2019 Market Outlook

I had a wonderful, relaxing break with Donna and the boys and I hope you had a chance to sufficiently re-charge your batteries as well!  Considering the heightened level of stock market volatility, I wanted to try and get our 2019 update on the state of the market out ASAP.  We’re going to go over the U.S. stock market in detail, as well as a few charts related to interest rates, oil, gold, and even Bitcoin (yeah, it still exists).

As in the past, you have three methods of absorbing this information.  You can WATCH the screencast by clicking this link, or if you’re more of a reader, click the link below to get access to the written version.  The third way to get “in the know” is to reach out, call, email, and set up a time to discuss it personally!  We’d love to hear from you!Due to the fact that this update is very “chart-heavy,” I’ll try to keep the wordiness to a minimum (not my strong suit).  If at any point you feel it would be helpful to watch the video screencast version instead, CLICK HERE to get re-routed.  Otherwise, let’s get down to business…

I wanted to start with a chart I shared at the very beginning of last year’s (2018) Market Outlook.  The purpose of sharing this with you is to express how horrible historical averages can pan out – and that “just because something happened in the past,” doesn’t mean it has to again this year.

Below is the average return of the stock market during mid-term election years like the one we just wrapped up.  The actual market performance was strikingly different than the average.  The market went up (not down) in Jan, and then went through two corrections (not up) in February and March/April.  Then it went up (not down) through the end of September and after peaking on Sept 21st, went through yet another correction through the end of the year!

As you read the above, reality was VERY different than the averages depicted in the chart below, I’m sure you’d agree!

When comparing 2018 to the prior year, 2017 was so ridiculously different.  In fact, 2017’s market action represented the lowest volatility recorded in the entire history of the S&P500, going all the way back to 1913.  It never even experienced a single pullback, let alone a “normal” correction.  But when the market volatility stays so low for so long, the metaphorical rubber band gets stretched and stretched and stretched… until we find ourselves in a market like we saw in 2018 – one that included three corrections in one year.

Not only did the stock market create acid reflux this past year, but the rest of the global markets could’ve made the toughest stomach toss its cookies.  There was nowhere to hide…

Stocks in the U.S. were down, obviously, but so were bonds.  At one point, U.S. Treasuries were down more than -8%.  Still, they closed out the year down -4.22%.  Commodities were throttled, led by oil and energy, and any effort to “diversify” a portfolio into so-called “safety” created even worse performance, as international stocks took home the award of “worst of the worst.”

So, let’s look at how this current bear market got started.  The top pane of the chart below is the S&P500.  The bottom pane is a momentum indicator called RSI (relative strength index).  Price (the market) has a tendency to follow momentum.

As you can see, the market was trending up with higher-highs back in late-August/early-September, while momentum was trending down.  This isn’t a reason to sell everything you own, because price doesn’t always follow momentum (just like the averages in the mid-term election years mentioned above), but it was the first “red flag” that raised concerns for the months yet to come.

If you recall, the market broke out to all-time highs in August, surpassing the highs that were printed in January ’18 (see the black dashed line below).  The market pulled back slightly, but then headed to new highs again, ultimately peaking on Sept 21st.  But… those highs weren’t able to hold and the market fell back below the line, creating something called a “bull trap.”

A bull trap is when the market breaks out, but fails (i.e. – failed breakout).  It’s called a bull trap because it fakes out a bunch of investors into the breakout, only to be left with losses if they used that line in the sand as the level above which they’d invest their money.

While we had negative divergence followed with a bull trap and breakdown below the previous all-time highs, negative evidence continued to build as the market bounced sideways, up and down, through October and November.  The psychology here is this:  As the market reaches the red dashed line, buyers step in and consider it a good value, so they buy, pushing prices up.  Then, as the market hits the blue line, sellers step in and unload their shares because they think the market is going to resolve to the downside.

This “battle” between the bulls and the bears plays out over the course of several weeks and while we had been raising cash (selling investments we owned in our portfolios) since mid-October, as long as we stayed above that red-dashed line, we were still in a state of defensive preparedness (think “caution/yellow light”).

<Nerd’s Note:  If you’d like more details on the above-referenced consolidation/trading range and how investor psychology plays into these chart patterns, please reach out and ask so I can share it with you!>

In fact, the blue-dashed line in the lower pane (momentum) was suggesting the opposite of what we saw in August/September.  Instead of negative momentum divergence, we started to observe positive divergence, suggesting the market could head higher, ending the correction.

However, the breakdown that occurred below the red line was another red flag, suggesting that sellers were in control, pushing prices down further.  This breakdown in market prices also led to a breakdown in the positive momentum trend, which wiped out the remaining positives that kept us partially invested in stocks.

Once the market broke through the floor that represented the “box” (or “sideways trading range/consolidation”) that occurred throughout October and November, the only line left to hold was the floor of support that represented the lows from back in February, March, and April.

While the yellow light was already turning red, once this level was broken, we were officially in “No Man’s Land,” and there was really no good reason to own stocks any longer.  At the most recent bottom, the market had fallen around -20% or so, give or take a percentage point, all depending on the index referenced.

Speaking of traffic lights, I’ve posted the chart below a few times on Facebook and Twitter.  Our clients seem to like it, as it’s a super simple representation of the risk levels I’ve been watching, based on the levels mentioned above, but instead using green, yellow, and red lights.  When the market was above the topside of the trading range, I had no problem being invested at > 80% or more in stocks.

However, when we fell below that level into the trading range, we wanted to be anywhere between 30-60% cash, depending on the portfolio model in question.  Then, when we fell below the range, we raise more cash, ultimately selling everything we owned after the Feb/Mar/April lows were violated (i.e. – red light).

A quick glance at the market today tells us a lot – and none of what it’s sharing with us is positive.

  • The market (black line) is below the 200-day moving average (i.e. – “trend”) in blue
  • The 50-day moving average (red) is below the 200-day moving average
  • The 50 and 200-day moving averages are both sloping downward.
  • Momentum (via RSI) has crossed < 30 into bearish territory again recently, after the failed momentum divergence mentioned above.

So what now?  I’m going to share two, very rough, possible scenarios.  These are NOT meant to be predictions.  I am a trend follower, not a trend predictor, so I have no idea how this will play out.  The trick isn’t predicting the market… it’s analyzing the current risk vs. reward landscape and allocating our portfolios accordingly.

The goal is to stay heavily invested when risk levels are low and then protect our money when risk levels get high.  Since 4-out-of-5 stocks move with the market, when the market is going down, even the best stocks get beaten up.  Investing against the trend is like trying to swim upstream.  It’s also a lot like trying to drive a car backwards through a windy road at night with no lights.  High risk / low return probabilities are not the kind of situations I like to play with.  Or as my pilot friends say, “I’d rather be on the ground wishing I were in the air, than in the air, wishing I were on the ground.”

So here’s a possible scenario that works out well for the market (black-dashed lines are my annotations).  In a perfect world, the market would pull back, maybe even head a little higher, shaking impatient investors out, and then head back and come within 1-2% of the December low.  Then, it would head higher, accompanied by an upward move in momentum (lower pane), heading back above the previous floor (now ceiling of resistance) represented by the Feb/Apr lows, catch a breather, and then head to new highs.

The other scenario would be for the market to pull back, head higher, shake out investors, but instead of heading even higher, it instead breaks down below the December lows and heads lower.  That December low then turns into a ceiling with which the market contends going forward, and the new lines in the sand get drawn at:

  1. The Summer ’16 highs
  2. The 2016 election lows, or
  3. The 2015-16 lows.

Again, I hate predicting because I really have no idea what the market will do (no one does), but while it would be “perfect” for the market to hold the December lows and head higher (as in Scenario #1, above), the worst case scenario for now seems to be one that bottoms out around 2,200 on the S&P500, which represents the 2016 summer highs, but anything is possible.  We just want to be investing with the trend, not against it.

Another, much slower chart I like to follow is a monthly chart of the S&P500.  The reason I like the “slowness” is because it doesn’t kick off many signals and it takes time to see the full picture of data (i.e. – monthly charts aren’t complete until the last day of the month is over with.  You should not analyze monthly charts intra-month).

I’ve plotted a 10-month moving average (again, moving averages are just “trendlines”) and where we want to pay close attention is when the market drops below the trendline.  It doesn’t happen very often, and when it does, the consequences in ones retirement portfolio thereafter can be dire… and there can also be what I call “head fakes,” or failed breakdowns, like we saw in 2015-16 (there were actually two head fakes that year).

The market closed below the 10-month trend in October, then barely got back above it in November, but in December, it fell right back thru the floor again, this time more decisively than all three of the last occurrences.

I shared what a head-fake looks like (above in the box drawn around 2015-16), but below is an example of what happens when the evidence here is the real deal.  The market closed below the 10-month trend in early-2008 and was never able to re-claim that level again until after the mortgage crisis and market crash of 2007-09 bottomed out.

The indicator below, like the above-referenced monthly charts with a 10-month moving average, is also very, very slow.  I watch it every month, but there are very few signals.  However, when a signal is triggered, they’re definitely worth paying attention to.

The indicator is called a Price Momentum Oscillator (PMO) and was invented by Carl Swenlin.  The blue up-arrows on the chart correspond with positive crossovers in the PMO in the lower-pane.  The red down-arrows correspond with negative crossovers in PMO.  I just coded the arrows so that it was easier to see where the signals take place.

Point being, there have been times (such as 1998 and 2015-16) when these signals were invalid head-fakes.  But there have also been times when it truly paid (or saved) to watch this indicator in 1995 (valid signal), the valid sell signal that came early in late-1999, and the valid sell signal that went off in the early part of the 2007-09 crash.  The question remains… will this recent signal end up being valid, or just another head-fake?  No one knows, but I’m not going to drive through a low-visibility storm with the pedal to the medal just to find out!

If you’ve been reading my commentary for a little while, then you’ve seen this chart before.  The NYSE Composite Index is comprised of almost anything you can invest in.  The A/D Line (lower pane) is simply the number of investments that went up, minus the investments that went down every day, plotted on a chart.

The reason this is so useful is because the NYSE, S&P500, Dow, and NASDAQ are all cap-weighted and as a result, they’re heavily represented by the biggest companies on the index.  So if the big companies go up, you’ll typically see those indices go up as well.  Tons of small companies can be crashing and you’d never know!

It’s like someone who has a life-threatening disease on the inside but looks completely normal on the outside.  You have to do tests to analyze the inside of the market in order to find the real truth of the matter.  And as you can see below, fewer and fewer stocks were participating (lower pane) when the market was continuing up (upper pane) back in Aug/Sept.  More recently, we’ve seen that negative divergence head lower through the sideways consolidation that took place in Oct/Nov as well.

The dashed line in the chart below has been one of my new favorite indicators this past year or more.  It’s called the Anchored VWAP (Volume Weighted Average Price) and was made (I guess what you could call) “famous” by Brian Shannon of Alpha Trends.  Truthfully, it’s not very famous at all, but it’s a really useful tool when analyzing the market.

The Volume Weighted Average Price is the average price paid by market participants for the investment in question.  In this case, we’re looking at the S&P500, and the “anchor” I’ve chosen is the 2016 Election Day.  So the dashed line below is the average price investors have paid for the S&P500 index since the 2016 Presidential Election.  Why is this important and useful?

Institutional money managers, separate account managers, mutual funds, and hedge funds pay close attention to this line in the sand because many times, if they want to sell (or buy) something, they own so many shares, it can take days (literally) to get out of something they want to sell!  So they have a tendency to want to buy or sell above/below the VWAP because that’s where the liquidity is.  The market flirted with this line three times before finally breaking down, and then breaking further through the Feb/Apr lows, as mentioned above several times.

Now, even if the market finds itself rebounding after bottoming out, one place I’m going to be extremely careful with is the “pocket” that currently resides between the Feb/Apr lows and the A-VWAP since the ’16 Election.  This is an area that could turn into whipsaw hell, because it’s likely a place where a lot of big/smart money institutional investors are waiting to unload shares at higher prices if they think this market is headed a lot lower.

So even if we start to see a positive trend forming, I’d be extremely careful and wouldn’t start buying everything in sight.  Rather, when the market does bottom and the trend becomes apparent, I’ll be easing in over time – not turning a switch and going “all in.”  That wouldn’t make much sense at all.

Last chart about the stock market for this year’s Market Outlook.  This is one I’ve used several times over the last few years.  It’s also been published in magazines with negative divergences in the A/D Line in the lower pane as well, but I removed them this time around.  The focus of the chart below is the red shaded areas in the upper-pane, which represent times when the 50-day moving average is below the 200-day moving average (as mentioned above in a previous chart).

You can see some head-fakes below in 1998, two in 2010, another in 2011, and two more in 2015-16.  This is why we don’t want to treat our portfolios like an on/off switch, taking ALL our money out and putting it ALL in a once.  Rather, we want to treat it like a dimmer switch, “dimming” the risk levels down and up using cash or other, safer investments, doing so using indicators like instruments on your vehicle’s dashboard.

You wouldn’t drive with only a gas pedal!  You need a steering wheel, brakes, turn signals, headlights, etc.  The same goes for risk management in retirement portfolios – it’s a conglomeration of evidence put together into one picture that measures the current market landscape and how much risk we should be taking.

Switching briefly to bonds, below is the interest rate chart for the 10-year Treasury.  As we all know, rates have been heading lower snice the early-80’s.  This is the primary reason bonds have done so well over the course of the last 35 years.  When rates go down, bonds go up.

Recently, rates have been bottoming out and heading higher, especially since early-2016. This year has been an ugly year for bonds as rates headed up since pretty much the first of the year.  However, we could be witnessing a bull trap in the downtrend line in rates, which could result in lower rates in the future, which would mean higher bond prices.

Further, as rates head lower, attracting more bond investors, this wouldn’t be so great for the stock market… but when investors become fearful, they sell their stocks and put them in bonds.  It’s almost a self-fulfilling prophecy, one fuels the other and vice versa.  Time will tell, but we could be approaching a great time to own bonds in the near future.

Switching gears a little bit here, below we have an oil chart and man… it looks ugly, doesn’t it?!  Oil is down more than -40% since the beginning of the 4th quarter!  However, I’m starting to see some positive momentum building up in the lower pane while price heads lower in the upper-pane.  I’d like to see momentum head higher, bottom above 30, and then head higher with price following, but this is one I’m going to be watching over the course of the next several weeks.

Gold!  We haven’t owned gold since the 4th quarter of 2011, but I’ve been watching for the chance to catch it on an strong uptrend at some point in the future.  2016 would’ve been a great, short-term move to catch, but it would’ve been a bottom-fish trade, trying to catch a falling knife only to get your hand cut up.  Rather, it’s best to let the knife hit the ground, settle, and then you can pick it up when it’s safe to do so.

Gold has tapped out at the $1,370 level three times in the last five years, all while printing higher lows in late-2016, and again in mid-2018.  If gold can get above $1,370 and hold that level for a few days, I’d be interested in holding it above those levels, but not below.

Ahhhh… Bitcoin.  🤦🏼‍♂️  What else is there to say, other than to mention the very clear downtrend with no support anywhere in sight.  I’ve been telling people who own it to sell since December of 2017.  Some of those I’ve had several conversations and even face-to-face meetings with and they’d made a LOT of money with this stuff.

Unfortunately, as is the case with many investments like this, these folks have become married to it, almost as if they’re in a relationship with the investment.  They treat it like a game of Black Jack and don’t want to sell “until it gets back up to ‘x’.”  There may be a time, someday, to buy Bitcoin, Ethereum, and other cryptocurrencies again, but this hasn’t been the case for some time now.  And no… it’s not “too late to sell!”  Sheesh…  A drop from $4 per share to $3 per share is a loss of 25%.

I realize I’ve beaten the concept below to death this year, but let me say it one more time… We’ve had a few head-fakes in the past (including the double-head-fake in 2015-16), but we’ve also had situations like the one we’re faced with today that ended much worse.  The question, again, is “what’s going to happen this time?”

And again, we don’t know.  If the market continues down, we’ll stay put, defensively positioned and ready to deploy cash when the market shows signs of bottoming and the trends reverse upward.  When that happens, we’ll ease our way back into the market, piece-by-piece, keeping exit strategies close in case things go sideways on us in a hurry.  But for now, it’s a game of patience.

We’re not trying to avoid every -10% or even -15% correction.  Those happen regularly in a healthy market.  What we’re trying to avoid is contagion – the big, huge market crashes are what we aim to avoid.

And whether you’re a client of ours or if you utilize a completely different retirement strategy altogether, all investors should focus most on what they can control.  If you’ve signed up for a 5k race and tailwind is at your back, it sure is nice.  However, if the wind is blowing in your face, running isn’t any fun at all.

This is just like the market and retirement planning.  If the wind is the market, do you think you’ll ever make it to the finish line without putting one foot in front of the other?!  No one makes it to retirement investing a dollar and waiting for the wind to blow!

So focus on what you can control:

  1. How much you save if you’re still working
  2. If you’re retired, focus on what you’re spending, and if your updated financial plan for 2019 says that you should maybe hold off on one of your vacations this year, then hold off until you we see what happens with this market.
  3. If you’re still working, you can control when you quit. So if the market has you spooked, look at your plan, update the numbers, and see whether or not you have any reason to panic.  Chances are, you’re still in great shape!
  4. If you don’t have a plan, get one! Investing without a plan is like investing and “hoping” you have enough… and “hope” is not a plan!

I hope you found this year’s Market Outlook to be both interesting and educational.  I can’t hesitate more – if you’d like to discuss this or any additional topics in more detail, please contact us.  We can schedule a phone call, a face-to-face visit, or if you’d like a second opinion on your retirement plan, we’re happy to do so at no cost, whatsoever.

Happy New Year!

Adam

* Adam Koos, CFP® is a CERTIFIED FINANCIAL PLANNERTM  Professional, as well as president and portfolio manager at Libertas Wealth Management Group, Inc., a Fee-Only Registered Investment Advisory (RIA) firm, located in Columbus, Ohio.

The opinions mentioned in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial adviser and strongly consider interviewing a fee-only financial advisory firm, prior to investing. Past performance is not guarantee of future results. Economic forecasts set forth may not develop as predicted. The views and opinions expressed in this commentary are those of Adam D. Koos, CFP® and do not represent the views of TD Ameritrade Institutional and its affiliates. Investing involves risk including loss of principal.

 

 

 

 

Categories: Adam Koos, CFP®, CMT®, Market Commentary

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