U.S. Equity Indexes To Wimper Higher
With the approach of the seasonally difficult period of August to October, many investors are understandably worried about some form of equity correction. After all, it has been over a year since we have seen over two consecutive significant down days (Brexit, June 2016) and 18 months since we have experienced an equity correction (January 2016).
With the long streak without a -5% correction in U.S. equities firmly in place, the market is having difficulty falling under its own weight. In the table below, we see that the S&P 500 is passing the 4 th longest historical winning streak (266 days without a correction, in 1958-1959). Why stop winning before a new record is set? In terms of percent gain during a long winning streak, we have only seen two cases which have significantly out-performed the current streak (1955 and 1994-1996). While it seems hard to imagine the current streak continuing another 129 trading days (over six months), in this market of superlatives and record-setting moves, we would not be surprised if the market targets the record 394 trading days without a correction.
To confound the many investors looking for weakness in August/September, the markets may very well do what they do best: prove the majority wrong. We noted in our Commentary last week (see the “Statistical Odds of a Seasonal Equity Correction”) that strong equity gains in the first half tend to attenuate the rough August/September period. Indeed, equity may continue to “wimper” higher in a saw-toothed movement before the ubiquitous year-end rally begins in November.
The central bank stranglehold on the markets has not yet arrived at the end. The Federal Reserve is only beginning discussions about shrinking its balance sheet. As mentioned in our Commentary “The Federal Reserve: Dismal Failure or Shrewd Complicity?”, if the time delay between the first discussion of a rate hike and the actual announcement of a rate hike applies for the balance sheet move, investors will be able to count on central bank complicity until well into 2019.
To reinforce our speculation that, in short-term, equity indexes will hold up, we note the thwarted recent attempt by bears to sell this market. On the S&P 500, each daily dip since the late May break above 2400 on the S&P 500 has been gobbled up by dip-buying algorithms. Below is a 15-minute chart of the S&P 500 over the past 6-weeks. 2400 is a very sensitive zone, as former resistance has now become a strong support. With the S&P 500 poised to break out to new highs, we still have lots more work to do before we’ll get a change in trend.
The Nasdaq-100 gave bulls a scare in June, but the uptrend looks to have resumed as the A-B-C corrective pattern appears complete. This week’s explosive move higher on the Nasdaq-100 likely invalidates the downtrend. A move above 5845 opens the door to more record highs in August.
Not a Blanc-Seing To Leverage Up
While we can only confirm that U.S. equity indexes are in a bubble in hindsight, many experienced, savvy investors recognize that we are living through a historical moment in financial market history.
Contrary to empirical evidence, we can reaffirm that equities will one day again experience a prolonged period of selling. However shallow rallies will continue to be bought until something changes market’s mentality. Algos and traders are not profound thinkers – as long as buying dips gets immediate gratification this behaviour will continue, despite the risks, until a dip goes too deeply into selling territory. This dip must go far enough to overcome the vested interest of the Wall Street machine (with the complicity of central bankers) to juice equities higher.
We could either see a soft trigger or a hard trigger to get an initial sell-off deep enough to begin a change in market trend and kill the buy-the-dip enthusiasm. This is only speculation on our part, but a soft trigger could be a rise in inflation (perhaps in the wake of surging oil prices) that forces central banks to do something that they don’t want to do (tighten monetary policy). A hard trigger could be a cataclysmic event or a stark sell- off in some financial asset class in a remote corner of the world.
The degree of leverage will also add a combustive fuel to the explosive cocktail that is being mixed up by the central banksters (see our June 23 Commentary). NYSE margin debt as a percent of GDP is at an all-time record high: never before have speculative investors doubled down to this extent on a market rise.
We believe that the passive investing craze, with the flood of money into index-tracking ETFs and which has been responsible for the relentless continuation of record highs on the equity benchmark indexes, will also be the cause of collapse in equity indexes one day. Just as “bad” stocks have risen in the past few years, thanks only to their inclusion in popular indexes, when forced selling finally occurs the “good” stocks will be dumped. Just as the rising tide has lifted all boats, the falling tide will indiscriminately sink all stocks within widely traded index products.
Today’s difficult market is forcing a “damned if you do, damned if you don’t” investment decision. If markets collapse and an investor suffers large loses, in hindsight he/she will kick themselves for not seeing the writing on the wall. In the meantime, how can an investor be so dense as not to get all-in this magnificent bull market? We repeat a very appropriate quote that applies very much to today’s market: “the problem with bubbles is that they force an investor to decide whether to look like an idiot before the peak, or an idiot after the peak.”
What to do? We see three different investor profiles with differing decision criteria for each type.
1.) The Trader. Traders need to continue betting on the upside. Shorting is still impossible, as the snap- backs are still more powerful and rapid than the hesitant intra-day selling.
2.) The Fund Manager or Investment Professional. Effectively no choice here. Missing out on the equity upside entails career risk. No manager can afford to underperform for an indefinitely long period, especially as performance is judged on a monthly or quarterly basis. As clients are more sympathetic to losing money in a bear market, most managers will ride this market all the way down, whenever the trend turns.
3.) The Long-Term Investor Saving For Retirement. The decision is this case depends on individual risk profiles. The closer an investor is to retirement, the less over-valued equities he/she should be holding today. Even younger investors, who are not constrained to beat some benchmark, are advised to sit back and wait for a better entry point.
Giving investment advice today almost requires a crystal ball rather than thoughtful analysis. We continue to prefer avoiding over-valued U.S. stocks (even as these assets continue to outperform) in favour of select foreign stocks which at least offer some support in terms of valuation should a global equity sell-off ensue. If reference to the above quote, our decision has been to look like idiots before the peak, hoping that market forces will soon be revived.
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