By John Reizner |
The month and quarter of September 2015 just came to a close with the stock markets having its worst quarter in four years. You don't have to be a stock market expert to question whether this seven year stock market rally may be running out of steam. Many investors are asking: where is the stock market headed?
Investors meanwhile wait with baited breadth for the Federal Reserve to begin the process of raising the fed funds rate. Whether or not that event actually occurs in the near term may be a different story. See here why interest rates may stay low.
But has the beautiful music of Fed Speak, like the Sirens in Greek mythology (in Homer’s Odyssey) lured stock market investors into dangerous waters as the nymph once lured sea-faring sailors in the ancient world to their untimely deaths?
Momentum on a twenty year monthly chart of the S&P 500 has crossed below zero only five times in the last twenty years. Two of those times were just prior to the important bear markets in 2000 just after the dot-com mania burst and after the major market top at the end of 2007.
However, I have applied a triple filter to the S&P 500 index: to the twenty year monthly chart of SPX.
The three filters are:
- SPX Momentum crossing below zero
- John Carter’s indicator TTM Trend indicator being red (bearish)
- A monthly SPX close below its ten-month simple moving average
There are only three cases in the last twenty years when all three factors were present: in November 2000 (preceding the dot-com crash), in January 2008 (preceding the subprime housing stock market meltdown) and in the present day.
Momentum tells the tale of this fall’s stock market decline as the SPX long term momentum crossing below zero was number three in this short list to befuddle the market at the close of September 2015.
Not only has monthly momentum crossed below zero, but the TTM Trend is bearish and the SPX has closed for the month of September below the ten month simple moving average.
The chart configuration marks a triple confirmation of a significant stock market top being in place. The market appears to be entering a bear market that may not just be a garden-variety decline.
Investors may do well to be cognizant of the triple confirmation of an equities market downturn and may consider not underestimating the meaning of these conditions.
The question facing investors now is where may the market be going from here?
The put-call ratio in the last couple weeks has been well above 1.0 – signaling a potential bullish reversal of the downtrend. The state of that indicator may mean that we potentially get a short-term rally – perhaps a sizable rally from here. But a rally may not transpire at all or in size.
The question is really are we undergoing in time a major leg down in the stock market that rivals the decline of 2000 or 2007? How low may we go?
A logical area for the stock market to find support is the highs of the previous two major tops: in both 2000 and 2007 – which is about four hundred S&P points lower than today’s close of SPX 1,923.
What I will say is that there may be support for the market in the current range. If this support breaks – then the old bull market highs may be a target range.
If one looks at major Gann levels on a twenty year monthly chart – Gann 1 rests around 1,353 on the SPX. Gann 2 rests around 1,067. These levels may be very long-term support. Bear in mind the chart confirmation is on a twenty year time frame. I mention these Gann price levels as they may be significant support for the market over time.
Gann 1 on the monthly chart of the Dow Jones Industrial Average rests around 11,500 and Gann 2 at around 9175.
If the stock market moves up enough to change the current conditions that I have described – then that will be another month and another interpretation of the evidence. There is no such thing as certainty in life – unless one is contemplating the prospect of death – but the odds here may be in favor a major stock market decline from the current level.
The scenario of a lengthy bear market may transpire over a period of time – bear markets in the past have lasted up to one or two years. This scenario may include another financial crisis – and potentially a crisis of the economy.
How does the so-called economic “recovery” lauded by Wall Street and the Fed fit into this picture?
The economy is hardly in real recovery mode. The haves may possess appreciated assets and the have-nots may have next to nothing. The middle class has been hollowed by the financial crisis and as a result of the longstanding exodus of our well-paying manufacturing jobs to China.
If asset-holders get punished by a stock market debacle– then the only economic survivors may be those individuals and constituencies working on government payrolls.
What kind of economic “recovery” are we having anyway? Is economic activity peaking at this stage of the expansion which has been prolonged by the Federal Reserve’s policies?
I wrote here that the economy appears to have only two green shoots: the somewhat buoyant housing market and flush auto sales. That many new auto loans have six year terms and are thus subprime may not comfort those that may believe that this recovery is real.
About forty-six million people now receive food stamps – over 15% of the U.S. population – many individuals and families do not have enough cash to buy a month’s worth of food. Any thought of a genuine economic recovery must be put aside by just that statistic. I could go on.
The business cycle has not been repealed no matter how many QE’s the Fed may begin or whether the Fed may do anything at all. It is almost as certain as the sun rising every morning that the U.S. will enter another recession in time.
There may be little doubt that the economy will run out of gas. In that case, may another ten million or twenty million people or more need food stamps to get by?
What will policymakers do then? How will the Fed be able to respond to a weakening economy when it has run out of ammunition to fight a recession or a depression? Will there be another round of QE? Will real estate markets turn down again? Will there be deflation, inflation or both? Will unemployment begin to increase?
These are all good questions. We may answer some of these questions by looking at what usually happens to the economy and the financial markets during an economic downturn. Recessions are usually preceded by a string of interest rates increases by the Fed. Stock market downturns are usually preceded by a string of interest rate increases.
None of these conditions have occurred in today’s topsy-turvy world of perennially low interest rates. It may be necessary to think outside-the-box in order to determine what may happen to the economy and the markets in the event of a downturn.
Interest rates may collapse in the next recession unless the Fed completely loses control of the situation (that is if our collective debt of about $18,000,000,000,000 and hundreds of billions per year in interest paid on the national debt do not force the market rate of interest up), real estate may turn down again, and prices may decelerate. Layoffs may increase and the misery of the unemployed may be perpetuated. The masses may become uneasy.
The Fed may panic and flood the banking system with money – or the authorities may adopt Ben Bernanke’s failsafe plan of dropping money from helicopters in order to stimulate consumption. Most of the money created by the Fed just exists in cyberspace anyway.
Interest rates may be low for years. If the Fed does raises short term rates in the near term, it may slow the decelerating economy and potentially invert the yield curve: a situation that precedes recessions. It appears to me that the economy is failing of its own weight. There may not be inflation in sight unless the Fed really desires an inflation in its belly. Cash may be king.
Economist Lacy Hunt has pointed to the downward trajectory of the velocity of money as an indicator meaning that future economic growth may be anemic at best and that inflation may not flare up. He advises that investors holding long term treasuries may be well-served by keeping them in their portfolios.
I agree with Hunt’s scenario of a muddling economy and low interest rates.
If the Federal Reserve becomes impotent in its attempts to stimulate growth, the chance of a major disruption to all our lives becomes more likely. The spendthrifts in charge of our government may pay the piper along with the American people in tow. Anything may happen: deflation – inflation – decreasing interest rates – or an interest rate shock – in a sequence that noone can predict- or martial law may be declared if things get testy.
Candidate Bernie Sanders is attracting support from the millennials and many Democrats with a solution to our country’s problems: the policies of democratic socialism. If that course of action were truly viable – then the Soviets might still be in power. The communists simply could not provide economically for their people beyond basic needs. The "success" of the Soviet economic model during its heyday was often overstated in the Western press. Rags to riches stories were by definition outlawed in socialist economies. Under Bernie Sander’s economic plan, the government should heavily tax the very wealthy - "the billionaires;" then Sander's and his designees would decide which consituents in America receive the money that has been taxed from more economically well-off groups. Economic decision-making would under this scenario move from individuals to the State.
If Bernie is elected, I am afraid that his government might decide to assess capital gains taxes in addition to estate taxes on individuals' estates. Taxes upon estates are justified, but adding a tax on the appreciation on the homes and businesses of families that occurs their lifetimes would place an undue burden on families. Stepped-up basis protects families from being taxed on the appreciation of what they have built over their lives. One level of taxes is sufficient to tax the estates of the rich and the billionaires.
I think that whoever gets elected this year will receive the blame for what happens to the economy during his or her presidency. The Federal Reserve is largely responsible for the economic "recovery" since the financial crisis along with three QE's that have also propped up the stock market. The middle class is still suffering and I think that America would be better off looking for philosophical inspiration from the works of Adam Smith than from a watered-down version of Das Kapital.
Editor's note 3/8/16: The writer's comments regarding Bernie Sanders were recently updated.