and is at support; so it should outperform from here.

KR KROGER CO 27.9400 Stop = 26.4033 Target = 33.5280

MRK – is down 26% from its high on 12/20/19. It was one of the top 70 best performing stocks in the S&P1500 as the S&P500 fell 33.92% from 2/19/20 to 3/23/20. MRK was only down 19.2% (see table below). MRK is now all the way back to its breakout level from August 2018, which should be support. RSI analysis on a weekly basis shows that MRK is long term oversold. Chart 3 shows that the previous 3 times that MRK was this oversold on a weekly basis (2011, 2015, 2017) it was a good time to buy.

MRK MERCK & CO 68.2200 Stop = 64.4679 Target = 81.8640


Michael Markowski: Why You Should Sell The “Bear Market Rally.”

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


In yesterday’s “Crash events forecasting also accurate at calling market tops and bottoms”, March 24, 2020, article the statistical crash probability analysis (SCPA) algorithm forecasted that the probability was 100% that the stock indices for the US, Japan, Germany, South Korea, and France would rally by at least 18% from their 2020 lows.  At the close of the US markets on March 25, 2020, an index in each of the six countries had rallied by a minimum of 18% off of their lows.

The rallies of 18% from the lows for the six countries is the fourth consecutive precisely accurate forecast by the SCPA.  Prior forecasts are contained in table below:

The probability is now 50%:

  • That the indices will increase by 23% from their 2020 lows during their relief rallies
  • That the high for the relief rallies has occurred 

SCPA’s April forecasts and probabilities:

  • 100%- relief rally will peak by April 8, 2020
  • 100%- 2020 low will be breached by April 30, 2020

SCPA’s long term 100% probability forecast is for all eight of the global indices to bottom between September and November of 2022.  The probability is 100% for the markets of the countries to decline by a minimum of 79% below their 2020 highs and 50% for 89% below 2020 highs.  

Everyone should take advantage of the Bear market rally that is currently underway to GET OUT OF THE MARKET!   The bear who has arrived could potentially be more vicious than the 1929 bear market.

Since the indices have all rallied to within 18% to 27% of their 2020 highs, buy and hold investors and advisors should give serious consideration to take advantage of any rallies to liquidate holdings.  The Bull & Bear Tracker, which is a trend trading algorithm, could be utilized to quickly recoup losses of 30% for investments that are liquidated and also any capital gains taxes that might be owed.  

The Bull & Bear Tracker’s average gain has been above 5% per month since July of 2019.   Since its first signal was published on April 9, 2018, and through the end of February 2020, the gain was 77.3% vs. 14.9% for the S&P 500.  The Bull & Bear Tracker is projecting double digit gains for March 2020 while the S&P 500 will most likely have double digit losses.   For more about the Bull & Bear Tracker’s performance go to https://bullbeartracker.com/news/.

An investor can only allocate capital to be traded by the Bull & Bear Tracker though an approved registered investment advisor.  The investment advisor could also be utilized for an investor to get the maximum proceeds from liquidating their investments.

Michael Markowski: Why You Should Sell The “Bear Market Rally.”

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The statistical crash probability analysis (SCPA) algorithm’s forecast for an interim market bottom to occur on March 23, 2020, was precisely accurate.  It was the algo’s third consecutive precise major global markets call for March of 2020.

The day after the “Probability is 87% that market is at interim bottom” article was published on March 23, 2020, the Dow Jones Industrials composite index rallied by 11.4%, its biggest one day percentage increase since 1933.  Additionally, Canada’s TSE index set an all-time record with a gain of 12.7%. Below are the gains for all of the global stock indices in the article.

According to the SCPA in the articles below the indices were forecasted to decline by 34% from their 2020 highs by March 21, 2020.

As of March 23, 2020, six of the indices had declined by more than 34%! 

The SCPA now says that the probability is 100% that the indices will rally by 18% off of the lows.  The probability is 50% that the indices could increase by 23% from their lows.

Everyone should take advantage of the Bear market rally that is currently underway to GET OUT OF THE MARKET!   The bear that has arrived could potentially be more vicious than the 1929 bear.  

SCPA’s April forecasts:

  • 100%- relief rally will peak by April 8, 2020
  • 100%- 2020 low will be breached by April 30, 2020

SCPA’s long term forecast is for all eight of the global indices to bottom between September and November of 2022.  At the bottom the minimum decline will be 79% below the 2020 highs.

Since the indices have all rallied to within 30% of their 2020 highs, buy and hold investors and advisors should give serious consideration to take advantage of any rallies to liquidate holdings.  The Bull & Bear Tracker, which is a trend trading algorithm, could be utilized to quickly recoup losses of 30% for investments that are liquidated and also any capital gains taxes that might be owed.  

The Bull & Bear Tracker’s average gain has been above 5% per month since July of 2019.   Since its first signal was published on April 9, 2018, and through the end of February 2020, the gain was 77.3% vs. 14.9% for the S&P 500.  The Bull & Bear Tracker is projecting double digit gains for March 2020 while the S&P 500 will most likely have double digit losses.   For more about the Bull & Bear Tracker’s performance go to https://bullbeartracker.com/news/.

An investor can only allocate capital to be traded by the Bull & Bear Tracker though an approved registered investment advisor.  The investment advisor could also be utilized for an investor to get the maximum proceeds from liquidating their investments.

 

TPA Analytics: Not All Pieces In Place For A Sustained Rally

Jeffrey Marcus is the President of Turning Point Analytics. Turning Point Analytics utilizes a time-tested, real world strategy that optimizes client’s entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. For more information on TPA check out: http://www.TurningPointAnalyticsllc.com


Michael Markowski: 87% Probability The Markets At An Interim Bottom

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


 

Based on my crash statistical probability analysis the probability is 87.5% that the stock markets of the US and the five other leading developed countries, which have been crashing since February 20, 2020, have reached an interim bottom.  

If the interim bottom has been made the statistical probability is 100% that the stock markets of the US, Japan, Germany, Canada, South Korea and France will experience powerful interim rallies that will result in double digit percentage gains as compared to their 2020 lows.  This will occur within days of the interim low being made. What will likely drive the rallies for all of the markets before they reverse to plumb to new lows is the US Congress passing a virus stimulus plan. A deceleration of the growth rate of new Coronavirus cases could also result in a quick and powerful relief rally.   

The probabilities and percentage increase targets in the above paragraphs were derived from my crash statistical probability analysis.  The analysis was explained in two of my recent articles which warned my readers to get out of the market.  As of March 23, 2020, the S&P had declined by 26% as compared to its closing price at March 6, 2020:

US Stock Market to decline by another 22% by Easter”, March 6, 2020

 “2020 Crash is third ‘Category 5 Hurricane’ in 90 years! Get out of market today!”, March 9, 2020

The new 2020 low made by the S&P 500 for today, March 23rd was poignant and increased the probability from 75% to 87.5% that the markets are near their interim bottoms.  It’s because the S&P 500 broke through the crash probability analysis’s 34% correction threshold. My articles of March 6th and March 9th explained the threshold’s significance.  The articles also made two very precise predictions for the markets of the crash inflicted countries that were relative to the threshold:  

  • 34% declines from their 2020 highs
  • declines to occur by March 21, 2020

When the predictions were published on March 6th, the corrections from their 2020 highs had ranged from 11% to 17%.  By March 18th, an index for each of the six countries had declined to or through the 34% threshold. South Korea and France were added after both of the articles were published.  However, two of the US’ indices, the S&P 500 had not corrected by 34%. The S&P 500 breached the threshold as of today (3/23/20) and got to 35.4% below its 2020 high. The NASDAQ’s correction from its 2020 high is at 33.0%.

Upon the markets for the countries reaching their initial post-crash highs the probability is also 100% that they will then reverse and then decline by 52% from their 2020 highs.  The steep declines to lower lows will occur by April 30, 2020. 

My ability to make such precise and accurate predictions is from my experience at conducting empirical research on extreme market anomalies that I have witnessed throughout my 42-year career.  The findings from my research are used to develop and power predictive algorithms which are utilized to predict similar extreme events in the future. The table below contains my algorithms which protect investors and enable them to make money in volatile and bear markets.

If it is not already, the 2020 crash will be recognized by historians as the most infamous stock market crash.  It’s the grand-daddy of all market crashes. The markets of more than one country beginning their crashes simultaneously after reaching all-time highs, then beginning their crashes the very next day is unprecedented.  The markets of three countries, Germany, Canada and the US reached all time highs on February 19, 2020. They then began their violent corrections that became crashes on February 20th, the very next day.

Since February 28th I have been working 18 hours a day to conduct empirical research on the five most infamous US stock market crashes listed in the table below.  My efforts yielded a significant breakthrough. The two crashes, which were by far the most lethal, 1929 and 2000 had the same genealogy as the crashes that have been underway for the six developed countries since February 20, 2020. The history for the two crashes was virtually identical   For example, the Crash of 1929 bottomed after 32 months and the NASDAQ 2000 bottomed after 31 months.

Based on my ongoing empirical research efforts regarding these same six countries, the statistical probability is 100% for the following events:  

  • The markets will have declined by a minimum of 79% when they bottom.  
  • The markets will bottom in fourth quarter of 2022.
  • It will take at least 15 years for the markets to return to their 2020 highs.  

My follow on article dated March 9th “2020 Crash is third ‘Category 5 Hurricane’ in 90 years! Get out of market today!”, was about the 2020 crash being equivalent to a “Category 5” designation which is assigned to only the most intense hurricanes.  To elaborate on this article, the discovery of the genealogy, statistical probabilities and pathology to identify lethal market crashes are analogous to a hurricane’s genealogy, statistical probabilities and pathology.

Unlike the stock market which has 100 years of available data, the ability to conduct empirical research on hurricanes only became available after the first plane few into the eye of a hurricane in 1943 to collect its barometric pressure.   Since then, the forecasting of hurricanes has become increasingly accurate. The intensity, geographical location and arrival times for a hurricane are very predictable. The result has been a significant reduction in hurricane fatalities.

The same forecasting can now be done for market crashes.  Instead of comparing barometric pressure readings, the Statistical Probability Analysis measures the degree of price volatility for market corrections which have the potential to become devastating crashes.   For a market to have the same genealogy as the 1929, 2000 and 2020 crashes, it must reach a specified percentage decline threshold within a consecutive-daily-declines period.   

The chart below covers four NASDAQ crashes.  The 2000 and 2020 category 5s experienced minimum corrections of 10% within days of their all-time highs.   The 2018 crash is not a Category 5 since its initial decline was less than 10%. Finally, the 2008 crash unlike the other three, did not occur after an all-time new high.  The NASDAQ and the S&P 500 peaked in October 2007.

The chart patterns for the indices of the five other countries including Japan, Canada, South Korea and France from February 19th to February 28th are almost identical.  The patterns for the Dow 1929 and the NASDAQ 2000 indices for the week to 10-day periods prior to their corrections becoming crashes were eerily similar.   

Deep research into the post-crash-to-the-final-bottom history for the 1929 and 2000 crashes enabled the identification of shared statistical probabilities and patterns.   The findings were then utilized to develop the indicated pathology for crashes of 1929, 2000 and 2020 as well as the projected pathology for all future crashes which have the same genealogy.  

The pathology and statistical probability analyses are now in the process to be programmed as crash tracking and post event forecasting algorithm.  The algorithm will monitor all markets which are ripe for a crash. It will automatically issue get-out-of-market warnings for future crashes. Finally, and most importantly, the crash tracking algorithm will forecast the following events and additional events as they unfold organically and after a crash has commenced:    

  • Interim low date range and target: enable those with cash to buy the market at the low and sell at the interim high before market reverses to make its final bottom 
  • Interim high date range and target: enables those who did not get out to sell out at higher prices 
  • final bottom and date range for final bottom:  enables long term by and hold investors to invest in something else while waiting for a bottom and reduces risk of buying prematurely and before bottom occurs 
  • number of years for a market that has endured a devastating crash to exceed pre-crash all-time high  

We are currently working as fast as we can to get a website developed for the algorithm. The event forecasts for the 2020 crashes needs to be available to all investors as soon as possible. My fear is that the declines for the markets of these six countries could happen much faster and be much deeper than the 1929 and 2000 crashes.  The probability of the first worldwide economic depression ever could occur.   

In the meantime, it is highly recommended that investors immediately engage a registered investment advisor (RIA) to assist in liquidating securities at the highest prices.  This will enable losses to be minimized. Time is of the essence. Many of the stock market’s biggest spikes over the past 100 years have occurred after crashes and at the beginning of secular bear markets.  

Michael Markowski: Dip Buyers, Beware Of Sensational Headlines

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk.Read more at BullsNBears.com


Many investors are salivating to trade the dips in a stock market which is becoming increasingly more volatile.  It’s because Wall Street for the week ended March 13th according to the headlines had its worst week since 2008.  Its human nature to want to buy at fire sale prices.     

March 13, 2020 headline:

After Worst Week Since 2008, What’s Next For The Stock Market?” , Benzinga March 13, 2020 

Investors became conditioned to buy the dips after the record setting 2008 crash.  The S&P 500 made a quick recovery after crashing down by 40% within six months to its lowest level since 1996 after Lehman declared bankruptcy in September 2008.  

Those who jumped in the last time the markets had their worst week since 2008, the week ended February 28, 2020, lost 8.2% in 10 days based on the S&P 500’s March 13th close.   Secular bear markets are famous for producing one sensational headline after another as a market continues to reach new lows.        

February 28, 2020 headline:

Wall Street has worst week since 2008 as S&P 500 drops 11.5%”, Associated Press February 28, 2020

From September 12, 2008, the last market close prior to Lehman’s bankruptcy to the bottom of the 2000 to 2009 secular bear market which began in 2000 and ended on March 9, 2009:

  • Passive buy and hold investors lost 39%
  • bullish traders who precisely got in at all bottoms and sold at tops made 136.5%
  • bearish traders who precisely sold short at all tops and bought the shares back at all bottoms made 162.3%

What likely happened due to the extreme volatility as depicted in the chart below most non-professional traders lost money.   Buy and hold bargain hunters who bought during the first five months after the 2008 crash began lost a minimum of 20%. From February 9, 2009, which was five months after the decline began, to the March 9th final bottom the market declined by an additional 22%.

The table below reinforces the difficulties that anyone but a professional investor had to make money from the 2008 crash.  $100 traded from September 12th to March 2009, would have declined to $74.20 at the 2000 secular bear’s final bottom.

The current market is much riskier than the 2008 market for dip buying.  Instead of being at the bottom of secular bear, the chart below depicts that the S&P 500 has been in a secular bull market since 2009.  In my March 5th article when the S&P 500 was 10% higher included my prediction that the secular bull likely reached its all-time high on February 19, 2020 and the secular bear began the very next day on February 20, 2020.

Based on my recent empirical research findings from analyzing prior crashes which have similar traits as the crash of 2020, the probability is high that the decline from the top to the bottom will be from 79% to 89%.  The final bottom will be reached between October and December of 2022. 

BullsNBears.com which covers all of the emerging and declining economic and market trends is an excellent resource site.  Click here to view one-minute video about the site.   

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.”

Profits & Earnings Suggest The Bear Market Isn’t Over.

Is the bear market over yet?

This is the question that everyone wants to know. Why? So they can “buy the bottom.” 

For that reason alone, I would suggest the current “bear market” is not over yet. Historically speaking, at the bottom of bear market cycles, as we saw in 1932, 1974, 2002, and 2008, there are few individuals willing to put capital at risk.

Given the large number of people on social media clamoring to jump back in the market given the rally this past Friday, it suggests that “optimism,” and “recency bias,” are still far too prevalent in the market.

As noted in this past weekend’s newsletter, Bob Farrell, a legendary investor, is famous for his 10-Investment Rules to follow.

“Rule #8 states:

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.

While the correction has been sharp in recent weeks, it hasn’t inflicted enough “emotional pain” to deter individuals from jumping back in. As I stated:

“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 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.

That’s how you know a “bear market” is over.

Price To Profits & Earnings

From an investment view, I prefer more data-driven analysis to determine if the current bear market is over.

In a previous post, I discussed the deviation of the stock market from corporate profitability. To wit:

“If the economy is slowing down, revenue and corporate profit growth will decline also. However, it is this point which the ‘bulls’ should be paying attention to. Many are dismissing currently high valuations under the guise of ‘low interest rates,’ however, the one thing you should not dismiss, and cannot make an excuse for, is the massive deviation between the market and corporate profits after tax. The only other time in history the difference was this great was in 1999.”

It isn’t just the deviation of asset prices from corporate profitability which is skewed, but also reported earnings per share.

As I have discussed previously, the operating and reported earnings per share are heavily manipulated by accounting gimmicks, share buybacks, and cost suppression. To wit:

“It should come as no surprise that companies manipulate bottom-line earnings to win the quarterly ‘beat the estimate’ game. By utilizing ‘cookie-jar’ reserves, heavy use of accruals, and other accounting instruments they can mold earnings to expectations.

‘The tricks are well-known: A difficult quarter can be made easier by releasing reserves set aside for a rainy day or recognizing revenues before sales are made, while a good quarter is often the time to hide a big ‘restructuring charge’ that would otherwise stand out like a sore thumb.

What is more surprising though is CFOs’ belief that these practices leave a significant mark on companies’ reported profits and losses. When asked about the magnitude of the earnings misrepresentation, the study’s respondents said it was around 10% of earnings per share.’

cooking-the-books-2

This is also why EBITDA has become an ineffective measure of financial strength. As I noted in “Earnings Lies & Why Munger Says EBITDA is B.S.:”

“As shown in the table, it is not surprising to see that 93% of the respondents pointed to ‘influence on stock price’ and ‘outside pressure’ as the reason for manipulating earnings figures. For fundamental investors, this manipulation of earnings skews valuation analysis particularly with respect to P/E’s, EV/EBITDA, PEG, etc.”

As Charlie Munger once said:

“I think that every time you see the word EBITDA, you should substitute the word ‘bullshit’ earnings.”

Corporate Profits Weaker Than Advertised

Before the recent market rout, the deviation between reported earnings and corporate profits is one of the largest on record. This is an anomaly that should, in reality, not exist.

However, it is worse than it appears.

There is an interesting company included in the calculation of corporate profits, which is not widely recognized in most analysis. If you are an astute follower of our blog, you may recognize this particular company by the size of their balance sheet as shown below.

Yes, you guessed it (and it’s in the title). It’s the Federal Reserve.

When the Treasury Department pays interest one the debt, an expense to the U.S. Government, the Federal Reserve takes that in as “profits” which is reported on their balance sheet. Then, at the end of the year, the Fed remits a portion of the “revenue” back to the Government (who also count it as revenue).

These profits,” which are generated by the Federal Reserve’s balance sheet, are included in the corporate profits discussed here. As shown below, actual corporate profitability is weaker if you extract the Fed’s profits from the analysis.

It’s quite amazing, and with the Fed massively increasing their balance sheet, their profitability will expand further.

Nonetheless, since the Fed’s balance sheet is part of the corporate profit calculation, we must include them in our analysis. While the media is focused on record operating profits, reported corporate profits are roughly at the same level as they were in 2011. Yet, the market has been making consistent new highs during that same period.

Estimating The Risk

The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to “remain irrational longer than logic would predict,” but it never lasts indefinitely.

Profit margins are probably the most mean-reverting series in finance, and if profit margins do not mean-revert, then something has gone badly wrong with capitalism. If high profits do not attract competition, there is something wrong with the system, and it is not functioning properly.” – Jeremy Grantham

The impending recession, and consumption freeze, is going to start the mean-reversion process in both corporate profits and earnings. In the following series of charts, I have projected the potential reversion.

The reversion in GAAP earnings is pretty calculable as swings from peaks to troughs have run on a fairly consistent trend. (The last drop off is the estimate to for a recession)

Using that historical context, we can project a recession will reduce earnings to roughly $100/share. The resulting decline asset prices to revert valuations to a level of 18x (still high) trailing earnings would suggest a level of $1800 for the S&P 500 index.

Let me suggest that I am not being “overly dramatic” or “super bearish.”  There is a good bit of data to support the thesis. As I noted on Twitter, you can pick your valuation range, and do the math.

Don’t believe me?

We can support that thesis with corporate profits.

If we look at inflation-adjusted profit margins as a percentage of inflation-adjusted GDP, we see the same process of mean-reverting activity over time. Of course, these mean reverting events are always coupled with recessions, crisis, or bear markets.

More importantly, corporate profit margins have physical constraints. Out of each dollar of revenue created, there are costs such as infrastructure, R&D, wages, etc. Currently, one of the biggest beneficiaries to expanding profit margins has been the suppression of employment, wage growth, and artificially suppressed interest rates, which have significantly lowered borrowing costs. The oncoming recession will cause a rather marked collapse in corporate profitability as consumption declines.

The chart below shows corporate profits overlaid against the S&P 500 index. As with GAAP Earnings in the chart above, I have projected the potential reversion in corporate profitability as well.

When we measure the cumulative change in the S&P 500 index as compared to the level of profits, we find again that when investors pay more than $1 for a $1 worth of profits, there is an reversal of those excesses

 The correlation is clearer when looking at the market versus the ratio of corporate profits to GDP. Again, since corporate profits are ultimately a function of economic growth, the correlation is not unexpected.  Hence, neither should the impending reversion in both series.

To this point, it has seemed to be a simple formula that as long as the Fed remains active in supporting asset prices, the deviation between fundamentals and fantasy doesn’t matter. It has been a hard point to argue.

However, what has started, and has yet to complete, is the historical “mean reversion” process which has always followed bull markets. This should not be a surprise to anyone, as asset prices eventually reflect the underlying reality of corporate profitability.

Recessions reverse excesses.

Are we at the bottom yet? Probably not, if history is any guide.

#MacroView: Fed Launches A Bazooka To Kill A Virus

Last week, we discussed in Fed’s ‘Emergency Rate Cut’ Reveals Recession Risks” that while current economic data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

We are likely experiencing more than just a ‘soft patch’ currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.”

The plunge in both 5- and 10-year “breakeven inflation rates,” are currently suggesting that economic growth over the next couple of quarters will drop markedly. The last time there was such a sharp drop in inflation expectations at the beginning of the “financial crisis.”

In the meantime, the markets have been rocked as concerns over the spread of the“COVID-19” virus in the U.S. have shut down sporting events, travel, consumer activities, and a host of other economically sensitive inputs. As we discussed previously:

“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.”

As noted, with the U.S. now shutting down and entrenching itself in response to the virus, the economic impact will be worsened. However, given that economic data is lagging, and we only have numbers that were mostly pre-virus, the reports over the next couple of months will ultimately reveal the extent of the damage.

We suspect that it will be more significant than most analysts currently expect.

With our Economic Output Composite Indicator (EOCI) at levels which have previously warned of recessions, the “timing” of the virus, and the shutdown of activity in response, will push the indications lower.

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a risk of a recessionary drag within the next 6-months.”

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

One reason we are confident the economic data will worsen near term is the correlation between the index and the annual rate of change of the S&P 500 index.

The financial markets lead the economy by about 6-months as markets begin to “price in” changes to earnings due to the outlook for economic strength. The recent plunge in the S&P 500 has deviated from the current EOCI index reading suggesting the index will decline towards recessionary levels over the next few months.

What the chart above obfuscates is the severity of the recent market rout. As shown below, in just three very short weeks, the market has reversed almost the entirety of the “Trump Stock Market” gains since he took office on January 20th.

The estimation of substantially weaker economic growth is not just a random assumption. In a post next week, I am going through the math of our analysis. Here is a snippet.

“Over the last sixty years, the yield on the 10-year has approximated real GDP plus inflation (shown in the chart below). Given this historical fact, we can do some basic math to determine what yields are currently predicting for the U.S. economy currently.”

Doug Kass recently did the math:

“Given ZIRP and QE policies around the globe which has pulled an extraordinary amount of sovereign debt into negative territory coupled with secular headwinds to energy prices, I have assumed that the 10 year yield will fall from 1.0x nominal GDP and average about 0.8x nominal GDP. 

According to my pal Peter Boockvar, the 10-year inflation breakeven (in the tips market) stands at 1.41% this morning:

So, let’s solve for what the market expects Real GDP to be (over the next 1-2 years) with this formula:

10-Year Yield (0.744% Actual) = 0.8x (Real GDP + 1.41% Actual (inflation))

The implied U.S. Real GDP of this equation is now negative — at -0.48%. (This compares to the consensus 2020 Real GDP growth forecast of between +1.75% to +2.00%) It also implies that nominal GDP (Real GDP plus Inflation) will be only about +0.93% – substantially below consensus expectations of slightly above 3%.”

Doug’s estimates were before to the recent collapse in oil prices, and breakeven inflation rates. With oil prices now at $30/bbl and 10-year breakeven rates to 0.9%, the math is significantly worse, and that is what the severity of the recent selloff is telling us. Over the next two quarters, we could see as much as a 3% clip off of current GDP.

This data is not lost on the Federal Reserve and is why they have been taking action over the last two weeks.

The Fed Bazooka

It’s quite amazing that in mid-February, which now seems like a lifetime ago, 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. 

That swing in asset prices has cut the “wealth effect” from the market, and will severely impact consumer confidence over the next few months. The decline in confidence, combined with the impact of the loss of activity from the virus, will sharply reduce consumption, which is 70% of the economy.

This is why the Fed cut rates in an “emergency action” by 0.50% previously. Then on Wednesday, increased “Repo operations” to $175 Billion.

However, like hitting a patient with a defibrillator, the was no response from the market.

Then yesterday, the Fed brought out their “big gun.”  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 sitting on critical long-term trend support.

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

  • Rate cuts? Check
  • Liquidity? Check

For about 15-minutes yesterday, stocks responded by surging higher and reversing half of the day’s losses. Unfortunately, the enthusiasm was short-lived as sellers quickly returned to continue their “panic selling.” 

This has been frustrating for investors and portfolio managers, as the ingrained belief over the last decade has been “Don’t worry, the Fed’s got this.”

All of a sudden, it looks like they don’t.

Will It Work This Time?

There is a singular risk that we have worried about for quite some time.

Margin debt.

Here is a snip from an article I wrote in December 2018.

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. The issue with margin debt, in particular, is that 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.”

Given the magnitude of the declines in recent days, and the lack of response to the Federal Reserve’s inputs, it certainly has the feel of a margin debt liquidation process. This was also an observation made by David Rosenberg:

“The fact that Treasuries, munis, and gold are getting hit tells me that everything is for sale right now. One giant margin call where even the safe-havens aren’t safe anymore. Except for cash.”

Unfortunately, FINRA only updates margin debt in arrears, so as of this writing, the latest margin debt stats are for January. What we do know is that due to the market decline, negative free cash balances have likely declined markedly. That’s the good news.

Back to my previous discussion for a moment:

“When an event eventually occurs, it creates a rush to liquidate holdings. The subsequent decline in prices eventually reaches a point which 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, further triggering further margin calls. Those margin calls will trigger more selling forcing, more margin calls, so forth and so on.

Given the lack of ‘fear’ shown by investors during the recent decline, it is unlikely that the recent drop in margin debt is a function of ‘forced liquidations.’ As I noted above, it will likely take a correction of more than 20%, or a ‘credit related’ event, which sparks broker-dealer concerns about repayment of their credit lines.

The risk to the market is ‘when’ those ‘margin calls’ are made.

It is not the rising level of debt that is the problem; it is the decline which marks peaks in both market and economic expansions.”

That is precisely what we have seen over the last three weeks.

While the Federal Reserve’s influx of liquidity may stem the tide temporarily, it is likely not a “cure” for what ails the market.

However, with that said, the Federal Reserve, and Central Banks globally, are not going to quietly into the night. Expect more stimulus, more liquidity, and more rate cuts. If that doesn’t work, expect more until it does.

We have already reduced a lot of equity risk in portfolios so far, but are going to continue lifting exposures and reducing risk until a bottom is formed in the market. The biggest concern is trying to figure out exactly where that is.

One thing is now certain.

We are in a bear market and a recession. It just hasn’t been announced as of yet.

That is something the Fed can’t fix right away with monetary policy alone, and, unfortunately, there won’t be any help coming from the Government until after the election.

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.

Michael Markowski: Market Will Decline 34% To 77% From Highs

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com

The simultaneous double-digit declines for the stock markets of four of the world’s developed countries from February 20 to February 28, 2020 was not only an historic event; but unfortunately, ominous in that it portends dire financial times ahead.  

Based on empirical data and statistics the probability is 100% that the US, German, Japanese and Canadian stock markets will decline by 34% from their 2020 highs by Easter.  The probability for a 77% decline before exceeding their 2020 highs is 66%.      

What caused the double-digit corrections for the five indices and their soon to be crashes was not the Coronavirus.  It was the bidding up of the shares of the four trillion-dollar valued tech stocks to ridiculous prices. See “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!”, March 5, 2020.

The fact that four of the five indices traded at historic highs on February 19, 2020 is extremely troubling.  Clearly, the crash that will soon occur is not your garden variety crash. See also, my March 5, 2020 article “Overvalued stocks, freefalling US Dollar to soon cause epic market crash!

My predictions, based on my statistical research, on how markets behave after minimum swift corrections of 10% and my 43 years of experience:

  1. All of the indices will decline by a minimum of 34% from their February highs.    
  2. The first worldwide recession has begun.
  3. The US and most of the world’s governments will have to bail out their airlines.
  4. The Secular bull market which began in March 2009 ended on February 19th.  
  5. The 9th secular bear since 1802 began on February 20th.

The stocks markets for countries simultaneously reaching all-time highs and then declining by 10% or more within 10 days is unprecedented.  However, there have been cases of this occurring for the US markets. For all three cases, the corrections became crashes with minimum declines of 34% within two to 25 days after the corrections commenced.

Statistical probabilities for the indices of the four countries based on the 1929, 1987 and 2000 crash statistics: 

  • 100% probability for minimum declines of 34%
  • 66% probability for declines of 44% from 2020 peaks to troughs 
  • 66% probability for declines of 77% before getting back to all-time highs
  • 100% probability it will take 1½ to 25 years before exceeding February 19, 2020 highs  
  • 66% probability that indices will bottom in Q4 of 2022

The significant declines coming for the indices of the four developed countries has increased the likelihood of an epic global market crash.  Crashes which begin in a particular country can become viral and cause crashes in other countries. The 10% plus correction for the Dow Jones composite index, which began on October 5, 1987, is a good example.  The Dow’s correction spread to the Nikkei and its decline of 21% began on October 14, 1987; the day after it reached its all-time high. The interaction between the US and Japanese markets likely fueled the infamous “Black Monday” crash which occurred on October 19, 1987.

The crashes which began for the Dow in 1929 and the NASDAQ in 2000 occurred at the end of secular bulls and the beginning of secular bear markets.  The Dow’s 1987 Black Monday crash caused minimal damage to the secular bull which began in 1982 for two reasons:

  • At the age of five years old, the secular bull was an adolescent.  Since 1802, the minimum lifespan of a secular bull or bear has been eight years.
  • The fall of communism, which began in 1989, helped the 1982-2000, secular bull to climb back above its October 1987 pre-crash high by July of 1989

Since the Dow’s 1987 Black Monday crash occurred two days after the index’s 10% correction, most investors did not have an opportunity to get out.  However, after the 1929 Dow and 2000 NASDAQ had corrected by 10%, investors had opportunities to sell out. 

After the NASDAQ, in 2000 declined by 11% from March 5th to 15th, investors had until March 29, 2000 to sell out before the index began to plumb new lows.

On April 14, 2000, which was 25 days after the correction began, the NASDAQ had declined by 34%.  It took the Dow 10 days to reach the 34% decline threshold from October 17, 1929, after its initial 10% correction occurred within a 5-day period.

From researching the 1929 crash and 2000 dotcom bubble crash the indices will decline by more than 70% from their peaks and hit their bottoms sometime in the fourth quarter of 2022.  The 1929 crash bottomed in 32 months and the NASDAQ 30 months after their corrections began.

The February 19, 2020, correction is especially worrisome for the US stock market and economy.   The NASDAQ and S&P 500 were the top performing of the five global indices for the 12 months ended February 19,2020.

For the 12 months prior to the to the dotcom bubble bursting in March of 2000, the S&P 500 lagged the NASDAQ and the three foreign indices.  The low performance of the index mitigated the negative impact that the collapsing NASDAQ could have had on the US economy.

The S&P 500’s underperforming was a blessing since for the 12 months ended March 2001, its 12% decline was much lower than the rates of decline for the five other indices.

The post 10% swift correction from a market peak behavior for precious metals further support my findings for the equities markets.  Since 1979 the prices of both gold and silver each corrected swiftly by 10% or more twice.  On all four occasions the prices of the precious metals went on to crash by a minimum of 34% after experiencing minimum 10% corrections within the same time frames as the two Dow crashes and the NASDAQ crash.

My prediction is that the S&P 500’s secular bull market which began in March 2009 ended on February 19, 2020.  The ninth secular bear since 1802 began on February 20th.   Based on the peaks of the last three secular bull markets as compared to the troughs of the of the three most recent secular bears, the S&P 500 could decline by an additional 47% to 80% from its March 6, 2020 close.

The video of my “Secular Bulls & Bears: Each requires different investing strategies” workshop at the February 2020 Orlando Money Show is highly recommended.  The educational video explains secular bulls and bears and includes strategies to protect assets during secular bear markets and recessions, etc.  

BullsNBears.com which covers all of the emerging and declining economic and market trends is an excellent resource site.  Click here to view one-minute video about the site.   

#MacroView: Fed’s “Emergency Rate Cut” Reveals Recession Risks

Last week, I discussed in “Recession Risks Tick Up” that while current data may not suggest a possibility of a recession was imminent, other “off the run” data didn’t agree.

“The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data, which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.”

“The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.”

In this particular case, while the market is suggesting there is an economic problem coming, we also discussed the impact of the “coronavirus,” or “COVID-19,” on the economy. Specifically, I stated:

But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S. 

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. 

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)”

“Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months.”

That analysis seemed to largely bypass the mainstream economists, and the Fed, who were focused on the “number of people getting sick,” rather than the economic disruption from the shutdown of the supply chain.

On Tuesday, the Federal Reserve shocked the markets with an “emergency rate cut” of 50-basis points. While the futures market had been predicting the Fed to cut rates at their next meeting on March 18th, the half-percent cut shocked equity markets as the Fed now seems more concerned about the economy than they previously acknowledged.

It is one thing for the Fed to cut rates to support economic growth. It is quite another for the Fed to slash rates by 50 basis points between meetings.

It smacks of “fear.” 

Previously, such emergency rate cuts have not been done lightly, but in response to a bigger crisis which was simultaneously unfolding.

While we have spilled a good bit of digital ink as of late warning about the ramifications of COVID-19:

“Clearly, the ‘flu’ is a much bigger problem than COVID-19 in terms of the number of people getting sick. The difference, however, is that during ‘flu season,’ we don’t shut down airports, shipping, manufacturing, schools, etc. The negative impact on exports and imports, business investment, and potential consumer spending are all direct inputs into the GDP calculation and will be reflected in corporate earnings and profits.”

This is not a trivial matter.

“Nearly half of U.S. companies in China said they expect revenue to decrease this year if business can’t return to normal by the end of April, according to a survey conducted Feb. 17 to 20 by the American Chamber of Commerce in China, or AmCham, to which 169 member companies responded. One-fifth of respondents said 2020 revenue from China would decline more than 50% if the epidemic continues through Aug. 30..”WSJ

That drop in revenue, and ultimately earnings, has not yet been factored into earnings estimates. This is a point I made on Tuesday:

“More importantly, the earnings estimates have not been ratcheted down yet to account for the impact of the “shutdown” to the global supply chain. Once we adjust (dotted blue line) for a negative earnings environment in 2020, with a recovery in 2021, you can see just how far estimates will slide over the coming months. This will put downward pressure on stocks over the course of this year.”

It is quite possible even my estimates may still be too high.

While the markets have been largely dismissing the impact of the virus, the Fed’s “panic” move on Tuesday was confirming evidence that we are on the right track.

The market’s wild correction over the past two weeks, also begins to align with the Fed’s previous rate-cutting cycles. While it initially appeared “this time was different,” as the market continued to rise due to the Fed’s flood of liquidity, the markets seem to be playing catch up to previous rate-cutting cycles. If the economic data begins to weaken markedly, we may will see an alignment with the previous starts of bear markets and recessions.

Of course, we need to add some context to the chart above. Historically, the reason the Fed cuts rates, and interest rates fall, is because the Fed has acted in response to a crisis, recession, or both. The chart below shows when there is an inversion between the Fed Funds rate, and the 10-year Treasury, it has been associated with recessionary onset. (This curve will invert when the Fed cuts rates further at their next meeting.)

Not surprisingly, as suggested by the historical data above, the stock market has yielded a negative return a year after an emergency rate cut was initiated.

There is another risk the Fed may not be prepared for, an inflationary spike in prices. What could potentially impact the economy, and inflationary pressures, is the shutdown of the global supply chain which creates a lack of supply to meet immediate demand. Basic economics suggests this could lead to inflationary pressures as inventories become extremely lean, and products become unavailable. Even a short-term inflationary spike would put the Federal Reserve on the “wrong-side” of the trade, rendering the Fed’s monetary policies ineffective.

The rising recession risk is also being signaled by the collapse in the 10-year Treasury yield, a point which I have made repeatedly over the last several years in discussing why interest rates were headed toward zero.

“Outside of other events such as the S&L Crisis, Asian Contagion, Long-Term Capital Management, etc. which all drove money out of stocks and into bonds pushing rates lower, recessionary environments are especially prone at suppressing rates further. But, given the inflation of multiple asset bubbles, a credit-driven event that impacts the corporate bond market will drive rates to zero.

Furthermore, given rates are already negative in many parts of the world, which will likely be even more negative during a global recessionary environment, zero yields will still remain more attractive to foreign investors. This will be from both a potential capital appreciation perspective (expectations of negative rates in the U.S.) and the perceived safety and liquidity of the U.S. Treasury market. 

Rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals combined with the demand for safety and liquidity will be the ultimate arbiter.”

A chart of monetary velocity tells you there is a problem in the economy as lower interest rates fails to spark an uptick in the flow of money.

My friend Caroline Baum summed up the Fed’s primary problem given the issue of plunging rates:

“All of a sudden, the reality of revisiting the zero lower bound, which the Fed now refers to as the effective lower bound (ELB), is no longer off in the distance. It could be right around the corner.

And this at a time when Fed officials are still saying that the economy and monetary policy are ‘in a good place’ and the fundamentals are sound. So what do policymakers do when the good place deteriorates into something mediocre, and the fundamentals turn sour?

Forward guidance, which I like to call talk therapy? Large-scale asset purchases? Unfortunately, the Fed goes to war with the tools it has, not the tools it might want or wish to have.”

Unfortunately, the Fed is still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S.

The reasons are simple. You can’t cure a debt problem with more debt. Therefore, monetary interventions, and government spending, don’t create organic, sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled.

There is already evidence that lower rates are not leading to expanding consumption, business investment, or economic activity. Furthermore, while QE may temporarily lift asset prices, the lack of economic growth, resulting in lower earnings growth, will eventually lead to a repricing of assets.

Furthermore, there is likely no help coming from fiscal policy, either. As Caroline noted:

“Fiscal-policy measures, which entail tax cuts and government spending, will be difficult to enact in this highly charged political environment. There is little evidence that the Republicans and Democrats can put partisan differences aside to work together.”

Or, as Chuck Schumer said to Ben Bernanke just prior to the “financial crisis:”

“You’re the only game in town.” 

The real concern for investors, and individuals, is the real economy.

We are likely experiencing more than just a “soft patch” currently despite the mainstream analysts’ rhetoric to the contrary. There is clearly something amiss within the economic landscape, even before the impact of COVID-19, and the ongoing decline of inflationary pressures longer term was already telling us just that.

The Fed already realizes they have a problem, as noted by Fed Chair Powell on Tuesday:

“A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that.”

More importantly, this is no longer a domestic question, but rather a global one. Since every major central bank is now engaged in a coordinated infusion of liquidity, fighting slowing economic growth, a rising level of negative yields, and a spreading virus shutting down economic activity, it is “all hands on deck.”

The Federal Reserve is currently betting on a “one trick pony” which is that by increasing the “wealth effect,” it will ultimately lead to a return of consumer confidence, and mitigate the effect of a global contagion.

Unfortunately, there mounting evidence it may not work.

MacroView: The Ghosts Of 2018?

On Jan 3rd, I wrote an article entitled: “Will The Market Repeat The Start Of 2018?” At that time, the Federal Reserve was dumping a tremendous amount of money into the financial markets through their “Repo” operations. To wit:

“Don’t fight the Fed. That is the current mantra of the market as we begin 2020, and it certainly seems to be the right call. Over the last few months, the Federal Reserve has continued its “QE-Not QE” operations, which has dramatically expanded its balance sheet. Many argue, rightly, the current monetary interventions by the Fed are technically “Not QE” because they are purchasing Treasury Bills rather than longer-term Treasury Notes.

However, ‘Mr. Market’ doesn’t see it that way. As the old saying goes, ‘if it looks, walks, and quacks like a duck…it’s a duck.'” 

As I noted then, despite commentary to the contrary, there were only two conclusions to draw from the data:

  1. There is something functionally “broken” in the financial system which is requiring massive injections of liquidity to try and rectify, and;
  2. The surge in liquidity, whether you want to call it a “duck,” or not, is finding its way into the equity markets.

Let me remind you this was all BEFORE the outbreak of the Coronavirus.

The Ghosts Of 2018

“Well, this past week, the market tripped ‘over its own feet’ after prices had created a massive extension above the 50-dma as shown below. As I have previously warned, since that extension was so large, a correction just back to the moving average at this point will require nearly a -6% decline.”

“I have also repeatedly written over the last year:

‘The problem is that it has been so long since investors have even seen a 2-3% correction, a correction of 5%, or more, will ‘feel’ much worse than it actually is, which will lead to ’emotionally driven’ mistakes.’

The question now, of course, is do you “buy the dip” or ‘run for the hills?’”

Yesterday morning, the markets began the day deeply in the red, but by mid-morning were flirting with a push into positive territory. By the end of the day, the Dow had posted its largest one-day point loss in history.”

That was from February 6th, 2018 (Technically Speaking: Tis But A Flesh Wound)

Here is a chart of October 2019 to Present.

Besides the reality that the only thing that has occurred has been a reversal of the Fed’s “Repo” rally, there is a striking similarity to 2018. That got me to thinking about the corollary between the two periods, and how this might play out over the rest of 2020.

Let’s go back.

Heading in 2018, the markets were ebullient over President Trump’s recently passed tax reform and rate cut package. Expectations were that 2018 would see a massive surge in earnings growth, due to the lower tax rates, and there would be a sharp pickup in economic growth.

However, at the end of January, President Trump shocked the markets with his “Trade War” on China and the imposition of tariffs on a wide variety of products, which potentially impacted American companies. As we said at the time, there was likely to be unintended consequences and would kill the effect of tax reform.)

“While many have believed a ‘trade war’ will be resolved without consequence, there are two very important points that most of the mainstream analysis is overlooking. For investors, a trade war would likely negatively impact earnings and profitability while slowing economic growth through higher costs.”

Over the next few months, the market dealt, and came to terms with, the trade war and the Fed’s tightening of the balance sheet. As we discussed in May 2018, the trade war did wind up clipping earnings estimates to a large degree, but massive share repurchases helped buoy asset prices.

Then in September, the Fed did the unthinkable.

After having hiked rates previously, thereby tightening the monetary supply, they stated that monetary policy was not “close to the neutral rate,” suggesting more rate hikes were coming. The realization the Fed was intent on continuing to tighten policy, and further extracting liquidity by reducing their balance sheet, sent asset prices plunging 20% from the peak, to the lows on Christmas Eve.

It was then the Fed acquiesced to pressure from the White House and began to quickly reverse their stance and starting pumping liquidity back into the markets.

And the bull market was back.

Fast forward to 2020.

“The exuberance that surrounded the markets going into the end of last year, as fund managers ramped up allocations for end of the year reporting, spilled over into the start of the new with S&P hitting new record highs.

Of course, this is just a continuation of the advance that has been ongoing since the Trump election. The difference this time is the extreme push into 3-standard deviation territory above the moving average, which is concerning.” – Real Investment Report Jan, 5th 2018

As noted in the chart below, in both instances, the market reached 3-standard deviations above the 200-dma before mean-reverting.

Of course, while everyone was exuberant over the Fed’s injections of monetary support, we were discussing the continuing decline in earnings growth estimates, along with the lack of corporate profit growth To wit:

With equities now more than 30% higher than they were then, the Fed mostly on hold in terms of rate cuts, and ‘repo’ operations starting to slow, it certainly seems that expectations for substantially higher market values may be a bit optimistic.

Furthermore, as noted above, earnings expectations declined for the entirety of 2019, as shown in the chart below. However, the impact of the ‘coronavirus’ has not been adopted into these reduced estimates as of yet. These estimates WILL fall, and likely markedly so, which, as stated above, is going to make justifying record asset prices more problematic.”

Just as the “Trade War” shocked the markets and caused a repricing of assets in 2018, the “coronavirus” has finally infected the markets enough to cause investors to adjust their expectations for earnings growth. Importantly, as in 2018, earnings estimates have not been revised lower nearly enough to compensate for the global supply chain impact coming from the virus.

While the beginning of 2020 is playing out much like 2018, what about the rest of the year?

There are issues occurring which we believe will have a very similar “feel” to 2018, as the impact of the virus continues to ebb and flow through the economy. The chart below shows the S&P 500 re-scaled to 1000 for comparative purposes.

Currently, the expectation has risen to more than a 70% probability the Fed will cut rates 3x in 2020. Historically, the market tends to underestimate just how far the Fed will go as noted by Michael Lebowitz previously:

“The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.”

Our guess is that in the next few weeks, the Fed will start using “forward guidance” to try and stabilize the market. Rate cuts, and more “quantitative easing,” will likely follow.

Such actions should stabilize the market in the near-term as investors, who have been pre-conditioned to “buy” Fed liquidity, will once again run back into markets. This could very well lift the markets into second quarter of this year.

But it will likely be a “trap.”

While monetary policy will likely embolden the bulls short-term, it does little to offset an economic shock. As we move further into the year, the impact to the global supply chain will begin to work its way through the system resulting in slower economic growth, reduced corporate profitability, and potentially a recession. (See yesterday’s commentary)

This is a guess. There is a huge array of potential outcomes, and trying to predict the future tends to be a pointless exercise. However, it is the thought process that helps align expectations with potential outcomes to adjust for risk accordingly.

A Sellable Rally

Just as in February 2018, following the sharp decline, the market rallied back to a lower high before failing once again. For several reasons, we suspect we will see the same over the next week or two, as the push into extreme pessimism and oversold conditions will need to be reversed before the correction can continue.

While 2019 ended in an entirely dissimilar manner as compared to 2018, the current negative sentiment, as shown by CNN’s Fear & Greed Index is back to the extreme fear levels seen at the lows of the market in 2018.

On a short-term technical basis, the market is now extremely oversold, which is suggestive of a counter-trend rally over the next few days to a week or so.

It is highly advisable to use ANY reflexive rally to reduce portfolio risk, and rebalance portfolios. Most likely, another wave of selling will likely ensue before a stronger bottom is finally put into place. 

Lastly, our composite technical overbought/oversold gauge is also pushing more extreme oversold conditions, which are typical of a short-term oversold condition.

In other words, in 2019 “everyone was in the pool,” in 2020 we just found out “everyone was swimming naked.” 

Rules To Follow

One last chart.

I just want you to pay attention to the top panel and the shaded areas. (standard deviations from the 50-dma)

We were not this oversold even during the 2015-2016 decline, much less the two declines in 2018.

Currently, not only is the market extremely oversold on a short-term basis, but is currently 5-standard deviations below the 50-dma.

Let me put that into perspective for you.

  • 1-standard deviation = 68.26% of all possible price movement.
  • 2-standard deviations = 95.45% 
  • 3-standard deviations = 99.73%
  • 4-standard deviations = 99.993%
  • 5-standard deviations = 99.9999%

Mathematically speaking, the bulk of the decline is already priced into the market.

“I get it. We are gonna get a bounce. So, what do I do?”

I am glad you asked.

Step 1) Clean Up Your Portfolio

  1. Tighten up stop-loss levels to current support levels for each position.
  2. Take profits in positions that have outperformed during the rally.
  3. Sell laggards and losers (those that lagged the rally, probably led the decline)
  4. Raise cash, and rebalance portfolios to reduced risk levels for now.

Step 2) Compare Your Portfolio Allocation To Your Model Allocation.

  1. Determine areas where exposure needs to be increased, or decreased (bonds, cash, equities)
  2. Determine how many shares need to be bought or sold to rebalance allocation requirements.
  3. Determine cash requirements for hedging purposes
  4. Re-examine the portfolio to ensure allocations are adjusted for FORWARD market risk.
  5. Determine target price levels for each position.
  6. Determine “stop loss” levels for each position being maintained.

Step 3) Be Ready To Execute

  • Whatever bounce we get will likely be short-lived. So have your game plan together before-hand as the opportunity to rebalance risk will likely not be available for very long. 

This is just how we do it.

However, there are many ways to manage risk, and portfolios, which are all fine. What separates success and failure is 1) having a strategy to begin with, and; 2) the discipline to adhere to it.

The recent market spasm certainly reminds of 2018. And, if we are right, it will get better, before it gets worse.

Quick Take: Recession Risks Tick Up

Over the last couple of months, there was a slight uptick in the economic data, which lifted hopes that a “global reflation” event was underway. 

As we have been warning for the last couple of months in our weekly newsletter, the ongoing collapse in commodity prices suggested a problem was emerging that trailing “sentiment” data was clearly overlooking. To wit:

“There are a few indicators which, by their very nature, should be signaling a surge in economic activity if there was indeed going to be one. Copper, energy prices, commodities in general, and the Baltic Dry index, should all be rising if economic activity is indeed beginning to recover. 

Not surprisingly, as the “trade deal” was agreed to, we DID see a pickup in commodity prices, which was reflected in the stronger economic reports as of late. However, while the media is crowing that “reflation is on the horizon,” the commodity complex is suggesting that whatever bump there was from the “trade deal,” is now over.”

Importantly, that decline happened BEFORE the “Coronavirus,” which suggests the virus will only worsen the potential impact.

I want to reiterate an important point.

The risk to the market, and the economy, is not “sick people.” It is the shutdown of the global supply chain.

China is a substantially larger portion, and economically more important, than it was in 2003 when SARS hit. As noted by Johnson & Palmer of Foreign Policy:

“China itself is a much more crucial player in the global economy than it was at the time of SARS, or severe acute respiratory syndrome, in 2003. It occupies a central place in many supply chains used by other manufacturing countries—including pharmaceuticals, with China home to 13 percent of facilities that make ingredients for U.S. drugs—and is a voracious buyer of raw materials and other commodities, including oil, natural gas, and soybeans. That means that any economic hiccups for China this year—coming on the heels of its worst economic performance in 30 years—will have a bigger impact on the rest of the world than during past crises.

That is particularly true given the epicenter of the outbreak: Wuhan, which is now under effective quarantine, is a riverine and rail transportation hub that is a key node in shipping bulky commodities between China’s coast and its interior.

But it isn’t just China. It is also hitting two other economically important countries: Japan and South Korea, which will further stall exports and imports to the U.S. 

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. 

(The EOCI is comprised of the Fed Regional Surveys, CFNAI, Chicago PMI, NFIB, LEI, and ISM Composites. The indicator is a broad measure of hard and soft data of the U.S. economy)

Given the current level of the index as compared to the 6-Month rate of change of the Leading Economic Index, there is a rising risk of a recessionary drag within the next 6-months. 

This is what the collapsing yield curve is already confirming as the 10-year plunged to the lowest levels on record. Currently, 60% of the yields we track have now inverted. 

Outside of the indicators we track, Eric Hickman previously made similar observations:

“The long history (49+ years) of these indicators can be used to get a sense of timing for when a recession may begin. I have measured historically how long these indicators signaled before (or after) the start of their accompanying recession. Comparing this time-frame to when these indicators triggered recently, suggests a range for when this recession may come. The chart below shows the time ranges (minimum amount of time historically to maximum amount of time historically) in which each indicator would suggest a recession start.”

“There are a few conclusions to this. First, five recession indicators have signaled. Second, there is nothing unusual in the timing that the recession hasn’t started yet. Third, no matter which of the five indicators you use, a recession will likely begin in 2020 and the average center-point of the indicators is in March, just a little over two months away. Don’t confuse the Fed’s ‘on-hold’ stance to have any more meaning than the hope that the consumer and labor market’s strength will continue. History suggests that this is not a good bet to make.”

The problem with most of the current analysis, which suggests a “no recession” scenario, is based heavily on lagging economic data which is highly subject to negative revisions. The stock market, however, is a strong leading indicator of investor expectations of growth over the next 12-months. Historically, stock market returns are typically favorable until about 6-months prior to the start of a recession.

The compilation of the data all suggests the risk of recession is markedly higher than what the media currently suggests. Yields and commodities are suggesting something quite different.

#MacroView: Japan, The Fed, & The Limits Of QE

This past week saw a couple of interesting developments.

On Wednesday, the Fed released the minutes from their January meeting with comments which largely bypassed overly bullish investors.

“… several participants observed that equity, corporate debt, and CRE valuations were elevated and drew attention to  high levels of corporate indebtedness and weak underwriting standards in leveraged loan markets. Some participants expressed the concern that financial imbalances-including overvaluation and excessive indebtedness-could amplify an adverse shock to the economy …”

“… many participants remarked that the Committee should not rule out the possibility of adjusting the stance of monetary policy to mitigate financial stability risks, particularly when those risks have important implications for the economic outlook and when macroprudential tools had been or were likely to be ineffective at mitigating those risks…”

The Fed recognizes their ongoing monetary interventions have created financial risks in terms of asset bubbles across multiple asset classes. They are also aware that the majority of the policy tools are likely ineffective at mitigating financial risks in the future. This leaves them being dependent on expanding their balance sheet as their primary weapon.

Interestingly, the weapon they are dependent on may not be as effective as they hope. 

This past week, Japan reported a very sharp drop in economic growth in their latest reported quarter as a further increase in the sales-tax hit consumption. While the decline was quickly dismissed by the markets, this was a pre-coronovirus impact, which suggests that Japan will enter into an “official” recession in the next quarter.

There is more to this story.

Since the financial crisis, Japan has been running a massive “quantitative easing” program which, on a relative basis, is more than 3-times the size of that in the U.S. However, while stock markets have performed well with Central Bank interventions, economic prosperity is only slightly higher than it was prior to the turn of century.

Furthermore, despite the BOJ’s balance sheet consuming 80% of the ETF markets, not to mention a sizable chunk of the corporate and government debt market, Japan has been plagued by rolling recessions, low inflation, and low-interest rates. (Japan’s 10-year Treasury rate fell into negative territory for the second time in recent years.)

Why is this important? Because Japan is a microcosm of what is happening in the U.S. As I noted previously:

The U.S., like Japan, is caught in an ongoing ‘liquidity trap’ where maintaining ultra-low interest rates are the key to sustaining an economic pulse. The unintended consequence of such actions, as we are witnessing in the U.S. currently, is the battle with deflationary pressures. The lower interest rates go – the less economic return that can be generated. An ultra-low interest rate environment, contrary to mainstream thought, has a negative impact on making productive investments, and risk begins to outweigh the potential return.

Most importantly, while there are many calling for an end of the ‘Great Bond Bull Market,’ this is unlikely the case. As shown in the chart below, interest rates are relative globally. Rates can’t increase in one country while a majority of economies are pushing negative rates. As has been the case over the last 30-years, so goes Japan, so goes the U.S.”

As my colleague Doug Kass recently noted, Japan is a template of the fragility of global economic growth. 

“Global growth continues to slow and the negative impact on demand and the broad supply interruptions will likely expose the weakness of the foundation and trajectory of worldwide economic growth. This is particularly dangerous as the monetary ammunition has basically been used up.

As we have observed, monetary growth (and QE) can mechanically elevate and inflate the equity markets. For example, now in the U.S. market, basic theory is that in practice a side effect is that via the ‘repo’ market it is turned into leveraged trades into the equity markets. But, again, authorities are running out of bullets and have begun to question the efficacy of monetary largess.

Bigger picture takeaway is beyond the fact that financial engineering does not help an economy, it probably hurts it. If it helped, after mega-doses of the stuff in every imaginable form, the Japanese economy would be humming. But the Japanese economy is doing the opposite. Japan tried to substitute monetary policy for sound fiscal and economic policy. And the result is terrible.

While financial engineering clearly props up asset prices, I think Japan is a very good example that financial engineering not only does nothing for an economy over the medium to longer-term, it actually has negative consequences.” 

This is a key point.

The “Stock Market” Is NOT The “Economy.”

Roughly 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% to everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population.


“This is not economic prosperity.

This is a distortion of economics.”


From 2009-2016, the Federal Reserve held rates at 0%, and flooded the financial system with 3-consecutive rounds of “Quantitative Easing” or “Q.E.” During that period, average real rates of economic growth rates never rose much above 2%.

Yes, asset prices surged as liquidity flooded the markets, but as noted above “Q.E.” programs did not translate into economic activity. The two 4-panel charts below shows the entirety of the Fed’s balance sheet expansion program (as a percentage) and its relative impact on various parts of the real economy. (The orange bar shows now many dollars of increase in the Fed’s balance sheet that it took to create an increase in each data point.)

As you can see, it took trillions in “QE” programs, not to mention trillions in a variety of other bailout programs, to create a relatively minimal increase in economic data. Of course, this explains the growing wealth gap, which currently exists as monetary policy lifted asset prices.

The table above shows that QE1 came immediately following the financial crisis and had an effective ratio of about 1.6:1. In other words, it took a 1.6% increase in the balance sheet to create a 1% advance in the S&P 500. However, once market participants figured out the transmission system, QE2 and QE3 had an almost perfect 1:1 ratio of effectiveness. The ECB’s QE program, which was implemented in 2015 to support concerns of an unruly “Brexit,” had an effective ratio of 1.5:1. Not surprisingly, the latest round of QE, which rang “Pavlov’s bell,” has moved back to a near perfect 1:1 ratio.

Clearly, QE worked well in lifting asset prices, but as shown above, not so much for the economy. In other words, QE was ultimately a massive “wealth transfer” from the middle class to the rich which has created one of the greatest wealth gaps in the history of the U.S., not to mention an asset bubble of historic proportions.

But Will It Work Next Time?

This is the single most important question for investors.

The current belief is that QE will be implemented at the first hint of a more protracted downturn in the market. However, as suggested by the Fed, QE will likely only be employed when rate reductions aren’t enough. This was a point made in 2016 by David Reifschneider, deputy director of the division of research and statistics for the Federal Reserve Board in Washington, D.C., released a staff working paper entitled “Gauging The Ability Of The FOMC To Respond To Future Recessions.” 

The conclusion was simply this:

“Simulations of the FRB/US model of a severe recession suggest that large-scale asset purchases and forward guidance about the future path of the federal funds rate should be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in most, but probably not all, circumstances.”

In other words, the Federal Reserve is rapidly becoming aware they have become caught in a liquidity trap keeping them unable to raise interest rates sufficiently to reload that particular policy tool. There are certainly growing indications the U.S. economy maybe be heading towards the next recession. 

Interestingly, David compared three policy approaches to offset the next recession.

  1. Fed funds goes into negative territory but there is no breakdown in the structure of economic relationships.
  2. Fed funds returns to zero and keeps it there long enough for unemployment to return to baseline.
  3. Fed funds returns to zero and the FOMC augments it with additional $2-4 Trillion of QE and forward guidance. 

In other words, the Fed is already factoring in a scenario in which a shock to the economy leads to additional QE of either $2 trillion, or in a worst case scenario, $4 trillion, effectively doubling the current size of the Fed’s balance sheet.

So, 2-years ago David lays out the plan, and on Wednesday, the Fed reiterates that plan.

Does the Fed see a recession on the horizon? Is this why there are concerns about valuations?

Maybe.

But there is a problem with the entire analysis. The effectiveness of QE, and zero interest rates, is based on the point at which you apply these measures.

In 2008, when the Fed launched into their “accommodative policy” emergency strategy to bail out the financial markets, the Fed’s balance sheet was running at $915 Billion. The Fed Funds rate was at 4.2%.

If the market fell into a recession tomorrow, the Fed would be starting with a $4.2 Trillion balance sheet with interest rates 3% lower than they were in 2009. In other words, the ability of the Fed to ‘bail out’ the markets today, is much more limited than it was in 2008.”

But there is more to the story than just the Fed’s balance sheet and funds rate. The entire backdrop is completely reversed. The table below compares a variety of financial and economic factors from 2009 to present.

Importantly, QE, and rate reductions, have the MOST effect when the economy, markets, and investors are extremely negative.

In other words, there is nowhere to go but up.

Such was the case in 2009. Not today.

This suggests that the Fed’s ability to stem the decline of the next recession, or offset a financial shock to the economy from falling asset prices, may be much more limited than the Fed, and most investors, currently believe.

Summary

It has taken a massive amount of interventions by Central Banks to keep economies afloat globally over the last decade, and there is rising evidence that growth is beginning to decelerate.

Furthermore, we have much more akin with Japan than many would like to believe.

  • A decline in savings rates
  • An aging demographic
  • A heavily indebted economy
  • A decline in exports
  • Slowing domestic economic growth rates.
  • An underemployed younger demographic.
  • An inelastic supply-demand curve
  • Weak industrial production
  • Dependence on productivity increases

The lynchpin to Japan, and the U.S., remains demographics and interest rates. As the aging population grows becoming a net drag on “savings,” the dependency on the “social welfare net” will continue to expand. The “pension problem” is only the tip of the iceberg.

While another $2-4 Trillion in QE might indeed be successful in keeping the bubble inflated for a while longer, there is a limit to the ability to continue pulling forward future consumption to stimulate economic activity. In other words, there are only so many autos, houses, etc., which can be purchased within a given cycle. There is evidence the cycle peak has been reached.

If the effectiveness of rate reductions and QE are diminished due to the reasons detailed herein, the subsequent destruction to the “wealth effect” will be larger than currently imagined. The Fed’s biggest fear is finding themselves powerless to offset the negative impacts of the next recession. 

If more “QE” works, great.

But as investors, with our retirement savings at risk, what if it doesn’t.

Falling Oil Prices An Economic Warning Sign

On Tuesday morning, I got engaged in a debate on the recent decline in oil prices following my report on COT Positioning in the space. To wit:

“The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will start to get liquidated which will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.”

It didn’t take long before the debate started.

“Aren’t low oil prices good for the economy? They are a tax cut for the consumer?”

There is an old axiom which states that if you repeat a falsehood long enough, it will eventually be accepted as fact.

Low oil prices equating to stronger economic growth is one of those falsehoods.

Oil prices are indeed crucial to the overall economic equation, and there is a correlation between the oil prices, inflation, and interest rates.

Given that oil is consumed in virtually every aspect of our lives, from the food we eat to the products and services we buy, the demand side of the equation is a tell-tale sign of economic strength or weakness. We can see this clearly in the chart below which combines rates, inflation, and GDP into one composite indicator. One important note is that oil tends to trade along pretty defined trends (black trend lines) until it doesn’t. Importantly, since the oil industry is very manufacturing and production intensive, breaks of price trends tend to be liquidation events which has a negative impact on manufacturing and CapEx spending and feeds into the GDP calculation.

“It should not be surprising that sharp declines in oil prices have been coincident with downturns in economic activity, a drop in inflation, and a subsequent decline in interest rates.

We can also view the impact of oil prices on inflation by looking at breakeven inflation rates as well.

The short version is that oil prices are a reflection of supply and demand. Global demand has already been falling for the last several months, and oil prices are sending warnings that “market hopes” for a “global reflation” are likely not a reality. More importantly, falling oil prices are going to put the Fed in a very tough position in the next couple of months as deflationary pressures rise. The chart below shows breakeven 5-year and 10-year inflation rates versus oil prices.

Zero Sum

The argument that lower oil prices give consumers more money to spend certainly seems entirely logical. Since we know that roughly 80% of households in America effectively live paycheck-to-paycheck, they will spend, rather than save, any extra disposable income.

However, here is the most important part of the fallacy:

“Spending in the economy is a ZERO-SUM game.”

Falling oil prices are an excellent example since gasoline sales are part of the retail sales calculation.

Let’s take a look at the following example:

  • Oil Prices Decline By $10 Per Barrel
  • Gasoline Prices Fall By $1.00 Per Gallon
  • Consumer Fills Up A 16 Gallon Tank Saving $16 (+16)
  • Gas Station Revenue Falls By $16 For The Transaction (-16)
  • End Economic Result = $0

Now, the argument is that the $16 saved by the consumer will be spent elsewhere, which is true. However, this is the equivalent of “rearranging deck chairs on the Titanic.”

So, let’s now extend our example from above.

Oil and gasoline prices have dropped, so Elaine, who has budgeted $100 to spend each week on retail-related purchases, goes to the gas station to fill up.

  • Elaine fills up her car for $60, which previously cost $80. (Savings +$20)
  • Elaine then spends her normal $20 on lunch with her friends. 
  • She then spends her additional $20 (saved from her gas bill) on some flowers for the dining room.

————————————————-
Total Spending For The Week = $100

Now, economists quickly jump on the idea that because she spent $20 on flowers, there has been an additional boost to the economy.

However, this is not the case. Elaine may have spent her money differently this past week, but she still spent the same amount. Here is the net effect on the economy.

Gasoline Station Revenue = (-$20)
Flower Store Revenue = +$20
—————————————————-
Net Effect To Economy = $0

Graphically, we can show this by analyzing real (inflation-adjusted) gasoline prices compared to total Personal Consumption Expenditures (PCE). I am using “PCE” as it is the broadest measure of consumer spending and comprises almost 70% of the entire GDP calculation.

As shown, falling gasoline prices have historically equated to lower personal consumption expenditures, and not vice-versa. In fact higher oil and gasoline prices have actually been coincident with higher rates of PCE previously. The chart below show inflation-adjusted oil prices as compared to PCE.

While the argument that declines in energy and gasoline prices should lead to stronger consumption sounds logical, the data suggests this is not the case.

What we find is there is a parity between oil price and the economy. Like “Goldilocks,” prices which are too hot, or too cold, has a negative impact on consumption and economic growth.

Importantly, regardless of the level of oil prices, the only thing which increases consumer spending are increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend. They can choose to “save more” which is a drag on economic growth in the short-term (called the “paradox of thrift”), or they can spend what they have. But they can’t spend more, unless they take on more debt. 

Which is what has been occurring as individuals struggle to fill the gap between the cost of living and incomes. (Read more on this chart)

A Bigger Drag Than The Savings

Importantly, falling oil prices are a bigger drag on economic growth than the incremental “savings” received by the consumer.

The obvious ramification of the plunge in oil prices is to the energy sector itself. As oil prices decline, the loss of revenue eventually leads to cuts in production, declines in capital expenditure plans (which comprises almost 1/4th of all CapEx expenditures in the S&P 500), freezes and/or reductions in employment, not to mention the declines in revenue and profitability.

Let’s walk through the impact of lower oil prices on the economy.

Declining oil prices lead to declining revenue for oil and gas companies. Given that drilling for oil is a very capital intensive process requiring a lot of manufactured goods, equipment, supplies, transportation, and support, the decrease in prices leads to a reduction in activity as represented by Capital Expenditures (CapEx.) The chart below shows the 6-month average of the 6-month rate of change in oil prices as compared to CapEx spending in the economy.

Of course, once CapEx is reduced the need for employment declines. However, since drilling for oil is a very intensive process, losses in employment may start with the energy companies, but eventually, all of the downstream suppliers are impacted by slower activity. As job losses rise, and incomes decline, it filters into the economy.

Importantly, when it comes to employment, the majority of the jobs “created” since the financial crisis has been lower wage-paying jobs in retail, healthcare and other service sectors of the economy. Conversely, the jobs created within the energy space are some of the highest wage paying opportunities available in engineering, technology, accounting, legal, etc.

In fact, each job created in energy-related areas has had a “ripple effect” of creating 2.8 jobs elsewhere in the economy from piping to coatings, trucking and transportation, restaurants and retail.

Given that oil prices are a reflection of global economic demand, falling oil prices have a negative feedback loop in the economy as a whole. The longer oil prices remain suppressed, the negative impacts of loss of employment, reductions in capital expenditures, and declines in corporate profitability will begin to outstrip any small economic benefit gained through consumption.

Simply put, lower oil and gasoline prices may actually have a bigger detraction on the economy than the “savings” provided to consumers.

Newton’s third law of motion states:

“For every action, there is an equal and opposite reaction.”

In any economy, nothing works in isolation. For every dollar increase that occurs in one part of the economy, there is a dollars’ worth of reduction somewhere else.

Technically Speaking: COT Positioning – Risk Of Correction Still High (Q1-2020)

As discussed in this past weekend’s newsletter, the market remains overly extended as the recent correction sharply reversed on expectations for more Fed liquidity. However, with the market extremely deviated from the long-term moving average, a correction is once again a high probability event. 

“Previously, we discussed that we had taken profits out of portfolios as we were expecting between a 3-5% correction to allow for a better entry point to add equity exposure. While the “virus correction” did encompass a correction of 3%, it was too shallow to reverse the rather extreme extension of the market. The rally this past week has reversed the corrective process, and returned the markets to 3-standard deviations above the 200-dma. Furthermore, all daily, weekly, and monthly conditions have returned to more extreme overbought levels as well.”

But it isn’t just the more extreme advance of the market over the past 5-weeks which has us a bit concerned in the short-term, but a series of other indications which typically suggest short- to intermediate-terms corrections in the market.

Furthermore, the markets are completely entirely the impact the “coronavirus” will have on the supply-chain globally. As David Rosenberg noted Monday:

“The impact of this virus is lasting longer and the effects, relative to SARS, are larger at a time when the Chinese economy is far softer. The follow-on effects on other markets has yet to be fully appreciated.”

Had the markets completed a correction that reduced the extreme overbought and extended conditions of the market, such would have offset the risk of the “viral impact” to the economy. However, without that correction, the eventual slowdown will likely have a great impact than is currently anticipated. 

However, even if we set aside investor sentiment and positioning for a moment, the rapid reversion is price has sent our technical composite overbought/oversold gauge back towards more extreme levels of overbought conditions. (Get this chart every week at RIAPRO.NET)

What we know is that markets move based on sentiment and positioning. This makes sense considering that prices are affected by the actions of both buyers and sellers at any given time. Most importantly, when prices, or positioning, becomes too “one-sided,” a reversion always occurs. As Bob Farrell’s Rule #9 states:

“When all experts agree, something else is bound to happen.” 

So, how are traders positioning themselves currently? 

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three key commodity-trading groups, namely:

  • Commercial Traders: this group consists of traders that use futures contracts for hedging purposes and whose positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and/or processing of the underlying commodity.
  • Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.
  • Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders.

This is the group that speculates on where they believe the market is headed. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to “human fallacy” and “herd mentality” as everyone else.

Therefore, as shown in the series of charts below, we can take a look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

The extreme net-short positioning on the volatility before to the correction last week, had suggested the correction was coming. However, while the correction reduced the net-short positioning somewhat, it remains at historical extremes. What the more extreme positioning tells us is there is plenty of “fuel” to drive a correction when one occurs.

Investors have gotten used to extremely low levels of volatility, which is unique to this market cycle. This complacency, due to low volatility, has encouraged investors to take on greater levels of risk than they currently realize. When volatility eventually makes it return, the consequences to investors will not be kind.

Crude Oil Extreme

The recent attempt by crude oil to get back above the 200-dma coincided with the Fed’s initiation of QE-4. Historically, these liquidity programs tend to benefit highly speculative positions like commodities, as liquidity seeks the highest rate of return. 

However, beginning in December, that support for oil prices gave way, and prices have collapsed along with expectations for global economic recovery. We have been warning our RIAPro Subcribers (30-Day Risk Free Trial) for the last couple of months about the potential for this decline.

  • As noted previously, “Oil completely broke down last week, and collapsed below all of the important levels. Oil is now testing critical support at $51. A failure there and a break into the low $40’s is probable.”
  • The support is barely holding and oil looks extremely weak. However, oil is extremely oversold so a counter-trend rally is highly likely and can be used to “sell” into.
  • Stops Triggered for any direct crude oil positions.
  • Long-Term Positioning: Bearish

Despite the decline in oil prices over the last year, it is worth noting that crude oil positioning is still on the bullish side with 397,000 net long contracts. 

The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will start to get liquidated which will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.

U.S. Dollar Extreme

Another index we track each week at RIAPRO.NET is the U.S. Dollar.

  • As noted previously: “The dollar has rallied back to that all-important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • That is exactly what happened over the last two weeks. The dollar has strengthened that rally as concerns over the “coronavirus” persist. With the dollar close to testing previous highs, a break above that resistance could result in a sharp move higher for the dollar.
  • The rising dollar is not bullish for Oil, commodities or international exposures.
  • The “sell” signal has began to reverse. Pay attention.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE, but as shown above, that has yet to be the case. However, it is worth noting that positioning in the US Dollar has been weakening. Historically, these reversals are markets of more important peaks in the market and subsequent corrections. 

It is also worth watching the net-short positioning the Euro-dollar as well. Historically, when positioning in the Eurodollar becomes NET-LONG, as it is currently, such has been associated with short- to intermediate corrections in the markets, including outright bear markets.

Net-long Eurodollar positioning has recently started to reverse from an all-time record. While the market hasn’t corrected as of yet, if foreign banks begin to extract dollar-denominated assets to a large degree, the risk to the market rises sharply. 

Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. In March of last year, I wrote “The Bond Bull Market” which was a follow up to our earlier call for a sharp drop in rates as the economy slowed. That call was based on the extreme “net-short positioning” in bonds which suggested a counter-trend rally was likely.

Since then, rates fell back to some of the lowest levels in 10-years as economic growth continues to slow, both domestically and globally. Importantly, while the Federal Reserve turned back on the “liquidity pumps” last October, juicing markets to all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Not surprisingly, despite much commentary to the contrary, the number of contracts “net-short” the 10-year Treasury remains at some of the highest historical readings.

Importantly, even while the “net-short” positioning on bonds has been reversed, rates have failed to rise correspondingly. The reason for this is due to the near-record levels of Eurodollar positioning, as noted above.

This suggests a high probability rates will fall further in the months ahead. This will most likely occur in concert with further deterioration in economic growth as the impact of the “coronavirus” is realized. 

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that financial markets can only rise further. The arguments supporting those beliefs are based on comparisons to previous peak market cycles. Unfortunately, investors tend to be wrong at market peaks and bottoms.

The inherent problem with much of the mainstream analysis is that it assumes everything remains status quo. However, such never tends to be the case for long.  

“Oil prices down 20% is not a good thing, even if it means lower gasoline prices. This is swamped by the negative implications for capital spending and employment in the key oil-producing regions of the U.S. Copper prices have dropped 11% in just the past two weeks and just above a three-year low, and this is a global macro barometer. Money flowing into bond funds, the lagging performance in the high-yield market, the slump in commodity markets and the weakness, both relative and absolute, in the Russell 2000 small-cap index, surely cannot be making the economic growth bulls feeling too comfortable right now..” – David Rosenberg

We agree.

With retail positioning very long-biased, the implementation of QE4 has once again removed all “fears” of a correction, a recession, and a bear market, which existed just this past summer. Historically, such sentiment excesses form around short-term market peaks.

This is a excellent time to remind you of the other famous “Bob Farrell Rule” to remember: 

“#5 – The public buys the most at the top and the least at the bottom.”

What investors miss is that while a warning doesn’t immediately translate into a negative consequence, such doesn’t mean you should not pay attention to it.

It is akin to constantly running red lights and never getting into an accident. We begin to think we are skilled at running red lights, rather than just being lucky.

Eventually, your luck will run out.

Pay attention, have a plan, and act accordingly.

MacroView: The Next “Minsky Moment” Is Inevitable

In 2007, I was at a conference where Paul McCulley, who was with PIMCO at the time, was discussing the idea of a “Minsky Moment.”  At that time, this idea fell on “deaf ears” as the markets, and economy, were in full swing.

However, it wasn’t too long before the 2008 “Financial Crisis” brought the “Minsky Moment” thesis to the forefront. What was revealed, of course, was the dangers of profligacy which resulted in the triggering of a wave of margin calls, a massive selloff in assets to cover debts, and higher default rates.

So, what exactly is a “Minskey Moment?”

Economist Hyman Minsky argued that the economic cycle is driven more by surges in the banking system, and in the supply of credit than by the relationship which is traditionally thought more important, between companies and workers in the labor market.

In other words, during periods of bullish speculation, if they last long enough, the excesses generated by reckless, speculative, activity will eventually lead to a crisis. Of course, the longer the speculation occurs, the more severe the crisis will be.

Hyman Minsky argued there is an inherent instability in financial markets. He postulated that an abnormally long bullish economic growth cycle would spur an asymmetric rise in market speculation which would eventually result in market instability and collapse. A “Minsky Moment” crisis follows a prolonged period of bullish speculation which is also associated with high amounts of debt taken on by both retail and institutional investors.

One way to look at “leverage,” as it relates to the financial markets, is through “margin debt,” and in particular, the level of “free cash” investors have to deploy. In periods of “high speculation,” investors are likely to be levered (borrow money) to invest, which leaves them with “negative” cash balances.

While margin balances did decline in 2018, as the markets fell due to the Federal Reserve hiking rates and reducing their balance sheet, it is notable that current levels of “leverage” are still excessively higher than they were either in 1999, or 2007.

This is also seen by looking at the S&P 500 versus the growth rate of margin debt.

The mainstream analysis dismisses margin debt under the assumption that it is the reflection of “bullish attitudes” in the market. Leverage fuels the market rise. In the early stages of an advance, this is correct. However, in the later stages of an advance, when bullish optimism and speculative behaviors are at the peaks, leverage has a “dark side” to it. As I discussed previously:

“At some point, a reversion process will take hold. It is when investor ‘psychology collides with ‘leverage and the problems associated with market liquidity. It will be the equivalent of striking a match, lighting a stick of dynamite, and throwing it into a tanker full of gasoline.”

That moment is the “Minsky Moment.”

As noted, these reversion of “bullish excess” are not a new thing. In the book, The Cost of Capitalism, Robert Barbera’s discussed previous periods in history:

The last five major global cyclical events were the early 1990s recession — largely occasioned by the U.S. Savings & Loan crisis, the collapse of Japan Inc. after the stock market crash of 1990, the Asian crisis of the mid-1990s, the fabulous technology boom/bust cycle at the turn of the millennium and the unprecedented rise and then collapse for U.S. residential real estate in 2007-2008.

All five episodes delivered recessions, either global or regional. In no case was there as significant prior acceleration of wages and general prices. In each case, an investment boom and an associated asset market ran to improbably heights and then collapsed. From 1945 to 1985 there was no recession caused by the instability of investment prompted by financial speculation — and since 1985 there has been no recession that has not been caused by these factors. 

Read that last sentence again.

Interestingly, it was post-1970 the Federal Reserve became active in trying to control interest rates and inflation through monetary policy.

As noted in “The Fed & The Stability Instability Paradox:”

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s. As shown in the chart below, when the Fed has lifted the short-term lending rates to a level higher than the 2-year rate, bad ‘stuff’ has historically followed.”

The Fed Is Doing It Again

As noted above, “Minsky Moment” crises occur because investors, engaging in excessively aggressive speculation, take on additional credit risk during prosperous times, or bull markets. The longer a bull market lasts, the more investors borrow to try and capitalize on market moves.

However, it hasn’t just been investors tapping into debt to capitalize on the bull market advance, but corporations have gorged on debt for unproductive spending, dividend issuance, and share buybacks. As I noted in last week’s MacroView:

“Since the economy is driven by consumption, and theoretically, companies should be taking on debt for productive purposes to meet rising demand, analyzing corporate debt relative to underlying economic growth gives us a view on leverage levels.”

“The problem with debt, of course, is it is leverage that has to be serviced by underlying cash flows of the business. While asset prices have surged to historic highs, corporate profits for the entirety of U.S. business have remained flat since 2014. Such doesn’t suggest the addition of leverage is being done to ‘grow’ profits, but rather to ‘sustain’ them.”

Over the last decade, the Federal Reserve’s ongoing liquidity interventions, zero interest-rates, and maintaining extremely “accommodative” policies, has led to substantial increases in speculative investment. Such was driven by the belief that if “something breaks,” the Fed will be there to fix to it.

Despite a decade long economic expansion, record stock market prices, and record low unemployment, the Fed continues to support financial speculation through ongoing interventions.

John Authers recently penned an excellent piece on this issue for Bloomberg:

“Why does liquidity look quite so bullish? As ever, we can thank central banks and particularly the Federal Reserve. Twelve months ago, the U.S. central bank intended to restrict liquidity steadily by shrinking the assets on its balance sheet on “auto-pilot.” That changed, though. It reversed course and then cut rates three times. And most importantly, it started to build its balance sheet again in an attempt to shore up the repo market — which banks use to access short-term finance — when it suddenly froze up  in September. In terms of the increase in U.S. liquidity over 12 months, by CrossBorder’s measures, this was the biggest liquidity boost ever:”

While John believes we are early in the global liquidity cycle, I personally am not so sure given the magnitude of the increase Central Bank balance sheets over the last decade.

Currently, global Central Bank balance sheets have grown from roughly $5 Trillion in 2007, to $21 Trillion currently. In other words, Central Bank balance sheets are equivalent to the size of the entire U.S. economy.

In 2007, the global stock market capitalization was $65 Trillion. In 2019, the global stock market capitalization hit $85 Trillion, which was an increase of $20 Trillion, or roughly equivalent to the expansion of the Central Bank balance sheets.

In the U.S., there has been a clear correlation between the Fed’s balance sheet expansions, and speculative risk-taking in the financial markets.

Is Another Minsky Moment Looming?

The International Monetary Fund (IMF) has been issuing global warnings of high debt levels and slowing global economic growth, which has the potential to result in Minsky Moment crises around the globe.

While this has not come to fruition yet, the warning signs are there. Globally, there is roughly $15 Trillion in negative-yielding debt with asset prices fundamentally detached for corporate profitability, and excessive valuations on multiple levels.

As Desmond Lachman wrote:

“How else can one explain that the risky U.S. leveraged loan market has increased to more than $1.3 trillion and that the size of today’s global leveraged loan market is some two and a half times the size of the U.S. subprime market in 2008? Or how else can one explain that in 2017 Argentina was able to place a 100-year bond? Or that European high yield borrowers can place their debt at negative interest rates? Or that as dysfunctional and heavily indebted government as that of Italy can borrow at a lower interest rate than that of the United States? Or that the government of Greece can borrow at negative interest rates?

These are all clear indications that speculative excess is present in the markets currently.

However, there is one other prime ingredient needed to complete the environment for a “Minsky Moment” to occur.

That ingredient is complacency.

Yet despite the clearest signs that global credit has been grossly misallocated and that global credit risk has been seriously mispriced, both markets and policymakers seem to be remarkably sanguine. It would seem that the furthest thing from their minds is that once again we could experience a Minsky moment involving a violent repricing of risky assets that could cause real strains in the financial markets.”

Desmond is correct. Currently, despite record asset prices, leverage, debt, combined with slowing economic growth, the level of complacency is extraordinarily high. Given that no one currently believes another “credit-related crisis” can occur is what is needed to allow one to happen.

Professor Minsky taught that markets have short memories, and that they repeatedly delude themselves into believing that this time will be different. Sadly, judging by today’s market exuberance in the face of mounting economic and political risks, once again, Minsky is likely to be proved correct.

At this point in the cycle, the next “Minsky Moment” is inevitable.

All that is missing is the catalyst to start the ball rolling.

An unexpected recession would more than likely due to trick.

Dallas Fed President Sees “No Move” In Fed Funds Rate

Dallas Fed President Robert Kaplan made some interesting comments today on interest rates, repos, and the coronavirus.


Dallas Fed President Robert Kaplan was on panel discussion today at the University of Texas McCombs School of Business on the “2020 Business Outlook: Real Estate and the Texas Economy” in Austin, Texas.

Bloomberg Econoday Synopsis

  1. Dallas Fed President Robert Kaplan is neutral right now on monetary policy, saying neither a rate cut nor a rate hike are necessary in the medium term. “My base case is no movement up or down in the Fed funds rate [in 2020], but I’ll be monitoring [things] carefully … this year,” Kaplan said in a panel discussion.
  2. Kaplan believes the outlook for the economy has stabilized and if anything has “firmed”, and though he now has “a more confident outlook” he isn’t ready to commit to a rate hike saying it’s “too soon to judge if a hike is coming, and you’ve got a number of [risky] factors going on.”
  3. Regarding a so-called “coronavirus cut” to reassure markets, Kaplan doesn’t see justification yet adding, however, that he is carefully watching how the virus unfolds and that he will have a better sense of its effects over the next few months. Kaplan also noted that he will be watching the first-half impact of the Boeing 737 production shutdown.
  4. On repo operations, Kaplan described the rise in the Fed’s balance sheet through year-end as “substantial” but he sees slowing growth through June. “I’d be hopeful and expect that as we continue bill purchases during the second quarter, the repo usage will begin to decline and the headline net balance-sheet growth for the Fed will moderate – certainly far more moderate than what’s we’ve seen to this period.”
  5. On inflation, Kaplan’s base case is an upward trend toward 2 percent in the medium term. Kaplan said the Fed is debating whether to lengthen out its look at inflation from a one-year average to perhaps a two-year average. “We look at a variety of factors to make our judgment.”

Regarding no interest rate movement, the market disagrees, and so do I.

On inflation, the entire fed is clueless about what it is.

In regards to a firming economic outlook, Kaplan may wish to ponder Coronavirus Deaths Surge, No Containment In Sight.

The supply chains disruptions will be massive. A “Made in China” Economic Hit is coming right up.

On repo operations, yep, it’s entirely believable the Fed will keep ballooning its balance sheet risking even bigger bubbles.

The yield curve is inverted once again. And that’s flashing another recession signal. On Average, How Long From Inversion to Recession?

MacroView: The Fed’s View Of Valuations May Be Misguided

On Wednesday, the Federal Reserve concluded their January “FOMC” meeting and released their statement. Overall, there was not much to get excited about, as it was virtually the same statement they released at the last meeting.

However, Jerome Powell made a comment which caught our attention:

“We do see asset valuations as being somewhat elevated” 

It is an interesting comment because he compares it to equity yields.

“One way to think about equity prices is what’s the premium you’re getting paid to own equities rather than risk-free debt.”

As we have discussed previously, looking at equity yield, which is the inverse of the price-earnings ratio, versus owning bonds is a flawed and ultimately dangerous premise. To wit:

“Earnings yield has been the cornerstone of the ‘Fed Model’ since the early ’80s. The Fed Model states that when the earnings yield on stocks (earnings divided by price) is higher than the Treasury yield, you should invest in stocks and vice-versa.”

The problem here is two-fold.

1. You receive the income from owning a Treasury bond, whereas there is no tangible return from an earnings yield. For example, if we purchase a Treasury bond with a 5% yield and stock with an 8% earnings yield, if the price of both assets remains stable for one year, the net return on the bond is 5% while the return on the stock is 0%. Which one had the better return?  Furthermore, this has been especially true over the last two decades where owning bonds has outperformed owning stocks. (Data is total real return via Aswath Damodaran, NYU)

2. Unlike stocks, bonds have a finite value. At maturity, the principal is returned to the holder along with the final interest payment. However, while stocks may have an “earnings yield,” which is never received, stocks have price risk, no maturity, and no repayment of principal feature. The risk of owning a stock is exponentially more significant than owning a “risk-free” bond.

This flawed concept of risk, as promoted by the Federal Reserve, also undermines their view of current valuations.

I have spilled an enormous amount of “digital ink” discussing the importance of valuations on future returns for investors, and most recently, why high starting valuations are critically important to individuals at, or near, retirement.

“Over any 30-year period, beginning valuation levels have a tremendous impact on future returns. As valuations rise, future rates of annualized returns fall. This should not be a surprise as simple logic states that if you overpay for an asset today, the future returns must, and will, be lower.”

Not surprisingly, valuations are often dismissed in the short-term because there is not an immediate impact on price returns. Valuations, by their very nature, are not strong predictors of 12-month returns. This was a point made by Janet Yellen in 2017:

“The fact that [stock market] valuations are high doesn’t mean that they’re necessarily overvalued. For starters, high valuations don’t portend lackluster returns in the near term. History shows that valuations provide no reliable signal as to what will happen in the next 12 months.”

That is correct. However, over long periods, valuations are strong predictors of expected returns, which is what matters for investors.

As my friends over at Crescat Capital, Kevin Smith and Tavi Costa, recently penned:

“The problem is that P/E, even Shiller’s cyclically adjusted P/E ratio (CAPE), is a potential value-trap measure in the current economy because of three issues:

  1. Profit margins are unsustainably high today, not only within this business cycle but compared to other business cycles making P/E ratios understated;
  2. The P/E ratio completely ignores debt in its valuation, not a good idea at a time when corporations have record leverage; and
  3. The most common measures of total market P/E use the mean rather than median company valuation which understates the average company’s multiple today by putting more weight on bigger, more profitable companies – the median better captures the valuation of the breadth of the market.

We believe median enterprise value to sales is one of the best measures to understand the extent of the bubble in the stock market today compared to history. By looking at sales and not earnings, we control for today’s likely fleeting, record-high profit margins. And because EV includes debt as well as equity in the total valuation of the company, it properly reflects the valuation of the business. Finally, our focus on the median company’s valuation illustrates the breadth of the valuation extreme in the market today.”

Let’s break down Crescat’s important points visually.

Since the economy is driven by consumption, and theoretically, companies should be taking on debt for productive purposes to meet rising demand, analyzing corporate debt relative to underlying economic growth gives us a view on leverage levels.

As Scott Minerd, CIO of Guggenheim Investments tweeted on Friday:

The problem with debt, of course, is it is leverage that has to be serviced by underlying cash flows of the business. While asset prices have surged to historic highs, corporate profits for the entirety of U.S. business have remained flat since 2014. Such doesn’t suggest the addition of leverage is being done to “grow” profits, but rather to “sustain” them. 

However, when it comes to GAAP earnings per share, which have been heavily manipulated by massive levels of “share buybacks,” the deviation between what investors are paying for earnings is the largest on record, far surpassing the “Dot.com” bubble era.

“The average investor does not need an advanced finance degree to understand these valuation points. It is a worthy endeavor to avoid getting caught up in the popular delusions associated with late-cycle market euphoria. We believe investors will need a good grounding in valuation and business cycle analysis to reject the common buy-the-dip advice that is soon to become prevalent in the still early stages of what is likely to become a brutal bear market.” Crescat Capital

As I stated above, what price-to-earnings (P/E) ratios tell us is that high valuations lead to lower future returns over time. However, what Jerome Powell misses in comments that valuations are elevated, but not concerning, is that it isn’t just P/E’s which are elevated.

“Below is another way to visualize the current market valuation extremes to understand the risks of a severe market downturn ahead. Here we look at each sector of the S&P 500 and compare its valuation today to compared to prior market peaks in the tech and housing bubbles in 2000 and 2007. We can see that an unprecedented 8 out of 11 sectors are at top-decile, historical valuations illustrating the breadth of the current market excess.” – Crescat Capital

“Below we show the gamut of measures currently at record high fundamental valuation for the market at large based on their historical percentile ranking. Data for MAPE and CAPE ratios go back prior to 1929! The other measures are based on the entire history of available data which goes back at least two and half business cycles:” – Crescat Capital

Low Interest Rates Support Higher Valuations

This is where we generally hear a common refrain from the mainstream media:

“Low levels of interest rates justify higher valuations.” 

To analyze the relative value argument, let’s look at the interaction of interest rates and stock valuations over the broad sweep of time. As shown, extremely high stock market valuations occurred in 1929, 2000, and recently. However, interest rates were extremely low only once (recently) during those three occurrences. If low interest rates coincide with extremely high stock valuations only one time out of three, then it is obvious that low interest rates do not cause, or justify, high stock valuations. Yet “low interest rates justify high stock valuations” is one of the certainties of the current mainstream narrative.

Source:  Robert Shiller, multipl.com.  Data through June 2017.

If we isolate the times when interest rates were extremely low, the 1940s and currently, we find in the 1940s stock valuations were low. So, the statement that low interest rates justify high stock valuations is only supported by one event….now.

A better understanding is achieved by the relative value argument that extremely high interest rates coincide with extremely low stock market valuations, which occurred in 1921 and 1981. Although a sample size of two observations is not enough to draw a statistically-significant conclusion, at least it is two events with the same outcome.

The historical relationship between extremes in stock market valuations with extremes in interest rates is as follows:

  • Extremely high interest rates, which have occurred twice, coincided with low stock market valuations.
  • Extremely low interest rates, which have occurred twice, have coincided with high stock market valuations only once; today.
  • Extremely high stock valuations have occurred three times. Only once (1/3 probability) did high stock valuations coincide with low interest rates; today.
  • If extremely low interest rates do not justify extremely high stock market valuations, then a rise in rates should not necessarily cause a decline in stocks, but rising rates do lead to market corrections and bear markets.

Crescat Capital also weighed in on this point as well:

“A common argument today is that low interest rates justify today’s high equity valuations. That is not true at all. When low interest rates are due to low growth and excessive debt, as is the case today, no valuation premium is justified.”

Make No Mistake

Jerome Powell clearly understands that a decade of monetary infusions and low interest rates has created an asset bubble larger than any other in history. However, they are trapped by their own policies as any reversal leads to the one outcome they can’t afford – a broad market correction.

As I wrote previously:

“In the U.S., the Federal Reserve has been the catalyst behind every preceding financial event since they became ‘active,’ monetarily policy-wise, in the late 70’s.”

This is the problem facing the Fed.

Currently, investors have been led to believe that no matter what happens, the Fed can bail out the markets and keep the bull market going for a while longer. Or rather, as Dr. Irving Fisher once uttered:

“Stocks have reached a permanently high plateau.”

Interestingly, the Fed is dependent on both market participants, and consumers, believing in this idea. With the entirety of the financial ecosystem now more heavily levered than ever, due to the Fed’s profligate measures of suppressing interest rates and flooding the system with excessive levels of liquidity, the “instability of stability” is now the most significant risk.

The “stability/instability paradox” assumes that all players are rational, and such rationality implies avoidance of complete destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption as it provides the “room” needed, after more than 10-years of the most unprecedented monetary policy program in U.S. history, to try and navigate the risks that have built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

The problem comes when they don’t.

Michael Markowski: Fed Downgrades U.S. Household Spending

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


The 2:00PM press conference held by US Fed Chairman Jerome Powell at the conclusion of the January 29th FOMC (Federal Open Market Committee) meeting started out with a bang. Within minutes the S&P 500 rallied to its high of the day. Shortly thereafter, the world’s leading stock index began to make lower highs and lower lows and closed near its lows for the day.   From its high to its close the venerable index declined by 0.60%.

The S&P 500 declined steadily after the initial spike because Federal Reserve Chairman Powell stated that US household spending had waned from “strong” to “moderate”.  He also emphasized that inflation in the US was below the Federal Reserve’s target. 

The volatility caused by the FOMC’s change in conditions for the US economy has increased the probability of a global market crash happening by the end of the first quarter of 2020.   See also “Wuhan Virus has potential to cause global market crash”, January 25, 2020.   

Retired Or Retiring Soon? Yes, Worry About A Correction

When I was growing up, my father used to tell me I should “never take advice from anyone who hasn’t succeeded at what they are advising.” 

The most truth of that statement is found in the financial press, which consists mostly of people writing articles and giving advice on topics where they have little experience, and in general, have achieved no success.

The best example came last week in an email quoting:

“You recently suggested that you took profits from your portfolios; however, I read an article saying retirees shouldn’t change their strategies. ‘If you’ve got a thoughtful financial plan and a diversified investment portfolio, the general rule is to leave everything alone.'” 

This seems to be an entirely different approach to what you are suggesting. Also, since corrections can’t be predicted, it seems to make sense.” 

One of the biggest reasons why investors consistently underperform over the long-term is due to flawed investment advice.

Let me explain.

Corrections & Bear Markets Matter

It certainly seems logical, by looking the 120-year chart of the market, that one should just stay invested regardless of what happens. Eventually, as the financial media often suggests, the markets always get back to even. One such chart is the percentage gain/loss chart over the long-term, as shown below.

This is one of the most deceptive charts an advisor can show a client, particularly one that is close to, or worse in, retirement.

The reality is that you DIED long before ever achieving that 8% annualized long-term return you were promised. Secondly, math is a cruel teacher.

Visually, percentage drawdowns seem to be inconsequential relative to the massive percentage gains that preceded them. That is, until you convert percentages into points and reveal an uglier truth.

It is important to remember that a 100% gain on a $1000 investment, followed by a 50% loss, does not leave you with $1500. A 50% loss wipes out the previous 100% gain, leaving you with a 0% net return.

For retirees, this is a critically important point.

In 2000, the average “baby boomer” was around 45-years of age. The “dot.com” crash was painful, but with 20-years to go before retirement, there was time to recover. In 2010, following the financial crisis, the time to retirement for the oldest boomers was depleted, and the average boomer only had 10-years to recover. During both of these previous periods, portfolios were still in accumulation mode. However, today, only the youngest tranche of “boomers,” have the luxury of “time” to work through the next major market reversion. (This also explains why the share of workers over the age of 65 is at historical highs.) 

With the majority of “boomers” now faced with the implications of a transition into the distribution phase of the investment cycle, such has important ramifications during market declines. The following example shows a $1 million portfolio with, and without, an annualized 4% withdrawal rate. (We are going into much deeper analysis on this in a moment.)

While a 10% decline in the market will reduce a portfolio from $1 million to $900,000, when combined with an assumed monthly withdrawal rate, the portfolio value is reduced by almost 14%. This is the result of taking distributions during a period of declining market values. Importantly, while it ONLY requires a non-withdrawal portfolio an 11.1% return to break even, it requires nearly a 20% return for a portfolio in the distribution phase to attain the same level.

Impairments to capital are the biggest challenges facing pre- and post-retirees currently. 

This is an important distinction. Most articles written about retirees, or those ready to retire, is an unrealized assumption of an indefinite timeline.

While the market may not be different than it has been in the past. YOU ARE!

Starting Valuations Matter

As I have discussed previously, without understanding the importance of starting valuations on your investment returns, you can’t understand the impact the market will have on psychology, and investor behavior.

Over any 30-year period, beginning valuation levels have a tremendous impact on future returns.

As valuations rise, future rates of annualized returns fall. This should not be a surprise as simple logic states that if you overpay for an asset today, the future returns must, and will, be lower.

This is far less than the 8-10% rates of return currently promised by the Wall Street community. It is also why starting valuations are critical for individuals to understand when planning for both the accumulation and distribution, phases of the investment life-cycle.

Let’s elaborate on our example above.

We know that markets go up and down over time, therefore when advisors use “average” or “annualized” rates of return, results often deviate far from reality. However, we do know from historical analysis that valuations drive forward returns, so using historical data, we calculated the 4-periods where starting valuations were either above 20x earnings, or below 10x earnings. We then ran a $1000 investment going forward for 30-years on a total-return, inflation-adjusted, basis. 

The results were not surprising.

At 10x earnings, the worst performing period started in 1918 and only saw $1000 grow to a bit more than $6000. The best performing period was actually not the screaming bull market that started in 1980 because the last 10-years of that particular cycle caught the “dot.com” crash. It was the post-WWII bull market that ran from 1942 through 1972 that was the winner. Of course, the crash of 1974, just two years later, extracted a good bit of those returns.

Conversely, at 20x earnings, the best performing period started in 1900, which caught the rise of the market to its peak in 1929. Unfortunately, the next 4-years wiped out roughly 85% of those gains. However, outside of that one period, all of the other periods fared worse than investing at lower valuations. (Note: 1993 is still currently running as its 30-year period will end in 2023.)

The point to be made here is simple and was precisely summed up by Warren Buffett:

“Price is what you pay. Value is what you get.” 

To create our variable return assumption model, we averaged each of the 4-periods above into a single total return, inflation-adjusted, index. We could then see the impact of $1000 invested in the markets at both valuations BELOW 10x trailing earnings, and ABOVE 20x. Investing at 10x earnings yields substantially better results.

Starting Valuations Are Critical To Withdrawal Rates

With a more realistic return model, the impact of investing during periods of high valuations becomes more evident, particularly during the withdrawal phase of retirement.

Let’s start with our $1 million retirement portfolio. The chart below shows various “spend down” assumptions of a $1 million retirement portfolio adjusted for an 8% annualized return, the impact of inflation at 3%, and the effect of taxation on withdrawals.

By adjusting the annualized rate of return for the impact of inflation and taxes, the life expectancy of a portfolio grows considerably shorter. Unfortunately, this is what “really happens” to investors over time, but is never discussed in mainstream analysis.

To understand “real outcomes,” we must adjust for variable rates of returns. There is a significant difference between 8% annualized rates of return and 8% real rates of return. 

When we adjust the spend down structure for elevated starting valuation levels, and include inflation and taxes, a far different, and less favorable, outcome emerges. Retirees will run out of money not in year 30, but in year 18.

With this understanding, let’s revisit what happens to “buy and hold” investors over time. The chart below shows $3000 invested annually into the S&P 500 inflation-adjusted, total return index at 10% compounded annually, and both 10x and 20x valuation starting levels. I have also shown $3000 saved annually and “stuffed in a mattress.”

The red line is 10% compounded annually. While you don’t get compounded returns, it is there for comparative purposes to the real returns received over the 30-year investment horizon starting at 10x and 20x valuation levels. The shortfall between the promised 10% annual rates of return and actual returns are shown in the two shaded areas. In other words, if you are banking on some advisor’s promise of 10% annual returns for retirement, you aren’t going to make it.

Questions Retirees Need To Ask About Plans

What this analysis reveals is that “retirees” SHOULD be worried about bear markets. 

Taking the correct view of your portfolio, and the risks being undertaken is critical when entering the retirement and distribution phase of the portfolio life cycle.

Most importantly, when building and/or reviewing your financial plan, these are the questions you must ask and have concrete answers for:

  • What are the expectations for future returns going forward given current valuation levels? 
  • Should the withdrawal rates be downwardly adjusted to account for potentially lower future returns? 
  • Given a decade long bull market, have adjustments been made for potentially front-loaded negative returns? 
  • Has the impact of taxation been carefully considered in the planned withdrawal rate?
  • Have future inflation expectations been carefully considered?
  • Have drawdowns from portfolios during declining market environments, which accelerates principal bleed, been considered?
  • Have plans been made to harbor capital during up years to allow for reduced portfolio withdrawals during adverse market conditions?
  • Has the yield chase over the last decade, and low interest rate environment, which has created an extremely risky environment for retirement income planning, been carefully considered?
  • What steps should be considered to reduce potential credit and duration risk in bond portfolios?
  • Have expectations for compounded annual rates of returns been dismissed in lieu of a plan for variable rates of future returns?

 If the answer is “no” to the majority of these questions. then feel free to contact one of the CFP’s in our office who take all of these issues into account. 

Yes, not only should you worry about bear markets, you should worry about them a lot.

Michael Markowski: Wuhan Virus & The Potential Of A Market Crash

Michael Markowski has been involved in the Capital Markets since 1977. He spent the first 15 years of his career in the Financial Services Industry as a Stockbroker, Portfolio Manager, Venture Capitalist, Investment Banker and Analyst. Since 1996 Markowski has been involved in the Financial Information Industry and has produced research, information and products that have been used by investors to increase their performance and reduce their risk. Read more at BullsNBears.com


Based on my reading the financial news and listening to the market pundits about the potential impact of the Wuhan Coronavirus the probability is very high that the global equity markets will experience a severe correction or maybe even a crash very soon.  It’s because the virus has not yet been discounted by the global markets.   

The media is reporting and the pundits are saying that the virus will have minor impact.  They cite the market statistics for the 2014 Ebola virus and the 2003 SARS virus. Read Bloomberg article, “Epidemics and Equities: What the Wuhan Virus Means for Markets”.  View Bloomberg video entitled, “There Is No Reason to Panic Over Virus, Says OCBC’s Menon”.   

That reporters, analysts and pundits are making comparisons to the 2014, Ebola virus is ridiculous.  Ebola cases were reported in only six of the world’s countries during 2014. These included five third world and emerging market countries; Liberia, Guinea, Sierra Leone, Nigeria and Mali.  The US was the only developed country with 11 cases and two deaths.  

For the 2003 SARS virus, the primary thesis by the media and the analysts is that the markets declined and rallied substantially by the end of 2003.  The reality is that the markets in the US and China had been in a steady decline since the bursting of the dotcom bubble in 2000.  The US market’s rally for the second half of 2003, coincided with the unemployment claims for the 2001 US recession peaking in June 2003.

Most importantly, the Wuhan virus is spreading much faster than SARS.  The first case of SARS was reported on November 16, 2002. From then until February of 2003, the SARS cases spread very slowly.

The first cases of the Wuhan virus were reported by China on December 31st.  Since then the virus in China has grown exponentially to 1,287 cases and 44 deaths as of January 25, 2020.  What is particularly disturbing is that China first reported an “outbreak of pneumonia of unknown etiology”, now named the Wuhan virus to the World Health Organization (WHO) at the end of 2019.  Since China did not report SARS to the WHO until February 10, 2003, and only after hundreds had the virus, its likely that the Wuhan virus originated well before the end of 2019.   

While the economic impact of the 2014, Ebola virus is not measurable SARS definitely had an economic impact.  Toronto was the world’s city which was hit the hardest by SARS. The impact on the Canadian economy was substantial.

SARS also impacted both the US and Chinese markets from November 17, 2002 through March 31, 2003.  The chart below depicts that both the Hang Sang and S&P indices plumbed to new lows during the first quarter of 2003 even though both indices had declined by a minimum of 40% for the period beginning April 1, 2002 through November 17, 2002.

The global markets especially in the US and China could not be more vulnerable.  Since the October 11, 2019, announcement of an agreed upon trade deal between the two countries, the Hang Sang increased by 6.2% and the S&P 500 by 10.9%.  The gains have driven the S&P 500 to an all-time high and the Hang Sang to a seven-month high. 

In addition to the US and Chinese indices being near their highs below are the other risk factors to consider: 

  • China in 2020 represents 16% of world economy versus 4% in 2003.  Thus, an economic slowdown in China will have a greater impact on the rest of the world.   
  • The web and social media user bases have grown exponentially since 2003.  Since the world is now more informed the risk to a number of industries which are vulnerable including travel and entertainment, etc., is more pronounced.

 

The last week of January 2020, will be critical.  The Chinese stock markets closed on Thursday January 23rd for a week to celebrate the Lunar New Year.  Should the new virus continue to spread it could result in a sharp decline in sentiment by Chinese and global investors for Chinese stocks.  The result could be a selling stampede when the Chinese market reopens on Friday January 31st.  The stampede could ripple across world markets and cause a global market crash.   

The Bull & Bear Tracker (BBT) which produced gains at an average of 5% per month for the past six consecutive months is an excellent vehicle for hedging against market crashes.  The BBT produces its greatest returns when the S&P 500 and Dow Jones indices are the most volatile.  In 2018 the Bull & Bear Tracker’s first signals produced gains of 7.96% and 9.84% for two of the S&P 500’s worst 25 percentage decline days from 2009 to 2020. 

MacroView: Elites View The World Through “Market Colored” Glasses

It is easy to suggest the economy is booming when your net worth is in the hundreds of millions, if not billions, of dollars, or when your business, and your net worth, directly benefit from surging asset prices. This was the consensus from the annual gaggle of the ultra-rich, politicians, and media stars in Davos, Switzerland this past week.

As J.P. Morgan Chase CEO Jamie Dimon told CNBC on Wednesday the stock market is in a “Goldilocks place.” 

Of course, it is when you bank receives an annual dividend from the Federal Reserve’s balance sheet expansion. This isn’t the first time I have picked on Dimon’s delusional view of the world. To wit:

“This is the most prosperous economy the world has ever seen and it’s going to be a very prosperous economy for the next 100 years. The consumer, which is 70% of the U.S. economy, is quite strong. Confidence is very high. Their balance sheets are in great shape. And you see that the strength of the American consumer is driving the American economy and the global economy. And while business slowed down, my current view is that, no, it just was a slowdown, not a petering out.”  

Jamie Dimon during a “60-Minutes” interview.

If you’re in the top 1-2% of income earners, like Jamie, I am sure it feels that way.

For everyone else, not so much. Here are some stats via the WSJ:

The median net worth of households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016, the latest available data. For households in the top 20%, median net worth more than doubled to $811,860. And for the top 1%, the increase was 178% to $11,206,000.”

Put differently, the value of assets for all U.S. households increased from 1989 through 2016 by an inflation-adjusted $58 trillion. A full 33% of that gain—$19 trillion—went to the wealthiest 1%, according to a Journal analysis of Fed data.

The problem that is missed is that the “stock market” is NOT the “economy.”

This is a point President Trump misses entirely when he tweets:

“Stocks are hitting record highs. You’re welcome.”

As discussed earlier this week, 90% of the population gets little, or no, direct benefit from the rise in stock market prices.

Another way to view this issue is by looking at household net worth growth between the top 10% and everyone else.

Since 2007, the ONLY group that has seen an increase in net worth is the top 10% of the population. This is not economic prosperity. This is simply a distortion of economics.

Another example of President Trump’s misunderstanding of the linkage between the economy and the stock market was displayed in his presser on Wednesday.

“Now, had we not done the big raise on interest [rates], I think we would have been close to 4% [GDP]. And I – I could see 5,000 to 10,000 points more on the Dow. But that was a killer when they raised the [interest] rate. It was just a big mistake.”President Donald Trump via CNBC

That is not actually the case. From 2009-2016, the Federal Reserve held rates at 0%, and flooded the financial system with 3-consecutive rounds of “Quantitative Easing” or “Q.E.” During that period average real rates of economic growth rates never rose much above 2%.

Yes, asset prices surged as liquidity flooded the markets, but as noted above “Q.E.” programs did not translate into economic activity. The two 4-panel charts below shows the entirety of the Fed’s balance sheet expansion program (as a percentage) and its relative impact on various parts of the real economy. (The orange bar shows now many dollars of increase in the Fed’s balance sheet that it took to create an increase in each data point.)

As you can see, it took trillions in “QE” programs, not to mention trillions in a variety of other bailout programs, to create a relative minimal increase in economic data. Of course, this explains the growing wealth gap which currently exists. Furthermore, while the Fed did hike rates slightly off of zero, and reduce their bloated balance sheet by a negligible amount, there was very little impact on asset prices or the trajectory of economic growth.

Not understood, especially by the Fed, is that the natural rate of economic growth is declining due to their very practices which incentivize non-productive debt. While QE and low rates may boost growth a little and for a short period of time, they actually harm future growth.

The Goldilocks Warning

While Jamie Dimon suggests we are in a “Goldilocks economy,” and President Trump says we are in the “Greatest Economy Ever,” such really isn’t the case. Despite a severe economic slow down globally, Dimon believes the domestic economy will continue to chug along with not enough inflation to push the Fed into hiking rates, but also won’t fall into a recession.

It is a “just right” economy, which will allow corporate profits to grow at a strong enough rate for stocks to continue to rise at 8-10% per year. Every year, into eternity.

This is where Jamie’s delusion becomes most evident. As shown in the chart below, since 2014, the S&P 500 index has soared to record heights, yet corporate profits for the entire universe of U.S. corporations have failed to rise at all. This is the clearest evidence of the disconnect between the markets and the real economy.

Note: It is worth mentioning the last time we saw a period where corporate profits were flat, while stock market prices surged higher was from 1995-1999. Unfortunately, as is repeatedly the case throughout history, prices “catch down” with profits and not the other way around.

Interestingly, in the rush to come up with a “bullish thesis” as to why stocks should continue to elevate in the future, many have forgotten the last time the U.S. entered into such a state of “economic bliss.”

“The Fed’s official forecast, an average of forecasts by Fed governors and the Fed’s district banks, essentially portrays a ‘Goldilocks’ economy that is neither too hot, with inflation, nor too cold, with rising unemployment.” – WSJ Feb 15, 2007

Of course, it was just 10-months later that the U.S. entered into a recession, followed by the worst financial crisis since the “Great Depression.”

The problem with this “oft-repeated monument to trite” is that it’s absolute nonsense. As John Tamny once penned:

A “Goldilocks Economy,” one that is “not too hot and not too cold,” is very much the fashionable explanation at the moment for all that’s allegedly good. “Goldilocks” presumes economic uniformity where there is none, as though there’s no difference between Sausalito and Stockton, New York City and Newark. But there is, and that’s what’s so silly about commentary that lionizes the Fed for allegedly engineering “Goldilocks,” “soft landings,” and other laughable concepts that could only be dreamed up by the economics profession and the witless pundits who promote the profession’s mysticism.

What this tells us is that the Fed can’t engineer the falsehood that is Goldilocks, rather the Fed’s meddling is what some call Goldilocks, and sometimes worse. Not too hot and not too cold isn’t something sane minds aspire to, rather it’s the mediocrity we can expect so long as we presume that central bankers allocating the credit of others is the source of our prosperity.”

John is correct. An economy that is growing at 2%, inflation near zero, and Central banks globally required to continue dumping trillions of dollars into the financial system just to keep it afloat is not an economy we should be aspiring to.

The obvious question we should be asking is simply:

“If we are in a booming economy, as supposedly represented by surging asset prices, then why are Central Banks globally acting to increase financial stimulus for the market?”

The problem the Fed and other central banks confront is that, when market levels are predicated on ever-cheaper cash being freely available, even the faintest threat that the cash might become more expensive or less available causes shock waves.

This was clearly seen in late 2018, when the Fed signaled it might increase the pace of normalizing monetary policy, the markets imploded, and the Fed was forced to halt its planned continued shrinking of its balance sheet. Then, under intense pressure from the White House, and still choppy markets, they reduced interest rates to bolster asset markets and stave off a potential recessionary threat.

The reality is the Fed has left unconventional policies in place for so long after the “Financial Crisis,” the markets can no longer function without them. Risk-taking, and a build-up of financial leverage, has now removed their ability to “normalize” financial policy without triggering destructive convulsions.

Given there is simply too much debt, too much activity predicated on ultra-low interest rates, and confidence hinging on inflated asset values, the Fed has no choice but to keep pushing liquidity until something eventually “pops.”

Unfortunately, when trapped in a “Goldilocks” economy, realities tend to become blurred as inherent danger is quickly dismissed. A recent comment from another “Davos elite,” Bob Prince, who helps oversee the world’s biggest hedge fund at Bridgewater Associates, made this clear.

“The tightening of central banks all around the world wasn’t intended to cause the downturn, wasn’t intended to cause what it did. But I think lessons were learned from that and I think it was really a marker that we’ve probably seen the end of the boom-bust cycle.”

No more “booms” and “busts?”

Thomas Palley had an interesting take on this:

The US is currently enjoying another stock market boom which, if history is any guide, also stands to end in a bust.

For four decades the US economy has been trapped in a ‘Groundhog Day’ cycle in which policy engineered new stock market booms to cover the tracks of previous busts. But as each new boom ameliorates, it does not recuperate the prior damage done to income distribution and shared prosperity.”

Well, except for those at the top, as Sven Henrick concluded last week:

“In a world of measured low inflation and weak wage growth easy central bank money creates vast price inflation in the assets owned by the few making the rich richer, but also enables the taking on ever higher debt burdens leaving everyone else to foot the ultimate bill.

There are two guarantees in life: The rich get obscenely rich, everybody else gets to carry ever more obscene public debt levels.”

That is the measured outcome of the central bank easy money dynamic that has been with us now for decades, but has taken on new obscene forms in the past 10 years with absolutely no end in sight.”

While the elites are certainly taking in the “view through market colored” glasses, the reality is far different for most.

It is true the bears didn’t eat “Goldilocks” at the end of the story, but then again, there never was a sequel either.