2018, 2007, Charts, And The Wisdom Of The Crowd

TRADE WAR TO BRING RECESSION AND BEAR MARKET?

Charts help us monitor the market's net aggregate opinion regarding all subjects on all timeframes.  When the net aggregate opinion is bullish, stocks tend to rise.  When the net aggregate opinion is evenly distributed between bulls and bears, markets tend to go sideways.  When the net aggregate opinion flips over to the bearish camp, stocks tend to fall.  Thus, charts help us monitor the wisdom of the crowd.

2007: 73 DAYS AFTER MARKET PEAKED

In 2007 after the market peaked, investors had to deal with a recession and a bear market;  stocks dropped over 50%.  In 2018, the S&P 500 peaked on January 26, or 73 calendar days ago.  The chart below shows the S&P 500's 110, 115, 120, 125, and 130-day moving averages.  On the left side of the chart the fastest moving average (blue) is on top and all the moving averages have positive slopes.  The right side looks significantly different with blue on the bottom and all the slopes are down, indicating market participants were concerned about the longer-term prospects for a recession and bear market.

2018: 73 DAYS AFTER THE MARKET PEAKED

The present day "wisdom of the crowd" does not have the same "we are concerned about long-term problems" look that was present on the 2007 chart above, telling us to keep an open mind about better than expected outcomes in the weeks and months ahead.

MARKET IS CONCERNED ABOUT A TRADE WAR

The trading range we have been covering for weeks is indicative of a market that remains concerned a protracted trade war could eventually lead to a recession and/or bear market. However, the fact that stocks (a) have not exceeded the February low and (b) remain inside the range, tells us the market also remains open to a resolution that will allow for a resumption of the primary trend.  In short, the market has not made up its mind as to the severity and potential impact of the trade dispute between the United States and China.

THE PRIMARY TREND REMAINS POSITIVE - FOR NOW

Has the market flipped into a downtrend, even on the most basic level?  This week's video answers that question in a logical and unemotional manner.   The video also covers a fundamental checklist for bear markets, historical returns after the S&P 500 drops below its 200-day moving average, and two key market areas investors and traders tend to greatly underestimate.

“Groups are remarkably intelligent and are often smarter than the smartest people in them. Groups do not need to be dominated by exceptionally intelligent people in order to be smart. Even if most of the people within a group are not especially well-informed or rational, it can still reach a collectively wise decision.”

— James Surowiecki - The Wisdom of Crowds

TRADE WAR: BULL AND BEAR SCENARIOS

Markets remain perilously close to a trade-war point of bull/bear inflection.  This week's video looks at two major scenarios: a bearish resolution and a bullish rebound.

Are We Hitting The Point Of Maximum Trade War Concern?

PRESS IS IN THE EYEBALL BUSINESS

Financial networks and websites are in the eyeballs and click business; not that there is anything wrong with that.  The uncertainty related to a possible trade war between the United States and China is good for attracting eyeballs and generating clicks. Therefore, some of what has been written needs to be taken with a "what business are they in" grain of salt.

A PRUDENT LOOK AT BOTH ENDS OF THE TRADE SPECTRUM

Are there reasons to be concerned?  Yes

Are there reasons to believe the worst may be behind us?  Yes

CASE A:  WE ARE NEARING THE PEAK OF FEAR ON THIS TOPIC

A rational argument can be made that Trump's tariffs are nothing more than a negotiating tactic to increase leverage when discussions begin with China.  China's response to Trump's moves have basically the same "we will not be pushed around at the negotiating table " objective.  

“Now listen to me. I am negotiating. Negotiation, this is what you do in business.”

— George Costanza

A protracted trade war is not in either side's best interest. Tariffs, even the threat of tariffs, create numerous squeaky corporate wheels for Trump in the United States and for Xi Jinping in China. Nobody wants to deal with squeaky wheels for a protracted period; it can be very draining. 

Trump is most likely looking for some way to declare victory or show some progress on the China trade topic before midterm ballots are cast.  He has some specific objectives, including steel, aluminum, market access, and intellectual property; hence the need for proposing to enact several tariffs.  China has simply responded in kind to maintain a powerful posture.  Trump does not want this topic in the problem hopper when midterms arrive; China does not want to be perceived globally as anti-free trade. 

We are not in a trade war with China, that war was lost many years ago by the foolish, or incompetent, people who represented the U.S. Now we have a Trade Deficit of $500 Billion a year, with Intellectual Property Theft of another $300 Billion. We cannot let this continue!

— Donald J. Trump (@realDonaldTrump) April 4, 2018

Trump was fairly silent on this topic for a few days that were marked by wild swings in the financial markets.  His April 4 tweet may mark the end of that silence and signify he wants to tone down the rhetoric and move closer to the negotiation/resolution phase.  If that is the case, which is still to be determined, it is possible today marked peak news-cycle-fear on the trade war topic. 

CASE B:  EGOS COME INTO PLAY

We would like to think the leaders of the United States and China can exercise the proper self control going forward, allowing for an eventual shift away from a ping-pong game of tariff announcements and toward the negotiation/resolution phase.

Unfortunately, when power, egos, and politics are involved, anything can happen, including an escalation from a trade battle to a full-blown trade war.  Therefore, while it is prudent to run through a few "what if" scenarios, we must remain flexible, disciplined, and open to all outcomes from an investment management perspective, which is exactly what we will do. 

Price Action YTD - What Can We Learn From History?

REFERENCE POINTS PROVIDE CONTEXT

““In strategy it is important to see distant things as if they were close and to take a distanced view of close things.” ”

— Miyamoto Musashi, Legendary Japanese Swordsman

A December 2016 post highlighted similarities between late 2016/early 2017 and the 1994-1995 period.  The analogy proved useful in 2017 with stocks posting a rare low-volatility year that featured a strong bullish trend, which compared very favorably with the strong-gains/low-volatility year of 1995.

EASIER MARKETS AND HARDER MARKETS

Since we know easier markets are typically followed by harder markets, it is not particularly surprising 1996 was not as easy as 1995.  Nor is it particularly surprising 2018 has been harder than 2017.  Price action in 1996 featured several bullet points investors in 2018 should easily identify with:

• 1996 started with a gain of 10.58%
• Stocks then dropped 11.04% and went into negative territory YTD
• The S&P 500 dropped below an upward-sloping 200-day moving average.

WHAT HAPPENED NEXT?

After dropping below the 200-day moving average and pushing into negative territory YTD, the S&P 500 resumed its primary trend by tacking on a gain of 25.78%.  After a rough period in the first half of the year,  patient investors were rewarded with a satisfying annual gain of 20.26%

HOW CAN IT HELP US IN 2018?

This knowledge helps us keep an open mind about all outcomes in 2018, including better than expected outcomes.  Just as 2017 followed its own path while sharing some key characteristics with 1995, it is within the realm of possibility 2018 could feature a "harder market" in the first few months of the year and still go on to post satisfying gains when the calendar hits December 31, 2018. 

LOW VOLATILITY IS NOT BEARISH

When volatility was low in 2017 we heard "this is not normal and is thus bearish".   In 2018 we are hearing "this is too much volatility and is thus bearish".  As calendar year 1995 proves, a low-volatility year, like 2017, is not necessarily bearish.  In fact, low volatility is a sign of strong bullish conviction.  When we view the increase in volatility that took place between 1995 and 1996, the shift between 2017 and 2018 does not seem particularly abnormal; in fact, it seems to fit the strong-bullish-trend script.  We covered these "don't be surprised if volatility picks up" concepts back on January 29, 2018.

HOW OFTEN DO STOCKS VIOLATE A 50-DAY MA? .... A 100-DAY MA? ...A 200-DAY MA?

If you have a pulse, you have probably noticed bearish articles covering "major trendline breaks" involving numerous "key" technical levels, including the 50, 100, and 200-day moving averages.  To put these "bearish" signals into some real-world context, this week's video reviews the frequency of "trendline breaks" within the context of a primary bullish trend.  After reviewing the facts, you can make your own call.

BEARS HAVE AN OPEN DOOR

Given the vast majority of industry-related articles have leaned bearish in recent weeks, it is fairly easy to keep an open mind about an ongoing correction and/or bear market.  As outlined on April 2, a sustained S&P 500 visit below 2,532 would give the bearish case a nice boost.  It is important under our approach to remain highly flexible and open to all outcomes from wildly bullish to wildly bearish.  The markets will guide us if we are willing to listen.