Weekend Thoughts

I know I've been posting a lot lately and that's because I'm trying really hard to sort out my thoughts. Let's assume for the moment that we are in a bear market. If that's the case the market is going to be treacherous for both bulls and bears alike. If you look back at the charts of the last 2 big bear markets  you will see them littered with plenty of sharp erratic dead cat bounces along the way down like the slope of a jagged mountain side. When despair becomes acute and bears  pile in, the market tends to stage vicious "hope" rallies often due to some sort of policy response/shift from authorities i.e. the fed or the government. However, it often takes several policy responses before the economy is able to finally turn around and so the hopes eventually turn to despair again.

If we are in the early innings of a big bad bear market, there's a good chance we will get a multi-month rally that retraces a significant amount of the initial first down leg. The rallies from March 2001- May 2001 and March 2008- May 2008 come to mind. Will we see the same thing this time around? If the market analog from 2007-2008 continues we will see the market retest the December lows sometime in about 1-2 months as bad economic news starts to appear. With earnings season to begin shortly that could be the catalyst...we'll soon see. I don't want to hang my hat on this analog though..

In terms of policy responses, we just saw the first one in that the Fed is now open to not raise rates this year and not have its balance sheet reduction on autopilot. If we are indeed in new bear market and on the brink of an economic contraction, this policy response is just the very beginning and we will end up seeing the Fed slashing rates aggressively before it's all over. Seems crazy to think this doesn't it? Look at the 5 year bond yield in the US which is at 2.5%. It is just about same yield as the 30 day T-bill rate which is about 2.4%. The bond market is pricing in that short term rates for the next 5 years on average will not be higher than present levels. If the economy is expected to be so strong, which would imply higher inflation and therefore higher interest rates, you would NOT see the bond market give this signal. Granted, bond market expectations can change but this type of signal is rare and has happened just prior to economic peaks.

I've seen bullish investors state that when the yield curve gets flat/inverted like this, you don't have to worry about it for another 6-12 months if you look at history. Well, I would buy that argument if the yield curve got inverted as the economy and the stock market was humming along nicely as it did in 2006 and the other times it happened.  That didn't happen this time around. The yield curve rapidly flattened  in the last couple of months due to weak global economic data with the stock market already well off its peak. This to me says that the danger is rather immanent and not 6-12 months away.

I know I could be wrong about all of this. What if I jumped the gun and the global economy and US somehow manage to skirt a recession?  I don't have a problem with being wrong but it's all about the probablities and the risk/reward set up. To position yourself for a bullish resolution to this (aside from a ST rally) when you see Fed complacency, ominous signals from the bond market, weak housing  and weakening  PMIs 9 years into an expansion, it is simply not a good risk/reward set up.

Near the January peak last year I mentioned that there were flashes of euphoria and there was complacency.  However it was not to the same degree that I remembered at the peak of 2000, but who's to say that 2000 should be the benchmark and that we have to see that type of giddiness to mark the peak? No 2 cycles are exactly alike and as I mentioned the other day, I believe there was enough bear market sign posts spotted to signal a bear market has arrived.

There has been a few similarities with investor behavior recently compared to that of 2000. In the last couple of years there was a big rush into ETFs similar to the rush of index mutual funds leading to the peak in 2000. Index fund investing has an appeal to it because of the low fees and the stats showing how they beat the majority of actively managed funds. The problem is that once any particular strategy becomes popular it eventually loses its effectiveness and will backfire. The motto of this blog always applies.We saw a big rush to robo advisors and commercials from Questrade bashing the traditional adviser telling people they could retire 30% richer by just investing on their own. This was reminiscent to the discount brokerage commercials in 1999 and 2000 telling people how easy it is to invest on your own and buy stocks. We saw people go crazy over bitcoin whereas in 1999-2000 it was internet stocks.

In terms of the economic climate, today is similar to 2000 - record long expansion, record low unemployment. However at the peak of 2000 there was this talk about the new economy and that the old boom and bust nature of the economy may no longer apply. We certainly didn't see that sort of arrogance but I don't think we necessarily have to in order to mark a top.

Whether I turn out to be right or wrong, one thing's for sure is that this is going to be a very interesting year in the market. If I'm wrong and this is just another 1998 type scare then I would suspect the market will go up over 20% this year.