Yesterday was shaping up to be an ugly day. On Monday we had closed below the August 9 intraday low of 1101.54 on the S & P 500. We had pointed out that level on a number of occasions as the market probed those low levels. We had characterized the action as part of the bottom testing process.
In a note I was preparing to send out yesterday morning, I had said the Monday’s action was akin to a quarterback being sacked for a loss. But there was at least one missing element in Monday’s action. Namely, it lacked confirmation. Confirmation is the word used to describe what happens when different markets and indicators act in a similar fashion to confirm the action of another market or indicator. For example, Dow Theory says that if the Dow Industrials make a new low/high and the Dow Transports don’t do the same thing, then the move is not confirmed, and should be considered suspect. So, on Monday, the S & P 500 made a new closing low for the year but the Fear Index did not. Translated–and based on just that one measure–market participants were less fearful on Monday than they were back on August 9.
Speaking of fear, it’s almost becoming palpable. Featured below is the cover of the latest issue of The Economist. The caption is, “until politicians actually do something about the world economy…BE AFRAID.” Now, while the caption is entirely true, what it suggests is that once it reaches top-of-mind at The Economist, investors have already factored much of the fear into asset prices. Indeed, if we head down the black hole, it will be ugly on portfolios. But one way to factor that fear into asset prices is to sell them and sit on the cash. What happens if there’s a lurch in the direction of doing something for the economy? Those same investors are going to wish they had that cash back in those assets they were in such a hurry to unload.
We hosted the Chief Economist from Strategas Research Partners for breakfast and lunch meetings today. He says we’re in the second half of a four-year business cycle, and he estimates that we have nine quarters left to go. That’s two and a quarter years before the economy begins to decline. If you think that’s optimistic, there wasn’t a person in the room who didn’t leave characterizing the outlook as gloomy. In last Friday’s blog I posted a survey about the likelihood of recession in the next 12 months. 66% of the responses placed the likelihood at 50% or higher. The economists, themselves, are no better, as this dead horse carcass illustrates. In the green box–for that time period–the economic releases have been better than what economists had forecast. Stocks should strat to reflect that, especially if anything goes right in Europe.
Here’s another. Rydex is a fund family that caters to traders. They’ve got leveraged funds that are directional and inverse, so you can express almost any view toward many asset classes, and they don’t care how often you’re in or out of their funds. As a consequence, the allocations to the Rydex funds are great laboratories for contrary sentiment indicators, and the best sentiment scientist is Jason Goepfert of sentimenTrader. He’s gone back and looked at all the times when assets in Rydex’s cash money markets have been 150% or more of their stock funds, and the returns following such times. The results are overwhelmingly positive. After 3, 6, and 12 months, there has never been a losing period for stocks, and the median returns are big, like 18.8% after three months, 26.3% after six, and 39.2% after 12–median returns, not averages skewed by outliers. For shorter periods, the returns were positive almost 90% of the time.
Finally, keep this in mind:
There’s someone buying all those stocks that are being sold.
While companies are buying back some shares, they can’t buy them all back. The brokers and investment banks don’t buy the shares. Almost by definition, they’re being bought by investors with longer time frames than the sellers. The sellers are worried about next week, the buyers are discounting future cash flows and are thinking about what the shares will be worth next year.
Graig Stettner, CFA, CMT
Chief Investment Officer
Tower Private Advisors