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Russell 2000
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World
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Investors came into Monday with active pre-market trading setting the tone. Expectations for a resolution to the debt ceiling debate drove futures sharply higher. After gapping a full 100 Dow points
higher at the open, however,
stocks proceeded to drop sharply. The Dow fell back 250 points in little more than two hours. A shockingly weak manufacturing index report kicked off the downdraft. After falling quickly to the 200-day moving averages, indexes began a move higher to end the day with modest losses and the Dow essentially flat. For most indexes, it was their sixth straight day of losses. Healthcare shares were battered on news the debt ceiling agreement would reduce Medicare/Medicaid payments. Tuesday began innocently enough. A lackluster consumer spending report resulted in mild selling pressure. The Senate and President approved the debt ceiling plan. With the debt ceiling plan no longer an overhang, investors were free to embrace the new notion that the second half economy looks much weaker than previously thought. The fireworks began. Markets plummeted almost straight down. Bulls were nowhere to be found leaving sellers to drive action into the close. When the dust settled, the S&P 500 had given up its 200-day moving average and its gains for 2011. The Nasdaq Composite was down just shy of 3%, it's second such day in only a week's time. The selling carried over the following morning. But this time it was the leading index, the Nasdaq 100, looking for support. And support it DID find at its 200-day moving average. The bounce from that technical reference line was convincing enough to lift the market for the day and end the consecutive losing streak at 8 for the Dow Jones Industrials. However, the reprieve was brief. Asian and European markets fell sharply overnight after a series of moves:
- Bank of Japan intervening to halt the rise of the Yen,
- a similar move by Switzerland's bank,
- ECB bond buying support for Irish and Greek bonds, but not for the newly ailing Spanish and Italian bonds.
In domestic news, the jobless report was mildly positive. But confidence was in ever-dwindling supply over fears the global economy is quickly slowing. The combination of financial and economic uncertainty washed away stocks in a torrent of selling. By day's end, the market was off 4-5%, its worst day since the end of the 2008-2009 financial crisis. The panicky tone of the trading put investors on pins and needles awaiting Friday morning's jobs report. The report met expectations to provide a positive market open despite rumors of an S&P downgrade to U.S. credit. Investors, reeling from the shock of the prior day's trade, weren't buying. Stocks remained under pressure through the morning until word that the ECB would step forward to support Spanish and Italian bonds. That brought stocks back from a 2-3% drop to near breakeven before fading a bit into the close on continuing rumors that S&P would downgrade the U.S. credit rating.
For the worst weekly losses since the financial mortgage crisis, the S&P 500 (SPY)
piled a 7.15% loss onto the prior week's weakness. The Russell 2000 (IWM) suffered a 10.55% setback. The recent outperformance of the Nasdaq 100 (QQQ) came to an end this week as that index matched the S&P's decline, giving up 7.19%. After this week's pounding, all indexes are below their 50 and 200-day moving averages.
Our World portfolio fared no better as all markets have been highly correlated through the recent declines. The World portfolio fell 9.5% this week. Since we now have an active Classic Model Cash signal, the World approach calls for staying in cash if you follow the "Long Only" or "Long and Short" strategy. Only if you follow the "Buy and Rebalance" strategy should you remain invested in the top 5 ETFs from our world ranking. Please go to the Classic Model "Description" page for details.
Our Classic Model is on a Cash signal while our Turbo Model remains on Buy.
Is the bull market dead?
While the media and public's attention was focused on the
debt ceiling debate and ultimate signing, markets were considering
the consequences of several bodyblows to the economic outlook. By
focusing on the former, you might have missed the latter. This week,
markets fully embraced the latter - the idea that the global economy
might well be headed into another recession. That would mean an
end to the cyclical bull market and the onset of a new bear cycle.
Let's review the facts and state of the various markets. The first
bodyblow was a poor ISM manufacturing report which shocked markets
though the effect was hidden/lessened initially because of the market's
focus on the ups and downs of the debt drama. A significant downward
revision to first and second quarter GDP delivered more cause for
concern. Then, consumer spending chalked up a third straight month
of flat-to-down results. Planned layoffs spiked upward. The debt
debate finally concluded, but left investors feeling no better as
they realized that spending cuts would mean lower profits for anyone
related to Medicare/Medicaid. Healthcare stocks sold off across
the board led downward by insurers and hospitals who would presumably
bear the brunt of the cutback in reimbursements. Healthcare is one
of the major employers in the U.S. and certainly the fastest growing.
Would these spending cuts mean a sharp slowdown in that hiring,
thus an even worse employment and consumer spending picture? Markets
seemed to jump to that conclusion (and/or the conclusion that capital
gains rates will return to prior levels).
Meanwhile, Europe quickly forgot the benefits of the mid-July Eurodebt
backstop agreements. Investors demanded higher interest rates for
Spanish and Italian debt, in the process undoing the very stability
and confidence that the European Central Bank (ECB) and European
Finance Ministers sought to provide from their July agreements.
Thursday of this week, the failure of European finance leaders to
successfully address rising interest rates caused a panic in stock
markets the dust from which is still settling out.
Two weeks ago, markets were buoyed by strong earnings primarily
from large-cap tech companies. Apple, IBM, Microsoft, et al. were
posting great results on strong overseas sales. Asian economies
were humming along, albeit in a period of increasingly restricted
monetary policy. Japan was recovering swiftly and strongly from
its earthquake. The Nasdaq 100 was setting multi-year highs and
looking on the verge to perhaps bring the stock market overall into
new high territory. Two weeks later, it has all come crashing down.
Earnings have continued to look good. However, the gains have been
focused almost exclusively on larger, global companies leaving the
smaller, domestic-focused companies with rather tepid results. Many
of the larger companies refused to whip up enthusiasm about their
second half prospects, preferring instead to dampen expectations
and offer words of caution about the road ahead. The Fed's Beige
Book recently offered a lackluster picture of economic growth though
expressing optimism that the second half would be better. This week,
markets no longer believe that outlook.
The unraveling of markets has led to calls for yet another round
of Fed easing, the QE3 talk. But what would that be? Interest rates
are already at historic lows. Indeed, the debt downgrade fears (which
were set aside this week by the rating agencies - the U.S. is still
triple-A!!) surprisingly had no impact on rates. U.S. Treasuries
found buyers from every quarter, making Treasury bonds the best
investment around over the past couple of weeks with a 5%+ surge
higher not counting the panic buying from later in the week! Who
would have guessed? That surge in Treasuries was confounding to
many but possibly a market tell that concerns about the second half
were far more important than the lingering Washington debt discussions.
Gold continued to move higher despite a U.S. dollar that was essentially
flat - another tell from investors that their economic and financial
concerns were trumping everything else.
Technically, the market took on the dreaded head-and-shoulders pattern
as it raced downward. To be sure, prior similar patterns of recent
vintage have proven false - it's hardly a reliable indicator. But
the fear quickly became palpable. Our Classic Model, unaware of
the fear other than through the behavior of the data, chose to step
aside and go to Cash early in the week. Our Turbo Model hangs in
with a Buy primarily because markets have become so stretched on
the downside (more on that below). Turbo will look for at least
some bounce back upward. Depending on the strength of that bounce,
we could see Turbo issue a Sell looking for renewed weakness. We
would point out that the Turbo Model banks the bulk of its hefty
returns during bear market periods. If we are entering a new bear
cycle, the fun for Turbo is about to begin!
This week's action begs the question: are we entering a new bear
cycle? And if so, what does that mean?
The data suggests that we are indeed entering a bear market. For
one, there have been 28 days of 4%+ losses in the stock market over
the past 35 years. Almost none of those occurrences showed up during
bull markets - they are bear market phenomena. Of interest, 15 of
those 28 4%+ days happened in 2008-2009, a testiment to how severe
and unusual that market period was. A more typical number is 4-5
such days within the full span of the bear market.
Chart 1: Bull markets rarely have such dramatic selloffs
Shifting to a bear market would change our expectations of market
action. We would begin to expect weakness from
stocks, with any upward moves to be sharp and brief - just as corrections
in bull markets tend to be sharp and brief. Turbo delivers such
heavy gains during bear markets precisely because of the more violent
nature of bear markets - the volatility becomes greater, which is
fuel for our Turbo engine.
Chart 2: Secular bear markets deliver sharp moves higher
and lower
We will offer a high level rational behind our bear market thesis
with Ed Easterling's chart showing that cyclical bull rallies do
not last beyond a two-year run (1 in 5 chance) and NEVER deliver
four straight years higher. Thus, if the S&P 500 were to recover
this year to post a gain, we would expect next year to be a down
year.
Chart 3: Cyclical bulls typically run short of breath after
two positive years
Here is a more data-heavy version of the secular bull/bear historical
behavior.
Table 1: One more cyclical bear market ahead - kicked off
this week?
Looking at more foundations of the bear market argument:
- If this
month's declines do not reverse, we will be notching a fourth straight
negative month for the index. The S&P 500 has not had a four-month
negative stretch in a bull market in over twenty years.
- We are
in the middle of the third quarter of 2011 market action. The S&P 500
posted a loss for the second quarter. Similar to our first point,
the S&P 500 has not delivered consecutive losing quarters in a bull
market in over twenty years.
Thus, we are on the edge of the bear
market cliff here. And only two weeks removed from what might have
been a bullish breakout. Such is the way with markets and especially
market tops where bullish investors bit-by-bit lose faith in their
ability to find gains ultimately stepping aside to leave the bears
in control of market prices. No bell is rung; no siren sounded.
It's a process. Just as in 2007 we had the August swoon when the
Bear Stearns hedge funds went under. Followed only two months later
by a 10% surge HIGHER in emerging market stocks, a surge that proved
to be the last hurrah of a market driven higher by booms in housing
and Chinese building for the Olympic games. This Nasdaq 100 move upward
could have been a similar last hurrah for market leaders Apple,
Bidu, et al.
The alternative scenario is that we are just finally getting the
cleansing correction we've longed for, that this market crash is
more reminiscent of the 1997 market crash from which stocks quickly
recovered to march on to new highs. We doubt it, if only because
the secular bear market data compels us to believe that investors
are more likely to view this event not as a buying opportunity in
a bull market, but rather as another 2008 experience where markets
became completely unglued. That seems to be the underlying emotional
response we saw this week - unbridled fear that the financial world
was once again coming off the rails. We expect the situation will
turn out to be less dramatic than that period - where very large
U.S. financial companies were teetering on the brink of failure
(with some of course going over the edge). We expect that QE3, if
you want to call it that, could well be the U.S. Fed helping the
European Central Bank backstop further European debt troubles to
restore confidence to that fragile market - the area that caused
this week's crash. Financial markets, banking, etc. are all built
on confidence and trust. Once those emotional underpinnings of trust
and confidence are lacking, markets let fear take charge. It's a
normal, though occasionally painful, part of our financial world,
a world which is now more globally interconnected than ever. That
should also imply "stronger", but investors are not yet
onboard with that assumption. The good news for our followers is
that we are ready to profit from a bear market, if indeed it arrived
on our doorstep this week...
Question: What did you say!? Were you implying ...!?
We received a number of responses to our weekly update last week talking
about the debt ceiling debate. Some of the respondants felt that we
were taking jabs at their favored political party/cause. Certainly,
our intent was not to take any real political stand on the issue.
Rather, our comments and complaints were that politicians were seeing
fit to hold financial markets hostage. We certainly were not alone
in that view, as virtually all financial professionals echoed those
same concerns. While it may be an effective strategy to getting one's
point across - to threaten allowing a default in order to advance
a political policy - it is fraught with danger in the long-term, especially
here in the U.S. The reason is that the U.S. stands at the center
of financial markets, with our Treasury bonds as the "risk-free"
asset. To play around with and jeopardize the presumed risk-freeness
of Treasuries is not only to potentially cause harm to our country,
but has huge financial implications worldwide. Our larger point last
week was to reinforce that we have some responsibility to the global
financial community. We have chosen this responsibility and benefitted
from it. Events of the past 3-4 years - first, a U.S.-centric financial
crisis, then this debt default scare - no doubt cause other nations
to ramp up their search for a competitor to U.S. Treasuries as the
risk-free asset, as well as the U.S. dollar as the primary global
currency. We should be mindful of this responsibility, across all
political parties/causes/affiliations. Don't be surprised if one generation
removed the U.S. dollar and U.S. Treasury bonds are held in lesser
regard. That may be a function of any number of things, but to accelerate
that day is not in our best financial interest. There is definite
benefit to being the standard-bearer, but it also brings responsibility.
Our argument is that our politicians should consider that when they
are going about their business.
With that clarification, we always welcome your thoughts, comments,
and suggestions for how we can best deliver investment and financial
information that is informative and helpful.
Warm wishes and until next week.
The TimingCube Staff
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