"The Hunt for Red October"

"The Hunt for Red October"

The following is a copy of Jeffrey Saut’s morning tack from www.raymondjames.com. I thought it was so apt a commentary in lieu of the fear that's going on in the current state of the markets that I reproduced the whole thing wholesale for my own blog…

And traders that didn’t heed my short-term proprietary model’s

“sell signal” of October 2, 2018 are currently heading “straight into that torpedo.” Indeed, yesterday we wrote:

Plainly, I agree with the astute folks at Bespoke and would emphasize that I have been on the “sidelines” for trading accounts since the October 2, 2018 “sell signal” from my short-term proprietary model. Our sense remains there will be a significant low around the midNovember energy peak, but the question will be are we going to see a “selling climax” bottom (easy to identify) or a “selling dry up” bottom (much more difficult to identify). The ideal bottoming pattern would be for some kind of sharp “throwback” rally beginning this week, which fails, leading to lower lows into the midNovember energy peak. And that certainly could happen with the SPX majorly oversold with only 10.1% of the S&P 500 stocks above their 50-day moving averages (DMAs), while a mere 32.1% are above their respective 200- DMAs. Likewise, the New Highs over New Lows is deeply oversold on a trading basis.

Well, from our lips to the “Gods of Wall Street’s” ears, because we had a sharp rally early yesterday morning that “failed”, leading to a 245-point Dow Dive into the closing bell. And for those false prophets that “promised” the S&P 500 (SPX/2641.25) would not break below its 200-day moving average (DMA) at 2766, we are currently more than 100 SPX points below that moving average as of this writing. That is why we NEVER make such predictions, because the equity markets ALWAYS go higher, and lower, than most expect. Certainly, we did not expect this decline to be this severe when our model flashed a sell signal a month ago. But, in this business, you take what the markets give you. To that point, we were taken with an article in Barron’s over the weekend featuring one savvy investor.

One excerpt from said article read: “Managing risk and understanding where you are in the cycle are really the two most important things for an investor, and they are interrelated. That’s because where we stand in the cycle is a main determinant of risk.”

Or how about this:

As we rise in the cycle, which means that prices are higher relative to values in general, the probability distribution of future returns shift to the left, which is to say it gets harder to make money and easier to lose money, and the expected return declines. On the other hand, if you can buy when we are low in the cycle, the probability is that price is low, relative to intrinsic value, and the probability distribution of future returns shifts to the right – that is, it is harder to lose money and easier to make money, and the expected return is higher. That all sounds very academic, but it is the difference between buying in, let’s say, early 2007 versus late 2008.

Clearly, we called the “top” in 2007 with the Dow Theory “sell signal” of November 21, 2007. Likewise, the majority of stocks bottomed on October 10, 2008 when 92.6% of stocks made new annual lows and we wrote that “the bottoming process has begun.”

As the investor concludes:

You can’t really tell. It could be the start of a down market for a while, or it could be just another wobble on the way up, and we’ve seen this before. In this bull market, we’ve had periods of weakness, one in early 2016. You can’t tell what these things mean at the time they are happening, and you can’t really intelligently bet on it.

Our sense remains this secular bull market will find a meaningful low around the mid-November “energy peak” that we have often mentioned in these missives. As Jason Goepfert, of SentimentTrader fame writes:

Everybody’s out. During the past 3 weeks, we’ve seen a near-record amount of sell programs at some point during the trading day. A fast, hard pullback. The S&P dropped more than 9% in only 26 days from its 52-week high in September. That’s among the largest, fastest pullbacks ever. Persistent negative momentum. The McClellan Oscillator hasn’t been positive for almost two months. That’s the 2nd longest streak in history. Waterfall. When the spread between Smart and Dumb Money Confidence is greater than 50% and the S&P closes at a multi-month low, buying the close and exiting at the first positive close led to 90% winning trades (26 of 29) within one week. Turnaround Tuesday. If the S&P lost at least 2% during a down Friday/down Monday, it rebounded into Friday 68% of the time (79 out of 116 times) by an average of 1.1% since 1928. Since 1950, the win rate is 73%, since 1990 it’s 80%, and since 2002 it’s 87% (20 out of 23).

We think a major bottom is approaching after four weeks of #$%&! This morning, as we write at 4:00 from Nashville, the S&P 500 preopening futures are flat on no real overnight news.

When the Markets get Emotional

When the Markets get Emotional

I’ve often heard investors say that a market correction is a good thing in the long run, but when it actually happens everyone acts like it’s a bear market. Like it’s the end of all things as we know it. When you buy the stock of a company, you should have a good idea of why you are buying it. In other words, know what you own and why you bought it in the first place. Take for example the largest holding in anyone’s investment portfolio, the fundamentals of this said company are the same as they were a month ago but chances are today its worth a lot less than it was then. Short term gyrations in the price of a stock are nothing more than market noise, like static on an old radio. The stocks of companies are long term assets in nature and that’s the best way to approach investing in them. Try to buy them well (below what they are worth) and hold on to them for long periods of time.

And speaking of the markets; most people acquit the markets with various indexes. Some of these indexes are capitalization weighted where the market cap of a few of the largest companies effect the whole index. The better known market indexes have become institutionalized, where big money is blindly put into the index based only on the liquidity the index provides and not on it's underlying fundamentals. In my mind a better way to gauge the state of the current market is to track the advancing/declining volume of the NYSE and make a cumulative running line of it. I then apply some moving averages to this line, then I subtract one moving average from the other and viola, I have created a momentum indicator based on the breadth of the market. Waning/waxing  momentum creates divergences with the said indexes indicating a shift in the supply and demand of stocks. One could do the same with the adv/dec line of the Nasdaq. The New High/Low list is another good indicator to keep track of. I don’t use the adv/dec of the NYSE anymore as it has lost its relevance as an indicator due to all the junk that is now included in it.

And lastly, turn off the TV and logoff the internet. Bad news sells and the media knows it. They are not there to keep you informed but only to attract as big a viewing audience as they can so they can generate advertising revenue. That’s just the nature of capitalism. And that’s okay as long as you don’t allow yourself to get caught up in their madness…Relax go outside and take a walk and appreciate the things you already have and leave the emotional nature of market extremes to the unwashed masses (many bodies, one mind)

David Driscoll on BNN-Bloomberg’s Market Call – Aug 7 2018

David Driscoll on BNN-Bloomberg’s Market Call – Aug 7 2018

The stock market is a dynamic multifaceted phenomenon where there is no one methodology that always works. Some investing styles work for awhile then under-perform, only to start working again later on. The individual investor will in time develop his own personal approach to the market that is right for him while realizing that he will at times undergo periods of under-performance. He will accept this as part of the cost of investing in the stock market…Below is David Driscoll’s (CEO of Liberty International Investment Management) take on the market as of Aug 7...This is his approach to investing in the markets.

MARKET OUTLOOK
Ignoring all the noise, it’s essential at this time that investors focus more on their portfolios than buying or selling individuals stocks. We’re now almost 10 years into one of the best bull markets in history. Will the market roll over this year, next year or in two years? Will rising interest rates spoil the stock market party? Will the yield curve invert this year or next? Will inflation slow down personal and corporate spending? Are earnings to be trusted? Since nobody knows the answers, investors should focus on prudent portfolio management by following these suggestions:

1. Avoid the noise. Companies will always adapt to whatever politicians throw at them.
2. Leave your emotions at the door. Investing should be mechanical, not emotional.
3. Hold some cash. If the stock market drops, you’ll need cash to take advantage of buying opportunities. After all, time and compounding is what makes stock investing profitable, not stock picking or stock trading.
4. Rebalance when necessary. If you own 30 stocks with an equal weight of 3.3 per cent and one of the stocks becomes a 6.6 per cent or greater weighting, sell half. It also helps preserve capital, especially if you own names with high betas (above-average price volatility). The higher the volatility, the greater the downside risk. We’ve rebalanced positions of Cognex and Shopify this year for these reasons and avoided subsequent large losses.
5. Avoid correlation risk. While Canadian banks are strong and stable, it wasn’t just one that fell 40 per cent in 2008: they all did. And if you’re retired and taking money out of the portfolio when a major market correction occurs, you raise the risk of running out of money in your lifetime. It’s better to diversify around the world in different sectors than have high levels of concentration in your portfolio.
6. Don’t chase yield. Focus on companies that grow their dividends so that your income doubles at a faster rate. A company may have an attractive yield of 5 per cent, but if the dividend growth is only 2 per cent a year, inflation will eat up that growth. It would take 36 years to double your income. The Rule of 72 is to take 72 and divide by the growth rate to get the number of years to double your income. 72 divided by two is 36 years. The average growth rate of companies around the world is about 7 per cent, so the income should be doubling every 10.3 years. And as the dividends grow, ultimately the share prices should follow.
7. Buy gradually. Consider buying only a half weight instead of the whole position. For example, if you have $10,000 to invest in a stock, buy only $5,000 to start and keep the rest in cash. If the market corrects, you can buy more at a lower price. Dollar-cost averaging is a time-trusted strategy that helps avoid huge losses.
8. If you’re investing in concept stocks, invest only what you can afford to lose. The volatile stocks today are in the cryptocurrency, junior oil and gas, technology or marijuana sectors. About 80 per cent of concept stocks end up worthless, so be disciplined when taking on this risk. Buy 10 names and hope the two that survive cover the losses of the other eight.
9. Downside losses are worse than upside gains. The more you go down, the more you have to rise to get back to break-even. In 2008, the market fell 40 per cent, so a $1 value then was worth 60 cents a year later. As a result, investors needed to make 63 per cent just to get back to break-even, not 40 per cent. In other words, it took five years for most fully invested mutual funds and ETFs to return to break even. Those who held 20 per cent cash and reinvested the money in 2009 returned to break-even in one year. The next four years were pure gravy.
10. Focus on companies that generate rising free cash flows. This helps improve the odds that you’ll invest successfully. The last newsletter on our website explains further.

Investing successfully is having the ability to keep yourself in the game by not losing all your capital to let time and compounding of dividends grow it.

Food for Thought

Food for Thought

Picked up some interesting tip bits from Jeffrey Saut this morning at https://www.raymondjames.com/pdfs/share/morning_tack.pdf

‘With all the current “chaos” in the media, I have to complete my thought and tell you what

I am convinced is going on. The People’s Republic of China has three major objectives right now: 1) Hurt the USA, 2) Prop-up their currency, and 3) Obtain cash to stimulate their economy.Therefore, given the fact that U.S. Treasuries are getting clocked, but utilities are rallying, I am convinced the jump in interest rates is due to the Chinese selling vast amounts of their Treasury holdings.By selling them they, 1) push U.S. interest rates higher, which hurts the U.S. consumer and possibly President Trump’s approval rating right before an election,

2) They get billions of U.S. dollars, allowing them make open market purchases of the

renminbi, which supports its value in international markets, and 3) with all those renminbi

they can now freely spend inside the country of China to stimulate their economy. With one transaction they accomplish three major objectives. This is the only thing that makes sense to me. And if I am right, once that selling subsides, we are in for one major rally in the U.S. financial markets.’

Joe Monaco, Monaco Capital

‘Fear surged today globally. Few realize that the sell-off presents an outstanding buying opportunity as the market is grossly oversold and pessimism is at an extreme  (conditions seen at market bottoms). As mentioned in my most recent report, investors should be buying into further weakness as further weakness will cause the market to reverse to the up side. Earlier tonight, the Dow Future was down 228 points, but has recovered more than 50% at this writing.Clearly, the market is showing downside resistance. Hence, if the market drops further, redeploy cash. A more detailed illustrated report will be sent tomorrow. Remember what Warren Buffett said: "Be fearful when others are greedy and be greedy when others are fearful." Refrain from joining the crowd.’

Leon Tuey

The markets are always interesting...and the media is very predictable. Don't listen to them...

Leon Tuey on the Markets

Leon Tuey on the Markets

There is a common belief that timing is not important and that no one can time the market. I beg to differ. Those who hold such beliefs are ignorant of the market’s logic. Also, it may well be just propaganda by the fund industry for if investors can identify a bull market top and pull their money out, what would the funds do for a living?

If investors understand the market’s logic, they can divine the future direction of the market (long-term, or shorter term). It is not rocket science. Understanding the market’s long-term direction is of primary importance. If investors had bought the following blue-chip stocks at the top in 2007 - Berkshire Hathaway, 3M, Microsoft, Royal Bank of Canada, United Technologies and hundreds ofothers, they would have lost 50% or more at the end of the bear market in March 2009 and they didn’t get even until early 2013.

To understand how a bull market begins and how it ends demands a deep understanding of the economic cause/effect relationships that drive the markets. The following must be clearly understood and appreciated.

The U.S. Federal Reserve System was created in 1913 to perform all roles monetary. It’s an independent body. One of its key statutory mandates is “To maintain orderly economic growth and price stability” (unlike the European model, which is primarily concerned with price stability). The most powerful tools at the Fed’s disposal to effect monetary policy changes are the basic monetary policy variables, bank reserve requirements, margin requirements, and the discount rate. Changes in the Bank Reserve Requirement and the Margin Requirement are infrequent; the discount rate changes the most frequently. When the Fed raises/lowers the Bank Reserve Requirement, however, investors should pay close attention as when it happens, it signals monetary tightening/easing. The single most bullish indicator for the stock market is when the Fed lowers the Bank Reserve Requirement; it’s a clear signal of monetary easing. To encourage investments, or to dampen speculation, the Fed will lower or raise the Margin Requirement. The Discount Rate is the only policy variable that changes frequently. Monetary tightening is when the Fed raises the Discount Rate many times in succession; drains liquidity from the system (contraction in the year-over-year rate of growth in the Adjusted Monetary Base, MZM, and M2. Data are available in U.S. Financial Data, reported every Thursday evening by the Federal Reserve Bank of St. Louis); and inversion of the Classic Yield Curve (13-week T-Bill yield vs. 30-year T-Bond yield).

The Fed’s mandate must be clearly understood and appreciated. Failure to do so will leave investors in a state of perpetual confusion and at the mercy of the “noise.”

To divine the market’s long-term trend, I monitor six factors to help me detect how a bull market begins and how it ends. These are the monetary (the most important and the real drivers of the market’s long-term trend), economic, valuation, sentiment, supply/demand, and momentum/internal/technical. The valuation and supply/demand factors are imprecise in terms of timing. Nevertheless, they must be closely monitored. The momentum/internal/technical factors don’t drive the market; they tell investors about the health of the market.

As mentioned on numerous occasions, if nothing else, if investors only understand and appreciate the following, they will always be on the right side of the market and will never be influenced by others’ opinions or news headlines:

1) Investors must understand the role of the U.S. central bank (the Fed). The U.S. Federal Reserve System was created in 1913 to perform all roles monetary, but one of their key statutory (written in law) mandates is to “To maintain orderly economic growth and price stability.” This agency has more and better information on the economy than anyone in the world. It was not created to promote hyperinflation or to create depressions. The Fed’s key mandate must be clearly understood and appreciated.

2) The stock market is a leading economic indicator. The economy does not lead the stock market. Hence, once these two points are clearly understood and remembered, the market’s logic becomes apparent. Hence, when the economy slows and heads into a recession, the Fed will ease and will keep easing until the economy responds (remember, that’s their mandate). The stock market, being a leading economic indicator, will have bottomed 6-9 months before the recovery begins, not after. For example, "the market" bottomed in October, 2008 and the recession ended at the end of June, 2009 and a [market] recovery commenced, eight months ahead of the [economic] recovery. Conversely, when the economy overheats; inflation surges; and speculation is rampant, the Fed will tighten by draining liquidity from the system and raise interest rates in an attempt to cool the economy. The stock market, being a leading economic indicator, will head south long before the onset of a slowdown or recession, not after. This chain of logic is so simple that anyone with an IQ slightly above room temperature would understand it. Yet, most on Wall Street with umpteen degrees and decades of experience can’t figure it out.

IDENTIFYING A MAJOR MARKET BOTTOM

1) The economy is in bad shape; jobs are hard to find; and headlines are black. Capacity utilization plunges. Talk of depression is widespread. The talking heads will declare “this time is different. They (the Fed) has lost control.”

2) Investors are crying the blues as their portfolios are showing huge losses. Worldwide, investors panic and a sense of despair and hopelessness prevails. Brokers are sleeping like babies; theywake up every hour and cry.

3) The Fed eases by injecting liquidity into the system and lowers the Discount rate three or more times in succession and will keep easing until the economy responds.

4) The Classic Yield Curve (13-week T-bill Yield vs. 30-year T-bond Yield) starts to steepen (short rates below the long rates).

5) The interest-sensitive sectors such financials, bonds, preferred shares, utilities bottom and start to head north while the major market averages continue to head south. Mesmerized by the decline in the market indices, investors are unaware that a “rolling” bottom has begun.

6) As the Fed eases further, the growth and consumer discretionary issues bottom while the major market averages move yet to new lows.

7) The market becomes grossly undervalued.

8) Investors are sitting on a mountain of cash and hold little equities. They have no appetite for stocks.

9) A selling climax occurs as investors panic. Seized by fear, investors “throw the baby out with the bathwater” as they can’t bear the loss anymore and are convinced the world will end. An emotional catharsis occurs and stocks move from weak hands into strong hands.

The bear market ends and a bull market begins.

IDENTIFYING A MAJOR MARKET TOP

1) The economy is booming; workers are hard to find; and headlines are glowing. Capacity utilization is running full tilt.

2) Investors are euphoric and the stock market becomes topic du jour at cocktail and dinner parties. Waiters, taxi drivers, bartenders, and shoeshine boys are giving clients hot tips; they think they are market mavens. Everyone is a genius and have the keys to Fort Knox.

3) Euphoria reins. Investors are heavily invested in equities and hold little cash.

4) Stock brokers, confusing their own genius with a bull market, buy Ferraris and Lamborghinis and dine in uber expensive restaurants.

5) The economy overheats, inflation surges; and speculation is rampant. Consequently, in their attempt to cool the economy, the Fed tightens meaningfully by draining liquidity from the system and raises interest rates numerous times.

6) The market becomes grossly overvalued.

7) After a long period of flattening, the Classic Yield Curve is inverted (short rates higher than long rates). Then, as the economy deteriorates, the yield curve starts to steepen (short rates start to move below the long rates).

8) Interest–sensitive sectors such as financials, bonds, preferred shares, utilities along with consumer discretionary, start to head south. Meanwhile, dragged up by the late-cycle issues, the major market averages keep moving to new highs. Investors are lulled by the new highs in the market indices, not realizing the broad market is already heading into a bear market. Not surprisingly, the various Advance-Decline Lines start to head south 3-6 months before the major market averages. New Highs start to contract and New Lows expand.

9) Finally, the major market averages top and join the rank and file by heading in a southeasterly direction.

Resources

https://www.raymondjames.com/wealth-management/market-commentary-and-insights/investment-strategy