What a mess. Big headlines in a time when traders are on the beach during a natural soft spot in the year leads to the type of market we have seen over the last couple weeks. While we’re chewing on Tums, it’s important to keep a few things in perspective.
US Market Correction Has Been Mild (so far)
Compared to the rest of the world’s stock market indices, the US is still holding up well. Almost all of Europe is down solidly -10% off the highs of the year while the S&P 500 is down barely 3% from the highs. The spooks are talking up the fact that the current high is 1,987 on the S&P warning that the number is subliminally forecasting a 1987 event. Bunk. Europe, and all that is happening there both economically and geopolitically, is really driving global stock markets lower. Europe has slipped into recession again, the Euro is falling and it’s driving up the value of the US dollar. Consequently, global dominos takes over with a rising US dollar driving industrials and other US based multinationals lower in price. A rising US dollar is also tough on commodities but there more going on with that story, in a minute. While the last couple weeks has been light on US economic reports, those that have been released are still telling the same favorable story. Employment is healthy with new unemployment claims hitting new lows again and both ISM surveys for manufacturing and services pushed strongly higher last month suggesting business activity is healthy. Earnings have come in healthy but as I suggested back in late June, most analyst’s had ratcheted up their expectations to a challenging level. The bar was set a little too high and stocks are simply adjusting back to reality lightly.
As I said earlier, commodities are a bit under pressure with the rising US dollar. Energy is a big piece of the commodities complex. If you remember, energy was supposed to be one of the leading sectors in a late stage bull market. That was the case until the end of June but since then, energy has seen more than it’s share of selling pressure forcing us out of several positions in recent weeks as stops were hit. I think there are some structural things affecting energy that may be noteworthy and I am reconsidering my position on energy as a result. One is that the massive production of oil and gas in the US has created an inventory bubble. Two, energy relies on strong global demand and Europe is no longer driving the demand they were a couple years ago. Finally, it is becoming more widely recognized at least in the US, that energy efficiency and greater deployment of renewable energy sources is now pulling away from demand for oil, gas and electricity. In fact, for the first time in history, “miles travelled” and electricity demand have not moved up in sync with the rise in GDP or growth in the US in the last two years. This is big! Strangely, the end of the reign of terror of the oil and gas industry might not come from the concept of peak oil (effectively running out of cheap oil and gas) but rather the very slow move toward lower profits by lack of demand. Lots of issues developing here and I will digest them over time.
Sentiment is Approaching A Bearish Low
Another thing to keep in perspective is relative sentiment figures. We know that investors have not supported this bull market with proper sentiment figures until the end of 2013 and even then, money flows into equity funds haven’t been impressive. Now, after a couple short weeks of corrective work, sentiment figures are angling back to the low end of the spectrum where most good buying opportunities have emerged. Remember, sentiment figures are contrarian as human nature leads us to sell low and buy high again and again. With that said, we haven’t hit the rock bottom of bearishness even by recent standards leading me to believe that this correction is not yet done. But we are getting closer.
Technical, Timing and Cycle Perspectives
As a last note, the technical set up still isn’t very good looking and won’t be until prices either move lower to somewhere below 1900, perhaps 1850 on the S& P 500 or until time passes with prices treading no where. I don’t know what will happen but given the technical damage in the last month including a massive sell off in High Yield bonds, small caps and our leadership groups, I am going to say it feels too early for us to look at this pullback as a buying opportunity. Cycle work suggests that late September is the best looking spot for a tradable low and the 4thquarter is starting to look very attractive for a potential big upside POP!. But between now and then, we have weak technical indicators, a market that has not corrected down to support yet, and a massive pile of headline risk in the system. We are therefore waiting to allocate the rather large pile of new investor money received in the last several weeks. We are also sitting on a larger than normal cash position (20-30% depending on the strategy) for our invested strategies and monitoring our stops regularly selling positions to cash as needed. There will be another great looking set up to get aggressive again and I’m hoping it happens this year. Between now then, we keep our powder dry and our emotional capital intact.
That’s it for this week – try to tune out the media, it’s pretty loud out there.
Cheers
Sam Jones
