Superior Long-Term Indicators Say U.S. Stocks are in 2nd Leg of a Bear Market

by Victor Sperandeo with the Curmudgeon



Curmudgeon Note:  This is the first of a two-part article.  We’ll look at economic fundamentals in our follow up post tomorrow.  Victor and I wish all readers a very merry Christmas, a joyous holiday season and a happy New Year.

Overview (Victor):

This October, I said U.S. equities were in a bear market, as dictated by the 200-day moving average (MA) indicator:

On 10/23/18 the S&P 500 index closed at 2,753.25, while on the October 24th, the Dow Jones Industrials (DJI) closed at 24,583.42.  Both those numbers were below their respective 200-day MA which was “sloping downward.”  The coincident of a close below a downward sloping 200-day MA is critically important for both speculators and investors.

The other long-term superior (technical) indicator is “Dow Theory,” which had not yet confirmed a SELL signal in October.  However, that was accomplished on 12/10/18, when the Dow Jones Transports (DJT) closed below its primary low (9896.11) at 9876.54.  That Dow Theory SELL signal was reported and explained (the day it occurred) by the Curmudgeon in this post.

We are now in the second leg down of the bear market in U.S. stocks.  Here are the important numbers and statistics for the DJI and DJT:

1.    DJI:

·       Top 10/3/18 at 26,828.39                                                      

·       Primary decline 10/29/18 to 24,442.92 =-8.9%

·       Correction rally 11/8/18:  26,191.22 (% correction of the decline =73.3%)

·       Second primary leg (so far) close as of 12/21/18: 22,445.37= -15.1%                                                                                      

·       Note that the median decline for the DJI in the 2nd leg of a bear market is 20%, which would equate to 20,952.

2.    DJT

·       Top 9/14/18 at 11,570.84

·       Primary decline 10/29/18 to 9896.11 =-14.5%

·       Correction rally 12/3/18:  10,850.44 (% correction of the decline= 57%)

·       Second primary leg (so far) close as of 12/21/18: 8874.79 -18.2%


Note that I have done this type of measurement classification from 1939 following the work of the great Dow theorist Robert Rhea, who classified movements back to 1896!  All the movements are within 10% of their medians for the last 123 years. This means that this latest move is very typical of bear market action.

The reason is the usual suspect -THE FED (!)- not a reaction to the current headlines:

Don’t blame this week’s stock market decline on anything else, as pundits might have you believe.

·       There have been over 20 government shutdowns have occurred since 1976. 

·       The “trade wars” have been in play since January 2018 – almost a full year with China trade tensions starting long before that.

·       Instability in Trump’s cabinet and advisers has been the case since he took office in January 2017. 

·       The Mueller Special Council investigation began May 17, 2017.   Nothing has been disclosed yet that implicates Trump or his current administration.

*None of the above events had previously impacted the U.S. or overseas stock markets.

It’s the Fed stupid!

The Fed increased its benchmark Fed Funds rate by 25 bps this week- the fourth increase this year.  It has also continued to reduce its balance sheet which the Curmudgeon referenced in his post on the dangers of Quantitative Tightening (QT).  Fed Chairman Powell said on Wednesday that the Fed would keep reducing its balance sheet by up to $50 billion per month. Since beginning the shrinking process in October 2017, the Fed has trimmed its portfolio of U.S. Treasury- and mortgage-backed securities by around $365 billion to $4.14 trillion.  

Those moves were seen by some as too aggressive, since the global economy is slowing precipitously (especially Europe and Japan).  In my humble opinion, this week’s Fed rate hike and statement that it was on track for two additional rate hikes in 2019 was a poor decision and easily understood by many professional observers. I strongly believed that an increase in rates would cause the markets to fall 5%!  In last Sunday’s Curmudgeon post I said: “If the Fed raises rates on December 19th, the U.S. stock market will decline another 5%.”  In hindsight, I was far too conservative:

*S&P500 fell -7.4%, NDX 100 fell -8.3% and Russell 2000 fell -8.4%.  That was the worst weekly decline since 2008.

Weak Global Economies:

I believe a 2019 recession in the U.S. (and most other major nations) is highly likely.  Let’s examine why?

Europe is a political and potential economic disaster with the three biggest nations in the EU - Germany, the United Kingdom (UK) and France all having major problems with their leadership.  All of whom look like they will be ousted in the near future. 

·       The so called “Yellow Vest “movement of France is spreading throughout Globalist Europe.  President Emmanuel Macron has an 18% approval rating -a dead man walking. 

·       Teresa May, Prime Minister of the United Kingdom and Leader of the Conservative Party since 2016, can be upended any day due to her weak Brexit politics.

·       Angela Merkel, Chancellor of Germany since 2005, has already stated she will not run again and is no longer the head of her center-right Christian Democratic Union party.

Japan and China economies are each slowing materially. The EU (actually the ECB) and Japan (BoJ) cannot lower interest rates, as they are at negative rates already.  They will not lower taxes either.  Therefore, they are figuratively on the Titanic that just hit the killer iceberg.

*Keep in mind that 45% of the S&P 500 earnings come from overseas profits (repatriated or not).

The markets see the handwriting on the wall:

·       In January 2018, the Shanghai Composite, the Hang Seng index, Ibex 35, Topix, and Nikkei 225 all topped. The latter tested its January high in October, then plunged over 17%. 

·       In May 2018, the FTSE (Footsie)100 topped along with the DAX, CAC, Straits Times stock indexes all topped.

·       The U.S. was no place to hide from the stock rout. The FAANG stocks (Facebook Amazon, Apple, Netflix, and Google) all closed at lows for the year.  After rising strongly in the first 9 months of 2018, Apple, Facebook, and Google are now DOWN for the year!

·       Also see the signs of defensive investments as U.S. Treasury Bonds and Notes, Gold & Silver, and the Japanese Yen were all up last week.

·       With commodity indexes at new lows this all points to deflation and lower or even negative GDP in 2019.

*Who do you believe - your wallet or your CNBC favorite talking head economist?

Closing Quote:                                                                                                                      

Ephesians 6:12 - ”For our struggle is not against flesh and blood, but against the rulers, against the authorities, against the powers of this dark world and against the spiritual forces of evil in the heavenly realms.”

Good luck -as anyone who is long stocks will need lots of it!  Till next time...

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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