BALL OF CONFUSION (Finding A Bottom)

January 16, 2019 | Vito Finucci


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What happened in 2018? What made money? What are the three things holding the market back? What part of the business cycle are we in?

vito finucci rbc london ontario

 

 

“… Ball of Confusion, that’s what the World is today.

Eve of destruction, tax deduction, city inspectors, bill collectors.

Evolution, revolution, gun control, the second of soul.

Shootin’ rockets to the moon, kids growin’ up too soon.

Politicians say more taxes will solve everything… and the band played on.

So round and around and around we go. 

Where the World’s headed, nobody knows.”

                -Ball of Confusion - The Temptations (1970)

 

 

After ten years, the longest bull market in history is on life-support. What started as a tough October, with a recovery in November, since December, has turned into a major sell-off.

Of course, no downturn has a single cause but the Federal Reserve bears the brunt of the criticism at the juncture as it raised rates yet again, but still insists on ore rate hikes in 2019. Markets reacted swiftly and negatively.

The numbers are remarkable. In just 13 trading sessions, the S&P 500 had lost 14%. Over 400 of the 500 names are trading below their 200 day moving average, and on one day the week before Christmas, new lows beat new highs 175-0.

In fact, it was the worst December on markets since the Great Depression (1930). The means worse than two weeks after Pearl Harbour in 1941, worse than during World War II (1942, 1943 and 1944), worse than during the Vietnam war in the early 1970’s, worse than a couple months after the crash of 1987, worse than two months after 9-11, worse than in the midst of the Great Recession in 2008 when it looks like every bank on the earth could go broke, and many other examples I could mention. None of this makes any sense.

The S&P 500 is now down over 3-, 6- and 12-months, a backdrop that has accompanied just two of 76 rate increases since 1980. It’s also the first time in 19 cycles, that the US market is down Nov-Dec in a US mid-term election year.

Something is awry here. Ball of Confusion indeed.

There is a long list of reasons for the sell-off. Among them:

  • Fed tightening interest rates too quickly
  • Fed removing QE too quickly
  • US Government shutdown
  • Flattening yield curve
  • Slowing China growth
  • ETF/Passive Fund selling
  • Weak energy prices
  • Tariff/Trade barriers
  • Brexit uncertainty
  • Italian budget crisis
  • Debt levels
  • US economy slowing

It wasn’t just a tough Q4 for markets. All of 2018 was tough. You know it has been a challenging year when close to 90% of all global asset classes generated negative returns. It is also the first year since 1972 in which no asset class returned at least 5% (source: Ned Davis Research).

In fact, cash went from the worst performing asset the last two years to the best performing asset. Cash has not been #1 for 19 years:

As tough as the US markets have been, some global markets were crushed, where since the highs of year, there are a number of countries who’ve been in bear markets for some time: Russia, Spain, Italy, South Korea were down 25%, China and Brazil down 30%, and Turkey more than 50%.

But in the terms of US mid-term election years. 2018 was “average” as you can see from these charts:

Financial markets seem to be having trouble digesting three main issues:

  1. Central bank tightening
  2. Trade wars
  3. Global growth slowdown

With respect to central banks, here’s how it looks:

In the USA, the Fed did zero for almost 8 years, then since the Presidential election, increased from zero to 2.50%.

But when compared to recent cycles and S&P drawdowns, something doesn’t look right.

 

 

S&P 500 Drawdown

 

Inflation

2018

-20.0%

2.2%

1974

-11.6%

11.5%

1979

-9.5%

11.9%

1975

-9.4%

9.2%

1980

-9.2%

12.6%

(Source: awealthofcommonsense.com)

With respect to rate increases, the Fed has already reduced 2019 from four to two, and will be “data dependent”. Heck, I think there’s a chance they even cut again in 2019.

With respect to trade, discussions have already started between the USA and China. I think there will be a deal. They both need it.

Finally, while economic activity may be slowing, there are no strong indications that the global economy is about to fall off a cliff in the next 12 months.

So yes, we’ve had a brutal quarter. How have markets fared after similarly brutal quarters? :

 

What to do now?

The first and most important thing to do is not panic. It’s so important I’d put it at first and second thing to do. Remember Warren Buffett’s diction of “Be fearful when others are greedy and be greedy when others are fearful”. Right now, yeah, there’s a lot to fear. Not once in the seven cycles I’ve witnessed has selling paid off longer term.

Here’s how this bull market compares to recent ones:

Market tops generally occur after a prolonged period of confidence (and greed) and I’d say that has not been the consensus for years. It just did not “feel” like past cycle tops we’ve witnessed. There’s been some technical damage done the last 60 days, it going to take some time to repair, and no doubt volatility will continue, but I still believe we are in a secular bull market with some time to go.


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