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.  

Clif Droke in Traders World magazine

Traders World, the leading magazine on Gann, Elliott Wave and technical analysis, has published an article by yours truly on the topic of moving averages.  The article discusses the best moving averages to use for evaluating the XAU Gold/Silver Index. Traders World issue #62 is now in circulation and you can view the article for free by visiting the following link:

http://tradersworld.com/Free-Issue/

Trump vs. the stock market

The broad equities market has gotten a respite from the selling pressure which plagued it for the last few months.  Some of this can be attributed to the Kress cycle “echoes” which we reviewed earlier this year.  The echoes, which are based on the 6-year, 10-year, and 30-year cycles, suggested that stocks could experience a rally in the March-April time frame based on past rhythms.  To date that expectation has materialized as traders cover short positions that were built up to excessive proportions in prior months. 

Adding to the upside in equities lately has been a long overdue relief rally in commodities and natural resource stocks.  Much of the selling pressure plaguing stocks in recent months was a spillover of commodity market weakness.  With commodities now on the upswing, stocks are getting a major reprieve.  

The following chart shows the PowerShares DB Commodity Index Tracking Fund (DBC), which largely corresponds to the CRB commodity price index.  The greater the distance DBC puts between its January low, the better it will bode for the near-term stock market outlook.  A continued rally in commodities would also signal to investors that the global market crisis is in a condition of stasis.  This in turn should serve to increase risk appetite among investors. 

To date, all the classic signs of an interim bottom are in place.  The NYSE advance-decline (A-D) line is outperforming the NYSE Composite Index.  NYSE advance-decline volume is also confirming the rallies.  Most importantly, the number of stocks making daily new 52-week lows on the NYSE has drastically fallen under 40 since last month. This tells us that the market’s internal health is improving and that internal selling pressure is no longer a major problem.

Moreover, the short-term and intermediate-term rate of change (momentum) of that new highs-new lows have dramatically improved in recent weeks.  Because the number of stocks making new lows has dropped significantly while the overall hi-lo differential has been positive, the momentum of the new highs-new lows has finally turned up after being down for months.  This indicator has been an invaluable aid to confirming that the near-term path of least resistance for stocks since last month is up.

  

Arguably the biggest boost to equities in the near term has been the upward turn in the crude oil price.  Oil is widely regarded as the most important indicator for the overall health of the global economy.  Plunging prices in the energy market in past months created a deflationary scare among investors and stoked fears of a global economic recession.  Those fears aren’t completely without foundation, but for now another proverbial bullet has been dodged as the oil price enjoys a much-needed relief rally.

Finally, I would point out the bullish nature of the Dow Jones Transportation Average (DJTA) which has also been a strong leading indicator for the broad market – particularly the Industrials.  The leadership of the DJTA has been bullish from a Dow Theory perspective, especially since the Transports led the way lower for the Industrials last year. 

As the following graph shows, DJTA is about to test an important chart resistance at the 7,800 area.  A breakout above this level would pave the way for another leg higher in the major indices from a Dow Theory standpoint.

In the previous commentary I noted that the bulls would likely do everything in their power to protect the 9,000 level in the NYSE Composite Index (NYA) from being violated.  The NYA found support above 9,000 and has benefited from a vigorous short-covering rally since as the implications of a breakdown below this key technical level are simply too severe to happen at this time. 

One reason for the premature nature of a break under 9,000 is the spillover impact such a breakdown would have on the global financial economy.  The upcoming presidential election is another factor.  Surpassing worries over the global economy lately has been the hysteria over the U.S. presidential race.  Investors have been polarized over the leading candidates in both parties, particularly over the primary victories of a certain billionaire candidate. My policy of not commenting on politics forbids me from injecting an opinion, but I’d like to share at least one insight. 

The current Republican front-runner has undeniably garnered a rather sizable protest vote among disenchanted voters.  In many ways Mr. Trump’s candidacy recalls the populist uprisings of past elections which saw the short-term success of candidates William Jennings Bryan, George Wallace and Ross Perot.  In each of these cases an uncertain economic outlook led to the rise of dark horse populist front-runners. 

In the final analysis, however, America’s inveterate tendency to vote for the most electable candidate (based on the conventions of the day) won out and the extremism that characterized the earlier stages of the elections was ultimately discarded.  Observers should keep that in mind as the country’s collective passions rise with temperatures this spring.     

It also would appear that Mr. Trump’s ascension has been tied, to an extent, to the economic and equity market sluggishness of the last year.  Indeed, his biggest victories to date have occurred when stock and commodity prices have been on the downswing and the market has been internally weak.  But what happens if the market rebound gains traction and continues beyond March-April seasonal strength?  Could this not fuel a resurgence in the prospects of his closest rival for the nomination?  If nothing else it would erode deflation fears among investors, which in turn would defuse the urgency of the protest vote.  While some may scoff at this unorthodox association, pundits would do well to monitor the correlation in the weeks and months ahead.

A 2008-style meltdown in 2016?

As the global market crisis continues, the danger posed by this crisis to the U.S. economy continues to be underestimated by economists and central bankers.  A report recently showed that U.S. job openings surged in December and the number of American voluntarily quitting work hit a nine-year high.  According to the report, this data points to “labor market strength despite a slowdown in economic growth.”

Further commenting on the supposedly improving labor market, Reuters stated: “The signs of a robust jobs market could ease concerns about the health of the economy, which were underscored by other reports on Feb. 9 showing a drop in small business confidence in January to a two-year low and further declines in wholesale inventories.” 

It was also noted that economists at the Federal Reserve look at these numbers to determine their monetary policy.  What this translates to is that the Fed now has another incentive to continue pursuing their tightening policy.  This is exactly the opposite of what the market needs.  Indeed, the direction of Treasury yields (below) is screaming to the Fed that looser money is what it desperately wants.

Reuters quoted Joel Naroff, chief economist at Naroff Economic Advisors, as saying: “If the labor market is tightening, can the economy really be faltering?”  Allow me to answer his question with an emphatic “yes!” 

Most economists continually underestimate the degree to which the stock market acts as an extension of money supply.  That’s why the saying, “As goes the stock market, so goes the economy,” is so true.  The global bear market in equities has already led to trillions of dollars in losses, and this will sooner or later show up in the U.S. economic numbers.  Unfortunately, by the time it does it may be too late for the Fed to take effective action to forestall recession. 

One would think by now that Fed Chair Yellen would have learned a lesson.  Yet the overall tenor of her recent comments suggests that she is completely oblivious to the negative effects that higher interest rates are having on equities.  The fact that one FOMC voting member recently implied that the Fed would likely raise rates four times this year testifies to how oblivious the central bank is to the growing threat of a U.S. economic slowdown.

Taking the sum of the various comments from FOMC members, it would appear there is confusion within the Fed.  There is no clear consensus from voting members on what tact the bank should take in the coming year in regard to interest rate policy.  A market-sensitive central banker like Ben Bernanke would know what to do.  He would heed the market’s cry for liquidity, liquidity, and more liquidity.  

By contrast, Yellen appears to be frozen in the oncoming headlights of the global crisis.  This is not what the market wants to see.  In times of crisis the market wants above all to have confidence in its policy makers.  Until it receives a calming message from the Fed, the uncertainty will likely continue.  And as veteran market analyst James Dines used to say, “bear markets are characterized by the high state of uncertainty.”

Meanwhile stock analysts and economists are debating whether or not the global economic crisis is sufficiently big enough to cause another 2008-style crash.  The crisis hasn’t metastasized enough to allow for a definitive answer yet, but here is a technical point worth considering: The following graph shows the NYSE Composite Index (NYA) going back over the last 10 years.  I think it’s noteworthy that the NYA is testing the 9,000 level which can be viewed as a technical/psychological benchmark with origins in the 2007-2008 credit crisis. Note that when the NYA first broke below the 9,000 level in January 2008 (circled), it served notice that crisis conditions were fully underway.  It was eventually followed by a waterfall decline in the major averages.

The significance of the 9,000 level in the NYA was further underscored in early 2013 when the runaway phase of the QE-fueled bull market kicked off.  The NYA hesitated for a few weeks after initially breaking above the 9,000 level in 2013, but after re-establishing support above this level it was off to the races and the market barely looked back from there until finally hitting the wall in late 2014.

History doesn’t normally repeat by the letter, so if the NYA breaks under 9,000 this time it won’t necessarily be followed by a similar cascade-style crash.  However, a break under the 9,000 would definitely be of concern and would indicate abnormal weakness.  It could also invite panic selling, which knows no bounds if it occurs within the context of a major financial or economic crisis.  I normally don’t put great emphasis on chart levels, but in this case I believe we should closely monitor the 9,000 level in the NYA. The bulls will likely do everything in their power (limited though it may be right now) to protect the 9,000 level from being violated in the near term.

The market rarely moves in a straight line, though, and that’s one reason why navigating a bear market is very challenging.  Bear market rallies tend to occur after major support levels have been tested, and the primary function of those rallies is to keep investors from selling.  They also tend to mask the presence of the bear and keep investors in a state of confusion, hence the reason why extremes in pessimism normally don’t occur until after the bear has run its course.