It is my sincere hope that everyone remains healthy, is being diligent with their social distancing, and is surviving the new virtual work world reality. Since my kids are now all adults and I’ve had a home office since 2001, my days haven’t changed much – well, except for the daily market freak outs, of course!
However, if I rewind my life back to when my kids were little, I must admit that trying to balance working from home and keeping everybody happy and occupied might have been a bit challenging. Although, who am I kidding, my wife is a champion with kids and would have “handled” the situation for me!
Turning to the markets, it will suffice to say that I’ve been a little busy lately as everybody wants to get a handle on how/why the market is doing what it is doing. And since there are so many points to consider here, this week I’m once again going to present a rapid-fire summary of what I see from my seat.
First, let me say once again that I do not manage money based on market predictions or gut hunches. As I’ve stated a time or twenty, I don’t know anyone that has been able to “call” the market’s next move with any consistency over time. So, I prefer to use what I call a “rules guided” approach to managing the risks in the markets.
Next, I’d like to repeat what I said last week. I do not know where the bottom is on this crisis/panic-driven decline. No one does. Anybody who pretends to know how low the market will go and/or where bond yields are going to level off at should be ignored.
Big Picture Take
We are seeing a waterfall decline (aka a “bad news panic” or “crash”) driven by three issues:
1. The coronavirus pandemic and the associated threats to our health and the economy
2. The crash in oil prices caused by the turf war between the Saudis and Russia
3. The dysfunction, illiquidity, and dislocations happening in the bond/credit markets
It is important to recognize that this “triple threat” is being led by the daily dose of horrible news on the virus front. But we can’t simply dismiss the other two issues as I believe they are playing an important role in the ongoing plunge in stocks.
Another key part of the massive declines seen in the stock market is there continues to be “forced liquidations” in the market. This can take many forms including capital requirement failures such as we saw on Friday as the CME Group was forced to auction off Ronin Capital’s holdings. There’s also margin calls, hedge fund “blow ups,” and mutual fund redemptions. All of the above cause securities of all kinds to be dumped on the market without regard to price.
“It’s the Economy, Stupid”
As we discussed last week, the stock market is in the process of discounting the impact this crisis will have on the economy. To be sure, this is a fast-moving situation. Last Monday at this time, JPMorgan (JPM) was calling for Q1 GDP to fall about 2.5% and for Q2 to decline by -4%. Two days later, their Q2 forecast was changed to -14%. The next day, Goldman (GS) issued a forecast for -24%. And this morning, Morgan Stanley puts the damage at -30%. Yikes.
The point is that the situation is changing fast, which is leading to even faster moves in the stock market as traders attempt to discount the new reality.
A Self-Inflicted Wound
But at the same time, we need to recognize that this economic downturn isn’t like any other because it is a self-inflicted wound. In short, the plan to flatten the curve of the virus is to create a sudden stop in the economy. The country is doing this on purpose. Once the virus threat has passed, I think we can assume that the consumer will resume spending money. And armed with some extra cash from Uncle Sam, it is safe to say that there will be pent up demand.
The Fed is on the Case
I have to say that I’ve been impressed with the Fed’s actions. Unlike 2008, Jay Powell & Co. are acting swiftly. And this morning’s “anything it takes” proclamation is encouraging. In short, the Fed is implementing their 2008 crisis playbook, and doing it quickly in order to not let things get out of hand.
Will the Fiscal Stimulus Solve the Problem?
In a word, no. However, from my seat, the goal of the stimulus is to lessen the impact of this crisis on the consumer and the economy.
What if the Fiscal Stimulus is Delayed?
If you will recall, Congress initially voted down Hank Paulsen’s TARP bill during the Financial Crisis. The response from the stock market wasn’t pretty. As such, today’s decline shouldn’t surprise anyone. But I have to believe that Congress will get this done – and quickly. I think lawmakers understand that a week of bickering would be disastrous for the stock market. Here’s hoping we get a bill today or tomorrow.
How Low Can Stocks Go?
The question on everyone’s mind – especially after another huge drop in the major indices – is, how low can stocks go? Obviously, we don’t know the answer here. But we do know some things.
We are seeing the emotional “panic” phase here
The current decline discounts a healthy amount of bad news
Valuations have improved – I got a buy signal on my weekly Value Line P/E indicator this morning
The Global Central Bankers are doing a good job
Fiscal stimulus is on the way
We have a guide to follow in terms of the virus
We have a guide to follow in terms of market behavior going forward
Keys to a Bottom
From my perch, there are a few things to look for/expect as we approach the initial “panic” low…
Good news on the virus. We want to see the number of new cases begin to decline. This will take time.
Stability in oil prices. This will help.
Stability in credit markets. This is a necessity. Watch symbol LQD for signs of improvement.
The “dead cat bounce” – After the panic low, stocks tend to experience a “sigh of relief” rally. Expect this to be breathtaking and give you the feeling that everything will be fine.
“Enough is enough” – At some point, values will be obvious and real buyers will emerge
The “retest” phase. After the initial bounce, bad news returns, and stocks move back toward the initial low.
Heed the second buy signal. One of the lessons I’ve learned is that when markets crash, you want to ignore the first buy signal or bounce. Unless of course, something occurs that “fixes” the situation (Example: The Fed changing course in early January 2019). Assuming stocks experience a “retest,” THIS is when it is usually a good point to put your offense back on the field.
Look for a Breadth Thrust. A key signal that the market has bottomed, and that a new bull market is about to begin is a “breadth thrust.” This is when the number of advancing issues/volume swamps decliners over a period of a couple weeks. There are many forms of this indicators and we track several on a weekly basis.
Reasons to Stay Positive
It is VERY easy to be negative here. But I think there are several reasons to have an optimistic view about the future.
We’ve seen this movie before, and the hero doesn’t die in the end!
The powers that be (central bankers and governments) are on the case. The bottom line is this will help on the other side.
The economic downturn is likely to be temporary.
The market is likely to follow the “Crash Playbook”
There is big money to be made by the biotech/pharma companies that can produce relief from the virus. My bet is these folks are working their tails off to be first.
Bear markets eventually give way to bull markets.
The average bull market gains between 86% and 106% (source: Ned Davis Research)
This means that a very good opportunity to make some real money lies ahead.
There can be no argument that this market is unpleasant. And the pain of the decline is definitely mounting.
However, it is important to remember that there will be money-making opportunities ahead. Think about where things will be one year from now… two years from now. Once the market recovers – and it will – think about how you would like to play the beginning of the new bull market. Will you be one who waits for “proof” that everything is okay? Or will you be one who tries to turn this debacle into an opportunity?
Using the benefit of hindsight, it is always easy to see what you “should have done.” My question is, why should now be any different?
Weekly Market Model Review
Each week we do a disciplined, deep dive into our key market indicators and models. The overall goal of this exercise is to (a) remove emotion from the investment process, (b) stay “in tune” with the primary market cycles, and (c) remain cognizant of the risk/reward environment.
The Major Market Models
We start with six of our favorite long-term market models. These models are designed to help determine the “state” of the overall market.
There was one important change to report on the Primary Cycle board as the Intermediate-Term Market Model moved to a sell signal early in the week. From my seat, this tips the board’s overall rating from neutral to moderately negative. The bottom line is stocks are now entrenched in a cyclical bear market within the context of a secular bull.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE. View My Favorite Market Models Online
The State of the Fundamental Backdrop
Next, we review the market’s fundamental factors in the areas of interest rates, the economy, inflation, and valuations.
There are no obvious changes to report on the Fundamental Factors board this week. However, it is worth noting that one the component models in the Valuation Composite (the P/E ratio on the Value Line Index) moved into the positive zone this week. I would expect to see further improvement in this area – but unfortunately, the remainder of the indicators/models contained in the valuation composite are only updated monthly/quarterly. Next, I think it is important to recognize that the fundamental models are not built to handle a self-inflicted, sudden halt to economic activity in response to a pandemic health emergency. As such, I think we must look ahead and try to ascertain what the economic outlook will be once the primary wave of the coronavirus passes. Of course, this is easier said than done. My working thesis is that the economy will likely recover quickly once the emergency ends. However, the question is how strong the rebound will be. Stay tuned.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE. View Fundamental Indicator Board Online
The State of the Trend
After looking at the big-picture models and the fundamental backdrop, I like to look at the state of the trend. This board of indicators is designed to tell us about the overall technical health of the current trend.
With the major indices now in a cyclical bear market and having reached this status in record time, it is not surprising to see a lot of red on the Trend board. The lone positive trend is the 50-day vs. 200-day moving average, which would appear to be destined to turn red at some point in the coming weeks. And given that the cycle composite is not helpful in this environment, the green on the board currently is misleading.
Next, we analyze the “oomph” behind the current trend via our group of market momentum indicators/models.
If you are looking for a good technical summary of the current market environment, the Momentum Board is it. It’s red. Completely. ‘Nuf said.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE. View Momentum Indicator Board Online
Early Warning Signals
Once we have identified the current environment, the state of the trend, and the degree of momentum behind the move, we then review the potential for a counter-trend move to begin. This batch of indicators is designed to suggest when the table is set for the trend to “go the other way.”
Last week, I opined that the Early Warning board was in a “Not Yet” mode (intended to be a reference to the famous line from the movie, “Trading Places”). While attempting to pick a bottom in this environment is akin to trying to catch a falling knife (which might wind up being a guillotine!), the Early Warning board does suggest that a trading opportunity is likely close at hand. Especially when you consider that the Short-Term Overbought/Sold indicator is a whisker away from giving a buy signal as well. But, if you are looking for some spice in your life and want to put a long trade on in anticipation of the “dead cat bounce” that is coming, I’d encourage you to give yourself more than one shot at buying – personally, I’d prefer to take three shots at it!
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability – NOT INDIVIDUAL INVESTMENT ADVICE. View Early Warning Indicator Board Online
Thought For The Day:
I think a hero is an ordinary individual who finds strength to persevere & endure in spite of overwhelming obstacles. -Christopher Reeve
All the best, David D. Moenning Investment Strategist
At the time of publication, Mr. Moenning and/or Redwood Wealth Management, LLC held long positions in the following securities mentioned: JPM, GS
Note that positions may change at any time.
NOT INVESTMENT ADVICE. The opinions and forecasts expressed herein are those of Mr. David Moenning and Redwood Wealth and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as investment recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.
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Mr. Moenning and Redwood Wealth may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
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