The King is Dead. Long Live the King!

March 16, 2020|4:13pm


Well it’s official, we’ve got a full-fledged crisis on our hands in the financial markets. Historic events now occur on a daily basis. Things I have never seen before in my 33-year career as a portfolio manager are now happening with regularity. Safety plays are no longer safe. The tech-ladened QQQ ETF is outperforming the Dow. Very strange moves such as the AGG ETF losing 4% in a day occur due to forced liquidations. Good times.

This morning, I’d like to run through what we know and what can be expected to occur. And since nobody wants to plow through two thousand words on the subject, my plan is to present my thoughts in a brief, bullet-point fashion. So let’s get started.

First, let me be clear; 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 and/or bond yields will go is a poser and should be ignored.

Next, and while this can be placed in the “Captain Obvious” category, this crisis isn’t over. Nor will it be over when the stock market bounces up the first time. No, this is going to take a while. My guess is it will take a few weeks for the stock market to discount the bad news and it will be a few months before the next bull market is born. But again, this is nothing more than educated guesswork on my part.

Next, I’m going to run through some of my key points – again, in a brief fashion…

  • The stock market has officially entered a “cyclical” bear market, which is occurring within a “secular” bull market. (Cyclical cycles tend to last months on the way down and about 2.5 to 3 years on the way up. Whereas “secular” moves usually last at least a decade. We believe the current secular bull was born on March 9, 2009 and is ongoing.)
  • According to history, the average “cyclical” bear market loses -30.6% over a period of about one year, while cyclical bears that occur within a “secular” bull lose -21.8% on average and last 283 calendar days (source: Ned Davis Research).
  • However, we are definitely in uncharted territory in the markets here as the indices now move faster than ever before. For example, in the past two weeks we have seen moves of 5% – 8% occur within a matter of minutes.
  • Important to Remember: The stock market is a discounting mechanism of future expectations.
  • What we are seeing right now is called “price exploration” (to the downside) as traders try to determine “how much is enough.” As in, at what price level is the bad news “baked in?”
  • It is hard to see how we will get any “good news” on the virus front in the next few weeks. In short, the testing phase is just beginning. So, we can expect some very big, scary numbers to hit the wires in the coming weeks. And we can probably expect stocks to react negatively to the bad news.
  • But at some point – and at some level – the bad news becomes priced in. (Example: Think about the way the market reacted during Trade War. For a while, markets reacted to every single tweet. But as time passed and the assumptions become clear, the market stopped caring/reacting to the news.)
  • Thus, we can expect the stock market to likely bottom BEFORE the news stops getting bad. Again, this is because the market is currently trying to “price in” the expected impact to the economy.
  • In order to flatten the curve of the virus’s growth rate, we must effectively “kill the economy.” The way to keep folks from getting this bug is to “hunker down” and stay home. I.E. Don’t go out and stimulate the economy. Stay put and watch NFLX!
  • At this stage, analysts are expecting (and stocks are pricing in) a mild, temporary recession. The thinking is that the crisis will fade within a couple months as the weather warms up. But then again, nobody really knows long or how deep the economic slowdown will be!
  • The assumption is that economic growth will resume once the crisis passes. The worry is that consumers could stay cautious for longer than expected.
  • I do not see how the stock market’s ultimate bottom can take the shape of a “V” this time around.
  • The Fed can’t kill the virus. Fiscal stimulus can’t kill the virus. (One of the best headlines I’ve seen this morning is, “Fed Fires Bazooka, Virus Still Standing.”) So, the only way for the crisis to fade is for the virus news to stop getting worse.
  • Remember that the violent declines are often associated with “forced liquidations.” Think margin calls, hedge fund failings, mutual fund redemptions, systematic trading strategy moves, (such as the popular Risk Parity systems) etc.
  • During a “forced liquidation” caused by redemptions, managers sell what they can, not what they want to. This explains why almost everything except government bonds go down in a bear market.
  • The biggest one-day advances (such as we saw on Friday) have historically occurred during bear markets.
  • Expect a “dead cat bounce” to begin when some good news comes out. This should last a few days and cause you to feel like the worst is over and things are better now.
  • Once a dead cat bounce occurs, the original reason for the decline tends to resurface and a test of the lows takes place. THIS tends to be the time to begin thinking about the next bull market as everyone that wanted/needed to sell, has likely already done so.
  • History teaches us that once a new bull is born, a big chunk of the gain occurs in the first one-third of the move (don’t quote me on the exactness of that stat – I’m citing my recollection here). So, it is important to be ready for the next cycle!
  • It is best to be looking for the bottom. To be ready for the next opportunity to make money. History shows that the average bull market gains 85.6% over 787 calendar days and bulls that occur within an ongoing secular bull gain an average of 105.7% over 1050 days (source: Ned Davis Research).

The goal in this type of environment is to lose the least amount possible. The definition of such will depend entirely on your investing approach/strategy. For example, active traders will want to be completely defensive. However, such an approach runs the risk of missing the beginning of the next bull market.

From my seat, the biggest goal is to avoid making a “big mistake” during this type of market. It is easy to succumb to emotions and do the wrong thing at the wrong time. So, sometimes the best thing to do is to ride it out. If you’ve reduced your risk to market exposure (which we have done to varying degrees), great. Now is the time to be looking ahead.

Finally, I should probably address the title of this morning’s meandering market missive, “The King is Dead! Long Live the King!”

This a play on history as town criers would announce the death of one king and the new king’s ascension to the throne directly after. The point here is that the most recent cyclical bull, which we believe began on 2/11/2016, ended/died on 2/12/2020. So, “the king is dead.”

However, my final point this morning is to recognize that we’ve seen this movie before (1987, 1990, 1998, 2000-03, 2008-09, 2011, 2015-16, December 2018). I.E. Stocks tend to follow a familiar pattern during a crisis. First is the panic low. Then the dead-cat bounce. Then a retest of the lows. Then a bottoming phase. And finally, a new bull market.

The keys here are (1) the hero doesn’t die in the end and (2) the next bull market is coming. Hence the phrase, “Long live the King!”

The question, of course, is when and from what level does the next bull market begin? And once again, I will be honest and say, I don’t know. But what I do know is that we get closer to the next bull each and every time the market plummets in a panicked fashion.

In closing, it is my sincere hope that everyone stays safe and healthy. I for one am planning on complying with the “hunker down” approach and will play my part in trying to avoid spreading this nasty bug.

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 no changes to report on the Primary Cycle board this week. From my seat, the board is neutral on balance. However, the hypothetical average return of the S&P given the current modes of the models is just 1.8%. And at this stage of the market debacle, this seems generous. I would also like to note that the Intermediate-Term Market Model appears to have booted the current cycle. As such, the model’s inclusion is now under review. 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 changes to report on the Fundamental Factors board this week. However, there can be little argument that the U.S. Economy is going to slow in response to the novel coronavirus and the resulting disease, COVID-19, perhaps significantly. As such, we should probably assume the Economic Composite will move to neutral (at best) at some point in the near-term. The same can be said for the Earnings Composite since earnings will undoubtedly take a hit this quarter. The only question is how long the Economic and Earnings models will be impacted.

* 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.

Not surprisingly, the Trend board took a major hit last week. Stocks are now trending lower and the bottom has yet to be found. And until stocks can start looking ahead to better days, the trend will likely remain under pressure.

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.

The Momentum Board currently sports a rare 100% negative reading. Thus, the bears must be given the benefit of the doubt here and will likely continue to remain in control for several weeks.

* 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.”

It is also discouraging to note that the Early Warning board moved to a less bullish stance this week. This is due to the fact that we require a fair number of our “get ready to go the other way” indicators to first reach extreme readings (check) and then reverse in order to trigger buy signals. Last week, some of the indicators had reversed higher and flashed buys. However, this week, three are moving to new lows and have yet to reverse. As such, we find ourselves in a “not yet” environment in terms of looking for a trend reversal.

* 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:

A happy person is not a person in a certain set of circumstances, but rather a person with a certain set of attitudes. -Hugh Downs

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.

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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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