The arrogance of youth bears a very heavy cost

I guess we were all pretty arrogant in our younger days, so from where I stand now, I can recognise it when I see it.  Most traders at the major funds/banks are young and have never experienced a real bear market.  Yes, the slumps of 2000 and 2007/2009 were brutal but were mere dress rehearsals for what is to come.

Buying the dips and chasing momentum have been stellar strategies for most of their lives, but not any more.  That game changed on October 3 when the Dow made its ATH and signaled The Top of the Great Asset Mania from at least 1945.  As a wonderful show of arrogance, this young ‘trader’ boasted on twitter on Monday December 1 what a genius he was to fill his boots with S&P call options

and to tell the world it would be foolish to short anything.  Was he right?  You tell.

That young man has two things working against him now – the market moving lower (down 3% on Tuesday right after his purchase) and the time value is elapsing.  I am not a great fan of options – unless the market is either bombed out (buy very cheap calls or sell expensive puts) or is in a ‘buying climax’ such as the S&P on Monday morning (buy cheap puts or sell expensive calls).

He made the fatal amateur’s mistake of buying at the top of a sharp counter-trend move as bullish fervour was running high based on news.  That is precisely the time to go against the herd. And as far as I know, nothing has been heard of StephenCo since Monday morning.

It reminds me of the old saw: Those who know, don’t talk.  Those that talk, don’t know.  With the aid of social media (a misnomer if ever I have seen one!), any arrogant youngster can talk – very loudly.

A Deflationary Depression lies directly ahead

My long standing forecast is for the global economy to suffer a deflationary depression that has almost certainly already started (the data points to come will get a whole lot worse).  A recession is a milder prelude to it and is characterised by a reduction in the growth of cash plus credit/debt in the system. So are we seeing signs of this happening?

One straw in the wind is the performance of the shares of the oldest travel company in the world – Thomas Cook.  It has lost a staggering 85% in value since May alone – so what is going on?  People are still taking holidays and the UK airports still pack ’em in like sardines.  Here is the sorry looking chart (but great for the bears, though)

In May, investors were looking forward to a bumper summer season but the unusual long, hot summer arrived and that cooled foreign holiday demand and takings were down.

I am quite sure Cook’s has experienced ‘inclement’ weather in previous seasons, but the shares have rarely been in danger of touching zero as they are today.  So what is provoking wave after wave of selling?

In one four-letter word – DEBT.

The company carries a £1.4 billion debt load on latest profit after tax of £13 million.  This is a highly geared company – and investors smell blood.  If next season turns out poorly, the company runs the very real risk of not being able to pay debt interest and bankruptcy looms.  This is a scenario that will haunt many more companies next year.

In the bull market, debt was no problem (and even encouraged) – rates were low/zero and it made sense to borrow to invest.   Except that many companies  failed to invest and used the funds instead to buy back shares, increase dividends and of course reward executives handsomely for pushing up the share price in what is termed a positive feedback loop.

But now we are starting the largest bear market in many decades, debt is now a problem – and a growing one.  A negative feedback loop is now in full swing.

I came across this quote the other day:  One of Europe’s top-performing fund managers says investors should worry less. “We don’t think about macroeconomics, we don’t think about interest rates, we don’t think about Trump, we don’t think about politics or Brexit,” said Kevin Murphy, who helps run the $1.5 billion Schroder Income Maximiser Fund, which has beaten 98 percent of peers in 2018 by focusing on U.K. value shares. “You’re much better off not trying to predict unpredictable events and focus on company fundamentals. the charts and sentiment” (my correction).  Otherwise, he is spot on.

With the bear market now in force, I would like to see his performance figures next year.  He may still beat 85% of peers, but they will all lose a ton of money – and see investors pull out in droves.  Redemptions in funds and ETFs of all kinds are growing.

Sorry, but the ‘fundamentals’  will do you no good when sentiment turns.  The basic problem I have with this kind of analysis is this: a company has many metrics to judge ‘value’ some favourable and some less so.  Which ones do you focus on – just the favourable ones and ignore the negatives?  Or vice versa? A manager has to choose – and thereby shows his/her bias right away.

If feeling bullish, you choose the positives and vice versa.  It’s as simple as that.

But with the charts, there is no choosing to do!  If the trend is up, you buy (on dips, of course).  If the trend is down, you sell (on rallies).  No bias required.

Yield curve has inverted – danger ahead

The yield curve refers to the spread in yields between a Treasury of one duration and one of another.  The 2s10s is the most commonly considered by market technicians.  Whenever this spread has dropped below zero, as it has this week, it is an almost sure sign of economic problems, such as a slowing in the rate of growth.  And it is extremely bearish for assets including shares.  Short term rates are higher than long term.

A sudden flight to safety to the long bond (away from equities) has pushed yields there down while the short term rate is more closely allied to the Fed policy rates which are more stable, thus forcing the spread negative.

A little-watched spread is that between the 5yr and 10 yr TIPS, which are inflation protected Treasury notes.  When inflation is high, the spread is positive and wide.  But when inflation expectations are low, the spread goes negative and shows the market expects price inflation to fall.  If the negative difference becomes wide, a rapid disinflation or even deflation (falling prices) is heralded.  This week, the spread ominously went negative for the first time in many years.

So now the bond market is lighting the way towards my promised land of the Deflationary Depression.  Many more signs will join the queue next year – and I predict we shall start to sight references to the D word in the MSM as markets work lower in 2019.  The R word is already commonplace.

But – and there is always one – this does not preclude a massive counter-trend rally to trap the new shorts trading off the yield curve ‘signal’.  In fact, we had one yesterday with an 800 pip bounce off Thursday’s low. There has been much MSM ink spilled covering this phenomenon last week and with the news being generally depressing, I am confident many have been drawn to the bearish side especially given the rapid speed of the stock collapse. I saw one recent DSI bulls reading at under 10%.

But they are too late (and a dollar short) – we took our short profits Thursday near the lows just as they were piling in.  You have to know when to zig and when to zag.  And just as quickly, stocks turned lower yesterday – and we are short again.

Is anyone buying the dips any more?

With the Dow plunging by several hundred pips a day, many bulls are getting nervous – but not this one I found recently on seekingalpha.com.  His piece is entitled: The Steep Stock Market Sell-off Doesn’t Make Sense” – and sets out to prove it by claiming:

Earnings growth remains healthy

The economy continues to grow, and

Equity valuations are at the lower end of their historical range.

backed up with copious data and charts.  He makes a strong case – based on past data, and there’s the rub.  Markets are not backward-looking (as so many analysts believe),  They look forward – and they are not liking what they see.

On the contrary, I believe the sell-off makes perfect sense as it does to anyone with even a smattering of Elliott Wave knowledge – and a deep understanding of how sentiment has changed from highly positive (and complacent) pre-October 3 to negative (and fearful) today.  So good value shares can become even greater value (on paper) as values slide.  A share at zero has a very cheap P/E!!

This is his forecast (as of Wednesday):  At this point, it would appear the recent equity market sell-off may be unjustified based on the fundamental strength of the economy and earnings. It should allow equity prices to rebound in the coming weeks and month to follow.  We shall see, but I fear he is using hope as a strategy, and that rarely works for long when conditions change.

I believe many bulls will stop believing in Santa this year.  And if my wave labels are correct, this is why

Note the high complacency on the way up to the January wave 3 high.  Dips were few and far between as bullish sentiment climbed into the heavens.  Stocks always go up, don’t they? It was another Goldilocks scenario – GDP was growing, inflation kept low and unemployment kept falling as interest rates remained low.

But now, the narrative has changed and Goldilocks has vanished – and conventional ‘news makes the markets’ traders are stumped for an explanation. The pros are stumped. 

Who could have seen that coming? No immediate news catalyst for this sudden tumble – or did everyone just realize Kudlow’s talk was just that…

As Bloomberg reports, it would be nice to write the market’s convulsions off to liquidity failures, or tariffs, the Federal Reserve or tech valuations.

But for the people living through these swings on trading desks, none of those explanations does the trick — and that’s what really worries them.

Yes, confusion reigns among the perma-bulls. This is a typical process when markets enter a bear market.  The smart ones will recognise what is happening and take action.  But most investors will sit tight, praying that their cherished ‘fundamentals’ will rescue them.

Gold heads north

It has been a long wait for gold to gird its loins for a significant advance but the signs are positive from last week’s action

My best guess for the EW labels is for an advance up in a D wave which is part of a large wedge/triangle pattern.  After that will come an E wave down, but first, I expect a move up to test the B wave high at the $1350 area.

The backdrop for this forecast is the ongoing gold-bullish stock rout (flight to safety) – and the backdrop for a coming retreat is the gold-bearish stock rout!  In the latter phase, traders will finally recognise we are in asset-deflation territory and there is no place to hide (except cash) and will sell everything that moves – even high quality bonds.  It will become an all-the-same-market.  Cash will really be the only asset to own.  But that is for later.

With the Dow (and other indexes) moving by hundreds of pips in minutes, it is essential to keep on top of the zigs and zags – and that is what I am doing for VIP Traders Club members. Can you benefit from my timely advice?  There is only one way to find out – take a two-week Free Trial now.