January Early Warning for Rest of Year

We now know that the first five days of the year were down which became a popular indicator for the year as a whole by Yale Hirsch of Stock Traders Almanac fame. While waiting for the month of January to conclude, I went back and looked at the first five days of every down year since 1951. Then I looked to see if January as a whole was down. Finally, I found all the times where January’s weakness exceeded the prior year’s December low as well as when the entire first quarter’s low was below the prior year’s December low.

The idea behind the research was to see which triggers were common in poor years for the stock market, not necessarily the accuracy in all years.

Listed below are all down years for the S&P 500 since 1951. Here is the key for the abbreviations used.

5 – First five days of the year were down

Jan – January as a whole was down

Dec – January’s weakness undercut the lowest closing price of December

Q – The low of the first quarter exceeded the low of prior fourth quarter’s low

2016 (so far) – 5, Dec

2015 – Jan

2008 – 5, Jan, Dec, Q

2002 – Jan, Dec, Q

2001 – 5, Q

2000 – 5 , Jan, Q

1994 – Q

1990 – Jan, Dec, Q

1981 – 5, Jan, Q

1977 – 5, Jan, Dec, Q

1974 – 5, Jan, Q

1973 – Jan, Q

1969 – 5, Jan, Q

1966 – Jan

1962 – 5, Jan

1960 – 5, Jan

1957 – 5, Jan

1953 – 5, Jan

As you can see, almost every single down year in the S&P 500 saw January as a down month. 1994 and 2001 were the exceptions. That’s pretty remarkable. Of course, that’s not saying that just because January is down the whole year will be down. It just puts us on guard to look for other indicators.

What we also see is that for the more significantly down years, not only is January down, but the low of January and/or the low of the first quarter exceeds the low of the prior December.

2016 has gotten off to the worst five day start in history, but it’s still way too early to say it’s a harbinger of things to come.

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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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Water Needs to Find Its Own Level in China

Last summer I included China’s stock market in a few pieces as it cratered lower and lower. Remember, as I explained, while China may be the second largest economy on earth, they are relatively new to the capitalist system. They have, are and will continue to experience “growing pains” as the powers that be seem to believe they know better when it comes to controls in their financial markets.

Over the summer as their market collapsed, the government instituted all kinds of manipulations to prevent further carnage. They tried injecting their own capital into stocks. They halted trading on hundreds of stocks. They eliminated short selling on others. They put circuit breakers in place to close the stock market totally if it fell by 7%.

At that time, I opined that all they were doing was prolonging the inevitable. Water finds its own level. You can’t prevent a selling stampede that’s all lined up. And just as their officials were  gearing up for the victory lap, sellers began to overwhelm the Shanghai index in late 2015 which has now spilled over to 2016. Instead of stemming the tide, the 7% circuit  breaker has led to pile on selling as investors try to get out as soon as the market opens to avoid getting shut out of selling when it falls 7%.

The first solution is to remove the 7% breaker which was hinted at today and let everyone sell. Rip off the Band-Aid. Be done with it. This may cause a mini-crash, but my sense is that a good buying opportunity will be closer at hand. The August lows are just under 2900 on the Shanghai index and I would be very surprised if they are not breached this month, maybe next week, in some type of waterfall, capitulatory decline.

Without any anecdotal data to back this up, I have operated under the premise that whenever a major stock market is down 50%, it’s time to start buying. Sock some away for retirement. Maybe some for the kids’ college. The Shanghai is close to that level again.

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Beware of Believing in Santa Claus

The traditional Santa Claus rally of the last five trading days of the year did not materialize. As I have mentioned before, Yale Hirsch of Stock Traders Almanac fame made popular the rhyme, “If Santa Claus should fail to call, bears may come to Broad and Wall”, meaning that bear markets typically follow in the ensuing years where there is no Santa Claus rally. While it all sounds nice and neat, the data do not support that conclusion.

In 2014, the last five days were down, but 2015, while difficult, was not a bear market year. 2012 saw Santa fail to call, but 2013 was a huge year for stocks. 2010 saw a mixed last five days which led to a flat 2011 although there was a 20% correction during the year. 2009 saw another mixed last five days, but 2010 was a strong year for stocks.

2007 was strongly down during the final five days and that correctly led to the worst year for stocks since the 1930s. 2005 also was a victory for the bears, but 2006 was a banner year for the bulls. 2002 saw a horrible close to the year, but 2003 launched a new bull market a enormous year for the stock market.

On the flip side, 2000, 2001 and 2002 were all bear market years, but the previous Santa Claus indicator failed to warn. As with many other stock market adages, what once worked and became tried and true no longer stands up to scrutiny.

I have a different method for the Santa Claus rally and I have been using this in my portfolios since the early 1990s. There are a set of rules that help identify a December low that is usually plus or minus a number of days around options expiration. From that low there has been a 90% probability of a rally into year-end over the past 25 years. The average percent gains have been staggering.

S&P 500 +2.83%

NASDAQ 100 +4.24%

Russell 2000 +4.13%

S&P 400 +4.24%

2015’s results were below average, but still between 1.33% and 1.91%.

Of note, 2015 was the first year in AT LEAST 26 years where the S&P 500 was the leading index from my December Santa Claus low to year-end. I am not sure what it means, but it’s something to watch this week.

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Three Last Minute Year-End Tips

As Kenny Loggins wrote, “Make no mistake where you are. This is it.”

The last day of the last week of the last month of the last quarter of the year. 2015 will soon be in the books and it will go down as a year where the stock market was down a little and the bond market was down more while commodities were down huge.

As I sit here finishing up my final blog post and newsletter of the year, here are four tips which you may able to take advantage of.

1 – To lower your tax bill, consider making that final charitable contribution.

2 – Don’t forget to take those required minimum IRA distributions if you are over 70 1/2 or have an inherited IRA.

3 – Harvest tax losses by selling losers and buying similar but not the exact same investments.

I am sure I will write this another few or so times, but I have really enjoyed writing this blog and interacting with so many people this year. Wishing you and your families a very Happy, Healthy, Safe and Prosperous New Year!

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Santa Claus is in the House!

The last week of 2015. I hope you have been enjoying the holidays.

The major stock market indices continue to behave as I spelled out over the past few weeks. Santa Claus came right on schedule and the seasonal trend has him taking a break to close the year with some mild strength to begin 2016. While I was very pleased that stocks reversed early last week and have followed through on the gains, we still need to see all of the indices close above their Fed day highs from two weeks ago. The S&P 400 and Russell 2000 seem poised to accomplish this right here, but the Dow, S&P 500 and NASDAQ 100 have a little more work to do.

Intermediate-term, last week’s upside reversal could have significant bullish consequences, but given the lower volume and diminished liquidity, I would like to see more confirmation. New highs/news lows, stocks advancing and declining and up and down volume all went from fairly negative to strongly positive over the span of a single week. Historically, that leads to double digit upside over the coming months.

On the sector front, it’s going to be vital for high quality leadership to emerge sooner than later. Defensive sectors like consumer staples have been leading, but the semis and consumer discretionary are trying to step up.

Lots of crosscurrents and trends this time of year, but most are bullish and high probability.

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Santa Needs to Get a Movin’

Since the Fed wrongly raised interest rates last week, the stock market has done a good job of following the script. First, it rallied sharply from 2pm to the close on the day of the announcement. Then, it saw weakness on Thursday and Friday followed by strength to begin the new and holiday shortened week. While that all looks nice, I did not expect the amount of weakness seen when combining Thursday and Friday. That definitely bothered me regardless of what happens from now until year-end.

The model going into this week was for the bulls to make a stand on Monday or Tuesday and then take stocks above last week’s high. Monday began the day okay and ended fine, but it was not very convincing. I expect more from the bulls. Stocks are in the most favorable short-term time of a year within the most favorable intermediate-term time of year. And in that, the Russell 2000 small caps are supposed to see strength and lead. Not only do I still expect that, but portfolios are certainly positioned for it.

I am not going to spend time on sector leadership here, but in short, it’s not what I want to see if stocks are about to surge higher. And maybe that’s the problem. Either the surge isn’t coming or the stock market needs some repair work first which may not be complete by year-end. We shall see.

My biggest short-term concern is that the major stock market indices sold off hard last Thursday and Friday, closing at their daily lows both days. Healthy markets typically do not see an immediate bottom from that set up. Rather, we usually see that lowest point breached over the coming few days and then stocks firm into the close. I know I may be too cute with this, but it’s what I see. Perhaps stocks can run longer and further than they look now and then retrench in January.

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All Signs Point to a Horrifically Wrong Decision by Yellen & the Fed

FINALLY, or YET AGAIN, it’s FOMC statement day. Unlike every meeting since 2007, I do believe the Fed is wrongly going to raise short-term interest rates for the first time since 2006. Since 2008, my thesis has been and continues to be that the Fed should not raise interest rates until the other side of the next recession. This is your “typical” post-financial crisis recovery that’s very uneven. It teases and tantalizes on the upside and frustrates and terrorizes on the downside. Another recession, albeit mild, is coming over the next few years. That’s okay. We’ll get through it. On the other side of it, our economy should get back to trend or average GDP growth, not seen since pre-2008. This could also coincide with Europe getting its fiscal act together after another sovereign debt crisis.

I have heard some pundits use the word “credibility”. The Fed needs to hike rates to either preserve or establish credibility. I am sorry, but that’s idiotic and doesn’t need any further rebuttal. Some believe that an unemployment rate of 5.0% represents “full” or “maximum” employment and that a rate hike is necessary to cool the jobs market. Another reason I totally dismiss as unfounded. How about the labor participation rate at 62.40%, a 38 year low?!?!

From my seat, it looks like an 80% likelihood and the markets are expecting the rate hike. China has stabilized, but is far from fixed. Europe is teetering on recession but that’s been the case. The dollar is well off the highs, but the bull market has at least another 20% left on the upside.

This will be the first rate hike ever with inflation under 1%.

This will be the first rate hike ever with the annual social security COLA at 0%.

This will be the first rate hike ever with wage growth needing to jump 100% to hit the Fed’s target.

This will be the first rate hike ever with industrial production on the verge of recessionary levels.

This will be the first  rate hike ever with GDP barely 2%.

This will be the first rate hike ever with inflation expectations close to 0%.

This will be the first rate hike ever with retail sales closer to recession than escape velocity.

This will be the first rate hike ever with non-farm payroll job growth continuing to decelerate.

Where’s the fire?!?!

What’s the hurry???

I could go on and on, but I think you get the picture.This is not a normal first  rate hike where the Fed is trying to tamp down inflation and/or worry about an overheating economy. This is simply to move off the 0% emergency level and get going. It’s also the wrong decision.


Money velocity, which tells us how often a dollar is turned over during a given period of time, has been in a steady downtrend since 1998 and stands at the lowest level since records were kept. See the chart above. It saw a small rally from 2003 to 2006 which the Fed quickly extinguished with rate hikes. Now they are going to raise rates with this important indicator at all-time lows.

Unfortunately, I do not believe this is a one and done deal for Yellen et al. With the voting members of the FOMC changing substantially in 2016, the Fed will become much more hawkish next year. I forecast a .25% rate hike every quarter next year in March, June, September and December to end 2016 in the 1.375% zone.

Finally, the historical trend for today is to see the major indices trade in a +0.50% to -0.50% range until 2pm est and rally into the close.

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Third Avenue Travesty

After peaking way back in 2014 and declining ever since, the high yield (junk) bond market has finally made national news over the past week with the very high profile blow up of the Third Avenue Focused Credit Fund (TAFCF). This was not some fly by night little fund or fund family. It’s a small, mainstream mutual fund family and the fund itself had more than $3 billion in assets in 2014. Last week, after massive withdrawals, the fund announced it was closing and that shareholders could not redeem their shares for cash anytime soon. Third Avenue was going to conduct an “orderly” liquidation. Good luck with that!

Over the past 20 years, my peers and I have often discussed this is exact scenario. What happens when there is a mass exodus in an illiquid asset class like junk bonds? If Third Avenue was a closed end fund (CEF) or exchange traded fund (ETF), sellers would simply drive the price lower and lower until sufficient buyers came in, presumably when the share price of the CEF or ETF was significantly below the value of the underlying assets in the fund. In other words, the CEF or ETF would trade at a discount to the net asset value of the fund.

In Third Avenue’s case, it is an open ended fund that issues more and more shares to meet investor demand. When redemptions swell, the manager chooses what to sell and when. And it’s unlikely that securities are sold on a pro rata basis. As TAFCF’s assets collapsed, my sense is that the fund manager sold most or all of the bonds that were easier to sell, i.e., liquid, hoping that he could stem the tide and high yield bonds would stabilize or even bounce. When the liquidations never ceased, the fund was probably left with the true crap of crap instead of the well diversified portfolio it had weeks, months or quarters earlier. In other words, at the detriment of the shareholders who stuck by the fund, they were left with illiquid garbage.

This raises a whole series of questions regarding the fund manager’s and fund company’s fiduciary responsibility to its shareholders. Clearly, they had absolutely no plan for a mass exodus, like disaster planning for many firms in my space. How could they allow the fund manager to sell the better quality bonds and turn the fund into a heap of crap? How could they penalize investors like this? While I am sure they will hide behind the nonsensical legalese of the prospectus, this is a travesty!

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Bye Bye Bernie

I have been watching the various presidential debates and haven’t missed one for the most part. I find them to be sometimes informative and on the entertaining side although the recent democratic one was a bit tortuous in my opinion (more on that later). The democrats have only had one, but I can’t get Bernie Sanders’ voice out of my head when I watch Seinfeld reruns. He sounds exactly like the actor who plays Yankees’ owner George Steinbrenner.

I remember standing in line at Panera behind two millennials who were wearing Sanders tee shirts. The order taker complimented them on their shirts and told them she couldn’t wait until he was president. One of the millennials answered that “it was about time the wealth was shared. There are too many rich people driving BMWs. I don’t even own a car.” I chuckled and before I could shut my mouth, the guy turned around and said, “they should tax all those rich people and give the money to everyone else.”

Anyway, when I saw the senator on the cover of Time in late September in a positive light, I thought it was the kiss of death for his candidacy, a view I still share today. At that time, he was riding high in the polls and neck and neck with Hillary Clinton. Sanders tee shirts and yard signs were everywhere. He was the flavor of the moment, which is why Time gave him such publicity.

The problem with the Time cover is that it usually means the end of the trend is close at hand. It takes so much public awareness for a person or event to be cover worthy that by the time it hits, it usually about over. While Sanders socialistic agenda and $16 trillion government program expansion may sit well with the populists and disenchanted, the markets never gave him any credibility nor chance to beat Hillary, let alone win the general election. By the time the primaries begin, he will barely be a footnote.

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