On Christmas Eve, I was saying to folks that I was a little surprised to see another heavy sell-off, especially given how much the market had been pummeled over the prior weeks. I also mentioned that I was expecting a “trade-able” bottom very soon, which we in fact got the day after Christmas. This does NOT mean the market will bounce right back to the land of “sunny skies and sweet smelling roses”.
In spite of the 1000+ point bounce, my market direction indicators show we are still solidly in a bear market, and the trend is still DOWN.
It is worth noting though that some of the best rallies of all time happen during bear markets, right after sharp selloffs. This what I believe we are in right now. The so called “dead cat” bounce (even a dead cat bounces if dropped from a high enough level).
A few points worth noting:
- Markets don’t go straight down, and then straight back up to new highs. The vast majority of market bottoms are “re-tested” after a bounce. If the bottom holds, and prices break out above the bounce, there is a good chance the bottom is truly in place. With this downturn, before we can say a bottom is in, we can expect to see the lows re-tested. So look for the current rally to stall and begin a reversal in the next few trading sessions, as traders who caught the bottom begin to take profits (likely after Jan 1 due to taxes). These “flip flops” in the markets tend to destroy those without trading experience. As an investor, be patient.
- The economy IS slowing, and the Fed IS tightening. In spite of what you hear from the “investment bank mouthpieces” on CNBC, I do believe we will see a severe recession developing in the coming months. I believe by June, we will all know someone who has been laid off. The old rule of thumb is “Don’t Fight The Fed”. Even without cutting interest rates, the Fed is draining $50 billion per month from their balance sheet. This is a “tightening” of credit and it is substantial.
- Europe, where I believe the most trouble will originate, is an economic disaster waiting to happen. The people in Europe know this, which is why most of the countries now are seeing the “Yellow Vest” protests. At the same time, the Chinese economy is entering a free fall, and it is clear they are exporting much less than they had been. We are not immune to their troubles.
- Stock valuations are still way too high! They won’t become more “normal” until the market drops at least 50% from its September peak. Often we look at P/E ratios for a sense of fair price, and the implicit assumption is that the price fluctuates while the earnings stay flat. During downturns, the earnings will drop drastically, so the price has to fall that much more to lower the P/E ratio. When companies are highly leveraged and in debt, earnings are far more sensitive to changes economic activity, and drop faster than they otherwise would.
- Finally, there are the political risks. Will the President see an impeachment this year? Will he end the trade talks with China or other trading partners? Will he keep the government shut down over a border wall? Will he attempt to fire the Federal Reserve Chairman? Will he double his Twitter commentaries? Any one of these will move the markets and create uncertainty.
Enjoy the bounce while it lasts. I believe the bounce will end in the first half of January, and the market selloff will resume.
I am still long gold and silver in various forms and have not started nibbling at stocks. And to this point, John LaForge, The Head of Real Asset Strategy at Wells Fargo, announced today he expects commodities to be the star of 2019, especially the precious metals.