“A” Bottom, “THE” Bottom or “NO” Bottom

Long time readers know that I am ALWAYS skeptical of bottoms where price ends the day in the bottom of the daily range. They rarely mark the ultimate low. When some of indicators turned positive at the of October 11, I wasn’t as full on bullish as I usually would be because stocks closed that day near their lows. In subsequent posts, I offered that while the majority of the price damage should be done, I would not be surprised to see a marginal new low made this month.

Tuesday’s action qualified as price made a marginal new low, but rallied smartly to close in the top 25% of the day’s range. That served to flush the sellers out. IF that was at least a short-term trading low, stocks would be stronger today. So far, that’s not the case. It’s not only technology taking it on the chin. The weakness is widespread with financials, biotech, transports, metals, materials and energy all seeing selling pressure.

My overall theme remains the same; the majority of the price damage has been done. Stocks should continue to be very volatile and thrash around somewhat violently until we get past the election.

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Clear as Mud. Volatility & Patience.

I keep writing about volatility ruling and boy, it is not disappointing! The huge swings high to low and low to high are extreme. It’s all part of the makings of a bottom for a good year-end rally. We did a really good job calling the peak a few weeks and then offered that the majority of the damage should be done after the collapse on October 11, but perhaps not all of the damage.

The best I can put it is that the stock market needs some time to repair the damage done by the decline. I expect more thrashing around, but no meaningful upside progress made until next month. The Dow kissed its average price of the last 200 days. The S&P 500 is resting on that same average now. The mid and small caps are well below all important averages. And the NASDAQ 100 looks more like the Dow.

Yep. It’s as clear as mud.

October 11 saw a number of our key short-term indicators turn positive. However, the stars seem to be sloppily aligning. Semis still look ugly. Transports and discretionary are marginally better. Banks just look plain putrid. At some point, they will be so bad, it’s actually good. But that’s not now.

Finally, high yield bonds and the NYSE A/D Line are non-committal. I think besides volatility, the theme is really that of patience. Selectively position, but keep enough powder dry. About the only think I am really encouraged by has been the action in gold and the mining stocks. They have not disappointed. I also like treasury bonds here for a rental, but I wouldn’t give them much room on the downside. They are oversold, owned by smart money and supposed to rally now.

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Volatility Reigns. Building Blocks Needed

And just like that I am back at the airport and waiting to head home on Wednesday night. Just what I like, a jam packed two days and only one night not sleeping in my own amazing bed. As I keep writing about, volatility is going to remain elevated throughout this earnings season and into the mid-term elections. Wednesday perfectly epitomized this as you can see from the intra-day chart below. The major indices saw ranges from high to low between 1.5% and 2%. Continue to expect this.

Three of the four key sectors have outperformed during this nascent recovery although I am not putting a lot of stock in this just yet. High yield bonds have also led. The percent of stocks in healthy uptrends has taken it on the chin and this needs some time to repair and eventually rally back above 60%. That will be crucial for the survival of the bull market.

Again, the majority of the price damage should be over. An immediate return to all-time highs is unlikely and unhealthy. Stocks need time to thrash around and rebuild a solid foundation or the next rally could be the last.

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Pink & Blue Are Not Just for Baby Stuff

In yesterday’s post I mentioned that during most stock market declines, it seems like everyone turns to charts and technical indicators as their economic and fundamental indicators fail. They quote their own “key” numbers and speaking from 30 years of experience, if it’s obvious, it’s obviously wrong. In other words, when so many pundits turn to the same charts, the market does its best to punish the most people. I want to spend a few minutes explaining the most basic and easiest to understand technical indicators which is what you generally hear in the public domain because most pundits aren’t advanced enough to take it any further.

The three charts below are of the Dow Industrials, S&P 500 and NASDAQ 100 in that order. The pink lines represent the average price of the last 200 days, also known as the 200 day moving average. It’s “moving” because every day as one piece of data is added, one piece of data from 200 days ago falls off. Many people simply use the pink line as a gauge of whether stocks are in an uptrend or downtrend. When price is above the pink line, it’s said to be positive and in an uptrend while the opposite is true when price is below the pink line.

You will also notice three upward sloping blue lines which do nothing more than connect the lowest prices from earlier in the year. That’s also known as a trend line. The more times price touches a trend line, the more important that line becomes. Two times is obviously the bare minimum and not exactly all that important.

During the decline, I heard some pundits opine that computer driven algorithms or trading programs were the cause of the drop. They were said to be gunning for the pink line so others who buy and sell based on the pink would be forced to take action. I find that mostly nonsensical.

What you can see from the three charts below is that all three indices declined to briefly breach their average price of the last 200 days along with saying hello to those trend lines. What’s more important is that at least for now, the bulls put up a stand at the levels they are “supposed” to, namely those pink and blue lines.

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Was It “A” Bottom or “THE” Bottom? Don’t Get Comfortable Just Yet!

As you know, I had been calling for a mid to upper single digit decline in stocks since late September. That pullback has certainly come to fruition this month with the major stocks market indices down between 7% and 10%. Last Thursday brought short-term panic readings in some indicators and that served to mitigate more weakness, at least for now. Usually when these conditions occur, the bulk of the price damage has been done for the time being and at this point, I don’t think this time is any different. As such, we redeployed some of our dry powder back into the stock market late last week.

Just because the odds favor most of the price damage being done, it doesn’t mean that the volatility is over. As I wrote about last week, I believe the markets will see heightened movement in both directions through early November and the mid-term elections. In other words, the market has now shifted to a short-term time horizon or a trader’s market where weakness should be bought and perhaps, in limited situations, strength should be sold.

This is all in the context of an ongoing bull market. Usually during declines, the same group of gloom and doomers email or tweet me that the bull market is over and armageddon is upon us. If I had time, I would go back and see just how awful this group was at forecasting. I would bet that they typically contact me within a day or two of a bottom. Anyway, regarding the end of the bull market, I will publish a full canaries in the coal mine next week. But in the meantime, bull markets do not typically end with stocks going from all-time highs to multi-month lows in a period of a few weeks. As you may recall, bull markets tend to work sideways and roll and roll over time. The first decline does not generate much in the way of panic. More on this next week.

What’s next for stocks?

As I said, volatility reigns. However, there are lots of instruments worth buying or putting on your shopping list. While stocks have bounced from the lows last Thursday, I do think there is a scenario or even two where those levels will be breached over the coming few weeks. Stay closely tuned. I keep watching the parade of pundits who advise buying right now. Those are the same pundits who never saw the decline coming in the first place and were fully invested. So how can they “buy” when they were fully invested throughout?

This morning I watched an interview with Larry Fink, CEO of Blackrock, one of the world’s largest asset managers. Fink has been one of those pundits who is habitually on the wrong side of market moves. I often find that pundits who are wrong have a higher degree of being wrong than those are who usually on the right side of markets. Today, Fink didn’t give so much of an outlook as he did an explanation of why stocks went down. Hedge funds. Yes, he said hedge funds. There have been a number of funds liquidating and returning money to investors and Fink believes they caused a 7%+ decline in stocks. Incredulously, I just shook my head. What hedge fund manager with the vast majority of their net worth in the fund is just going to hit the sell button all at once or over two days? The answer? NO ONE! It was an absurd explanation. Unless a fund is forced to sell because of some type of margin call, they would liquidate in an orderly fashion over a period of weeks or longer.

As I pick this back up in the evening, I am now in Baltimore for a few days visiting with clients and stocks have exploded higher, led by technology and small caps. Why? Because initial snapback rallies usually see the most beaten down, rally the hardest. During the decline, it seemed like there were way too many pundits talking about the charts and technical indicators. All of a sudden when fundamentals failed to explain the decline, the masses had to turn elsewhere. But don’t worry. As soon as a rally really gets moving, they will abandon the technical rationale and go back to spewing about the economy and earnings. It happens every time. Rinse and repeat.

Summing it all up, the downside objective of the mid to upper single digit decline I forecast last month has been met, but I am not yet ready to declare an all clear. The vast majority of the damage should have been done for now, but stocks are in need of some repair which can be accomplished with time passing.
While a 7% pullback usually recovers in a few months, seeing the indices head right back to all time highs in straight line fashion would be very atypical and cause me to have the most concern since the bull market began in March 2009. That scenario could even lead to the end of the bull market like we saw from the August 2007 low to the October 2007 peak.

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Just Like the Crash of 1987, an Interest Rate Driven Decline in Stocks

When I woke up today, I wasn’t planning on doing this update. My original plan was to begin a new Street$marts and talk about stock market crashes and the panic I saw in the market over the past two days as well as address some emails I received. This was going to be just one of the articles written. As I got going, it got longer and longer and longer with all of the charts and I ran out of time.
Stocks are seeing wild swings right now and Thursday was the first day where the bottoming process began. I didn’t say it was the ultimate low to close your eyes and buy. I did like what I saw with some panic creeping in. That could mean the first bottom is in or close at hand unless Friday turns out to be bad for the bulls. We shall see.
With the dramatic market volatility of late, I want to take a look at what kind of decline this is, meaning how similar is it to other declines and can we learn anything. So far, we are seeing what I called “normal, healthy, routine and expected” when the nice folks from NBC Connecticut stopped by yesterday. Here is the link.
I commented on Twitter how interesting it was that the media paraded out all of the permanently negative pundits for their victory lap. People who have been negative for 10+ years somehow think they have been proven correct and NOW it’s finally different. The bull market is over, according to them. At least they’re consistent!
I have also found it ironic that so many of the people who completely missed this decline are the ones now opining on how to play it and when it will end. At least it caused me to chuckle. I remember how so many pundits told investors to sit tight the entire way down from 2007-2009 and then crowed when stocks finally rallied. There’s just no accountability and that leads to no credibility. In my case, I am accountable to my clients every day, week, month, quarter and year. Numbers don’t lie and sometimes over the years I have to do a mea culpa. In plain English, every now and then, I have to admit that I stunk.
I want to thank the good folks at Yahoo Finance and Seana Smith for doing a follow up segment with me via Skype to find out what my thoughts were on the decline after warning of this on September 25. You can find the discussion at the 5:20 mark on the link below. Boy, I cannot believe how fat I look over Skype! Am I that fat? I probably could use a little weight shedding into winter!
Back to the topic at hand. As you know, I rely a lot on history for a lot of my analysis. While markets may not repeat, they do rhyme as Twain is purported to have said. I went back to 1985 and looked for times when stocks declined at the same that the yield on the 10 year treasury note was rising considerably.
Let’s pause for a minute. Most people think that stocks always go down when long-term interest rates rise and that bear markets begin with rate spikes. Well dear readers, the facts aren’t in evidence to support that. In fact, bear markets typically begin with long-term interest rates in decline as the market shifts to a more defensive posture. In other words, the stock market begins to anticipate some kind of system or economic weakness ahead of the bear market so long-term interest rates roll over.
With that theme in mind, what I found since 1965 was really interesting.
6 times we have seen the stock market pullback more than 6% with the yield on the 10 year treasury note rising sharply right before. It’s has not happened all that often. The first and granddaddy of them all was 1987. Before people start with the emails, yes, I know it was an outlier and crashes are generational events. But it does fit with my theme.
The yield, essentially the interest rate, on the 10 year treasury note is below from 1987. You can see how it was going up, up and up right until the day the stock market crashed which I am showing with the purple arrow. The second chart shows how stocks topped out in August 1987 but rates just kept going higher. First, stocks corrected 10% in September 1987 and rallied into early October before massive dislocations occurred with rates and the dollar into the crash. No recession ensued.
Next, lets’ move to 1994 where long-term interest rates were rising sharply in February and March. Eventually, the stock market sent a strong message that it was not happy about the higher rates and corrected 10% as you can see from the second chart. The real carnage took place in March 1994 with an almost straight line decline to the bottom. That decline was the largest in almost four years at that point and felt a whole lot worse to investors who were not used to the volatility.
1996 is next and you can see a steady rise in long-term rates all year before stocks said enough was enough. The July pullback was the largest decline since 1994 with rates being a primary driver. The second chart, just like 1996 and 1987 before it, saw the real peak in stocks well before the downside acceleration began. It’s almost like stocks peaked, routinely pulled back, tried to rally and then fell hard under their own weight of higher rates.
2006 is below and the theme remains the same. Interest rates, interest rates, interest rates. In 2006, they ran hot all year right to the peak which also atypically coincided with the high in stocks. The stock market had a very simple 9%+ decline without much complexity like in previous years.
And now we come to 2018 where this theme plays out twice. Rates were rising sharply since September 2017. And while there were other factors involved in the Q1 decline, like volatility products and China, I am 100% the same was true in prior years. Interest rates laid the groundwork for some spark to cause the decline in stocks.  On the second chart, you can see the January high in stocks followed by a sharp decline with much complexity. That’s similar to 2006 although with more “crash like” action with a few huge down days in absolute terms.
Today, we are seeing a similar landscape. Yields on the 10 year note have been spiking since August. Stocks basically peaked in September with a secondary peak in early October and have fallen sharply.
In all cases listed, stocks quickly bottomed and rallied to new highs although 1987 took the longest after such a large decline. None were part of long-term declines. The economy also continued to expand without recession in the near future. A much more worrisome warning will come when interest rates begin to roll over with stocks marching higher but the foundation of the stock market crumbles. That’s seen at almost every single major peak of the last 100+ years. It’s something that’s on my radar screen for 2019 and 2020.

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Crash Sequence Unfolding?

As you know from my emails, quarterly report and most blogs, I have been forecasting a stock market pullback for the past few weeks. Even when the Dow Jones Industrials finally achieved my late Q1 forecast of new all-time highs across the board on September 21, I was very concerned about a crumbling market foundation that would lead to a mid to upper single digit decline in October.

I couldn’t have been any clearer when I discussed my forecast on CNBC’s Squawk Box on September 25th.


I repeated it on Yahoo Finance’s Midday Movers later that day.


Speaking of Yahoo Finance, I am scheduled to join the Midday Movers team on Thursday between 11:30am and 11:45am. Just go to finance.yahoo.com.

The reasons for the impending weakness were numerous and they are proving to be very well founded. Participation in the rally waned. The market became split with an almost equal number of stocks making new highs as new lows with the major stock market indices hovering near all-time highs. In other words, there were an equal number of troops dying as there were troops forging ahead.

Wednesday was one ugly day folks. It was the day of recognition for many investors that something had changed in the character of the stock market. I know. I know. Interest rates had been spiking and you heard the media and pundits say that people were selling stocks and buying bonds. That sounds all well and good except for the fact that unlike what we are used to seeing, bonds did not rally on Wednesday when stocks collapsed.

And for those who are going to email me and pontificate the benefits of gold during times like these, well, gold barely moved and remains mired in a multi-year bear market. And no, there wasn’t a flight to the U.S. dollar either.

Volatility is spiking. When this happens, it is unusual for it to quiet down right away. And days like Wednesday rarely mark the final price low. The bears are making good progress, but they don’t appear to be done just yet.

In our portfolios, I am very thankful that we took dramatic action almost across the board to sell equities, raise large amounts of cash and/or hedge our exposure, long before the carnage began. With so much dry powder, I will soon be frothing at the mouth to execute my shopping list for a year-end rally. This is when my job is fun.

I chuckle when I see those in the media prognosticate from here when they got this decline entirely wrong to begin with. The act as if they saw this coming and took appropriate action.

Shortly, I expect the usual number of emails and calls from those who have been fully invested or worse, wanting to know what to do now. My answer has been the same for my entire career, whether I have been right or wrong about the market’s move. If you weren’t smart enough or lucky to get yourself protected before this decline began, I wouldn’t compound a problem with a problem.

When declines like Wednesday occur and I send impromptu updates, stocks usually bounce much sooner than later unless a crash sequence is underway. The market doesn’t have that feel right now, but it’s not something I would totally rule out.

For the foreseeable future, we should see huge swings down and up as stocks ultimately find a low, especially on Thursday. The rest of the week and first few days next week are going to be very important. I will keep you updated on www.investfortomorrowblog.com as much as I can.

Finally, to close with the silver lining, I still believe the bull market is alive and Dow 27,000 and higher remain in the cards.

As always, if you would like to discuss your portfolio or strategies, please reply to this email, call the office directly or use my online calendar. https://heritagecapitalllc.acuityscheduling.com/schedule.php

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Bulls Need a Stand

After some early weakness on Monday, the bulls put up a little fight before succumbing to selling into lunch. From there, they did have enough energy to  bring stocks back to breakeven. Given the semi-holiday, that was semi-impressive. The bulls now have a little momentum and are supposed to run to the upside for at least a day or so. The S&P 400 and Russell 2000 have declined sufficiently to reach their long-term trend or the average price of the last 200 days as you can see below. That can often lead to a bounce.

If stocks can rally, I would expect bonds to bounce back as well after being crushed at one of the greatest paces in history.

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Bulls Fail Again

My continued theme of a stock market pullback continues. The weakness is unfolding as expected. Small and mid cap indices have been hit the worst, but now the NASDAQ 100 is joining in. The rotation into the Dow and S&P 500 remains, but they are also down as well. Semis, discretionary and transports have rolled over and now the banks are in jeopardy of following suit. Energy, industrials and healthcare are sectors where investors are trying to hide and that may last a little while longer until the final leg down in the pullback. During that stage, I expect the leaders to get hit hard over a short period of time.

After Thursday’s weakness, the bulls were supposed to step up on Friday or at least not allow much downside. That didn’t work out so well as early strength was rejected pretty quickly and the bears went back to work. With overseas markets sharply lower, I would expect a lower open today with the bull pushing back on this semi-holiday trading day. We are supposed to see a rally into lunch. Once again, it will be incumbent upon the bulls to thwart any selling waves this afternoon.

I noticed more than a few indicators over the weekend which said that the risk in stocks has increased dramatically. While I continue to see much higher prices ahead, I am starting to wonder if this is the first nail in the coffin of the bull market.

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The Bulls Better Step Up, and Fast!

For most of Thursday, the bears growled loudly with the largest losses being seen since the Q1 correction. But rallies and bull moves do not die easily. The bull fight and fight and fight until they finally throw in the towel and the market sees what I termed the “gap of recognition”. It is a sharply lower opening that continues lower throughout the day. The bull never recover the gap until after the decline ends and the next rally begins. That’s what I am waiting for now.

Beginning at 2:30pm, we often see the bulls step up when mutual funds begin to balance their buy and sell orders. During initial bouts of weakness from a peak, bulls are usually frothing at the mouth to buy. And right on schedule on Thursday at 2:30pm, the bulls came in to buy as you can see below.

With that predictable move, today presents and interesting day for the bulls. They are supposed to come back and stocks should be up. If we see early strength met by more selling in the afternoon, I think the odds would increase for my gap of recognition next week.

We know from this week that being long is wrong and the S&P 400 and Russell 2000 continue to lag or lead on the way down, whichever you prefer. Now, the NASDAQ 100 is joining the party and threatening to break the uptrend.

Transports and discretionary have gone from leaders to laggards while semis try to hang in. Banks, on the other hand, are seeing some buying pressure after being hit hard. That’s primarily because bond yields have spiked higher, giving banks a better opportunity to make money.

Junk bonds have now seen back to back tough days.

I have been warning for weeks about a potential mid to upper single digit decline in stocks. I stand by that. I think it’s here. There should be a super buying opp in a few weeks.


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