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Weekend Reading: On A Cliff’s Edge

Written by Lance Roberts | Aug, 11, 2017
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After a week on vacation, I got the joy of coming back to an Administration threatening North Korea over nuclear weapons.

Now, you would suspect the possibility of nuclear war might just be the catalyst to send markets reeling, but looking at the market’s reaction on Thursday, I suspect there will be t-shirts soon reading:

“I survived the threat of nuclear war and the ‘great crash of 2017’ of 1.5%”

As shown, the market did register a short-term “sell signal” last Friday and downward pressure has continued to build all week. The sell off on Thursday led to a break of the 50-dma and is threatening the bullish trend support line which has existed since the beginning of the year. IF the market does not regain the 50-dma by close of the markets today, I would suspect we will likely be looking for a decline to 2400. Such a correction, a whopping 3.03%, would likely shock many investors who have become overly complacent in recent months due to the abnormally low levels of volatility.

The sell-off on Thursday also resulted in a sharp snapback in volatility which had recently touched historically low levels. While this is likely not the beginning of the next cyclical upswing in volatility just yet, it should serve as a good reminder of what will happen when volatility does return.

One interesting note was the consternation by the mainstream media and analysts over why stocks did not perform better in the recent earnings reporting season when it was so good. Well, despite the much trumpeted operating earnings growth of 7.67%, reported earnings (the actual earnings that matter) only rose by 0.51%. Furthermore, revenue, which is what happens at the top-line of the income statement, has remained mired at the same level as it was in Q4. With markets having already priced in much of the forward estimates, there seems to be little catalyst to push stocks higher at this point leaving investor risk elevated.

While the markets can certainly remain “irrational” longer than logic would dictate, it only seems prudent to step back and the question of “what will likely happen next?”

For me that question has three outcomes:

  1. The bull market continues for another 12-18 months as “greed” and “exuberance” push asset prices to further extremes. The subsequent “reversion to the mean” wipes out the majority of gains from the 2009 lows resetting valuations and investor psychology for the next bull market.
  2. There is a mid-term correction within the next few months, like the beginning of 2016, which fails to shake out investors and sets the market up for the final leg of the bull market melt-up as the final capitulation of buyers makes its appearance. The subsequent “reversion to the mean” resets the market by 50-60%.
  3. The market drifts sideways for the next couple of months, and then, as the realization that legislative agenda is not forthcoming, the debt ceiling fight or some other political debacle sends investors rushing for the sidelines. The sell-off sends “algo’s” into a “sell the rally” mode and margin calls exacerbate the selling. The stampede to “sell everything” will result in the same “reversion to the mean” which will, as noted, wipe out 50-60% of investors portfolios as the next recession resets expectations to economic realities.

There is no case that be made that supports “the bull market will continue forever.”

When you are standing on the edge of cliff, looking at the ground far below, there is always that momentary desire to take a leap. Fortunately, for most, rationality takes hold.

Unfortunately, in the financial markets, irrationality historically prevails and very few investors survive the fall.  

So, with that said, here’s what I am reading this weekend.


Politics/Fed/Economy


Markets


Research / Interesting Reads


 “Wide diversification is only required when investors do not understand what they are doing.” – Warren Buffett

Questions, comments, suggestions – please email me.


Lance Roberts

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Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter and Linked-In

2017/08/11
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