We have been warning investors of increasing volatility as the calendar turns more toward the 2020 election. Elections cause uncertainty, and uncertainty is the enemy of the stock market. The stock market is not cheap, and has been touching new all-time highs for months, which implies the next series of marginal new all-time highs may require more and more effort on the part of buyers to achieve. And, if one adds into the mix the potentially fading effect of all that stimulus from the financial crisis back in 2009, which probably got a temporary boost from the two trillion dollars of debt added to the nation’s balance by the Republican’s narrowly focused tax cut, then it is easy to make a case for increasing volatility.
I should probably also mention the recent new item of uncertainty in evidence this past week, as institutions have begun to worry about an inverted yield curve, a condition which happens when long term interest rates drop below short term rates. Institutions are prone to take this as a warning of a coming recession. So, the bottom line is the bull stock market now has a taller “wall of worry” to climb. Alexander and I expect more volatility in the coming months, with some months likely to experience some dramatic episodes of volatility.
The stock market has now declined enough for pundits to begin to talk about a new bear market in anticipation a recession, or at least the end of economic metrics like unemployment touching levels, which historically depict a strong and vibrant economy. This is the notion that when things are as good as they ever have been economically, then the only path forward are post peak conditions, or a long slide toward the next bottom in the economy. This notion was around in the 1990s, even though the bull stock market continued to roar along only to begin to encounter some headwinds after the Clinton administration accomplished a rare balanced federal budget. So the bottom line for this section is the bull market will end when supply begins to overcome demand, and no one knows if that will happen soon, or years from now. In the interim we shall monitor the ever changing balance of supply and demand, and then make portfolio adjustments as needed to manage the implied risks.
TATY — A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS
TATY is shown in the first chart above with the S&P-500 overlaid in red and blue candle chart format. As the market has been gyrating hundreds of Dow points a day, TATY has continued to generate numbers consistent with firm underlying demand. This week’s persistent decline caused TATY to close in the red zone for the first time in a while, which is still consistent with demand stronger than supply in strategic terms. As long as TATY does not begin to paint out numbers in the caution zone surrounding the 115-125 level, then it is reasonable the expect a renewed assault on all-time highs once this current weakness is over. Should TATY make an excursion into the caution zone, then the probabilities that the stock market may be forming a major top would rise. The measured strength, or weakness, in the next rally would become critically important in determining, if investors should become aggressive in protecting accumulated profits, and begin lowering their risk profiles. Should the TATY rally begin to fail near the red zone, then the probability of a major top being formed would rise dramatically. Until such a “Big Chill” setup completes its necessary steps, then the probabilities will remain favorable for an assault attempt on new all-time highs after the current correction has reached its conclusion.
SAMMY — A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS
SAMMY is shown above in the chart above, and in the chart below with the SPXL 3X ETF overlaid. SAMMY painted a “whole body” candle below its lower Bollinger Band on Friday. When this happens it is usually a signal that sellers are entering a zone, where their propensity to sell normally exhaust itself. So SAMMY has now entered a zone, where we should begin to look for evidence of resurging demand in the short term. Upon evidence of resurging demand, we may decide to add new long positions to portfolios in an effort to enhance overall performance with an intermediate trade, or to absorb excess cash. There are also some growing positive divergences in some of the strategic indicators, so any tactical buy signal issued in the near term may have the added benefit of the strategic positive divergence. Investors may also observe that SAMMY is showing a positive divergence to the overlaid price in the last chart, so positive divergences now exist strategically and tactically. However, while the TATY premium/discount indicator (see lower panel of the chart) has declined below the zero line, it has not reached the red line at minus eight, which would signal a greater discount to “value” trade setup. The greater the discount to “value” the more washed out the sellers, and less implied risks for new purchases. I’ll monitor this potential setup, and then make a decision, if we want to participate in a tactical intermediate trade.
THE BOTTOM LINE
Investors will likely encounter increasing volatility from now until after the 2020 election. We plan to use this increased volatility to enhance the performance of client portfolios, so the more volatile investment environment would not necessarily be a negative. There are positive divergences beginning to grow in some strategic and tactical indicators, which implies the current leg down in the correction, or possibly the entire correction, may be nearing an end. If an opportunity for a low risk intermediate trade develops, then we will consider taking advantage of the current oversold conditions, and a discount to “value” situation to possibly initiate another purchase of VOO or QQQ.
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