Here Comes the Bounce

The major stock market indices staged an impressive comeback on Friday as they all reversed early losses to close nicely higher. Given the very orderly pullback along with some modest losses of roughly 3% except in the NASDAQ, the odds now favor the bulls stepping up right here for at least a short-term bounce. Should the bounce materialize, the next question will be if it’s a bounce all the way to new highs or just back towards 18,000 before rolling over again.

With the NYSE advance/decline line still acting so strong, it’s unlikely that this indicator will help us much on this rally. High yield bonds, however, is one area that we should very closely watch for clues about the next month. Plainly put, we want to see them head to their old highs, if not outright score new ones. Should stocks rally without junk bonds, my opinion will be that the stock market is in for a deeper bout of weakness this quarter.

While almost every major sector saw a reversal on Friday, not all are behaving constructively. REITs, staples, and precious metals are clearly the leaders, but those are not the usual suspects during healthy advances. Discretionary, industrials and materials have constructive price patterns, that is, as long as Friday’s low was the end of the weakness. Should these sectors close below Friday’s lowest price, I think the stock market would struggle to find other good leadership groups to push it higher.

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2016 Continues to Look Like 2008

Several weeks ago when I was ranting how 2016 looks nothing like 2008, 2016 not a 2008 Redux and later The One Comp to 2008 that Does Hold Water I compared the January 2008 period to that of 2016. It’s a comp that continues to make the rounds so here it is updated, yet again.

2016 2008

If this comp continues to work, which they seldom do to fruition, here’s what’s coming next.

2009

Remember, the January 2008 decline was 20% all in and 2016 was roughly half that if you are looking to forecast the magnitude of the current rally.

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2008 Redux This is Not

2016 is just a week old, yet all I am reading and hearing is that it’s going to be a terrible year for stocks and similar to 2008. 2007 – 2009 was a generational bear market, the likes of which have only been seen during the Great Depression. These types of strong deflationary spirals take decades of mistakes to create and leave investors scarred even longer. In the western world, we have never, ever seen a repeat within 10, 20 or even 30 years.

Heading into 2008, the housing crisis was already in full bloom. Leverage at the banks and on Wall Street was at epic levels. Corporations had very little cash on hand to buffer any weakness. Today, the massive leverage has also been purged from the system. Banks are sitting on more than $2 trillion in cash and corporations have another $1.5 trillion. Housing is stable and lenders are tight with their money. The economy may not be hitting on all cylinders, but it’s far from teetering on collapse. There are no Lehmans, Bear Stearns, Fannies, Freddies, AIGs and the like hanging on by a thread.

To compare 2016 to 2008 is either grandstanding or just plain ignorant.

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Q3 Stock Market Scenarios Unfolding Nicely

Last week after the Dow plunged 350 points and began to bounce, I offered the two most probable scenarios for stocks, both of which included new multi-month lows before any real rally would begin. Stock Market Scenarios for Q3

My conclusion was, “just because we saw extreme readings on Monday doesn’t mean that the ultimate low was seen. I would argue against that. Monday’s snowball day was an important piece, but far from the final piece. Wash out readings like I listed above typically do not coincide with the final low. There is usually more constructive work to be done by price.”

Below is the chart I included with the the green (more bullish) and orange (less bullish) scenarios.

Today, the chart is starting to show signs of a potential low in the green bullish case, right on schedule, as you can see below, but it’s too early to offer more comments until I see how sentiment behaved so far this week. One thing is certain; the stock market will need much better internals to mount any significant rally, meaning that the number of stocks rallying and declining needs to shift to the bullish side along with the volume on each side. For months, it has been neutral at best or slightly on the negative side.

While the markets and media are singularly focused on Greece, everyone’s eyes should be on China which is a much, much bigger issue.

Care more about how the market reacts to news rather than what the news actual is. Watch for spikes in bearish sentiment to set the stage for another leg up in the bull market. The bull market remains old and wrinkly but very much alive.

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Bears Having Their Day

Not even half a day of weakness and talk of the big C is out. The dreaded correction! It’s amazing that after a 73 month secular bull market, it’s still the most hated and disavowed bull ever. Yes, it’s now been 42 months since the last 10% correction, but markets don’t fall just because of age. Corrections occur to repair breaks and right now, there aren’t enough things broken to warrant a full fledged correction.

The most glaring concern is that the Dow Industrials continue to divergence from the Dow Transports and the Dow Utilities are even weaker. Coupled with sentiment, it makes the short-term murky as I have written about lately. Before you jump on the bears’ bandwagon, we have seen this picture before and it doesn’t end well for the bears. Weakness to the lower end of the trading range continues to be a buying opportunity until proven otherwise.

Don’t ignore the recent strength in banks, consumer discretionary and my very contrarian play in energy going forward. That’s not the kind of leadership you typically see if the stock market was in real trouble.

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7 Years Ago

As I drove home from Vermont today on Martin Luther King Day, I thought about past MLK Days, which is something I would normally do to pass the time away. My two boys were in the back seat napping and listening to music and I had Sirius on in the background. I vividly recall MLK Day 1994 as it was the single coldest day I have ever skied at Mount Snow, -25F with 20 mph winds that made it feel like -50F. I lasted all of two runs with an intervening break in the lodge on top. It was also the earliest I ever hit the bar and stayed there all day.

Market-wise, MLK 2008 is indelibly inked in my memory. Coming off a huge 2007 for our strategies in a difficult market environment, we began 2008 with a positive view of the stock market. At year-end, the market was finishing up its 2nd 10% decline in 5 months and I thought we would be a solid bounce to sell into in January. That didn’t happen.

Instead, stocks saw an orderly decline that appeared to end on the 9th. After a few days of pause, the selling floodgates started to open on Thursday and Friday before MLK Day. Over the weekend, the first major piece of financial crisis news hit. Previously, we had seen bits and pieces like sub prime loads beginning to default and two Bear Stearns hedge funds blowing up. But each time, the market digested the news and headed higher. MLK weekend 2008 it all changed.

When Japan opened Sunday night, I knew it was going to be bad. In fact, markets all over Asia were bleeding red to the tune of 5-8%. Our futures immediately signaled at least a 500 point decline when trading resumed on Tuesday from a Dow at 12,000. When I woke up Monday morning and saw Europe in collapse and our futures “limit down” which is the maximum point decline allowed pre-market, I knew our clients would be very concerned, especially if they didn’t hear from me with some kind of reassuring explanation. So I spent my MLK Day 2008 on the phone calling each and every client letting them know that I expected to see a 500-1,000 point decline in the Dow on Tuesday morning. I also explained that while there would be some short-term pain, I believed it was absolutely the worst time to sell. In fact, if anything, it looked like the final “flush” in the decline that began late on 2007 and a bottom should be at hand shortly. Investing is a marathon not a sprint and not only did I remind clients of that, I reminded myself as well!

Thankfully, every single client but one listened to my advice and some even bit the bullet and added money to their accounts early in the week. Stocks closed that post MLK Day Tuesday well off their lows and all seemed like it would be okay from there. Then Apple had a really bad earnings miss that afternoon and once again, overnight trading indicated another disastrous open. But a funny thing happened on the way to a crash as was being predicted. After another ugly open, buyers came storming in throughout the day and the Dow actually closed sharply higher, regaining all of the lost ground from Tuesday and the previous Friday.

Tuesday’s and Wednesday’s action post MLK was stage one in the stock market’s first quarter bottom that led to the May peak above 13,000 and the last good opportunity to sell before the crisis really unfolded.

January 2008 was the worst month I delivered to clients since launching my firm and the most difficult of my career at that point. There were a lot of “strange” messages being sent from our market models that didn’t make a whole lot of sense to me then. I just kept scratching my head wondering if our models were broken. In hindsight, they were dead on in warning of major systemic issues down the road that I had never seen before. After doing countless hours of research in spring 2008, the only comparison I could find was the period from 1929 to 1932 where the Dow lost 89% of its value. I am certainly glad I continued listening to our models in 2008!

While 2008 ended up being the year no one ever wants to repeat, MLK Day 2008 will always stick out in my mind as the day I chose fight over flight by calling all of our clients proactively. It was also a time where I knew I could handle whatever the market threw at me, good, bad or otherwise.

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