The last year has
been a scary time to be an investor. In 2015, the slowdown in China’s
economy caused undue apprehension to investors and contributed to a
nausea-inducing rollercoaster ride which began last July and has continued
until now.
By the end of
2015 low energy prices were taking a toll on the high yield debt market, which
in turn catalyzed another stock market swoon. Although
the decline wasn’t severe, the January 2016 market panic ended with the biggest
spike in bearish investor sentiment since the 2008 credit crash. This
reflects the pronounced tendency among investors to panic at the slightest hint
of danger, a spillover effect from the historic 2008 crisis.
Added to the
concerns over China have been the endless scares over the euro zone
economy. Beginning
with the spill in January, investors have had one concern after another
concerning the stability of Europe’s transnational economy which in turn has
resulted in periodic financial market turbulence. More
recently, Britain’s exit from the EU has cast an additional pallor over the
euro zone outlook and introduced even more volatility to the stock
market.
Yet to those who
pay attention to stock market internals it should be clear that a change in the
market’s character began in January and has gradually shifted the main internal
trend. Last
July the market was plagued with a surfeit of stocks making new 52-week lows on
the NYSE and a dearth of new highs. This problem continued to fester
throughout the summer of 2015 until finally the market could no longer hold its
level and collapsed under the weight of the internal selling pressure last
August.
Even after the
August 2015 bottom and subsequent recoil rally the new 52-week lows never
entirely dried up. As the major indices rallied to their
all-time highs in the bounce-back, the new lows once again increased. It
wasn’t until after the bottom in February of this year that the new lows
contracted and fell below 40 on a daily basis to confirm that the market’s
internal health was finally improving. Except for a handful of instances,
the new lows have remained steadfast under 40 since then. The
new 52-week highs have also greatly outnumbered new lows since the February
bottom.
The reversal in
the market’s internal character has allowed the market to reverse the downside
internal momentum that was a staple of last year. This
has allowed the market to build a positive internal momentum structure which is reflected in the following
graph. Shown here is the Hi-Lo Momentum (HILMO) rate of change indicators
which reflect the market’s positive internal momentum currents. Note in particular the nearly vertical path
of the dominant intermediate-term momentum indicator (circled). This is a veritable needle in the backside of
the bears each time they attempt to raid the market. FYI, one year ago the chart looked the
opposite of what it does now.
What this means
is that the overall path of least resistance for stocks is to the upside. It
doesn’t guarantee a smooth flight path for stocks, of course. But
since February it has meant that sell-offs have been short-lived due to the
refusal of the market to stay down for very long. It
has also meant that bears have had a frustrating time due to the tendency for
the periodic selling panics to reverse quickly and feed on intense
short-covering.
Another
indication which doesn’t augur well for the bears in the longer-term is the
bond market outlook. Not only are
10-year Treasury yields at record lows, a favorable development for the
longer-term financial market, real estate and overall economic outlook, but
corporate bonds are showing tremendous strength vis-Ã -vis a year ago. Below is the chart of the Dow Jones Corporate
Bond Index. This reflects the increasing
demand for high-quality corporate debt; the trend was much weaker in the spring
and summer of 2015, but has since turned a corner and is making new highs. Historically, rising corporate bond prices
have eventually presaged stronger equity prices.
Moreover, the
comparative yield spread between the yields on Dow 30 stocks and 10-year
Treasuries is as wide as it has been in years in favor of Dow yields. Last year the spread was at times
non-existent as Treasury yields were sometimes higher than the yields on Dow 30
stocks, which argued against owning equities.
Now the situation has been reversed and argues strongly in favor of
longer-term stock ownership.
For the last year
the S&P 500 has been stuck in a lateral trading range. In
many ways this resembles the range-bound market of 2005, which was also
characterized by positive internal momentum. Yet
the 2005 stock market was frustrating for the bulls in that the market clearly
wanted to take off but was kept range-bound until finally breaking out
emphatically in 2006. Then, as now, the bears were
emboldened and are licking their chops for the opportunity to score big on the
next “big short.” But given the market’s buildup of
positive internal momentum over the last several months, they should carefully
rethink their longer-term strategy. If the market’s trading range proves
to be consolidative rather than distributive, they are apt to be in for a nasty
surprise after November’s presidential election.
For now, the
see-saw battle among bulls and bears continues with neither side enjoying a
distinct intermediate-term advantage. The longer the market’s internal
momentum profile continues improving, however, the more likely the bears are to
be eventually disappointed in the longer term.
The trading range, along with its intermittent turbulence, may have a
few more months to run before a post-election upside breakout is finally made.
Many investors
may express doubt or even frustration at the proposition that the bull market
which began in 2009 could continue another one, two or even three years
further. The frequent protestation that this
bull market is “long in the tooth” is heard both loud and often among the
doubters. And why should it continue, they
reason? For what possible purpose could be
served by having the market push higher without a significant setback, lo,
these last seven years? The answer is readily apparent if
one merely examines the question from outside the pale of conventional thinking.
Whenever there is
a question of motive involving the financial, political and economic destinies
of the nations, the single best source for discovering the philosophical basis
behind these actions is the great political theorist, Niccolo’ Machiavelli. Machiavelli
has supplied posterity with perhaps the broadest, finest survey of Greco-Roman
history from which every possible political outcome from any event can be
derived. His great masterwork is The
Discourses on Livy, which distills the great lessons from a thousand years
of Roman history into a single tome.
One theme he
emphasizes is the constant clash at all times in history between the moneyed
ruling class and the great masses of freemen. Concerning
this clash he writes, “For without doubt, if one considers the respective aims
of the nobles [upper class] and the populace [middle class], one sees in the
former a strong desire to dominate, and in the latter merely a desire not to be
dominated.”
The above
sentence provides the reason for most of the discord in the political and
economic life of any nation. It can also be applied to the
motives of those heavily involved in the financial markets, for the great game
of the stock market is nothing if not a desire among the dominant players to
fleece the less-dominant participants through tricks, ruses and
stratagems. It stands to reason then that
successful speculation for the outsider consists chiefly in the ability to recognize
these tricks.
“In most cases,”
Machiavelli says further, “discord [i.e. crashes, panics, and depressions] is
caused by those who possess, because the fear of losing generates in them the
same desires as those who wish to acquire. Men do
not feel their possessions secure if they do not also acquire the possessions
of others. And the more they possess, the more
power and capacity they have to cause turmoil. Furthermore,
their improper and covetous behavior ignites in the hearts of those who do not
possess the urge to avenge themselves and rob those who do, gaining the wealth
and honors that they see so badly misused by others.”
The above
statement can be applied to the present bull market and explains why it must
continue until the end game strategy among the dominant players is
complete. It has been observed that secular
bull markets end only when the greatest number of outsiders (i.e. small
players) enters the market as indiscriminate buyers of stocks. For the
dominant players must have someone to sell to and, as they cannot unload their
vast holdings amongst each other, large scale participation among smaller
investors is required to complete their final strategy.
Consider that the
end game of the previous bull market was the 2008 credit crash, which dealt a
grievous blow to the U.S. middle class from which it has yet to fully
recover. With millions of middle class
Americans dispossessed of their houses and stock holdings, what fruit could
possibly be left for the dominant players to pick? The
answer is found in a news item on Fortune.com:
“America’s upper
middle class is larger and richer than it’s ever been, controlling about 52
percent of the country’s income. The share of households earning
between $100,000 and $349,999 for a family of three doubled from roughly 13
percent of the population in 1979 to nearly 30 percent in 2014. The
middle class accounts for 32 percent of the population and controls 25.8
percent of the income.”
My late mentor,
Samuel J. Kress, was of the opinion that most of the major financial market
calamities and debt busts are largely fueled by the upper middle class. According
to his thinking, they are the economic class which is the most aggressive in
trying to become rich. Upper middle class investors are
close enough to the upper class that they can “taste it”, and so they undertake
undue risks in their attempt at reaching the next level. When they
fail, the result is credit crises and market crashes. Those who
are comfortably middle class, by contrast, are much more likely to remain
content with their lot and are more risk averse by nature.
Since the upper
middle class emerged from the 2008 credit crisis aftermath relatively
unscathed, it’s clear that they will be targeted by the dominant players in the
run-up to the next major crash. As the conditions for a major crash
aren’t yet fully developed, the bull market must continue until those
conditions have been prepared. Upper middle class investors,
moreover, must become committed participants in the stock market much as middle
class investors were in the run-up to 2008. Until
this happens, the bull market should be assumed to be yet still alive.
