It’s been a good couple weeks for the global financial markets in an all-inclusive way. Stocks, bonds, commodities, oil, gold, and high yield credit have all been rebounding nicely off the 1/25 and 2/11 lows. As we discussed in early February, the set up for a stronger than expected rally was clear and obvious. Now we’re realizing that event. But we must keep our eyes on the bigger picture which still points to a potential tradable low in the broad stock market later, perhaps the end of the quarter.I’ve heard some argue that a low is already in for 2016.I’d say that’s optimistic but either way, I think we’re getting close.
New Lines in the Sand for the US Stock Market
Investors should always understand what kinds of potential risks and rewards they are taking when engaging with the stock market. We can measure that looking again at any of the broad indices by highlighting likely price resistance and support levels based on technical price patterns, valuations, and cycle work. I won’t bore you with the heavy brainwork, but for us, there appears to be some likely upside and downside targets establishing for the S&P 500. On the downside, we see a likely support level about 8% below where the S&P 500 is currently trading. That level is roughly 1790. On the upside, if this rally can run above the highs set last Friday (S&P 1945), then prices could push all the way up to 2000 on the index. Given all the issues we will be surprised if the US stock market has that kind of firepower now, but even if it did, the 2000 mark is going to be really hard to beat as it represents the falling 200-day moving average. So, from where we are today, the US stock market has just about an equal opportunity on the upside as it has to the downside in terms of percentage gain and loss. That’s still not a bad set up in terms of risk and reward but we would be very careful about any new additions from here. Most additions to net exposure should have already happened as we did in mid-February by about 10-15% across all strategies.
We should note that these lines are really heavily dependent on short term technical parameters for stocks. From a fundamental perspective, things are still not so favorable. Best estimates for downside risk bringing the S&P 500 and other benchmark US stock indices back to long term averages for valuation, would point to the 1500 level for the S&P. That’s a long way down, almost 22% lower than the close of last week. Our expectation remains the same as it has been for several years; We are expecting a quick and nasty garden variety bear market that is resolved to the upside. What does garden variety mean? It means the US stock market could ultimately see a loss of 15-25%, perhaps during the current downtrend. Garden variety means nothing “special” or similar to either of the two 50% wealth destruction events since year 2000.We do NOT subscribe to the fear mongers out there suggesting we are doomed to a 2008 scenario.More on this in a minute.
Getting Close to a Buy
Several updates ago, we offered a potential investment model for internationals.In that discussion, we purposely did not include emerging markets or Latin America specifically as the environment was poor for developing markets.But that is changing and we’re starting to see a potential set up for buys in Emerging markets, specifically Latin America.Several things need to happen.First we need to see their markets start new uptrends.At present, we are only seeing their market’s stabilize.Second, we would need to see some stability in commodities and energy as emerging market economies are still very much dependent on their exports of natural resources to survive.Finally, we would need to see the Federal Reserve lay off the rate hike pedal and give us some forward guidance suggesting they are done raising rates for the foreseeable future.We are the most skeptical of the last condition happening, as it seems the Fed is hell bent on throwing the US economy into recession.But oil and commodities seem to be finding a base in here and now that the US dollar is also in retreat, we have a potential set up to invest in emerging markets again.
High Yield Corporate and Emerging Market Bonds
I hate to even say this publically, but both of these asset classes have given us short term buy signals in the last week or two.It is not a strong enough buy signal to get really excited and we’re a bit skeptical that these buy signals will hold for very long considering the rising default risks.But it is what it is and most of the best investments you’ll ever make are the one’s where you are holding your nose and hitting the buy button.We have taken very small entry level positions in both high yield and emerging market debt funds in all Blended Asset and Income models in the last few days.We also now own Treasury Inflation Protected Bonds for the first time in many many years.What do you know, we own Gold and TIPS, and the smell of inflation is in the air.Treasury bonds conversely still look downright ugly from a set up perspective and we will be quick to cut our only exposure (BAB – Build America Bonds) if and when the trend turns south.
Commodities and Base Metals
There is also something happening here.Again, we do not have enough evidence to engage with commodities or base metals yet (like Steel and Copper) but we are seeing favorable price patterns develop at near 12 year lows.Many things would need to become more definitive for us to embrace this trade including a strong move in the inflation indicators, some signs of new and robust economic strength and of course an uptrend in prices.All things considered, it feels like investors are going to have to wait a while for any of these to happen but we do want to call out the potential for developing buys sometime in 2016 based on what’s happening on the price side of things.
Why this is NOT 2008 – Part 100
It does not take a genius to see the similarity in the current market trends to those of 2008.We see the same top in the stock market as everyone.But you must know that every stock market top has very similar features and looks.This one is no different than 2008, or 2000 or any of those in the 60s and 70’s.But bear markets come in all different shapes and sizes.It’s really the downside pattern and duration that makes them all unique and no one knows what that’s going to look like this time.Here’s what we see and believe.We believe that market returns since 2012 have been pulled forward to a degree on the back of years of quantitative easing by the Fed and subsequent substantial financial engineering on the back of an overextended zero interest rate policy.I’ve spoke to both of these issues at length in the past.It means that we have probably seen some unjustified gains in select mega cap stocks and sectors since 2012 that should be corrected.But not all stocks had unjustified gains.In fact several sectors have suffered badly or gone no where in the last 5-6 years and these are major food groups for the US stock market including financials, banks, energy, industrials, materials, and high yield credit not to mention the entire world of international markets.These present oversold opportunities for investors who are looking to invest in something cheap.So parts of the market could be overdone while other parts of the market may even be trading at unjustified LOW prices.This is not a market condition or environment that leads the major averages to 2008 style losses.
Industrial production has also been in the news a lot as an indicator pointing to recession in the US.Aggregate industrial production numbers are down but let’s pick it apart a bit.Take a look at this chart offered by Bespoke on Friday.
What we see is the devastating impact of the energy crisis on the aggregate numbers.If we remove energy from the equation, one would be hard pressed to say that industrial production is anything other than normal and certainly not recessionary.But with energy factored in, it looks terrible, like a recession.Look back at the period between 2008 and 2010.Here we see almost the opposite condition when energy was adding some buoyancy to the Industrial Production index.That is what recessionary pressure really looks like.
Finally take a look at another Bespoke chart below showing Initial Jobless Claims (inverted) next to the S&P 500.Jobless claims are making near all time lows now and typically, these claims begin to rise 3-6 months in advance of a peak in the stock market or the broad economy.Focus on the time period between March and Sept of 2011 when the S&P 500 fell 15.5% even while jobless claims made new lows.In the end, the stock market snapped back to match the trend of falling claims (rising in the inverted chart).Could it happen again?Now?Certainly.
I have to remind myself almost daily that I am the weakest link in the chain when I have some preconceived notion of how things will play out.There is a lot of conflicting evidence out there now, so I can safely say, I don’t have a solid feel for the future.But I wouldn’t be so quick to throw out this market’s potential.As usual, we’ll be playing things as they come, making all adjustments as necessary.
That’s it for now – stay tuned.
Sam Jones
