Storm Clouds Limit Upside – Patience – Ignore Hype

INVESTOR’S first read.com – Daily edge before the open
DJIA: 26,201
S&P 500: 2,920
Nasdaq Comp.:7,872
Russell 2000:1,486
Friday,  October 4, 2019
 9:08 a.m. 
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gbifr79@gmail.com
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TODAY:
A lot of storm clouds on the horizon (recession, political uncertainty, bear market, international tensions). The Fed will try to counter that with another rate cut, and there will be promises of progress on trade.
These will trigger rallies, some dramatic.
I believe we are in a bear market and  the early stages of a recession. How intense both will get depends on  events down the road.  New negatives can delay recoveries. What happens between now and 2021 is key. It doesn’t look pretty.

Algorithm Investing

I rant about buy-oriented institutional algorithms  making most of the investment decision today, how a sudden change in their programming could cause a flash crash.
The Economist  reports algos account for 35% of the stock market, 60% of institutional equity assets and 60% of trading activity. Artificial intelligence (AI) is being used more and more to write programs. Careful guys/girls, the best computer is the human brain.
Myths
    I am repeating the following, since a 10-year bull market can block out memories that things can get far worse than anyone on the Street can imagine.
In 1969, who would have thought there would be four recessions and 5 bear markets in the next 12 years.  Stuff happens.

But, the Street is mesmerized by a giant “myth.”
The Myth
-that economies grow forever.
-that lessons from the Great Recessions were learned – can’t happen again.
-that stock markets always recover quickly from bear markets
-that the current excessive stock market valuations will last forever
-that the Fed will come to the rescue when the stock market takes a big hit.
-that single digit P/Es will never return.
-that untethered chaos, civil and political unrest, and violence are not possible in the U.S..
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TOP ECONOMIST STATES REASONS FOR RECESSION 

I have tracked A. Gary Shilling for decades and believe him to be one of the nation’s leading economists based on an incredible record for forecasting accuracy.
    Shilling’s October  INSIGHT listed reasons why RECESSION is underway now. To mention a few:

-OECD has slashed economic forecasts.
-N.Y. and Cleveland Fed model outputs have reached recession levels.
-Capital spending is falling
Transportation stocks  continue to drop. Transports tend to lead industrials in signaling trouble since materials need to be shipped before they are turned into  finished products.
Trade wars are causing business caution.
-Treasury yield curve is inverted.
-Corporate profits are sliding.
-The Fed is losing its battle against disinflation.
Consumer spending alone is holding back a full-blown recession.
-Growth of nonfarm payrolls and weekly earnings continue to slide, as well as consumer confidence.
Purchasing Managers’ index (PMI) for manufacturing has dropped below 50 signaling contraction.
-A low manufacturing capacity utilization is discouraging capital expansion.
-Eurozone and U.K. on edge of recession, China’s growth slowing.
-Shiller’s cyclically adjusted P/E  (28.9) is 71% above long-term average (16.9).
TECHNICAL:
On the surface, yesterday was a one-day reversal with the market closing at the highs for the day after a sell off in the first hour of trading.
Just how valid that reversal was will be tested today. Expect the market to open a bit lower, the key will be if sellers run out of steam and buyers rush in.
      RECESSION talk will ramp up now that the ISM Non-manufacturing for September came in well considerably ,lower than August.
There has never been a recession without a bear market.
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Minor Support: DJIA:25,980; S&P 500:2,890; Nasdaq Comp.:7,855
Minor Resistance: DJIA:26,387; S&P 500:2,921; Nasdaq Comp.:7,897
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Friday Oct. 4  “Fed Rate Hype, Administration to Hype Trade Progress. Brief Rally ? Nimble Traders Only”

What’s happening with the economy should not have surprised the Street. The early signs of recession have been there for many months and reported here  daily.
This plunge should not surprise the Street.  With the DJIA at 26,820 on Monday, Sept. 30  I headlined, “Ignore Fed and Administration Hype, ..adding  Cash reserve of 80%”
Why would I go to that extreme – 80% cash ?
We all know the Fed will shortly announce more rate cuts, the Administration and/or Street will hype  progress on trade and trigger a rally.
However, at some point, their efforts to prop the market will fail and then it will be straight down.  Why risk it ?

Investors must be prepared for the stock market and political environment to enter a very dark period where a bear market can take the major market averages down 35% – 60%. The severity of the bear market depends on what new negatives hit the market as it is tumbling.
The Street is spoiled by a 10-year bull market. They want to keep partying.
But, the Street is mesmerized by a giant “myth.”
The Myth
-that economies grow forever.
-that lessons from the Great Recessions were learned – can’t happen again.
-that stock markets always recover quickly from bear markets
-that the current excessive stock market valuations will last forever
-that the Fed will come to the rescue when the stock market takes a big hit.
-that single digit P/Es will never return.
-that untethered chaos, civil and political unrest, and violence are not possible in the U.S..
This can get ugly, real ugly. All that is needed is for one or several major institutions to break ranks and sell, others to follow.

The upside is, all this carnage will produce an unprecedented  buying opportunity. Investors must be prepared for it, even if they must leave the party before “last call.”
I issued my bear market bottom “BUY” on March 10, 2009 as the DJIA at 6,800. I would like to do that again when all this unwinds.

IMPORTANT NEWS TODAY
The current plunge in stock prices was triggered by  Tuesday’s report  for Septembers’ ISM manufacturers’ index which plunged the most since the Great Recession  (2007-2009).
That was manufacturing,  today at  9:45 a.m. we get the PMI “Services”  report and at 10 a.m. today we get the ISM Non-Manufacturing “Services” report, significant since they cover a greater sector of our economy. Bad reports would confirm a recession and hammer stocks. Also at 10 o’clock we get Factory Orders, which should stink.

Wed. Oct. 2  “Ignore Fed and Administration Hype”
Yesterday’s abrupt reversal and crunch is an example how vulnerable this overpriced market is. I think it was more a matter of buyers walking away when the ISM report hit, than overwhelming selling.  That’ll come at lower levels when doubts and fear mount.
        We had the same freefall in late July/early August. No one wants the bull market to end and will stay as long as possible, but are quick to run for cover when it looks like a bear market or severe correction will strike.
There is sizable support between DJIA: 25,500 and 26,200’ S&P 500:2,850 – 2,920; and Nasdaq Comp.:7,770 – 7,830.
That’s where buyers showed up in August. That band of support will be broken at some point.
Conclusion
:  Expect one or several sharp rallies to be triggered by optimistic comments by the Fed, the Administration, the Street.
The Fed will promise or hint at lower interest rates, the Administration will claim progress in trades talks, and the Street will forecast an earnings rebound in 2020.
We are dealing with something we have not dealt with for 45 years – a dysfunctional government as impeachment proceedings move forward.
This is NOT something the Street’s algorithms were programmed for.  Expect these algos to be tweaked in coming weeks and that stands to be for less buying as well as some selling.
The whole idea here is to prop the market up and delay a recession until after the 2020 election.   Nonsense !  We  are in the early stages of a recession, it will get worse next year.
Confidence drives stock prices.  Confidence will take a huge hit in coming months, and that will eventually take a huge toll on stock prices.
TECHNICAL: There will be the typical knee-jerk buying reaction by institutions  today, but yesterday’s surprise plunge was a jolt to confidence. Playing rallies here is for the nimblest of traders.
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Wed. Oct. 2  “Bull/Bear Tug of War to be Resolved Soon”    

So far, impeachment proceedings have not dented the veneer of the Street’s bullishness.
Richard Nixon was re-elected a bit more than three months after the first signs of wrongdoings by his administration, the arrest of five men trying to bug  the Democratic National Committee’s Watergate hotel and office complex offices.
A bear market started two months later, one that lopped 50% off of the S&P 500 Index.
Nixon resigned August 8, 1974 before he could be impeached. A recession (Nov. 1973-Mar. 1975), the Yom Kippur War (Oct.1973) and OPEC oil embargo (Oct. 1973-Mar. 1974) contributed to the market’s demise.
What we are face here is similar in that a recession and bear market loom, but far different, far more divisive and far more injurious to investor confidence with impeachment proceedings underway.
Once things start to unravel, there is no stopping the carnage until the plunge has run its course.  Negative news is relentless, putting a lid on rally attempts and driving prices lower.
The big difference today is so much of the decision process is computerized, which means no change in the balance between bulls and bears until the algos are re-programmed.
That will happen as fear and reality mount.
Bottom Line:  The Bulls are desperately trying to hold the line. Even if the market breaks above minor resistance (DJIA: 27,020, S&P 500: 3,000), there is another line of resistance a little above that (DJIA:27,300, S&P 500: 3,008). TECHNICAL
 Sad to say, but IMHO the Fed and Administration have surrendered their credibility with an inconsistent and  flow of information.  Be wary of press releases from  either. They are designed to prop the market, which will plunge without the hype.  The Fed  has lost its clout about rates and why would China cave to trade concessions with Trump’s power sapped by the prospect of impeachment ?
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The Street tends to shrug off a lot of things that could end up hammering stock prices: war, recession, a bear market resulting from overvalued stocks facing an earnings recession that can be worsened by a recession, and now the potential for the impeachment of the nation’s president.
That’s what a 10-year long bull market can do to the people who benefitted the most – corporate management and Wall Street.
       At some point, the BIG money will hit the silk and it will be straight down  12% to 16% before investors can say ouch.  That’s just the first leg down.
That’s because the Fed, Street and Administration have propped this market up with hype about the economy and the magic of interest rate cuts !
Investors are being conned !  There are no new eras ! Bear markets happen !
All it takes is for several major institutions to break ranks and sell and others will follow.
The impact will be instantaneous as computer algos, mostly programmed to track the same bullish metrics, will get the sell at the same time.
The hype will continue in an attempt to prop the market hopefully through 2020 election year.
Impeachment a real  possibility, and that will lead to more divisiveness and  stifle consumer and investor confidence.
This one has the potential to get real ugly.
Stock markets recover from bear markets, so why not wait it out ?
For one, over the last 46 years we have had three bear markets with the S&P 500 dropping 50%.  Many investors got shaken out near the bottom not to return until long after the  market lows. Those who held on didn’t see portfolios regain losses for years.
Depending on one’s tolerance for risk, a cash reserve of 80% is justified.
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Friday Sept. 27 “Street’s Arrogance to Risk to Precede  the Fall ?”
Naturally, current events surrounding Donald Trump and the prospects for  the U.S. House initiating impeachment proceedings  flashes back to the early 1970s when President Nixon was the subject of the same thing.
Nixon took office in Jan. 1969. Incidents leading to the House Judiciary Committee passing three articles of impeachment: obstruction of Justice, abuse of power and contempt of Congress were filed  on July 27, 1974. On August 8, 1974, President Nixon resigned, but was later pardoned by President Ford.
Perhaps the formation of the White House “plumbers” unit in the fall of 1971, intended to plug leaks in the White House set the stage for a series of shocking events between the White House and  Congress and the press, including the formation of the  Senate Watergate committee, high level resignations, coverups, payoffs, erasures of tapes, the “Saturday Night Massacre”, and a Supreme Court ruling.
Ironically, Nixon was re-elected on November 11, 1974.
A bear market (1/1/73 – 10/4/74)  intervened taking  the S&P 500 down 50%; a recession started  in November 1973 and ended in March 1975.
Contributing to this chaotic era was the Yom Kippur War (Oct 6 -26) and OPEC’s oil embargo (Oct. 1973 – Mar. 1974) and a four-fold increase in the price of oil.   Wild stuff !
Just how this will play out this time in uncertain. We are in the early stages of a recession, which the Fed acknowledges and is responding to with rate cuts.
A bear market may have already started, and who knows, maybe another mid-east oil crisis if war breaks out between the U.S. and Iran.
The market is historically overpriced. The prudent thing to do here is to have a healthy cash reserve (30% to 85%) depending on one’s tolerance for risk.
The new normal for corrections is the flash crash, a near vertical plunge in prices as highly leveraged institutions stop buying, worse yet – start selling with the result being a 12% – 16% plunge followed shortly after by a failed attempt to rebound, then another huge plunge.
So far, the Street is ignoring the risk, perhaps in denial after being spoiled by a 10-year bull market.

TECHNICAL 
Today’s market will start on the upside with algo-buys automatically nibbling at lower prices over the last  8 days, but bulls must push up beyond DJIA 27:306, S&P 500:3,021 and Nasdaq Comp. 8,243 to get the market moving upward again.
While impeachment is grabbing the headlines, the bulls are hoping for good news on U.S./China trade talks October 10.
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Thursday Sept. 26  “Market  Takes a Pretty Good Punch, but……”
     Looks like a jousting match between Trade talks and impeachment proceedings  to determine which dominates the direction of stocks.
      While there is  enough weakness in certain economic  indicators to warn of recession, the Street doesn’t care (yet).
All recessions to date have been accompanied by bear markets.
Expect news releases about improved U.S./China trade prospects anytime the market slides down. Absent that, the Fed will step in to stabilize the market, it’s the new norm.
The other side of the coin is the market will respond to bad news on trade, as well .  For some reason, the Shanghai Composite stock index dropped sharply yesterday, which may suggest  uncertainty about upcoming  U.S/China trade talks.
      The market is demonstrating it can take a pretty good punch what with recession talk, trade uncertainty and now impeachment.
But
at some point, the market will keep going down. It will happen out of nowhere, because the Street’s algos will get a sell all at the same time and whoooosh.
      What to do depends on one’s tolerance for risk. Anyone needing funds from their investment account near-term better have a healthy cash reserve. Senior citizens not in a position to ride out a bear market should also have a good cash reserve.
YES, with more unsubstantiated hype about trade, the market can (likely will) move higher, but that only extends the market’s overvaluation. Corporate earnings are down this year and estimates for 2020 are being slashed by the Street.
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What No One on Wall Street Wants to Hear
>We are in the late innings of an economic expansion, so a recession is a good bet. The current expansion started in June 2009, has lasted 122 months, the longest  in history, twice as long as the average length of 11 cycles since 1945.
> Of the 10 recessions since 1950, the average time between the low point in the unemployment rate and the start of a recession was just 3.8 months.  The unemployment rate is 3.6% which was hit in May.  Technically, we won’t know when the start of the current recession is official for months after the fact, since that conclusion is  reached by the Nat’l Bureau of Economic Research (NBER) and they consider  host of economic indicators.
>Bear markets lead the beginning of recessions by 3 to 12 months.  The current bull market at 126 months is 4.2 times the average of the last 15 bulls going back to 1957
 >Nine out of the last 10 recessions have occurred with a Republican in the White House.
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George Brooks
Investor’s first read.com
A Game-On Analysis, LLC publication
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Investor’s first read, is a Game-On Analysis, LLC publication for which George Brooks is sole owner, manager and writer.  Neither Game-On Analysis, LLC, nor George  Brooks  is  registered as an investment advisor.  Ideas expressed herein are the opinions of the writer, are for informational purposes, and are not to serve as the sole basis for any investment decision. References to specific securities should not be construed  as particularized or as investment advice as recommendations that you or any investors purchase or sell these securities on their own account. Readers are expected to assume full responsibility for conducting their own research pursuant to investment in keeping with their tolerance for risk.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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