Danger in 2019

There's an expression that goes "history doesn't repeat but it can rhyme". Well, there is quite the rhyme I see when comparing how the market looked like in the first few months after the peak in October 2007 vs October 2018. I'm not a fan of market analogs because no 2 time periods are alike but  but damn the similarities are uncanny! It's as close to a reply as I have ever seen with the main difference being that after the peak in October 2007 it took an extra month for the market to drop about 19% vs what happened this time around ...but just look at the significant peaks and troughs as circled...it's crazy scary how similar they are! It should also be noted that the VIX hit a high of about 37 near the January 2008 low whereas it hit about 36 at the December 2018 low, yet another important match!

2007-2008

2018-2019

So, let's have some fun with this analog and see what it predicts in the next couple months. According to the 2008 analog (not shown in the chart above) the market could have a little scoot higher before it will start to rollover and retest the lows which should happen within 1-2 months but I wouldn't put much faith in this analog playing out exactly the same way.  There are however some important fundamental and psychological similarities with 2008 and now.  First off, as I had discussed in a previous post there are significant signposts to indicate that a new bear market started in October. There are some holdouts but in my opinion there's enough to indicate that the bull market could have very well ended. There is currently not the same degree of economic weakness now compared to the start of 2008 but the global economy has indeed rolled over with the US Fed rather oblivious to it and still in tightening mode which in in my opinion is the most critical thing you need to have to kill a bull market.

Given what I see from the forecasts for 2019 by the "experts",  it is generally expected that there will be no recession and therefore the market will have a sizable rebound as valuations are now more reasonable along with this being the 3rd year of a presidential cycle which is historically market positive. That's not the sort of wall of worry type of expectation you would want to see. Granted, Wallstreet strategists typically have a bullish bias but in my opinion, there is too much bravado in the face of the decline we have seen. There are negative folks out there which is to be expected after a 20% drop, but I don't get the same run for cover feeling I got in 2011 when the market dropped 20%. Seems this time around  there are much more people inclined to view this as a buying opportunity rather than a signal to get out. And this time around we have a clueless Fed head in Powell who is pondering how much he should raise rates this year when in 2011 and other times the market dropped 20% and had a bullish resolution to it,  the Fed was on the ball and accommodating.

In February 2008, rates on 2 year treasuries were notably below the fed funds rate - a screaming signal that the Fed had to cut rates immediately which they did end up doing in March of 2008. The yield on 2 yr treasuries is presently at  2.5% which is the same as the Fed Funds rate - it's not a screaming signal but is still a strong signal that rates are too tight. It's suggesting that the Fed won't raise rates for 2 years and that implies a significant slowdown in the economy is coming at the very least. The bond market is telling the Fed it was wrong to tighten in December and that rates need to come down. Unfortunately, it looks like ego will make Powell very slow and reluctant to issue a mea culpa until its too late.

Greed and tight monetary policy. I've been saying for years, that's what kills bull markets. Did we see greed at the peak? We did see it in bitcoin but not in stocks in general, but we did see complacency. Monetary policy is not officially deemed as tight until the yield curve inverts however the curve is very flat and parts of the curve have inverted. As I mentioned with my previous post, because interest rates were so low for so long there will likely be a higher than normal sensitivity to rising rates and that could mean that the classic signs of yield curve inversion may not be needed to signal that monetary policy is too tight. A lot of those who are still bullish on the market are saying "relax, we have nothing to worry about until the yield curve inverts and even then the stock markets doesn't peak for another 6-12 months".  I think this is yet another sign of complacency given the emerging signs of weakness we are seeing in the economy. The consensus for a while has been that a recession won't happen until 2020. Well, how many times do the experts call a recession correctly? I can't recall if this has ever happened! Recessions and major declines by nature catch most people off guard.  "I didn't see this coming!" will tend to be response afterwards.  My guess is that a recession happens either in 2019 or in sometime after 2020. There is enough evidence to suggest that we can indeed get a recession in 2019. Still too soon to say for sure but the evidence is mounting.

Remember what I said about expectations when it comes to making bets and how the herd is often slow footed in acknowledging a change in a trend. In my opinion, expectations for the market is too high given weakening fundamentals and tight monetary policy. The Market can surely bounce further here after that December thumping but until fundamentals and/or the Fed change direction I don't expect rallies to be sustainable in the long term. If the US and China manage to secure a trade deal that should provide a relief rally but I don't think such a rally would be sustainable either.

By the way, Trump just said that the market decline in December was a "glitch". If you are bullish that should make you cringe!

I'm still going to be opened minded about how the market plays out this year but I can no longer give the bulls the benefit of the doubt as I have in the past. I believe you will need to have a trading approach to make money this year with the willingness to play the downside. The best way to play the downside is with put options because your risk is limited whereas if you short stocks the fear of unlimited losses and margin calls can do you in.