Don the Crash Helmets! It’s Bloody and Ugly Out There!!

By now, everyone knows that the Dow Jones Industrials fell by 1000 points last week, including a 531 point down day to close the week. More selling lies ahead in the short-term. It’s getting ugly. There’s blood in the streets. Sell what you can not what you want. Margin calls are coming. Maximum pain thresholds are being hit for the individual investor. Panic is here!

Before I opine on what it means, let’s put it all in perspective. 531 points is a 3% decline and 1000 points is just under 6%. Since the Dow peaked on May 19, the popular index has corrected 10% so far. In a worst case scenario, it could grow to 15-20% if China unravels beginning Sunday night.

For several months I have written many times about my concerns with the market. The most timely blog post was right at the most recent top on July 20.

Trouble Brewing Beneath the Surface

There were plenty of opportunities to take action, hedge, play some defense, sell, just do something proactive! I am sure that the vast majority of investors did absolutely nothing. In our portfolios, I am happy to report that we definitely took action several times by selling to raise cash as well as buying bonds which typically act as a flight to quality or “safe haven”.

I am not arrogant enough or naive enough to believe that during a full-fledged stock market correction that we won’t lose some money, but I am definitely pleased with our high levels of cash. This is a market time that separates the wheat from the chaff. The “pretenders” in the business get exposed. Investors don’t plan to fail. They fail to plan.

I often speak about the investing risk/reward ratio, referencing 18,500 on the upside and 16,900 on the downside. That negative skew caused us to take various defensive measures in many of our 12 strategies over the past few months. With the Dow finally closing below 17,000 with more downside to follow, the risk/reward is in the process of swinging firmly back to the positive side. It’s time to build a shopping list and prepare to deploy some of the beautiful cash that has built up.

Before I dive into the details of the stock market, I am going to start with my conclusion. While the evidence is certainly not as strong as it was a few months ago, I do not believe that the 6+ year bull market has ended; read, all-time highs lay ahead. The weakness looks like the first full-fledged correction since October 2011. The behavior we are currently seeing looks similar to what we actually saw in 2011, as you can see from the two charts below.

dia16 dia11

As I write this over the weekend and have not seen any stimulative action yet around the world, the preponderance of the evidence suggests that stocks are about to the enter the bottoming process, as soon as this week. While that doesn’t mean an immediate return to Dow 18,300, it does suggest that the repair process starts sooner than later, although high volatility won’t end soon.

From time to time as my great friend and colleague, Sam Jones, likes to say; Calling All Cars. It’s time add cash to your accounts. Blood is in the streets. Panic is setting in. It’s time to take on a little more risk or open a new strategy that’s more aggressive. That will likely be my theme for the next few weeks. On a personal level, I will be making my entire 2015 retirement plan contribution over the next few weeks so you truly know I how view the current situation.

If you have any questions about the market’s correction or your portfolio, please don’t hesitate to contact me directly by replying to this email or calling the office.

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My Oh My… The Music Has Stopped

If you listen to the media or have an active Twitter feed about the markets, you would think stocks have literally collapsed into the depths of a bear market. We MUST be down at least 10-15%! Yet as I type this, the S&P 500 has pulled back all of 6%. It’s a little more than half way to the 10% correction level.The Dow hit my initial downside target of sub 17,000 and the S&P 500 is on its way to 1970 – 2000.

Sentiment has swung dramatically from ebullient in June and July to pessimistic now on its way to possibly despondency shortly. Options traders are positioning for Armageddon. Volume in popular stock market ETFs SPY and QQQ is exploding higher as investors seek the refuge of liquid broad indices over individual stocks.

Technicians are talking about a new bear market and things like Dow Theory Sell Signals and the “dreaded death cross”. (I have written several blogs about Dow Theory and it’s probably time for another.) Market leaders in biotech, healthcare, consumer discretionary are finally getting hit. Market generals, Amazon, Regeneron, Google, Netflix, Facebook, Disney, etc. are being bludgeoned as the music “suddenly” stopped in the game of market musical chairs.

Markets typically don’t bottom on Fridays. I have to find my notes, but I recall Friday being the least likely day for a low although I do remember the post 9-11 bottom being on a Friday. Stocks are currently in the middle of the recognition wave where investors no longer believe it is a mild pullback to stay the course. The masses now believe there is further downside to go. Very light panic has set in. “Sell what you can, no what you want” is often heard. We should be seeing the bears on the popular financial channels any day doing the “I told you so” tour. Cue perennially wrong perma-bears Marc Faber, Jim Chanos, Peter Schiff, Porter Stansberry, etc. They are waiting in the wings!

From my seat as someone who has not been bullish for a while and raised significant cash over the summer, this looks like the beginning of the bottoming process. Unlike the routine and regular bull market pullbacks that just bottom out of nowhere 3-5% off the highs, this one has some more depth and teeth. While the zone to find a low has begun, it may be days or longer. Tops take a long time to develop, sometimes months or quarters, but bottoms are usually not a single day in time. They are quicker yet still require the necessary pieces to be complete.

The markets are a lot closer to a low than they were yesterday and last week and last month. It’s just going to take some more time and patience.

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Two Market Scenarios for the Quarter

In the last issue of Street$marts, I wrote about stocks being in a “murky” period for the next few weeks. I am going to pat myself on the back and say it has certainly looked “murky” since early October although I wish I had been more aggressive in taking action. The dark clouds have recently dissipated and the sun is starting to pop out. Once the decline began, it looked like the second half of October would see a low and that’s been confirmed.

I recently shared research that indicated a 15% chance of a 8-11% decline during the Q4. This was based on the S&P 500 seeing a fresh high in September or October which usually insulates the market from much more than a 10% decline. So far, on a closing basis the Dow and S&P 500 have dropped almost 7% and 7.5% respectively, and 8.6% and 9.4% on an intra-day basis. The other major indices have seen more significant weakness.

Either by skill or luck, I am always happy to nail a low as it occurs, especially now, when so many others were calling for much more serious damage. With the world fixated on Ebola, Europe’s economy, earnings and ISIS, fear was prevalent last week, the likes of which we haven’t seen since mid June and in some cases, 2011.

So far, all we know for sure is that “A” bottom was achieved. Whether it was “THE” bottom remains to be determined. If prevailing sentiment becomes “sell the rally”, the upside is likely to continue. However, if the masses believe that we just saw the final bottom of 2014 on the way to new highs, a more difficult path will be in store as I discuss below.

I continue to watch two scenarios as the most likely paths over the coming months. The green line in the chart below is obviously the more bullish of the two. It has last week’s low as “THE” low from which the year-end rally has already launched and all time highs are to be seen within a few months. The orange line forecasts a lot more volatility with the currently rally petering out shortly and marginal new lows seen within a few weeks. From there, the real rally begins, similar to 2011, with higher prices down the road.

 What is obviously missing from the scenarios above is a truly bearish one that has the bull market already over and this current rally representing a good selling opportunity leading to sharply lower prices right into the New Year and beyond. At this point, I just don’t see it. We simply do not have enough dead canaries to warrant such a negative outcome. And speaking of dead canaries, I will update the Canaries in the Coal Mine next week.

For now, the takeaway is to watch for signs that the rally is hitting stumbling blocks. High yield (junk) bonds had a truly epic day on Friday, recovering five days worth of declines in one day. That nascent advance must live on. Good sector leadership needs to emerge and not from consumer staples, utilities and REITs. Although the banks are a bellwether sector, the bull market can live without them for a while longer, but that will likely lead to the eventual demise.

Before I finish this article, there are things that concern me. It’s not all roses out there! After 67 months, the bull market is showing its age. Traditional Dow Theory just gave its first negative trend change in some time as both the industrials and transports closed below their August secondary lows. That’s long-term problematic unless both make fresh all time highs in the coming months. What would bother me even more is if one index scores a new high, but the other one does not. Anyway, we have time to explore this further next week.

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So Far So Good!

Just two ago, I wrote about the stock market “groping” for a bottom and laid out a scenario for that to begin on Wednesday. The beaten down Russell 2000 was the key as it very quietly had been outperforming the market for three days. That behavior is not what you typically see if a crash was unfolding. Our indicators and systems backed up my own thoughts and our equity strategies went to maximum exposure at the close on Wednesday.

When I woke up Thursday morning and saw the global stock markets in collapse, I thought it was going to be a truly interesting day. With so many things looking good a few hours earlier, I was either very wrong, which has happened before and will happen again, or this sharply lower open was an absolute gift to the bulls. At this point I am very glad I stayed the course and even took what I would classify as personal gambles at the open by buying oil and shorting the VIX.

After the lower open, stocks staged a very impressive comeback and the internals looked much better along with sector leadership. Our own flagship sector strategy has had a very tough month coming in to this week, but as with the Russell 2000, it bucked the market downtrend and closed higher on Tuesday, Wednesday and Thursday. For the past week or so, I have strongly suggested that clients add money right away as this correction was nearing an end. And I followed my own advice by making my kids’ college fund additions as well as my 2014 retirement plan contribution into the market weakness.

Time will tell if we just saw “THE” bottom or “A” bottom, but even if stocks don’t go right back to all time highs, the preponderance of evidence suggested a good rally was close at hand. There are two scenarios I am watching now and I will spell those out in the Street$marts edition I am currently writing.

Remember, the largest one day stock market rallies usually occur after a decline. In 2008, we saw 4-8% one day moves many times. The larger the decline, typically, the larger the snapback. If you hated certain stocks, ETFs or funds on the way down, use the strength to rebalance your portfolio the way you want.

I am keenly watching how the plain vanilla high yield (junk) bonds funds act now. They are very stretched to the downside and are supposed to rally smartly. It’s put up or shut up time for the short-term, intermediate-term and perhaps even long-term.

Finally, I mentioned watching Apple and Netflix for signs of leadership. Apple hung in really well and should see new highs this quarter. Netflix announced bad earnings and was bludgeoned. IF this is the final rally of the bull market, IF, I would expect the rally to leave many key stocks behind. In other words, it would be narrow. The rising tide would not lift all ships. Again, IF.

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Stock Market Groping for a Low

If you woke up this morning, turned on the computer or TV and saw another Texas healthcare worker with Ebola, European markets under siege yet again and our own stock market futures in collapse, you probably did not feel so great. Anxiety? Panic?

As the morning progressed and our stock market opened, your saw an immediate mini panic with the Dow down 370. At the same time, the 10 year treasury note’s yield absolutely and totally collapsed under 2%. That is capitulation in stocks and flight to quality or safety in bonds. Heading to the exits en mass. Throwing the baby out with the bathwater. Choose any cliche you want.

(Side note. Our Global Asset Allocation strategy has owned treasury bonds almost every day this year and today is the first time we are seeing a sell signal in that asset as its price has spiked to unsustainable levels.)

Is this “A” bottom or “THE” bottom or even a bottom. We should know more by the end of the day. If stocks rollover yet again during the afternoon and close below the lows of the morning, the panic is likely to follow through until we see another panic set up. If, however, stocks can hold the morning low and firm throughout the day, even to still close down, that would be a good sign that at least a bounce, if not full fledged rally is here.

The Russell 2000 index of small cap stocks, which has been bludgeoned since July has performed very well this week on a relative basis. And so far today with stocks taking it on the chin early, small caps fought back to unchanged. This is bullish behavior and not typically what we see if stocks were on the verge of additional collapse or even crash. It will be VERY telling to see how the Russell 2000 ends the day.

Besides the small cap stocks, Apple and Netflix have been pillars of relative strength of late. When stocks finally bottom and bounce, I would closely watch these two large caps for leadership.

On the sector front, none have been spared the carnage of the last month with energy being decimated the most, close to the point where they have performed so poorly, it’s actually good going forward. I remain positive on REITs, biotech, transports and semiconductors for now, but that should change with the heightened volatility from day to day and week to week.

I fully expect wild swings today and probably the rest of the week.

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Who Turned the Lights Out… Again

 Yesterday, I wanted to see what leadership emerged after Wednesday’s big surge and more importantly, I wanted definite confirmation from the plan vanilla high yield (junk) bond mutual funds that the canary wasn’t dying. That was before the open.

I have to say that the depth and tenaciousness of Thursday’s decline definitely caught me off guard. While giving back 25% or even 50% of the big rally would not have out of the ordinary, losing all of it certainly was. It reminded me of January 2008 as stocks were groping for their first low of the year.

The anticipated up day in plain vanilla high yield bond funded ended up as a moderately lower day in the end. That is not good. It says that liquidity is leaving the market and shows concern that the economy may not be as stable and strong as the jobs report indicated. At this point, high yield bonds look like they want to continue lower as water finds its own level. The positive from my selfish perspective is that there should be a very solid buying opportunity over the coming month for a good trade into the New Year. I can’t believe I just typed “New Year.” Wow, did this year fly by!

Looking at the stock market, earlier this week I wrote that there was a 15% chance of a 8-11% correction taking the Dow below 16,000. That scenario certainly looks like it’s shaping up. With the August lows in the S&P 400 and Russell 2000 long breached, the S&P 500, Dow and Nasdaq 100 should not be too far behind.

Given the depth of the pullback, a scenario should unfold where stocks see some capitulatory selling next week or soon thereafter followed by a feeble rally and final decline into the ultimate bottom. I will discuss more if and when this unfolds. For now, it’s probably too late to sell and too early to buy. Patience is the virtue.

Have a safe and enjoyable weekend, especially if it’s a long one for you! I would be surprised if the media doesn’t start talking correction, crash, etc. with possible Blue Monday.

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History Says 15% Chance of 8-11% Decline Right Now

Today (Wednesday) I am excited to head to New York City for a day full of media (and a tiny bit of shopping). My first stop is with the good folks at Yahoo Finance to create two or three segments on what’s hot now. I know for sure we will do one on market bubbles which should be controversial and interesting. I imagine there will be one about the bull market or Fed and then one on the hot story of the day, like today’s thrashing in the stock market. It’s always a good time to visit Jeff Macke.
From there I head to the New York Stock Exchange for a 3:45pm interview on CNBC’s Closing Bell. After all these years, I am still wowed when I visit the floor. Finally, I am thrilled to join Fox Business’ Making Money with Charles Payne for a whole hour from 6pm to 7pm. Sometime in between, I hope to buy a suit which I am told that I desperately need.

The short-term picture remains murky for the next few weeks, but looking out beyond that, markets should regain their solid footing and march higher later this quarter. October has a reputation of being a bad month for stocks. Most people recall the great crash of 1929, crash of 1987, mini crash of 1989, crash of 1997, crash of 1998 and Lehman collapse of 2008, which all occurred in October. Keep in mind that some macro news event usually was given the credit (or blame) for causing the decline, isn’t that always the case? In a vacuum, October looks like a very scary month, but that would be a big mistake!

Taking a wider view, you realize that in almost every case above, stocks were already in decline before October began. The month actually acted as an accelerator rather than an initiator. Furthermore, October was most often a turning point for stocks in that declines continued into October, bottomed mid to late month and then a significant rally began. You would be hard pressed to find many examples of times when October did not see at least an interim low.

Given that stocks peaked last month, I went back and researched how the market behaved in the fourth quarter after a new high in September. The results may surprise you!

Since the bull market began in 2009, the only significant Q4 decline was in 2012, -8%, or 1/5 times(20%).

Since 2000, besides 2012, 2007 was the only other year. The Dow peaked in October and declined 11%. That’s 2/14 or 14% of the time.

There were no Q4 declines from a September or October peak in all of the 1990s! Read that line over again.

1989 saw the mini crash of 9% from an October peak and 1980 had a very unusual 10% from a November peak.

Since 1980, there five significant Q4 declines from a high or just 15% of the time.

So here we are on October 7, having seen a September new high peak heading into Q4. History says there is a 15% chance of 8-11% decline from the September Dow high of 17,280. If this is one of those times, the Dow is looking at a possible downside range of 15,379 to 15,898. Anything else on the downside would be a 35+ year precedent setter. 

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Reading the Short-Term Tea Leaves

To reiterate a comment I think I have made each and every week for at least three years, the bull market may be old and wrinkly, but it’s not dead. It continues to be the most disavowed and hated bull market of the modern investing era and that’s why it will live on. On an almost daily basis, another “market professional” comes out of the woodwork on why stocks should not be at these levels.

Several good friends of mine in the industry have been calling for a 20% decline since early 2012. They tell me that the stock market is manipulated and is heading for doom. Those are the same people who when on the correct side of the market, tell me that it’s all just the normal functions of the capitalist system. To me, it all sounds like sour grapes and rationalizing a wrong position. I have been wrong many times in my 25 year career and will be wrong many more times before all is said and done. It’s okay to be wrong, but it’s not okay to ignore the evidence and stay wrong.

Given my long-term view, that doesn’t mean that the stock market won’t pullback or correct from time to time. It’s been just about three years since the last full fledged 10%+ correction which ended up being roughly 20%. Stocks are long overdue for significant downside, but that doesn’t mean it will happen tomorrow. I have been in the pullback (4-8%) camp for several weeks and remain there today.

At this point I see three possible scenarios for stocks over the coming months, two of which can be seen below. The first one is labeled “bullish scenario” as it has the current bounce running out of steam sooner than later, followed by a decline that exceeds last week’s low by a small margin into the “cushion zone”.

The “cushion zone” is an area where the market spent most of its time between mid February and late May recharges its batteries for that powerful spring rally to all time highs. On the way back down, it’s also the area where stocks should find some cushion as if someone leaped off a ledge and into a giant mattress. That zone should cushion the market’s fall and start a new rally to all time highs next month.

On the other hand, the chart below is the “bearish scenario” which has the stock market actually rallying further than the “bullish scenario” in the very short-term, but stopping before hitting new highs. From there, stocks roll over again, similar to the path we saw in 2011, falling more than 10% and through the “cushion zone”.

 

The good news is that we won’t have to wait long to eliminate one of the aforementioned scenarios. There is a third path that is also possible, but I won’t fully flesh that out for now.

Is your portfolio properly positioned this year? If you are not sure, don’t hesitate to hit REPLY or call the office to schedule a meeting, call or Skype.

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Getting Anywhere?

Early Monday I wrote about the market setting up for a bounce. And that was certainly the case on Monday. Tuesday, however, was a different story as stocks gave back all of Monday’s gains and then some. Wednesday’s solid action, once again, puts the stock market on bounce alert.

I keep using the word “bounce” instead of rally because it looks like there needs to be some more work on the downside before the current pullback wraps up. With each successive red day, the markets seem to be rebuilding the wall of worry necessary to begin the next meaningful rally. The problem is that this does not happen overnight.

Stocks are “supposed” to make some upside headway right here and now. Treasury bonds are “supposed” to pullback right here and now. Gold is “supposed” to rally right here and now and the dollar is “supposed” to decline right here and now. That’s the short-term scenario, some of which I positioned clients for while some isn’t worth the risk.

I am still keenly watching which sectors lead the bounce and which cannot get off the carpet. Right now, very few look enticing for more than a quick trade.

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Monday is Bounce Day

After some normal volatility on Friday, the bulls held their own and are positioned to see some green as the trading week opens. There are two scenarios I am watching here.

The first is the lows hit on Friday. If the major indices close below those levels sooner than later, we should see some trap door, elevator shaft, immediate selling. That’s the more bearish path. Scenario number two has the market bouncing for a few days and then rolling over to revisit the lows from Friday where the bottom is quickly formed.

As I mentioned last week, the quality of the bounce is so important right now. Poor participation or sector leadership may well have more intermediate-term consequences, but if the bulls can make an internal stand, the stage can be set for Dow 17,500.

Just like with the stock market, treasuries are at an important juncture as well. They are positioned to see more upside, but that needs to be much sooner than later to stave off a multi-week pullback.

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