Candidates confirm: No crash this year

A CNN Money article this weekend provided contrarian investors with a moment of clarity.  “Trump and Cruz predict stock market ‘crash’” the headline proclaimed.  Contrarians couldn’t find a more emphatic statement of mainstream bearish capitulation than that.

The market opinions of high-profile public figures are always as fascinating as they are instructive.  Most public figures have only an elementary grasp on the financial markets; this is doubly true for politicians and political candidates.  In instances when these figures make public predictions about the market it’s almost a guaranteed contrarian bet that they’ll be wrong.

“The problem with using monetary policy to juice the system is that it creates bubbles,” Cruz said.  Trump expressed a similar sentiment when he said Americans were “being forced into an inflated stock market and at some point they’ll get wiped out.”

Never mind that both statements can be disproven.  A loose monetary policy doesn’t create bubbles; it can feed or augment them but not create them.  Bubbles are a manifestation of mass investor psychology and are the result of synchronized human endeavor.  Central banks can provide liquidity to fuel asset bubbles, but the Fed has no control over how or when a bubble gets started. 

As for Trump’s statement that investors are “being forced into an inflated stock market,” that’s also untrue.  No one is forcing investors into equities; if anything Wall Street has had extreme difficulty trying to persuade casual investors away from money markets and into stocks.  Despite the lofty levels to which stocks have soared in recent years, direct participation among retail investors is astonishingly thin.

The Cruz/Trump crash prediction also provides insight into the mindset of the multitudes.  They’re still feeling fearful and uncertain about America’s economic outlook.  Their collective misgivings about the economy have allowed equities to rally as vigorously as they have since the February market bottom.  Indeed, it seems that the “Wall of Worry” has supplanted the “Slope of Hope” as the bulls have regained command of the stock market. 

The takeaway on the market prognostications of candidates Cruz and Trump is that a crash is highly unlikely in the balance of 2016.  Their statements show that fears of an asset bubble and subsequent market crash are entrenched among mainstream observers.  This in turn strongly suggests that the worst case scenario has already been priced into equities in the intermediate-term.  Any hopes among the bears for a crash will likely have to wait until after the 2016 election is over. 

The Millennial Moment and the global crisis

It’s a trite saying but a profound one all the same: “History always repeats.”  We’ve all heard this bromide countless times, yet how many of us have truly pondered its significance? 

The truism that history tends to repeat itself over time is the basis of the cyclical view of human affairs as applied to the financial market.  Cycle investors believe that by studying past episodes of a similar character they can divine the outcome of currents events.  It’s not surprising then that the cyclists among us have turned their attention toward the global financial market slowdown and tepid pace of the U.S. economy recovery. 

When cycle analysts examine current financial and economic affairs they can see obvious parallels between the Depression Era of the 1930s leading up to World War II.  They see the increasingly interconnectedness of the world’s industrialized countries and the threat posed by China’s economic slowdown.  More and more, even central bankers and technocrats are worried about the possibility of an economic slump that is truly global in nature.

Christine Lagarde, managing director of the International Monetary Fund, made clear the IMF is fully aware of the danger posed by the global slowdown.  In a recent speech she said:

“The good news is that the recovery continues; we have growth; we are not in a crisis.  The not-so-good news is that the recovery remains too slow, too fragile, and risks to its durability are increasing.  Certainly, we have made much progress since the great financial crisis.  But because growth has been too low for too long, too many people are simply not feeling it.  This persistent low growth can be self-reinforcing through negative effects on potential output that can be hard to reverse.  The risk of becoming trapped in what I have called a ‘new mediocre’ has increased.”

Federal Reserve Chair Janet Yellen also acknowledged the possibility of spreading financial market turbulence because of China’s slowing economy.  In her latest speech, Yellen stated: “There is much uncertainty…about how smoothly [China’s] transition will proceed and about the policy framework in place to manage any financial disruptions that might accompany it.”

The fact that the world’s leading central bankers have at least recognized the danger posed by China’s slowdown will at least make it easier to combat the problem.  The famous investor Laszlo Birinyi of Birinyi Associates calls it the Cyrano Principle: when the problems facing financial markets are as obvious as the nose on your face, central bankers will have a remarkably easy time making the appropriate policy response. 

Yet as Dr. Ed Yardeni of Yardeni Research has observed, the proposals of Lagarde and other policy makers toward ending the crisis mainly involve increasing the role of government.  Yardeni pointed out that there was no mention in Lagarde’s speech of supply-side measures like cutting taxes and reducing government regulations.  She apparently believes that more government can solve the problem.  But as Yardeni wryly observed, “Too much government…got us into this mess in the first place.”

Central banks, led by the Fed, have elevated easy money policies to a sacred doctrine to maintain a stable financial market.  Most first world countries recognize the importance of a healthy financial system and the wealth effect of a buoyant stock market.  Even Democrat politicians, long opponents of the Wall Street establishment, have capitulated to the “stock market matters most” doctrine and have pledged their hearty endorsement of it. 

There’s no denying that in a financial economy like the United States has, juicing the stock market provides a spillover effect and does lift the economy to some degree.  Monetary stimulus and direct intervention can only go so far in resuscitating a stagnant economy, however.  When individuals no longer feel the urge to take risks and are more concerned with protecting their money as opposed to growing it, there’s not much central banks or governments can do to change their attitudes.  This is where the cycles come in.

The cycle which governs (or corresponds with) the combined productive and consumptive power of an entire era is the 60-year cycle, or K-wave.  The K-wave is the primary rhythm which tracks the inflationary and deflationary tendencies of the economy.  More than anything else, it’s a demographic cycle which follows the waxing and waning of a country’s long-term population growth.  The “waves” of inflation and deflation which accompany the rise and fall of generations are the results of human endeavor in the aggregate.  When a generation is both large and young, its upside potential as producers and consumers is very great and consequently it gives birth to a swelling K-wave.  This is what ultimately creates inflation, along with a rising level of productivity and standard of living for everyone.

By contrast, when a nation’s population begins aging and loses its vigor, the resulting fall of the K-wave creates deflationary undercurrents, if not outright deflation.  The falling K-wave is characterized by introversion and individualism.  People are more afraid of taking risks in a falling K-wave than they are in a rising wave; they’re also more likely to save money than spend and invest it.

Beginning around the turn of the Millennium it was evident that the U.S. was in the contracting phase of the K-wave.  Falling wages and interest rates and declining investment activity were symptomatic of this contraction.  The older generation was leaving its prime productive years and entering the winter season of life.  Among corporations, most of which are led by the older generation, R&D and capital investment spending has been in decline for years.  This was yet another sign that the contractionary impulse of the long-wave was making its presence felt.

Skeptics of the long-wave cycle ask how they can know when the long-wave has reversed.  The answer is found in demographics.  When a teeming new generation is on the cusp of their prime productive years, it’s only a matter of time before the K-wave turns up again and inflation returns.

There’s an old saying that “youth must be served.”  Each generation feels entitled to a good time, and they eventually will go out of their way to ensure its arrival.  The theory of human endeavor rhythms states that a rising generation, full of energy and ambition, will by its combined productive powers create technologies and innovations which are unique to them.  This outpouring of creative energy produces the corresponding need for capital.  This is where the stock market comes in and it explains why each generational long-wave is accompanied by a super bull market in equities.

Each American generation of the last 120 years has had its own Super Cycle bull market.  The G.I. Generation had the Roaring Twenties.  The Silent Generation had the super bull market of the 1950s and ‘60s.  The Baby Boomers experienced the magnificent long-wave boom of the 1980s and ‘90s.  Generation X had the powerful but abbreviated housing bubble/bull market of the 2000s. 

The Millennial generation is the next in line to be served.  Born between 1981 and 2000, the Millennials recently surpassed the Baby Boomers as America’s largest generation by numbers.  They are by far the most educated and tech-savvy generation in America’s history and they have the potential to create an economic super boom rivaling the long-wave boom created by the Baby Boomers.

Since the turn of the millennium the U.S. has increasingly had to shoulder the burden of the global economy on its own.  No longer can we take for granted synchronized long-wave cycles among the developed nations as we did in the 1980s and ‘90s.  Japan and many European countries are in the midst of a demographic tsunami, while China is about to enter its own version of aging demographic based on its disastrous one-child policy.  In the coming decades it will be the United States that will reaffirm its role as the premier power in the world.  The impetus behind this leadership, increasingly, will be Millennial in composition. 

Millennials were among the hardest hit by the Great Recession and many of them spent several years living in their parent’s basements well into their early adult years because of the slack economy.  They are unique among the living generations in that they have a far more jaded view of personal debt than their predecessors.  This will give them an edge as they gradually find meaningful work and begin accumulating savings and looking to invest their earnings. 

The doom-and-gloomers would have us believe that since the credit crash and Recession, the U.S. has entered a period of terminal decline.  They further preach that with the aging of the Baby Boomer generation, our country’s best days are behind it.  What they’ve failed to realize is that Millennials will be gradually transitioning into the economy to pick up the slack left by the exiting Boomers.  Indeed, this younger generation is poised to deliver a much needed stimulus to the economy once the long-wave generational cycle kicks into full gear.  

The Millennial generation is unique among American generations of the last century in that it has had to delay the gratification of its consumerist tendencies just as they’ve entered their prime years.  This will inevitably lead to an explosive release of pent-up energy when the time arrives for them to be served.  When the Millennial Moment finally arrives, in other words, it will be huge.  

Roadblocks to a full-fledged bull market

Since bottoming in February, the stock market “tape” has been very constructive.  The NYSE advance-decline (A-D) line led the rally off the February lows, which is the first thing we look for when judging the strength of a bottom.  Even more importantly, the cumulative NYSE new highs-new lows indicator continues to climb off its bottom of a few weeks ago and is advancing on a daily basis (below).  Internal momentum, as reflected in the highs-lows, also remains positive.

It’s worth mentioning that as the major indices, led by the S&P 500 (SPX), approach their 2015 highs it will be important to watch for signs of internal weakness.  This was the main problem throughout 2015, as the new 52-week lows would increase each time the major indices rallied toward the all-time highs.  That hasn’t happened this time around, which is an encouraging sign. It doesn’t mean the market is free and clear of potential pitfalls, however.

Let’s take a look at some of the roadblocks to a resumption of the longer-term bull market.  While most indicators are currently positive, there are three potential threats to the re-emerging bull market in stocks: the broad commodity market (notably crude oil), the financial sector, and China stocks. 

On the financial front, the PHLX Bank Index (BKX) closed under its technically important 15-day moving average last month and remains under it as of this writing.  Bank stocks don’t have as much downside leeway as other industry groups right now since the banks, by and large, haven’t seen as extensive a rally as other market groups.  A failure to quickly recover above the 15-day MA could invite another bear raid on the banks.

The main potential roadblock standing in the way of new all-time highs this spring is the beleaguered commodity market.  The following graph of the Commodity Research Bureau Index (CRB) is dangerously close to its multi-year low.  If the index breaks under the February chart support the resulting stop-loss run could lead to further weakness which spills over into the broad equity market, much as it did last year.

The primary culprit here is the crude oil price, which is also threatening to test its January-February pivotal low.  A breakdown below this chart benchmark would cause a sympathy move lower in the oil/gas stocks.  The energy sector stocks were the main source of the internal weakness in 2015 and early 2016.  

If by contrast oil can establish support above the January-February low, it could instead serve as a confirmation for traders that a major bottom is in for crude oil.  This more than anything else would buoy investor confidence that the threat of a global economic crisis, insofar as it pertains to the U.S., has diminished. 

A final consideration is China.  In many ways, China is the X-factor in the global crisis and will likely determine whether or not it’s over or whether we’re merely seeing a temporary respite in an ongoing crisis.  A breakdown to the January-February double-bottom lows in the China stocks would most likely have a negative impact on the U.S. equity market, much as it did in 2015.  By contrast, the recent breakout above the 3,000 trading range ceiling in the Shanghai Composite Index (below) is encouraging.  If the Shanghai Composite can build on this by establishing support above this benchmark level, it could easily pave the way for another leg higher for U.S. and global equities. 

Much depends on the China equity market near-term outlook.  I consider the Shanghai Composite Index to be one of the most important indicators traders should be watching right now.

Most importantly, though, is the overall technical condition of the NYSE broad market.  While the major indices have been sluggish lately, the tape continues to reflect internal strength.  The new 52-week highs are still over 100 daily while the new lows have been well under 40 on a daily basis.  The market’s internally healthy state can be seen in the NYSE directional indicator, which is based on the new 52-week highs-lows.  As emphasized in previous reports, as long as this indicator is still rising the near-term path of least resistance for stocks is still up.

In the coming weeks the bulls will have a chance to prove the bear market is over.  In order for this to be confirmed, the major indices should test their November 2015 resistance levels without a corresponding increase in the number of stocks making new 52-week lows.  The market failed this simple test numerous times last year.  

Also, if the commodity market continues to weaken, we’ll need assurance that it won't spill over into the equity market like it did last year.  This will also be confirmed as long as the new 52-week NYSE lows remain below 40 on a daily basis while the new highs substantially outnumber new lows.  The period between now and early May will likely provide us with the results of both tests.

MSR Performance Review

The past year has been an exceedingly challenging one for traders and investors alike.  Most hedge fund managers drastically under performed last year, and many haven’t fared much better in the first quarter of 2016.  For those with a technically sound and conservative trading discipline like the one we use for the Momentum Strategies Report, the year has been stellar so far.

Here’s what our MSR stock and ETF trading portfolio recommendations look like through the end of March.  A picture is worth a thousand words, and the following graph shows how MSR outperformed most Wall Street hedge funds last year.

Unlike most Wall Street analysts, the Momentum Strategies Report kept our subscribers on the correct side of the market throughout 2015 by simply following the market tape.  More importantly, we’ve made impressive gains for our subscribers in 2016 to date and have dramatically outperformed the broad market by focusing on beaten-down sectors which have benefited from the February-March recovery rally.

Unlike other advisory services, MSR maintains a stock/ETF portfolio of typically less than three (affordable) trading positions at any given time. We select only the safest, strongest stocks with an emphasis on relative strength and momentum. The MSR system has enabled us to consistently stay on the correct side of the market while limiting volatility and maximizing gains.

Our goal for the months ahead is to exceed even this performance by delivering the best possible stock and ETF selection based on our reliable and battle-tested technical discipline.