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Does February’s stock market swoon put all of us on notice that a crash of 1987 magnitude (or even greater) may be possible? It most definitely should.

Shot Across The Bow

March 1st, 2018 by Kurt L. Smith
  • While bonds continued their slow, steady march to higher yields (and lower prices), the stock market corrected. One thousand Dow points lost in just over an hour. Stock indexes swooned, even falling below the levels I marked in my November Letter as the Top of Tops.

    I am sure you didn’t sell in November, just as I am sure you didn’t sell 3,000 points higher at 26,500 in January. You are not conditioned to sell; you are conditioned to buy the dips. We have enjoyed thirty-plus years of bull market reinforcement, not to mention every bit of economic, scholarly and sage advice written to further reinforce stocks for the long run.

    Last month’s letter predicts the bond crash of 2018. Despite the stock market’s gyrations of late, the bond market neither soared or crashed.  The bond market continues to deteriorate, yet at a seemingly glacial pace over the past several months. Ten year US Treasury notes were 2.01% on September 2nd and touched 2.95% in February (Bloomberg) while activity in municipal bond markets remain somewhat muted. Overall, new higher yields for US Treasury notes and bonds, furthering the bond bear market but no crash, yet.

    You may remember Black Monday. On Monday October 19, 1987 the Dow fell 508 points or 22.6%, in one day. I certainly remember, as the Dow rose at a torrid pace that year and my wife and I were invested in Peter Lynch’s Fidelity Magellan mutual fund. With a need to fund the down payment for our new house we exited the fund in the early summer. What you may not remember is what occurred before Black Monday. The Dow peaked on August 25th at 2,736 and fell in a first move down, to 2,475 on September 22nd, a decline of 9.5% over nineteen trading days.

    Thirty years later the Dow topped at 26,616 on January 26th, 2018 and fell to 23,360, a decline of 12.2% in just ten trading days. Why the Dow fell in 1987 or why it fell in 2018 is not important. What I do believe to be important is that markets do not move in straight lines or only in one direction.  More importantly, context is key.

    In context, Black Monday and the stock market crash of 1987 was a correction not just of stocks but also for bonds. The yields we saw in October 1987 in treasuries and municipals we have not seen since, not to mention the almost unbelievable Dow at its 2,475 low.

    Thirty years later we have seen the end of the bond bull market and the unfolding bond bear market is gathering converts every day. This is why I believe the end of the bond bull market in late 2012 is key. Interest rates on US Treasury bills, notes and bonds are moving higher (bond prices are falling) across all maturities. Does such a fact portend a turn in stocks? Not necessarily. Does February’s stock market swoon put all of us on notice that a crash of 1987 magnitude (or even greater) may be possible? It most definitely should.

    We may have forgotten 1987 or 2000 or 2008 for that matter, but that doesn’t mean a stock market crash of 22% in one day cannot be exceeded. These are markets we are talking about and markets change, sometimes violently.

    Hopefully you are one who has enjoyed the benefits of both the bond and stock market thirty-plus year bull. For my clients I would say while you have been investing in a bond bear market for over five years now, the experience stock investors may face in a bear stock market will probably be decidedly different and painful.

    If February’s stock swoon is indeed a precursor to the bear market, as I believe it to be, one of the defining factors will be the lack of any place for most investors to hide. US Treasury bonds rallied a bit when the Dow dropped by over 1,000 points on February 5th.  Anyone who had bought bonds that day looked good for a short while, but the bond market traded to new highs in interest rates (new lows in prices) merely days later.

    We have enjoyed global synchronized growth as one explanation for the worldwide rally in stock prices, especially to historic highs in the US. Globally, synchronized bear markets with stocks joining bonds could be equally awe inspiring, with decidedly different results.  As we saw last month, selling off 12% in just ten days, we may not have to wait long to determine the bear is taking hold.

    This is the problem, not only for the longest stock market recovery on record (celebrating nine years this month) but also for an aging bull market. Events like 1987 can occur at any time (following steep run-ups), but 2018 has already established itself as worse than September 1987. That does not portend well for what may occur next.

    Plainview, Texas GO

    S&P AA (AA- Under)

    BAM Insured

    Due 2/15 Dated 2/15/18 Maturity: 2/15/2038

    Sale Amount: $24,750,000

    1 2019 5.00% 1.45%
    2 2020 5.00% 1.65%
    3 2021 5.00% 1.80%
    4 2022 5.00% 1.95%
    5 2023 5.00% 2.10%
    6 2024 5.00% 2.26%
    7 2025 5.00% 2.40%
    8 2026 5.00% 2.55%
    9 2027 5.00% 2.63%
    10 2028** 4.00% 2.70%
    12 2030** 3.00% 3.00%
    13 2031** 3.00% 3.10%
    14 2032** 4.00% 3.20%
    15 2033** 3.125% 3.25%
    16 2034** 3.125% 3.30%
    17 2035** 3.25% 3.35%
    18 2036** 3.25% 3.40%
    19 2037** 3.375% 3.45%
    20 2038** 3.375% 3.48%

      *Yield to Worst (Call or Maturity) **Par Call: 2/15/2027

    Source: Bloomberg

    This is an example of a new issue priced the week of 2/27/18

    Prices, yields and availability subject to change



    Big Profits Drove a Stock Boom. Did the Economy Pay a Price? via @nytimes