More Questions Than Answers

March 30, 2020|2:56pm


We’ve talked a lot lately about what I call “The Crash Playbook.” In short, this is a guide developed since the mid-1980’s on how market crashes/crises tend to play out. The premise for the playbook is, as the saying goes, “history doesn’t repeat itself, but it often rhymes.”

The main reason the market tends to follow the playbook is the various stages (Crash, Dead-Cat Bounce, Retest, Bottoming Phase, New Bull) are based on the emotions of investors. The idea is that while no two market moves are alike, investor behavior tends to be similar over time.

So, from my seat, the question of the day is if we have completed the first two chapters and are now moving into the third – the retest phase. Or, if we remain stuck in chapter one. While I don’t know the answer, I’m of the mind that the next week or two will provide some serious clues.

Throw Out The Playbook?

However, my son, who is a portfolio manager for Clarus Wealth Advisors with nearly a decade of PM experience already (how the heck did that happen, btw?) asked what I deemed to be a darned good question on Friday. “Dad,” he began, “how do we know the playbook will hold up this time around? We are experiencing an unprecedented event. So might we need a new playbook?”

I know what you’re thinking. The youngster is basically saying, “This time it’s different.” And as we all know, those four words tend to create difficulty in one’s portfolio.

Yet, in his defense, I had challenged him earlier in the week to think outside the box and to keep his mind open to anything here. As such, I thought the question was solid. And for the record, my initial response was something along the lines of, “Hmmm…”

No Appropriate Analog

It goes without saying that we are experiencing an economic situation like nothing we’ve seen before. Sure, the economy of the United States, and other countries for that matter, have stopped on a dime before. The 9/11 Terrorist Attacks and Japan’s Tsunami are decent examples. But never has economic activity across the globe been shut down – on purpose.

Thus, the financial markets are busy “discounting” what comes next. The problem is nobody really knows what comes next. Other than an almost complete stoppage of economic activity, that is.

Obviously, this creates uncertainty. And we all know how Ms. Market hates uncertainty, right! So, at this stage of the game, understanding the questions that are most important to the market might be mission critical. So, while many of the questions posed below can be placed in the “Captain Obvious” category, my guess is that these are the key questions market participants need answers to. So here goes…

So Many Questions

There are so many questions here, which, in my humble opinion, makes it REALLY tough to know when “enough is enough” in terms of downside action in the stock market.

For example, one of the most obvious questions, which happens to be vital in terms of trying to discount the future appropriately is, how long will “the great cessation” last?

Are we talking about a few weeks as the White House recently opined (to the chagrin of just about everybody in the room)? A couple months? Three to four months? Longer?

Or will the virus simply “burn out” once the weather warms up?

The short answer is, nobody knows.

Next up in the long list of important question is, what will the economic damage be?

The consensus thinking appears to be that the U.S. is already in recession. I could show you any number of charts to support this idea. However, the chart below of last week’s initial claims seems to make the point pretty well that these are indeed unique times.

View Chart Online

So, what does this mean in terms of GDP? The guesses from Wall Street’s best and brightest are all over the map. Currently Morgan Stanley has the most pessimistic view in calling for GDP to decline 30% in Q2. Frankly, that sounds a bit extreme. Goldman’s (GS) estimate is at -24%, JPMorgan’s (JPM) at -14%, Deutsche is at -12.9, and Bank of America is at -12%.

Regardless of who you believe, it appears the quarter isn’t gonna be pretty.

The next question to ponder is, what happens to earnings? The bad news is we really can’t know how bad the oncoming recession is going to be. However, what can be viewed as “kinda good news” is we can be pretty sure a recession will occur. And therefore, we can look back at history to see how economic downturns have impacted earnings on the S&P 500.

Below is a chart from Ned Davis Research showing how EPS for the S&P fared during recessions in the modern, post-war era.

View Chart Online
Source: Ned Davis Research

The bottom line is the average earnings decline experienced during recessions since 1948 has been -25% while the median has been -14.8%. The worst hit was seen during the Financial Crisis. Obviously, this was a big, bad recession and earnings fell -91.9%. Other big hits occurred during the Tech Bubble bear (-54% beginning in 2001) and the -36.9% seen after the Gulf War of 1990. So, clearly there is serious risk to earnings if the U.S. experiences a nasty recession. Thus, the 33.9% drop from the S& 500’s all-time high to the recent low might not be enough. Ugh.

If you prefer to be optimistic, the shallowest declines in EPS during recessions were -3.3% in 1948, -4.1% in 1953, and -4.6% in 1980. These recessions were more of the short-and-sweet variety. So, if you believe that the U.S. is going to dip in and out of recession quickly, then one can argue that the downside discounting already done to stock prices is likely enough.

Next Question…

The next question is really tough. How do you open the economy back up? Quickly and all at once? Slowly over time? County by county? City by city?

The lifting of shelter-in-place orders will ultimately come from the local governments that imposed them. So, while the White House may encourage folks to get back to work, here in Colorado, we’ve got to wait on the governor and/or mayors to give us the all-clear proclamation.

Finally, What Does the New Normal Look Like?

So, when everyone comes out of hibernation and is allowed to conduct a little commerce in an up close and personal way again, what will the new “normal” look like?

Will folks just forget the weeks/months of worrying about a virus that could upend their lives at any moment and return to business as usual? Ask yourself, will you jump on an airplane immediately for that late-summer vacation? What about the cruise the family was talking about? Do you dare visit great grandma in her nursing home? What about shopping at the mall?

Or will people think twice about sitting so close together at a baseball game? And will a ride on a packed subway ever be the same until every American has been vaccinated for COVID-19?

While my point is likely obvious, the key here is that there are a BUNCH of questions that cannot be answered at the present time. Therefore, anybody thinking that the stock market is going to simply march higher from here and head right back to new highs might want to think again.

To be sure, I believe there will be great opportunities for investors on the horizon. I just think the markets will need to get comfortable with possible answers before the next bull market can begin in earnest. It is for this reason that I believe last week’s “bounce” is likely to fail and lead to a “retest” phase. However, I will also admit that this is a very popular view, which, of course, makes me nervous!

But in closing, the good news is the next bull market IS coming. It’s just a question of when! Oh, and word that the Fed might consider buying stock ETFs if things get worse is certainly encouraging!

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 are three items of note this week on the Primary Cycle board. First, the Leading Indicators Model slipped from a positive to neutral. Next, while the Intermediate-Term Market Model hasn’t exactly nailed this market, there was some improvement within the internal components, which resulted in the hypothetical historical return rising from -19.2% to -1.0%. Finally, the Desert Island Model managed to push up into the neutral zone from negative. As a result, I’ll give the board an overall rating of low-neutral this week.

* 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 again this week. However, as I mentioned last week, I think it is important to recognize that the majority of the fundamental model components are updated on a monthly basis. As such, I would expect to see the Economic and Earnings composites take a substantial hit in the next month or so, and the Valuation composite to improve. As a result, the best I can do here is a high neutral rating. The bottom line is we just don’t know how long or how severe the self-inflicted recession is likely to be.

* 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.

The biggest weekly rally in many years caused the Trend board to perk up a bit. But while some of the financial press is calling the 20% move up off the bottom by the DJIA a new bull market, this is where the mathematics of loss comes into play. For example, the DJIA closed Friday -26.78% from its peak. Thus, the index will need to rise +36.6% in order to get back to the old high. For the record, the MDY needs a gain of 48.3% to return to break even from the old high and the IWM (Russell 2000 Small Cap ETF) needs to gain 50.6%.

View Trend Indicator Board Online

The State of Internal Momentum

Next, we analyze the “oomph” behind the current trend via our group of market momentum indicators/models.

Although the trend board showed some marked improvement in response to last week’s bounce, the Momentum Board was less impressed. However, it is modestly positive that two indicators moved from negative to neutral and one went from red to green. It’s a start. But remember, for a new bull market to begin, typically we see momentum thrusts across several breadth measures. So far, only one out of four has flashed a buy signal (the percentage of stocks above their 10-day moving averages).

* 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 suggested that a trading opportunity was likely close at hand. However, the trouble with the inevitable “dead cat bounces” that occur during crash/crisis market cycles is they are very difficult to play. Personally, I prefer to focus on the second round of buy signals that tend to occur after a retest of the lows. Was Friday’s decline the start of such a phase? We shall see.

* 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:

Laughter is the shortest distance between two people. – Victor Borge (But please be sure to stay six feet apart!)

All the best,
David D. Moenning
Investment Strategist

David D. Moenning


At the time of publication, Mr. Moenning and/or Redwood Wealth Management, LLC held long positions in the following securities mentioned: None

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.

Any investment decisions must in all cases be made by the reader or by his or her investment adviser. Do NOT ever purchase any security without doing sufficient research. There is no guarantee that the investment objectives outlined will actually come to pass. All opinions expressed herein are subject to change without notice. Neither the editor, employees, nor any of their affiliates shall have any liability for any loss sustained by anyone who has relied on the information provided.

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.

Investments in equities carry an inherent element of risk including the potential for significant loss of principal. Past performance is not an indication of future results.



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