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The Weekly Optimist

Dec 17

Neither Bulls Nor Bears Are Happy

I’m going to try and make this simple for non-professional investors, and perhaps for some professionals as well.

A leg up in a bull trend has obviously ended at S&P 500 2941,and so now the debate is whether the stock market has begun just a correction in an ongoing bull trend, or if a bear market is now in its early phases. A bear market has no official definition, but the generally accepted guideline is corrections are less than a twenty percent decline, and bear markets decline twenty percent, or more, off the high. Lay people may want to think of this as the difference between a nasty cold, and a potentially deadly case of pneumonia.

Bear markets have been promoted by big institutions as lasting about 18-24 months, so they say investors should just ride out the pain and not try to avoid it, since of course that is impossible (especially for them). In addition to being obviously self-serving, these ruminations are grossly inaccurate, and most likely a product of data mining. For example, there was a bear market lasting from 1966 to August 1982, sixteen long years, with the Dow locked in rallies and declines from 500 to 999. Finally in August 1982 the Dow rocketed higher supported by huge positive numbers in numerous measures of market strength. And, oh yes, there have been bear markets lasting decades, a biblical lifetime type bear in England comes to mind, and a multi-decade bear in Japan, which began in 1989. So the bottom line in this brief bit of history is bear markets must be respected as the ultimate destroyer of investment wealth.

Given that the difference between corrections and bear markets is a matter of not only of time, but also in terms of wealth destruction, then investors should do all they can to avoid becoming participants in the latter.So where are we now in this exercise of probabilities, which may have profound implications for growing, or protecting, the wealth of investors? Here is the most simple and straight forward answer I can offer given the current status of an array of supply and demand based indicators. If the stock market is in the midst of a correction, then it will be likely nearing an end once the price presses new lows for the decline with strong positive divergences having been painted out in a number of supply and demand indicators. Some indicators are currently showing marginal positive divergences, but evidence that the price decline to date has caused a washout type bottom has yet to arrive. This implies the probability of lower lows for the decline. Once this decline finds its bottom, perhaps during a newsy type event, then if the positive indicator divergences are still in place, it would be reasonable for a rally to develop,which has the potential to assault new all-time highs. This is the best case scenario, and currently a lower probability.

If the stock market is in the early phase of a newly minted bear market, then what appears to be a correction setup in the previous paragraph,will likely turn out to be only the first leg down in a multi-week,multi-month, or in the extreme case a multi-year bear market. In the bear case the next significant rally will fail to make new all-time highs, and once the now counter-trend rally fails, savvy investors will take notice and begin to sell the rally in size. As recognition spreads among investors that the bull has indeed expired, then the potential for episodes of panic selling will rise,and with it a parabolic rise in risks to accumulated wealth. Mature bear markets are animals to behold as no manner of “good news” can levitate them, and waves of selling interrupted by violent, albeit short lived, rallies become the order of the day.

Investors would do well to remember how bear market mathematics work. For example a fifty percent decline means investors must then make back one hundred percent to get even! And, once unlucky investors are cut in half,they may still be vulnerable to being cut in half again! You don’t believe me,then Google a chart of the Dow from the all-time high on September 3, 1929 at 381.17 to the bottom on July 8, 1932. Count back from the July low to the late winter and early spring of 1932 when the Dow was trading at around 80, and just a few weeks from its bottom at 41 and change on July 8, 1932. After declining from 381.17 that 80 number in the spring may have looked like a bargain, and it was if investors did not mind getting cut in half again! No I’m not suggesting that investors are vulnerable to a disaster on the scale of 1929-32, but I am suggesting that the uncertainties surrounding the potential for wealth destruction during bear markets should compel investors to protect their wealth sooner rather than later.

A long history of a positive seasonal bias from roughly Halloween to Easter, and some indicators displaying budding positive divergences, would seem to imply that the current decline may find a bottom in the days ahead? If the decline ends soon, then the next significant rally will become critical in determining if the stock market is only correcting, or if the market has begun the early phases of a new bear market. The difference between the two is copious amounts of wealth safely banked, or portfolios made vulnerable to the ravages of a bear market due to failure to take defensive action as the warning signs grow stronger.

There are other ways this current weakness could play out, but for now the two candidates outlined above are the most probable. Market analysis is an ongoing detective story for which we get new clues daily, so depending upon the latest clues the probabilities may change.

TATY, a supply and demand indicator, is shown in yellow on the attached chart, and the S&P 500 cash index is shown in red and blue candle chart format.

Regards,

Gregory H. Adams

Senior Portfolio Manager

Dec 9

The Long Goodbye

The Byrds, a 1960s pop music group, incorporated the words of the preacher in Ecclesiastes into their best known hit song, which was set to music that is as iconic and memorable as the biblical lyrics.

              And a time to every purpose under heaven

             “To everything there is a season

              A time to be born, and a time to die

              A time to kill, and a time to heal

              A time to laugh, and a time to weep”

The recent passing of Senator John McCain, President George H. W. Bush, and myfather-in-law, General William A. Gantt, provided for at least one of the presiding ministers at the funerals to quote these ancient words once again. Death, the uninvited guest, can cause us to have moments of reflection as an event, no matter how long anticipated, suddenly arrives. In the cases of these three men, which served their country with distinction, the moment of their passing followed the opportunity for a long goodbye during their declining health. The lifetime of service of Senator McCain and President Bush is well known, but that of General Gantt almost not at all, because the military recognized that the General’s gregarious and affable nature, and personality, could be put to good use  —  covertly. The General’s service could be considered representative of countless others, which would suddenly disappear for periods of time during unannounced travel to foreign and hostile countries on Cold War missions, which were never discussed upon returning home to family. And now, years later, after our long goodbyes we honor them in a singular moment at their funeral for their service, as they pass away, and intoour memory. So what does all this have to do with the stock market?

Major stockmarket tops are in like manner as the long good bye, as opposed to a singular moment when a major bull trend finally expires as measured by an index. Capitalization weighting and the math involved in stock indexes can obscure the degradation occurring in many dozens of underlying stocks, as a stock index approaches its terminal peak. Major tops are processes, as opposed to events. Since October the stock market has begun to display some characteristics, which in the past have been precursors to bear markets. The process of declining underlying strength in objective measures of supply and demand is continuing. For example, a bear warning signal was recently completed as the TATY indicator declined into the caution zone surrounding the 125 level, and has now stalled out near the red zone not once but twice.

The effects ofthe favorable seasonal period, which occurs roughly from Halloween to Easter each year, must begin to show up as strengthening numbers in an array of supply and demand indicators soon, or the triggering of the recent bear warning may give way to more episodes of actual bear behavior. Even newly minted major bear markets can sometimes linger near all-time highs for weeks before getting down to the business of wealth destruction, as recognition slowly gives way to panic selling. The capital preservation drill is an exercise in avoiding the panic episodes of mindless selling, which often occur as bear markets mature. The early innings of a new bear market can be sneaky and very difficult to diagnose, but the late innings not so much.

Objective measures of supply and demand have changed enough since October to slant the strategic big picture toward favoring a developing bear market. The shifting strategic picture implies we must begin to make a turn toward protecting profits and portfolios, as opposed to trying to maximize profits. So the bottom line is given the developing strategic picture, a time has arrived for new tactics tobe implemented to address the arrival of new  and potentially harmful circumstances. Please take a look at the attached exhibits, and then read on for a briefing on our tactical plan for changing strategic circumstances.

The first chart above should be very familiar, as it is the S&P 500 weekly in red and blue candle format, and the supply and demand indicator, TATY, overlaid in yellow. Last week this chart showed divergences, which this week I have not included. The important information on this chart is that the indicator has stalled out again just above the red zone. I have been giving the bull trend the benefit of the doubt, because although the indicator has labored near the red zone, it hasbeen painting our rising bottoms  —  until Friday. The rising bottoms and the potential arrival of the positive seasonal pattern demanded that I respect that another assault on new highs was still possible. However, with the collapse of the rising indicator bottoms on Friday, it is becoming more obvious that another successful assault on new all-time highs is becoming a declining probability. So, hard evidence has now developed that the strategic big picture is likely shifting toward a developing bear market. Only a strong resurgence in the supply and demand measures would likely halt this shift toward a bear trend.

The tactical picture must now account for the changing strategic picture. The second chart below is the S&P 500 on a daily chart with Fibonacci retracements of the decline from the all-time high at 2941 to 2603 shown. The recent rebounds have encountered resistance at the common 62% retracement level. As the chart shows,there have been two trips up to this zone, and both failed to go higher. So now we have TATY stalling near the red zone, and the price struggling around S&P-500 2800 after a “long goodbye” type negative divergence during most of 2018. A picture seems to be emerging, does it not? Well analysis is all fine and good, but what does all this mean for portfolios?

Alexander and I have been fortunate recently to have a number of potential clients decide to entrust us with their wealth. Most of these new clients have portfolios, which are coming over to us, but which have not yet arrived. We are trying to complete these transfers for obvious reasons given the shifting big picture. Unfortunately, most of these accounts have been loaded up with high commissions, and high trails to the selling brokers, under performing mutual funds. Even if the market was still strong there would be lots of work required to clean up these incoming portfolios. In these cases, tax considerations notwithstanding, rallies will be used to exit these underperforming products into strength. Given that mutual funds are dinosaurs, which can be sold only on the market close, up days will be critical to get the best possible price for clients. Ditto for individual underperforming stocks, as we will do our best to get as favorable prices as possible. The decline this past week may have been strong enough to put in a short term bottom, so another substantial rally soon in this volatile environment is a good possibility. A rally above S&P 500 2800 would be a huge gift at this point, but for now 2800 appears to be strong, and now tested, resistance.

For clients already in our managed ETF model, we will be peeling off some of your VOO and QQQ into residual episodes of strength, with an eye toward both of those ETFs going ex-div around the 15th. Any rally attempt from current levels will likely linger until after the ex-div date. Alexander and I like dividends, so we always check potential sell candidates to see if an ex-div date is looming near term.

In summary, the positive seasonal trend of years past has not yet shown evidence of having arrived yet this year, but evidence that the supply and demand balance under the market is weakening is emerging. If this pattern continues, then portfolios will need to be re-configured for preservation of capital. Are we on the cusp of a “winter of discontent”? In the days and weeks ahead critical risk and wealth management decisions will be required.

Dec 3

Santa Claus Rally?

The financial media has begun to beat the drum about a possible Santa Claus rally, and soon I have no doubt there will also be discussions about the so called Super Bowl indicator. These kinds of topics make for nice cocktail party talk, but alas do nothing to aid investors in making sound decisions about their wealth.

The Law of Supply and Demand is the bedrock upon which all of the capitalistic system is built, and it is the only absolute in the science of economics, also known as the dismal science. So from my point of view, if an investor wants to make good decisions about the stock market, or any market, the first consideration must be some reasonably accurate assessment about the strength, or weakness, in the ever changing balance of supply and demand. A perfect measurement of this balance remains beyond what is possible at the moment, but fortunately a less than perfect system of measurement is capable of yielding risk adjusted performance results, which most sophisticated investors would covet. Unfortunately, the investing “crowd” tends to pursue other approaches, which year in and year out fail to deliver strong performance, and too often leave investors at the mercy of the ravages of a bear market, an insidious wealth destroyer best avoided, especially by investors over age 50.

Please take a look at the attached chart before reading the rest of this week’s update. The supply and demand indicator, TATY, shown in yellow, was frequently touching the 160 level, depicted by the light blue line, prior to January of this year. However, in the weeks after the first quarter correction the indicator painted out a negative divergence, depicted by the down sloping red line. This negative divergence, representing fading strength in the supply and demand balance, finally resulted in the current correction. You will also notice that as the first quarter correction was ending both the TATY indicator, and the premium/discount indicator in the lower panel, were positively diverging with the price, as the correction in price approached its end (upsloping green lines on the chart). This is not uncommon as corrections, and/or bear markets, approach their termination and yield to a new bull leg, or bear rally. So what does this have to do with the current situation?

In these past several days the price has been testing its panic low at S&P 500 2603, and in like manner as the first quarter correction, a positive divergence in the TATY indicator, and in the premium/discount indicator, has begun to appear. The up sloping green lines on the indicator, and premium/discount indicator, clearly show that some investors have been using the recent weakness to accumulate stocks. Believers in the Santa Claus rally nonsense may actually be rewarded, if the positive divergence in both these two indicators continue to gain strength. The key issue yet to be determined is will this positive divergence yield only an anemic counter trend rally destined to fail below the all-time high at S&P 500 2941, or will the indicators continue to gain strength causing TATY to begin to assault the 160 level while painting out bottoms in, or near, the red zone? And, the premium/discount indicator continues to gain enough strength to levitate and stay above its zero line. The bottom line is simple this week, the budding rally must generate enough strength in the indicators to result in the price rally sustaining itself. A TATY top in, or near, the red zone surrounding the 140 level would have potentially very serious negative implications, as it may tend to confirm the recent bear warning setup.

In summary, recent developments in the TATY indicator, and the premium/discount indicator, suggest the recent correction may have ended, or the first leg down in a new bear market may have ended, and a period of rally may lie ahead in the coming days and weeks. However, given the seriously negative implications of one of these probabilities, investors must remain vigilant for any signs of fading strength in both indicators. Quite frankly, the TATY indicator is currently struggling intraday to levitate itself above the red zone. If the indicator fails to gather strength soon, and evidence appears that it cannot get above the red zone, then appropriate defensive action will be required in client accounts, especially those which are now being transferred in to Optimist Capital LLC from other financial firms. A review of these accounts has revealed that many are loaded up with poor performing stocks, or even worse high commission poor performing mutual funds. Obviously even if the correction is over and a new leg up has begun in the ongoing bull trend, action will be required to clean up accounts with poor performing holdings, tax considerations notwithstanding. The days and weeks ahead will likely be critical, and sound investment decisions based on objective market generated information will be required to first protect, and then increase client wealth. As my late friend and mentor the Rev. Dr. Wilson L. Nearing would often observe about his profession: “This ain’t no place for amateurs”! Ditto for the markets!

The never ending detective story of the stock market continues, and I can hardly wait for it to yield new clues daily.

Nov 26

The Nature of the Beast

Paul Desmond, the recently late CEO of the highly respected Lowry Research Corporation, did one of the most significant and exhaustive studies of major tops in the stock market in an award winning white paper. What Paul found was that all major tops since 1925 have followed the same basic process of diminishing demand and increasing supply until the foundation supporting the bull trend crumbles. This process usually gains momentum as more and more investors begin to recognize the bull trend has probably ended and a bear market is upon them. The angst associated with this spreading recognition tends to accelerate until episodes of panic selling begin to become more common, which eventually results in an episode(s) of climatic selling driving stock prices down to levels, which then reinvigorate demand from sophisticated and courageous investors.

So the nature of a bear market beast is quite different from a run of the mill correction in an ongoing bull market, although aspects of the process are obviously the same. Paul’s research was based solely on NYSE and NASDAQ data, which is copious. However, I made the case to him a number of times in our wide ranging discussions about the market, that to ignore the contribution of the growing use of derivatives to the overall balance in the ever changing supply and demand equation was to ignore an important and growing component affecting prices. My own work has module components representing the important contribution of derivatives to the balance of supply and demand. So what are a series of supply and demand indicators telling us now?

In 2014 I gave a series of presentations about how major tops form. The first slide above is from a talk I did at St. Simons Island to a group of wealthy investors. The red circles on the chart show the tendency of the indicator called TATY to stall near the red zone surrounding the 140 level preceding declines in the stock market. The period shown includes some significant tops including the 2007 top, which preceded the worst stock episode since the Great Depression. The 2007-2009 decline has now been labeled “The Great Recession” by the financial media, so dramatic was its impact on investors. Please note on the chart that the indicator was kind enough to even warn that the rebound rallies during the bear market were in danger of expiration, and some of the powerful rebound rallies lingered for twelve weeks. So, very important information if one had missed the top and was looking to exit during the rebound rally. The second chart shows the expiration of the rebound rallies in more detail, but as one can see the information provided by this indicator, properly applied, would spare investors a lot of angst and grief. Also, please note how the second chart depicts the acceleration into panic as the bear market matured, and then approached its termination, compared with how the price lingered near its all-time highs early on. The initial all-time high occurred in July (not shown on the chart), then the actual high occurred in October 2007, and a test of the high then occurred in December 2007. So now I hope clients have a better understanding of the nature of vicious bear markets as opposed to a pause, or correction, in a bull market.

The last chart shows how the stock market ended this holiday shortened week. The market is testing its panic low at S&P 500 2603 while painting out positive divergences with the indicator. A breech of the 2603 previous low with the positive divergences remaining in place would likely create the conditions needed for a substantial rally. Such a development may signal the end of a correction of about 11% from the high at 2941, or perhaps the end of the first leg down in a newly minted bear market? There are other possibilities as well, but for the purpose of this update I’m only going to mention the two most probable from a supply and demand perspective. The stock market is entering the most favorable seasonal of the year, so once this leg down is complete and a rally begins important decisions will be required. The characteristics of the next significant rally will be critical in determining if the bull expired at S&P 500 2941. Obviously the days and weeks ahead will be important for increasing client wealth, or making a turn toward protecting it. At the moment the market’s behavior has been such that both bulls and bears can make their case, kinda sorta like politics these days!

The supply and demand indicator TATY is shown in yellow on the attached charts, and the S&P 500 cash index is shown in red and blue candle chart format.

Nov 19

A Rally Underway But..

The S&P 500 has declined from its all-time high at 2941 to 2603 during this recent period of weakness. So what is next?

The jury is still out on whether the bull trend is still alive, or if Mr. Bear has made a surprise appearance at the bull party. The decline to date remains in the range of a normal bull trend taking a breather before gathering enough strength to mount another leg higher. However, bear markets are often characterized by periods of relentless and mindless selling, interspersed with episodes of violent rallies. Convicted bears will likely observe that the current weakness has displayed some persistent selling with so far only one rally, which dutifully stopped right in the math resistance zone I mentioned in a recent update. So from my point of view, the stock market is sending signals, which could satisfy convicted bears as well as convicted bulls. Me, I’m an agnostic and waiting for the market to paint out objective evidence that the bull still lives, or expired at S&P 500 2941.

So here is the bottom line on what we do know given objective and measurable evidence, as opposed to consulting countless opposing opinions. TATY, a supply and demand based indicator shown in yellow on the attached chart, has visited the red zone again this week, but so far has not developed enough strength to paint out any bottoms in, or near the red zone. However, the weakness of this past week also failed to push the indicator back into the caution zone surrounding the 120 level (yellow lines). And, the premium/discount indicator in the lower panel of the chart has rallied from below the red line at minus eight. If the premium/discount indicator remains above minus eight, and TATY remains above the caution zone, then I’m willing to continue to hold long positions, even if the price revisits the S&P 2603 level, or takes it out marginally on some kind of newsy panic type event. Such a positive divergence vis-à-vis a series of supply and demand indicators would also compel me to consider doing some buying in accounts with cash needing to be put to work. Please note this is not a prediction, but one potential setup worth mentioning to clients before it happens during a stress filled episode.

 

So to summarize, there is not yet any objective evidence that the bull expired at S&P 2941, but there is creeping evidence that the current rally must gain strength soon or risk causing TATY to stall out in, or near, the red zone. This would be a negative development since the indicator has already visited the caution zone. Such a development would likely tip the scales toward too much risk for too little remaining potential gain. On the contrary, if TATY does clear the red zone and begins to paint out bottoms in, or near, the red zone, then the potential for additional gains would likely not be at the expense of taking too much risk. It is a risk trade-off situation either way, and only the market knows at this point which development will happen first. There are other potential setups, but at the moment their probabilities are not high enough to review in a weekly update.

Regards,

Gregory H. Adams

Senior Portfolio Manager

Nov 11

Has the Bull Expired?

The last several updates have cautioned that the verdict was still out on whether the bull market had expired, but that clients should be aware that volatility was likely to increase sharply. In the days, and weeks ahead, the stock market will likely give us sufficient clues to determine the health of the bull, and if indeed the bull has expired, and we are now in the early phases of a newly minted bear market. Please remember that the generally accepted guideline for a bear market is a decline of 20% or more from a new high. The S&P 500 all-time high was at 2941 and change, so the current volatile decline is a correction at this point. The remainder of this update will deal with how the stock market may tell us, if it just undergoing a normal correction to invigorate demand, or if it is likely the bull expired at S&P 2941, and then entered into a bear market lasting weeks, months, or years. Obviously any clues to make this determination are important for clients to protect their wealth from the ravages of a bear market, which in the last 35 years have seen bear declines in the range of mild bears in the twenty something percent range to really nasty bears approaching 60% in the NYSE, and 90% in the NASDAQ.

If the bull still lives, then once this correction has run its course a rally back toward new all-time highs will occur. The behavior of this rally vis-à-vis the supply and demand indicator, TATY, will be extremely important. This week TATY declined into the caution zone surrounding the 120 level, and then closed near the 125 level, which confirmed a “Big Chill Warning”. This means that the decline has been nasty enough in volatility, and price, to get the attention of normally perpetually optimistic investors, causing a bit of a chill to go up their spines. Such declines are often enough to make bull minded investors to consider taking some profit, or pulling back on new purchases, a shift in attitude from all out optimism, to a more sober outlook toward potential future gains in the stock market. This shift in attitude shows up in the balance of the supply and demand equation, which then shows up in the numbers being registered by TATY, which represents the strength, or weakness, in the balance. The change in the numbers for TATY can then be objectively compared to previous periods, when the market painted out major tops. At the moment all TATY is telling us is that the psychology of investors, especially institutional investors, is likely becoming more sober toward the prospects for further new all-time highs. The details of what to look for to re-confirm the bull case follows.

Once the current correction approaches an end, then TATY will very likely already be painting out a positive divergence with the price, and will likely be climbing above the caution zone surrounding the 120 level, as the correction is completing its final probes for a bottom. This behavior has been consistent over the last three decades, and recently during the February-April swoon (see attached chart), but of course there are no guarantees in this business that the past will always be prologue. The positive divergence in TATY to the still declining price will also very likely be repeated in the lower panel of the indicator, where the premium/discount indicator oscillates around its zero line in its never ending journey from premium above value, to discount to value. and back again. Corrections compress the price from premium to discount to dynamically fluxuating value, and currently this indicator is well below minus eight, which is significant compression signaling me that it is too soon to be a buyer. This indicator, like TATY, tends to paint out a positive divergence with the price, and when it rises above the minus eight level (red line) and then the minus three level (green line) then the odds have begun to favor purchases. This likely occurs because sophisticated investors are tip toeing back into the market, while the less informed are throwing in the towel keeping the price depressed. These kinds of conditions tend to be when the odds are most favorable for putting cash to work. However, there is still important indicator behavior needed to confirm a coming rally is a continuation of the bull trend, and not a bear trap. Read on for those details.

If the bull lives, then TATY will rally into the red zone, and then try to rally above the red zone while likely also painting out ever higher lows above the caution zone. In like manner, the premium/discount indicator will likely rally above its zero line and paint out bottoms above the minus eight level (red line), and usually episodes of weakness do not decline much below the minus three level (green line). When these conditions are in place the previous bull trend then slowly re-asserts itself, and presses the price toward new highs until the next “Big Chill” warning. This describes how this process has played out at major tops since the 1990s, and given the major tops contained in that sample, one may have a reasonable expectation that it may again, but with the caveat that the market can, and will do as it pleases, so one must consider this process as a stream of probabilities, and not a forecast of certainty. There is no certainty to be had in the emotional arena of the stock market. So now days, or weeks, in advance clients have been briefed on which clues the market may yield, which are important in the context of our supply and demand approach to confirm a continuing bull trend. This is an outlook not based on guessing about the impact of countless global events, but rather on information created by the stock market about its own health. If a bear market began at S&P 2941, then read on for the behavior, which will likely exist before the bear becomes seriously destructive to investors wealth.

If Mr. Bear has now crashed Mr. Bull’s party, then how will we know vis-à-vis our supply and demand approach? Well not to worry, the detailed explanation for the bull case above is almost exactly the same for the bear case with one important exception. The process described above, or a setup very similar in concept, but perhaps varying in a little here or there, will likely unfold in the days, or weeks ahead. However, the previous strength of the bull trend to push TATY consistently above the red zone surrounding the 140 level will not be in evidence, and TATY will struggle to reach the red zone, and then stall out in, or near the red zone. At the same time the premium/discount indicator in the lower panel will also show less ability to generate strength compared to its behavior during the previous bull trend. And, once TATY runs out of gas and stalls, which may occur near, or more likely below a new price high, then investors should slant their investment strategy from one of maximum gain, to one of defending accumulated profits, and the preservation of wealth. Supply and demand based indicators, because they objectify the bull/bear phenomenon, have a record of identifying when risks have risen too high for investors to continue to pursue diminishing returns. Properly applied, these tools can produce an investing edge, however they cannot tell us how deep a subsequent bear market may go in advance. Even so, the knowledge that risks have risen to a dangerous level can be key to preserving wealth, which in my world is objective number one.

So now clients have a rough road map of how the next bear market may announce its arrival, at least in the context of history vis-à-vis a family of supply and demand based indicators. So in the days, and weeks ahead, we shall see if Mr. Bear elects to travel his usual road to Mr. Bull’s party, or this time takes a road less traveled? In this business, one goes with the best odds, as there is no certainty.

TATY, a representative supply and demand indicator, is shown in yellow on the attached chart, and the S&P 500 is overlaid in red and blue candle chart format. Please note that the February to April 2018 decline (see the attached chart) was a correction, and not a bear market according to the 20% guideline.

Nov 5

A Leg Down?

The months long negative divergence (orange line on attached chart) has resulted in the largest correction in the stock market, since the February to April slide earlier this year. The stock market subsequently touched new all-time highs after that quick and nasty correction ended. Over the next days and weeks we shall see if the current correction has put in a foundation for new all-time highs, or if the first leg down in a new bear market has just ended, and a rebound rally short of new all-time highs is underway?

The recent decline from S&P 500 2941 to 2603 appears to be complete. A rebound rally appears to now be underway, and the characteristics and behavior of this rally both in price, and vis-à-vis a series of supply and demand indicators will be critical in determining if the bull is still alive, or expired at S&P 500 2941. If the current rebound rally is only a bounce in a larger downtrend, then there is some math resistance at S&P 2772 and 2812. A rally substantially above 2812 would be a big positive for the bull case. If the price struggles to go higher in the 2772-2812 zone, and TATY shows signs of stalling in, or near, the red zone surrounding the 140 level, then I would expect another leg down to follow, which would likely take out the recent 2603 low. This potential outcome would paint out a setup similar to the one, which occurred at the April 2018 low (see chart). The April low ended that correction and new all-time highs followed. If this is how the market decides to play out this time, then we will have to deal with the potential that all of the correction has once again run its course, or just part of a larger developing bear market has been completed. There are other possible ways for this to play out, but for now this discussion will be limited to just the most probable.

So what is our strategy and tactics given what we do know? Unless evidence to the contrary arises, we will position accounts for a counter trend rally, which will likely fail in, or near, the 2772-2812 zone basis the S&P 500. If the rally stalls, and TATY also shows signs of stalling out in, or near, the red zone, then the risks vis-à-vis price additional gains will have become too high for prudent investors not to harvest some profits, and protect their wealth. On the contrary, if both the price and TATY continue to develop strength, and especially if the indicator begins to paint ever higher lows in, or near, the red zone, then there would be evidence that the aging bull trend has not yet expired. Obviously, the days and weeks ahead are going to be extremely important in terms of increasing wealth, or turning our attention toward protecting it.

This past week Goldman Sachs declared the bull market was alive and well, and at the same time Morgan Stanley boldly announced the arrival of a new bear market, so whom to believe? Neither from my point of view, as only the market knows, and it will give us clues about its strength, or weakness, which lies ahead. For now the market is telling us that it wants to rally, so until that changes we will ride the rally.

 TATY, a supply and demand indicator, is shown on the attached chart in yellow, and the S&P 500 is shown in red and blue candle chart format.

Regards, 

Greg

Oct 28

The Big Chill

The last several updates have cautioned that the verdict was still out on whether the bull market had expired, but that clients should be aware that volatility was likely to increase sharply. In the days, and weeks ahead, the stock market will likely give us sufficient clues to determine the health of the bull, and if indeed the bull has expired, and we are now in the early phases of a newly minted bear market. Please remember that the generally accepted guideline for a bear market is a decline of 20% or more from a new high. The S&P 500 all-time high was at 2941 and change, so the current volatile decline is a correction at this point. The remainder of this update will deal with how the stock market may tell us, if it just undergoing a normal correction to invigorate demand, or if it is likely the bull expired at S&P 2941, and then entered into a bear market lasting weeks, months, or years. Obviously any clues to make this determination are important for clients to protect their wealth from the ravages of a bear market, which in the last 35 years have seen bear declines in the range of mild bears in the twenty something percent range to really nasty bears approaching 60% in the NYSE, and 90% in the NASDAQ.

 

If the bull still lives, then once this correction has run its course a rally back toward new all-time highs will occur. The behavior of this rally vis-à-vis the supply and demand indicator, TATY, will be extremely important. This week TATY declined into the caution zone surrounding the 120 level, and then closed near the 125 level, which confirmed a “Big Chill Warning”. This means that the decline has been nasty enough in volatility, and price, to get the attention of normally perpetually optimistic investors, causing a bit of a chill to go up their spines. Such declines are often enough to make bull minded investors to consider taking some profit, or pulling back on new purchases, a shift in attitude from all out optimism, to a more sober outlook toward potential future gains in the stock market. This shift in attitude shows up in the balance of the supply and demand equation, which then shows up in the numbers being registered by TATY, which represents the strength, or weakness, in the balance. The change in the numbers for TATY can then be objectively compared to previous periods, when the market painted out major tops. At the moment all TATY is telling us is that the psychology of investors, especially institutional investors, is likely becoming more sober toward the prospects for further new all-time highs. The details of what to look for to re-confirm the bull case follows.

Once the current correction approaches an end, then TATY will very likely already be painting out a positive divergence with the price, and will likely be climbing above the caution zone surrounding the 120 level, as the correction is completing its final probes for a bottom. This behavior has been consistent over the last three decades, and recently during the February-April swoon (see attached chart), but of course there are no guarantees in this business that the past will always be prologue. The positive divergence in TATY to the still declining price will also very likely be repeated in the lower panel of the indicator, where the premium/discount indicator oscillates around its zero line in its never ending journey from premium above value, to discount to value. and back again. Corrections compress the price from premium to discount to dynamically fluxuating value, and currently this indicator is well below minus eight, which is significant compression signaling me that it is too soon to be a buyer. This indicator, like TATY, tends to paint out a positive divergence with the price, and when it rises above the minus eight level (red line) and then the minus three level (green line) then the odds have begun to favor purchases. This likely occurs because sophisticated investors are tip toeing back into the market, while the less informed are throwing in the towel keeping the price depressed. These kinds of conditions tend to be when the odds are most favorable for putting cash to work. However, there is still important indicator behavior needed to confirm a coming rally is a continuation of the bull trend, and not a bear trap. Read on for those details.

 

If the bull lives, then TATY will rally into the red zone, and then try to rally above the red zone while likely also painting out ever higher lows above the caution zone. In like manner, the premium/discount indicator will likely rally above its zero line and paint out bottoms above the minus eight level (red line), and usually episodes of weakness do not decline much below the minus three level (green line). When these conditions are in place the previous bull trend then slowly re-asserts itself, and presses the price toward new highs until the next “Big Chill” warning. This describes how this process has played out at major tops since the 1990s, and given the major tops contained in that sample, one may have a reasonable expectation that it may again, but with the caveat that the market can, and will do as it pleases, so one must consider this process as a stream of probabilities, and not a forecast of certainty. There is no certainty to be had in the emotional arena of the stock market. So now days, or weeks, in advance clients have been briefed on which clues the market may yield, which are important in the context of our supply and demand approach to confirm a continuing bull trend. This is an outlook not based on guessing about the impact of countless global events, but rather on information created by the stock market about its own health. If a bear market began at S&P 2941, then read on for the behavior, which will likely exist before the bear becomes seriously destructive to investors wealth.

 

If Mr. Bear has now crashed Mr. Bull’s party, then how will we know vis-à-vis our supply and demand approach? Well not to worry, the detailed explanation for the bull case above is almost exactly the same for the bear case with one important exception. The process described above, or a setup very similar in concept, but perhaps varying in a little here or there, will likely unfold in the days, or weeks ahead. However, the previous strength of the bull trend to push TATY consistently above the red zone surrounding the 140 level will not be in evidence, and TATY will struggle to reach the red zone, and then stall out in, or near the red zone. At the same time the premium/discount indicator in the lower panel will also show less ability to generate strength compared to its behavior during the previous bull trend. And, once TATY runs out of gas and stalls, which may occur near, or more likely below a new price high, then investors should slant their investment strategy from one of maximum gain, to one of defending accumulated profits, and the preservation of wealth. Supply and demand based indicators, because they objectify the bull/bear phenomenon, have a record of identifying when risks have risen too high for investors to continue to pursue diminishing returns. Properly applied, these tools can produce an investing edge, however they cannot tell us how deep a subsequent bear market may go in advance. Even so, the knowledge that risks have risen to a dangerous level can be key to preserving wealth, which in my world is objective number one.

 

So now clients have a rough road map of how the next bear market may announce its arrival, at least in the context of history vis-à-vis a family of supply and demand based indicators. So in the days, and weeks ahead, we shall see if Mr. Bear elects to travel his usual road to Mr. Bull’s party, or this time takes a road less traveled? In this business, one goes with the best odds, as there is no certainty.

 

TATY, a representative supply and demand indicator, is shown in yellow on the attached chart, and the S&P 500 is overlaid in red and blue candle chart format. Please note that the February to April 2018 decline (see the attached chart) was a correction, and not a bear market according to the 20% guideline.

Oct 22

Volatility is Here to Stay

If a bear stock market is upon us, then it may be the most advertised bear I can remember. The financial media, and the internet, have been posting numerous articles declaring that rising interest rates, and over valuation have, or imminently will, be the kiss of death for the aging bull market in stocks. The media, and the experts quoted may be right, but what is the market itself telling us about its health? I’m fortunate that in my circle of market analysts, colleagues and friends, there are seasoned veterans at the top of their professions, but at the end of the day the market is the best expert on the market.

 

Clients are probably wondering, if the recent sharp decline in the S&P 500 from its recent all-time high at 2941 to 2711, is the kickoff to a newly minted bear market? It is a reasonable question given the numerous articles announcing the arrival of Mr. Bear. However, most bear stock markets do not announce their arrival to the many, and most of the sophisticated few capable of making such a diagnosis are often just as surprised as the less sophisticated many trying to outperform the popular averages. And, please do not look to the major brokerage houses to give you a heads up on when it has become too risky to stay at the bull party, as their record is simply abysmal in regard to protecting their clients from being trapped in major tops, especially given the many millions they devote to “research”. What follows is an exercise in paying attention not to the hype from the big investment houses, nor the financial media, but rather a straight forward look at some market generated information relative to its history, as major tops of the recent past have formed. The recent past in this context means from the 1990s until the present, a period which is current enough for most of you to remember, and which contains some really big major tops, and subsequent bear markets.

 

A recent update said a sharp decline, coming seemingly out of the blue, in the 3-8% range should not be a surprise. And, I said such a decline would be as normal as you and I breathing in and out. So to date the S&P has declined around 7%, but surprisingly for all the pickup in volatility the attached supply and demand indicator, TATY, has not yet registered a weekly close in the caution zone surrounding the 120 level. And, the premium/discount indicator in the lower panel is still below the red line at minus eight, which implies that prices are trading at a discount to recent levels of “value”. I prefer to be a buyer after the premium/discount indicator has arrested its decline, and is positively diverging as the price remains depressed. A recovery in this indicator to the green line at minus three usually signals that sellers have spent their propensity to sell, and sophisticated investors are executing staged buying programs into the lingering depressed prices. I have not done any staged buying in client accounts, because even though the decline has been contained in the range mentioned a few weeks back, the premium/discount indicator has not yet signaled that big sophisticated investors have begun to buy. So the bottom line is there is objective evidence that it is likely too early to be a buyer, and clients should be warned that lower lows may be needed to motivate buyers to become active, as the current modest decline is not generating any buying interests, which can be measured as significant.

So here is the bottom line on the market’s current condition. The usual setup foreshadowing major tops of the past has not yet developed, so the jury is still out vis-à-vis my supply and demand family of indicators. Conversely, there is also scant evidence that prices have declined enough to motivate big sophisticated investors to begin to buy in size, so the old English phrase “betwixt and between” applies to the current situation. Given these conditions, I think it is safe to say that all we can really expect short term is a more volatile market than we have experienced, since the negative divergence began to develop in TATY back in late January and early February (orange down sloping line). If clients will study closely what happened during the February-April period of weakness, then over the days and weeks ahead something similar relative to the behavior of the indicator may be likely? Please notice how the price of the S&P 500, in red and blue candle format, successfully tested the spike low made in the first week of February in April. I’ve drawn dark green lines on the chart to illustrate how this indicator, and the premium/discount indicator in the lower panel, painted out huge yawning positive divergences during the test of the February price low in April, which suggested big sophisticated investors were buying the exhaustion into the test of the previous low. The rest as they say is history. Obviously, we are not at any such comparable point, and may not be for many more days, or weeks? We will need to see more “cards” before we can say the bull expired at S&P 500 2941, and there is not enough evidence yet to say the current phase of the correction is nearing an end either. Both possibilities suggest more volatility ahead. In my world volatility can equal opportunity.

 

TATY, a supply and demand indicator, is attached in yellow, and the S&P 500 cash index is overlaid in red and blue candle format.

 

I’m back in Palm Beach after a short trip to San Diego to see my new grandson, and to visit briefly with my college roommate and his wonderful wife. At an intermediate stop in Atlanta, I was fortunate also to attend a reunion of my Georgia Tech Sigma Nu pledge class. How quickly the intervening years have flown by, but thankfully the friendships of the past have only grown stronger, and the optimism symbolized by a new life entering the world has as well.

 

Warm regards to all,

 

Greg

Oct 15

Forecasts & The Market

The stock market has reached an interesting juncture after the sharp decline in the price this past week. So, I’m sure most of my clients receiving this update are wondering if the “sky is falling” crowd is right, and the bull has finally expired? If you want to see an objective assessment of current conditions, then read on.

Down here in south Florida the local news begins to talk about storms leaving the coast of Africa long before there is any hard evidence that they are a threat to the mainland USA, or especially the Florida beaches and the Gulf of Mexico region in general. If a tropical depression actually develops, then the local weather begins to speculate on when a hurricane Watch will be issued. And, once the tropical depression begins to circulate with winds sustained at 75 mph or greater, then a hurricane Watch is issued, and the media drama begins to ramp up. At some point determined by the National Hurricane Center a hurricane Watch is changed to a hurricane Warning, as the storm begins to become an actual threat to lives and property. As the storm morphs through this progression the impending drama builds, compliments of the media’s need to maintain market share.

The run up to a major stock market top is in some ways in like manner as the progression from tropical depression, to hurricane Watch, and finally to an outright hurricane Warning for the areas likely to be impacted by the looming landfall. For weeks now there have been declarations by various financial “experts” that a major stock market top was at hand, even though there was scant evidence of any such danger in the metrics related to the balance of supply and demand for stocks. As interest rates ticked up in recent days, some in the financial media have become more strident in their pronouncements that another financial Armageddon may be at hand on the scale of 2007-2009, or worse. Scary stuff for sure, and these folks may be right, but alas their outlook is not yet supported by the evidence being produced by the market itself. Read on for an analysis of what the stock market is currently saying about its own health.

In recent weeks I’ve pointed out the negative divergence building in a family of supply and demand indicators represented in these weekly updates by TATY, the indicator in yellow overlaid by the S&P 500 in blue and red candle chart format in the attachment. As the negative divergence has persisted, I began to warn clients that an increase in volatility was likely, and that “a spontaneous and nasty decline in the range of 3-8% could occur at any time”. This week TATY touched the caution zone surrounding the 120 level during the sharp and nasty decline in price, although the indicator managed to close above this critical zone. This is important, because in like manner as a hurricane Watch, TATY is now signaling that there has been a significant change in the supply and demand balance. This triggers what I call the “Big Chill” (think the equivalent of a hurricane Watch), as the dust up in price has been powerful enough to pierce the recent euphoria associated with new all-time highs. This will likely motivate sophisticated investors to lessen their equity exposure on the next rally back toward the all-time highs. Should this occur, then the added drag of investors feeding stock into residual strength may trigger an outright Warning that risks have become untenable. Hard evidence of this condition would arrive, if TATY labors to reach the red zone surrounding the 140 level, and then stalls out in, or near, the red zone. This type warning has been consistent over the last 1440 plus weeks of data, so the odds are favorable that the setup will repeat, with the caveat of course that no indicator is perfect in this business. However, in thirty-five years of searching for a better major top indicator I’ve never found anything close to beating the record of my supply and demand indicators. So that summarizes the strategic big picture conditions, which is TATY has issued a major top Watch, yet to be confirmed by a major top Warning, if the indicator struggles higher and then stalls out in, or near, the red zone. For the tactical implications, please read on.

The first tactical point is the attached chart is in weekly format, so not appropriate for any day traders among you. The weekly chart format implies that a good portion of the remainder of 2018 may be chewed up as the indicator goes through its gymnastics from Watch to outright major top Warning, if any. In the interim, the current decline must come to an end, and then a rally phase will need to form and gain momentum. If clients will take a look at the lower panel of the chart, you will see that the decline in price has pushed the lower panel indicator well below the red line at minus eight. This is an indication that the price is temporarily trading at a discount to “value”, even though “value” itself is in a state of dynamic flux. Programming this phenomenon nearly drove the programmer nuts, and it took him over a year to finally make “value” form a horizontal line for the indicator to oscillate around from premium to discount to “value”, and then back to premium in its never ending circuit. The indicator looks so simple that most clients do not pay it any attention, but to me it is of critical importance in buying well for clients. At this point the premium/discount indicator has not turned to reach the green line at minus three to suggest sellers may have exhausted their propensity to sell. I may buy this decline for a tactical trade, but at the moment the sellers are still too much in control according to the indicator.

The bottom line is the strategic big picture is changing, and it is time to issue a major top Watch. The tactical picture is such that I may be able to take advantage of the recent increase in volatility for the benefit of clients. Clients are mostly invested, but some of you have some cash in money markets earning almost nothing, so if I can put on a tactical trade, which has favorable odds of beating CD like yields by a multiple factor, then I’ll pull the trigger. If not, then we will see if the supply and demand indicators flash a Warning to leave the bull party, and if so then we will scale back our equity exposure into episodes of residual strength.

Please do NOT fear this recent increase in volatility. It is a blessing in disguise for those equipped with the training, tools, experience and courage to navigate a volatile market environment, which is the most profitable environment for the well-equipped skillful few, and a trap for the less skilled and less equipped many. The coming days and weeks are likely to be much more volatile, so read the coming weekly updates carefully to continue be fully briefed about what I’m doing with your wealth and why.

As always I’m available day or night 24/7 at 561-771-8077, if you have questions.

Please come by and visit us at Optimist Capital LLC, 2401 PGA BLVD, Suite 148. We are located across the breezeway from Carmine’s in the Marina Gardens Center.

Regards,

Greg Adams

Senior Portfolio Manager