The powerful waterfall declines.
The massive oversold readings they generate.
The intense (but short-lived) bear-market rallies that follow, usually inspired by some policymaker somewhere trying to come up with a “solution.”
It’s déjà vu all over again, folks.
Yesterday, European Central Bank President Mario Draghi tried to sell investors on the idea that there are “no limits” on what monetary magic he can perform. That apparently is his next catch phrase, now that “whatever it takes” was already used up.
Then overnight, we heard increasing chatter that Bank of Japan Governor Haruhiko Kuroda will act next week. Then he said in Davos, Switzerland that he has “many options” and “further room” for more QE. The comments gave asset prices another boost.
But here’s the thing: Draghi already threw the kitchen sink at the markets in December. Investors weren’t impressed, and stocks tanked not long after. The BOJ did the same thing, launching so-called “supplementary” easing steps. Investors weren’t impressed with those, either, and stocks tanked not long after.
|Something may be coming soon out of the Bank of Japan.|
This refusal to buy (for more than a few hundred points or a few hours/days) what central bankers are selling is a key reason we’re in a bear market. Investors now appreciate the important point I’ve been making for awhile: If any of this spaghetti being thrown against the wall actually worked, we wouldn’t need more central bank pasta every few months.
But enough about my philosophical views. Today, I want to do something different for you. I want to share a couple pages from my “Bear Market Playbook.”
Let’s go back to December. I saw the markets trying to rally on positive seasonality and a temporary cessation in the selling in key markets like junk bonds. But I also continued to see signs of behind-the-scenes turmoil in corners of the credit market, in foreign equities and bonds, in leveraged loans, and elsewhere. I also saw ongoing underperformance in more credit-sensitive small capitalization stocks and financials.
Those were the very same indicators that first warned of trouble in stocks last spring. They were some of the very same indicators that alerted me in 2006 and 2007 that a major bear market was looming. So I concluded, based on my playbook, that the rally was total bunk – a brief respite amid a broader downturn that was nowhere near over.
My course of action: Refuse to let the bounce shake us out of longer-term bearish positions. I recommended my subscribers hold on to virtually all of them. I even went a step further, adding a couple fresh bearish positions — focusing in particular on the most vulnerable names. That included European mega-banks and companies with outsized exposure to emerging markets.
That approach was richly rewarded as reality came crashing down for overinflated stocks in early 2016. So I pulled out the playbook again and shifted into high gear. I used the waterfall declines in vulnerable stocks to recommend subscribers peel off rounds of profits.
But I also continued to see a lack of panic selling. The declines were weirdly orderly, and the VIX remained relatively tame — despite several days where the Dow swung by a few hundred points.
That wasn’t what I’ve seen in true short-term selling crescendos in past bear markets. So I only recommended people take partial profits on some positions. I also recommended they “grab and roll down” to lower strike prices on select options. That helped them pocket some gains, while still leaving them with skin in the game.
As we got more and more oversold, I shifted to a strategy of lowering their overall exposure. Then as some of my targeted stocks got closer and closer to my original downside targets, I implemented one last strategy. I recommended they place some above-market, limit sell orders.
|“Stocks can move very fast and very far, but sometimes reverse in the blink of an eye.”|
The idea: In crescendo selling phases of bear markets, stocks can move very fast and very far, but sometimes reverse in the blink of an eye. Better to have some pre-set targets out there so you don’t miss out. Sure enough, my targets on a few positions were hit … then the market bottomed out amid hope for more central banker happy talk.
That brings me to the late-week oversold rally, spurred on by the factors I mentioned earlier. Will it last? Will it go further? What does the playbook say to do next?
Frankly, it looks like all of the rallies I saw in 2007-09 along the way to the ultimate low. Some were spurred by Federal Reserve rate cuts. Some were spurred by comments from the likes of former Fed Chairman Ben Bernanke or Former Treasury Secretary Henry Paulson that the housing crisis was “well-contained.”
Others simply came out of the blue after you had temporary selling crescendos. I remember one in early 2007 when mortgage lender New Century Financial went broke, and another when troubled investment bank Bear Stearns collapsed and had to be rescued by the government and JPMorgan Chase (JPM) in early 2008.
But none of them held — not until all the policy mistakes and economic excesses of the bubble were wrung out … all the vulnerable companies who went crazy during the boom went broke or got taken over for pennies on the dollar … and all the bullish investors who kept chasing every short-term rally finally gave up.
I don’t see signs of that being the case yet. I still see too much hope, too little panic, and too much blind trust in failed policies that we know don’t work. So my advice is as follows:
Let the rally run its course. It could last for a few more days since the BOJ and Fed meet next week. We could even see 16,500-16,600 on the Dow if enough momentum buyers glom on.
But don’t get sucked in. Use any significant bounce like that to lighten up on any vulnerable positions you didn’t unload when I warned repeatedly last spring, summer, and fall that we were facing a potential market crunch.
Then when the short-term momentum runs out … when the next supposed “solution” is actually announced … and when the oversold condition is worked off, pounce. Add new positions designed to help you profit from the next leg down.
Does that make sense to you? Or do you think global policy actions here will put a lasting floor under asset prices? Did we get enough selling earlier this week to set the stage for more than an oversold bounce? Or do you think there’s more to come?
How are you positioning your portfolio in light of this massive volatility? Please let me and your fellow investors know in the comment section.
With another crazy week coming to a close, the market discussions are really heating up online.
Reader Josephus offered this take on the tumultuous sell offs and rallies:
“This financial storm will hit bad. As with weather, you have to stock up with a lot of energy to keep warm, so stock up with real money and cash and let it rip. Once the storm spins itself out, you will still have plenty left, unless you give it away to the spendthrifts.”
Reader Steven said: “The problems with Europe’s financial markets appear to be systemic. They are the expected result of their policies. They only have two choices: Continue their policies until all of the liquidity is concentrated into what will become a financial black hole OR admit failure and defeat and walk the ‘belt line’ of public scorn and consequences.
“The latter is hardly likely to happen, so I would advise positioning your finances and assets well beyond the event horizon as it were.”
On the flip side, Reader James C. offered a bit of optimism about the outlook, particularly in Asia. He said:
“China will lead the recovery in the world economy. Even if its economy slows sharply over the next few years, its long-term prospects remain bright. China faces many obstacles to growth, like its fragile banking system and the lack of a transparent legal system. But if reforms continue, there are good reasons to believe that rapid growth can be sustained.”
If you’re looking for investing strategies beyond what I’ve offered, Reader Jason suggested the following: “Load up on 2016 American Eagle Silver Dollar coins and batten down the hatches. The Dow’s little mini-spike higher is nothing but a lull before the storm!”
Or you could try Reader Jim’s tongue-in-cheek suggestion: “My new retirement plan is to stash my rubles in an Italian bank.”
Thanks for sharing! We could all use a little humor in these trying times. Make sure you add your trading ideas to the mix this weekend when you get a chance. You’ll find the discussion section below.
I haven’t had much to say about the gathering of millionaires, billionaires, policymakers, and press in Davos, Switzerland this week. The reason: The World Economic Forum always involves a bunch of speechmaking, debate, and chit chat – but little real news. Events are highly scripted and no one really speaks out of tune.
But I’m definitely seeing and hearing more reports about increasing worries behind the scenes. And if you are looking for a Davos fix, here’s one item quoting International Monetary Fund head Christine Lagarde and her concerns about the global economy. Here’s another discussing intensifying worries about the fate of the European Union.
The snow, ice, high winds, and rain is really coming down across a wide swath of the Mid-Atlantic and Northeast now. Dubbed Winter Storm Jonas (unofficially) by the Weather Channel, it’s causing accidents, power failures, school and work closures, and airport delays and cancellations in several states.
How much does Google (GOOGL) pay to have its search bar show up on Apple’s (AAPL) iPhone? Apparently $1 billion in 2014 alone. That’s one shocking bit of news from a lawsuit that Oracle (ORCL) is pursuing against the search giant. Google fought to have that information kept out of the public domain.
Staying ahead of the game as always (Ahem), Moody’s said it’s reviewing the credit ratings of 175 major energy and mining companies around the world. That includes energy giants like Royal Dutch Shell (RDS.A), as well as extremely troubled domestic producers like Chesapeake Energy (CHK). Debt downgrades may follow at any time.
Do you think the policymakers gathered in Davos have a handle on what’s going on – or are they clueless about the turmoil to come? What do you think about Moody’s decision to reconsider its energy credit ratings? Are you surprised by how much tech companies pay each other for things as simple as search bar placement? Let me know in the comment section here.
Until next time,