2nd Quarter 2019 Scouting Report

It’s already ¼ of the way through the year.  Crazy!  As always I’ve put together a recorded screencast so that those who like watching a VIDEO can follow my mouse, watch, and listen to me explain my way through this quarterly update on the state of the markets.  However, we’ve kept with our tradition of also providing a written version, for those people who would rather read than watch.  Naturally, I’d recommend the video and some headphones.  I think it helps things “sink in” better than reading, but that’s just me.  Alrighty… without further anticipation, let’s get to it!

I know we’re already in the 2nd quarter of 2019, but I wanted to share some data I didn’t have back in January during the Market Outlook screencast.  The good folks at Stock Trader’s Almanac were kind enough to send me the next two charts, the first of which is pretty eye-opening:

  • First, focus on the black line below, which represents the average movement of the stock market in a midterm election year (last year) since 1950. See how it pretty much goes nowhere until October and then shoots up?
  • Then look at the 2018 line to see what actually occurred – talk about a huge dispersion in performance relative to the averages! 2018 was definitely “different.”

The table below is the year-end performance data for all asset classes (except foreign currencies) in 2018.  As you can see, there was “nowhere to hide” last year.  In fact, anyone who diversified their portfolio outside of the U.S. stocks and bonds only hurt themselves by doing so.

Here’s the 2019 chart from my friends at Stock Trader’s Almanac.  You can see how the S&P500 and NASDAQ track pretty much right along side one another with the NASDAQ leading the pack over the last several years.  That being said, if the first chart (above) is any reminder, averages shouldn’t be treated as laws or guarantees.  I could tell you the story about the six-foot man who drowned in a river that was an “average” of 4-feet deep across.  Get it?!

TIMEFRAME!  That’s what this next chart is all about.  A client came into our office this week and was trying to understand why he was hearing all about this “historic bull market” on the radio and TV when in reality, his statements have painted a different picture.  If you ask me, 2017 was a really healthy bull market.  2018 on the other hand… not so much.  So if you’re wondering what they’re talking about when you hear about the “historic bull market” what they’re referring to is the short-term, 44-day bounce off the Dec/Jan lows.

The first lesson in managing investments is knowing your timeframe before you invest a dime of your money into a portfolio.  I have a friend in Maine who sells everything in his portfolio and goes to cash every day.  I have another friend in Colorado who buys investments with a hold time of only 2-3 weeks at most.  My timeframe has been built for serious, long-term investors and I’m looking out six-to-nine months… not 44 days.

Did you know that the market drops more than -10% per year, every-single-year, on average?  It also drops 3-5%, three times per year, on average.  These are big reasons why I built our firm’s timeframe out to six-to-nine months.  We’re not trying to avoid every -10% drop as it only takes 11% to break even.  Same goes for -15% drops… even those are temporary with a mere 18% required to get back to where we started.  What I’m trying to avoid are the big, catastrophic crashes.

Below, the market dropped more than 14% between July and August of 2007.  Then it went up by roughly the same amount in only two months.  Then it dropped, again more than -14% between Oct and Dec, bounced a little more, but generally speaking, there were lots of bounces, pullbacks, and rallies back in the early stages of the last market crash…

…but look how that story ended (see below).  A market that fell almost -58% from top-to-bottom was one that included several bounces of anywhere between +5-18% with pullbacks and corrections along the way.  It took 18 months before it was over (recall 2000-02 was a two-year bear market), and as you can see in the momentum indicator below (lower pane), there were many crosses below 30 during this crash and zero crosses above 70.  In a healthy bull market, momentum should be in a range between 30-100.  In an unhealthy bear market, it tends to move in a range between 0 – 70.  Remember this for later on in this article.  I’m going to refer to momentum a lot!

In the next chart below, I have a few things to point out.  Let’s take it step-by-step.

  1. The long-term trend broke down signaling “extreme defense” in December (red down-arrow). Holding onto stocks beyond this point (unless there were anomalies that were still rising) made very little sense from a risk vs. reward standpoint.
  2. Momentum (lower pane) had been declining while the market went higher. This is clear-cut, negative divergence and more evidence that the market is unhealthy.
  3. However… the good news I see here is:  Not only has the long-term trend reversed up as of mid-March, but this past week we observed an upward breakout above the declining trendline in momentum. While it’s very small, still very early, and could be just a head-fake, it’s constructive and encouraging.
  4. Still… we have the all-time-highs to contend with and the BIG test is going to be whether or not the market can clear that overhead ceiling and hold without breaking down and falling thru a trap door. #TimeAndPatience

Again, the “Tale of Two Markets” between 2017 and 2018-present.  I needed to zoom-out here to explain a few things:

  1. The importance of the January ’18 highs (black dashed line), which we just broke above this past week. I’d like to see the market hold here and move sideways, ideally,
  2. The importance of the Oct/Nov/Dec/Mar highs (thin, red-dashed line), which will serve as an extremely important floor of support below our feet. This is one of the places I’ve got my eyes on for side-stepping the market and protecting capital,
  3. The challenge faced at the all-time highs (ceiling of overhead resistance) that lies ahead, and
  4. Again, in the lower-pane, how obvious it was that momentum was moving up and down in a bullish range (30-100) in 2017 while since early 2018, it’s been unhealthy, even after the “historic” 44-day bounce off the lows. Higher prices without confirmation in momentum doesn’t sit well with me.

Here is the exact same chart as the one above, just zoomed in so that you can see the levels easier.  I didn’t want to share this one without the previous because I wanted viewers to be able to compare the two and see the January ’18 highs with their own eyes.  Nothing new to share, however… but this paints a good picture of the “floors and ceilings” I’m paying close attention to.

Here’s a chart we’ve been sharing with our clients at the office, comparing the market today to 2015-16.  Feel free to scroll up and down to compare the two.  Now, what I want to point out is the current level of the S&P500 in the chart above, how it’s traded higher, cleared the 200-day moving average (rose-colored trendline/shaded area).  Then, look below at the area I circled, back in 2015, when the market was in roughly a similar place.

Without hindsight at our advantage, we don’t know what will happen today in the market, and that’s the beauty of being trend-followers – we’re following and reacting to the trend in real-time, not predicting or attempting to anticipate future moves.  What we do is observe what the market does, buy/sell as necessary, and allocate our investment portfolios in accordance with the risk vs. reward landscape of the markets at the current time… today.  Notice in the chart above how momentum (in the lower-pane) never got above 70, then the market headed down again.  Just some food for thought, but definitely something I’m watching.

The next chart is super long-term, but I like it because long-term charts throw up much less frequent signals and clues – and because they’re so infrequent, they need to be respected.  Each candlestick (small, black and white boxes) in the chart below represents one full month.  What I’m doing here is eliminating the noise intra-day, intra-week, and even the noise throughout the month to get a snapshot of the stock market over time, just observing the month-end price and that’s it.

I’ve coded the chart so that the red, shaded areas represent anytime the market closes below the 10-month moving average (i.e. – 10-month trend), which is another serious piece of evidence that suggests avoiding stocks.  Notice how the red flags went up in early 2008?  Then we had “head fakes” or in other words, false signals for:

  • Four months in 2010
  • Five months in 2011
  • Two months in 2015, followed by an upward head-fake before
  • Another three months in 2016 (just three months later),
  • Just one month in October, and then
  • Two more months in February and March.

The good news is, we’re back above the 10-month moving average, which is a very positive, long-term sign.  However, what I don’t like is the negative momentum divergence in the lower-pane (again).  Starting to see a theme here?  What’s keeping me cautiously optimistic is the higher prices we’re seeing in the market, coupled with weak momentum – and the further back you look, the more you slow down the charts, the worse it looks.  Again, time & patience with a keen eye on the markets is key here.

I don’t mean to come across so pessimistic here, but the chart below is another one I’m paying close attention to.  This is a chart that represents a basket of financial stocks.  While the S&P500 has managed to clear its 200-day moving average, financial stocks (below) have not.  Instead, they’ve limped along with declining momentum and a clear inability to break above their November/December highs.  It’s extremely difficult to have a healthy bull market when financials and banks are struggling in the U.S.

Similarly speaking, the chart below is the Russell 2000, which is an index of small-cap stocks (small companies).  Similar to financial stocks above, the R2K is also struggling to reclaim its 200-day moving average, or its October highs.  The silver lining here is that its momentum decisively broke out above 70 during the initial bounce off the lows (lower-pane).  The reason I’m paying such close attention to small caps is because they’re “riskier” than most stocks, and if the market as a whole is going to reverse upward into a new, fresh leg of higher prices, we need risk appetite to reflect in higher prices in the small-caps.  So far, we’re not seeing the sustained strength required to label this as a healthy bull market.

Nerd’s Note:  I didn’t annotate it, but see if you can find the inverse head & shoulders pattern in the chart below.  Email me if you see it!

This is one of my favorite charts to watch when looking at the big picture.  Like the monthly S&P500 chart (scroll up three pictures, above), the chart below is also a monthly look at the market, but this one goes back 25+ years.  The red (down) and blue (up) arrows in the upper and lower-pane are identical.  I just added the lowers so that viewers could more easily see the crossovers in the moving average and signal line (in the lower-pane), which is what creates the buy and sell sig’s.

  • What I don’t like: We’re on a sell signal since November, and since these signals are so infrequent, they have to be respected.
  • What I do like: In the lower-right, you can see that, while we’re still on a valid sell signal, the recent price movement in stocks has caused the black moving average to curl upward, indicating that it’s possible we could see a fresh new, long-term buy signal in the next few months.  But we can’t get cute and try to anticipate the signal.  We have to be patient!

Okay, here’s a fun one.  Most people don’t like this stuff.  Let’s be honest… most of these charts are confusing and by this point in the article (or if you watched the video), I’ve probably lost more than 50% of the viewers.  The biggest reason being the lack of a “story” to go along with the picture.  Everyone wants to know if it’s the tariffs and the trade war, if it’s Jerome Powell, or if it’s China or BREXIT that’s causing all this chaos.

The truth is, none of that matters.  If the markets go up and you make money, do you care why?  What about the inverse – if you leave your money in the market, it crashes in the next year or two, and you lose -40% of your retirement portfolio, will you feel better if you know why it happened?

This kind of thinking is completely normal human behavior and this psychology is exactly what causes investors to “get it wrong” so much of the time.  Humans want to know why, but it doesn’t matter “why.”

  • If the price is rising and the trend is up, we want to own the investment in question (and does it matter what the investment is? If you own the Swedish Krona and you make money, but it sounds strange to own the Krona in your portfolio, will you be upset?!).
  • What if the price is falling and the trend is down. Do we want to own something else (or maybe nothing at all?!).

What else really matters, other than price and trend?!

<Steps off soap box>

Okay, but here’s a chart that might be a little more fun.  I’ve shown it before in a few of my weekly updates on the state of the market, so if you’ve seen it before, this is updated as of April 10th.  The lower chart is the Unemployment Rate since 1994.  The upper chart is the stock market.  Notice anything interesting?

When unemployment has risen in the past, the stock market has peaked and crashed within roughly 12 months.  In 2000 it was a little early and in 2006 it was really early, but I think it’s interesting and something that I continue to pay attention to.  Can the unemployment rate in this country go down any further?  Think about it… the 3.80% of those who are unemployed are changing jobs or never going to work again.  We don’t see numbers much lower than this and there’s no such thing as zero percent of the country unemployed.

So while the ECONOMY might feel like it’s doing well right now, just remember that the stock market tends to crash roughly nine months before a recession begins.  Said another way, if you wait for a recession to begin, by the time the recession start has been confirmed, you’ve already lost a ton of money.

The next chart shows us interest rates since the late-70’s.  Recall that, when rates go down, bonds go up in value.  Granted, interest rates don’t bottom like stock markets… they take a LONG time to bottom (whereas stocks tend to “V-bottom” after a crash, like in 2002 and 2009).  We saw a head-fake this past year, above the downtrend line going back to 1981, and a pullback coming into 2019.  While rates could definitely go (a lot) lower again, this could be the long, drawn-out bottoming process in interest rates and if it is, buying and holding bonds is not going to be for the faint of heart.

Bitcoin… yeah, it’s back in the news again, but I’ll be quick.  I have just a few points I want to make:

  1. Bitcoin has fallen -90% since the high in 2017 when everyone was telling their families at Thanksgiving to go buy it.
  2. Since the bottom earlier this year, it’s risen by more than +91%.

Now think for a second… look at the chart.  It went down -90%, has risen +91.2%, but isn’t even 1/3 of the way back to break-even!

This is what we’re always sharing at our office when it comes to the “sequence of returns.”  If you lose -50%, you have to MAKE +100% to get back to even.  Looking at the Bitcoin chart above, and then looking at the “Impact of Losses” chart below, how much do you need to make in order to break-even after a -90% loss?

That’s right… +900%

Let your mind marinate on the chart below for a little bit and you’ll start to realize why we implement our patented Defense FirstTM strategy and trend-following philosophy.  It’s not easy to do, but the reasoning is simple:  “Avoiding losses during market crashes is much more important than shooting the lights out in a bull market.”

Here’s a Crude Oil chart that I shared back in January.  Notice the huge drop in price, but the positive momentum divergence in the lower pane, hinting at potentially higher prices in the future…

Here’s an updated Crude Oil chart as of April 10th, and you can probably see why I’ve liked oil as an investment this past quarter.  Prices followed momentum higher, oil broke above its 200-day moving average, and momentum broke out above 70.  All good things here… and a pullback would be completely normal in the short-term.

Here’s the gold chart I shared in January.  I liked the higher lows, and the intermediate term looked good both in trend as well as a hedge against stocks, but it was that overhead “ceiling” of potential resistance at $1,370 it needed to contend with in order to shoot dramatically higher.

Here’s the updated chart, which has moved a little higher, still with higher lows (which is good), but again, $1,370 is going to be crucial if we are going to see a big move here.

Here’s another one I like… a basket of Software stocks, which has not only cleared its Oct/Nov/Dec/Mar highs, but broke out to new, all-time highs, accompanied with momentum confirmation in the lower pane.

And here’s another one I like… Semiconductors.  Also cleared its fall ceiling, the 200-day moving average, and has moved above its all-time high along with confirmation of momentum.  I also noted in the chart (in the lower-pane) that, even when semiconductors bottomed in late-December, momentum never crossed below 30, which is an extremely positive sign.

So we’ve come to the end and I think that a good way to wrap things up is to zoom out and look at the big picture.  This S&P500 chart goes back 25 years and it’s very clear to see the big head-fakes in 1998, 2011, 2015, and 2016.  The question today is very simple:  “Is 2018-19 just another head-fake, or is it the real thing this time?”

Of course, the answer to that question isn’t easy.  In fact, it’s impossible to answer because no one knows what the market will do tomorrow, next week, next month, or next year.  Anyone who proactively suggests predictions on the market is someone I’d avoid.  As a trend-follower, my goal each and every day is to analyze the markets from the top-down.  My first question is always, “Is the long-term trend of the stock market up, down or flat?”  This is the biggest question that bears the most important answer, because if you try to invest against the prevailing long-term trend, it can get pretty ugly.

But investing your money without any exit strategy and without any plan is like driving blindfolded through downtown at rush hour with your foot planted on the gas with the pedal to the metal.  You might get lucky, get a few green lights and experience a few near-misses, but eventually you’re going to crash.  It’s that simple.

If you’re closing in on retirement, you can focus on what you save, what you spend, and you can follow an air-tight financial plan with a high quality, fiduciary, fee-only financial advisory firm.

If you’re already retired, you’re likely not saving money any longer, but between the creation and monitoring of a solid retirement income plan, combined with an efficient investment portfolio with the appropriate exit strategies in place, you can experience a fun, stress-free, and successful retirement.

But in either case, you need to have a plan!

Some individuals, couples, and business owners feel that they’ve accumulated enough assets to where they don’t need a plan.  They just want their money invested and that’s it… but even the wealthiest of clients need a plan, and it can be for any number of reasons, including but not limited to:

  • Charitable strategies to reduce income tax (and/or capital gains tax).
  • Estate planning strategies to reduce taxes while leaving a larger legacy of wealth in the family for generations.
  • Business succession strategies to ensure families are taken care of in the case of a premature passing of the business owner.
  • Business transaction strategies to keep the sale of a company as tax efficient as possible so that the owner keeps as much of the proceeds in his/her pocket as possible.

The list goes on – and this is the more complicated stuff.  Naturally, most everyone needs a retirement plan as well as some sort of income planning near or after retirement begins… but the markets and investments can only push your sails so far.

In the end, it truly comes down to creating a plan, adjusting it over time as life changes occur, and monitoring it on a regular basis.  These are the things one must do in order to protect themselves, their family, and to summit the mountain of retirement success.

Till next time…

Adam

 

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

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