Markets Move, Not In A Straight Line

If the stock market is reflective of social mood, and I believe it is, then we have experienced quite a mood change in the fourth quarter of 2018. From all-time stock market highs to the lows of the year, to what may be the worst December stock market since the Great Depression, the market, and mood, has changed.

Your mood may have changed as no one likes to see gains evaporate, particularly at historic clips. Markets, as I have preached for years, do go up and down after all, so this must be a part of it. Yes they do, but ups and downs do not reflect the true risk with this market.

The reason I find it important to forecast and call changes in trend is because with each later stage of the thirty-plus year (if not ninety year) bull market, I see the risks inherent in subsequent turns as much greater than we have previously experienced. We therefore should not be surprised when the unusual or extreme occurs because, like prior downturns, we are aware the surprising will probably occur.  Or in this case, take December as an example.

In my 2012 letters I called the end of the bull market for bonds. Short-term interest rates have never been lower and longer-term interest rates were only lower briefly in 2016.

In my November 2017 letter, I called the Top of Tops as it appeared to me the stock market was answering the question: how high is high? Stocks had begun their turn higher in early 2016 such that in August 2016 I said “I think you will really enjoy the stock market rally which appears to be gathering steam.” From the Dow Jones around 18,000 in August 2016, I marked 23,500 in November 2017 as a nice jumping off point and answer to the how high question.

Obviously, answering how high is high is difficult; how high is highest even more so. But I believe I have served you well these past months and this is only the beginning. The trend for both stocks and bonds is now lower, confirming my stock call fourteen months ago.

Making calls for calls sake is not how I am paid. I am paid to execute, to execute a strategy. While the direction of bond prices (and their respective yields) is important for good execution of this strategy, some maybe lost with respect to the role of stock prices.

Stock prices, but more importantly the social mood they reflect, are a huge factor in bond market prices. Think about the role of optimism: everyone should be optimistic about the prospects of the bond they are buying to continue to pay and later mature in your account. We know no other feeling; we have been primarily financially optimistic people for ninety years now.

Most people assume that bonds are worthwhile when the growth prospects for stocks are no longer growing. This goes back to some economic textbook or the reason to be diversified as bonds may do better if stocks falter in a given year. This is not what I am talking about.

If social mood (and the stock market) has peaked as I suggest it has, optimism has also peaked. Understanding the trend is important, but so is the understanding that the speed of change can have dramatic consequences.

Who knew that we would have yearly lows in stock prices in the same quarter that we posted a new stock market high? Who knew that we would be down close to twenty percent in the averages in the same time frame or that we might have the worst December for stocks since the Great Depression? The answer is this is all possible once you realize the trend for the market changed and is now down.

Much worse is of course possible, in my opinion, and this is because stocks and bonds are aligned in their trend. It is difficult to be pessimistic in bonds while the mood for stocks is at an  all-time peak. But now that is not the case, so I expect to see a few unbelievable things happen in the bonds markets in the coming months.

We have been operating in a bond bear market since 2012, so our approach and strategy has plenty of history. What is new and will continue for many months and years going forward is the influence and approach of others in the bonds market, particularly as optimism wanes and pessimism reigns. With the Select Approach^TM we are prepared and we have strategy.

Since stocks peaked in October we have seen prices on longer treasury bonds rally. While stock prices have swooned bond prices are up as the ten year yield has dropped from 3.26% on October 9 to 2.72% on December 26. Remember, markets go up and down but the direction of trend for both stocks and bonds is down. The idea that bonds will work if stocks don’t is an optimistic idea and I expect this idea to fade and bond prices to fade with it.

For comparison sake, the ten year treasury traded at 2.01% in September 2017 and was 2.47% at my Top of Tops call in November 2017. So while the note traded at a new low price (high yield) of 3.26% in October, the rally into December was merely corrective. I expect new highs in treasury yields (and now lows in prices) in the coming months.

Recognizing the alignment of dual bond and stock bear markets is crucial to understanding the risks now present in the financial markets. Pessimism is on the rise and will be reflected in stock prices. Longer-term bonds as well as other,  albeit smaller, asset classes are not worthwhile either. Cash as defined by short-dated bonds, is the place of safety and the preservation of your capital. Continue to move towards cash.