"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.