Russell 2000

It is the “Core of the Core” that now concerns us the most. That is where Federal Reserve (and global central bank) policies have left their greatest mark. It is at the “Core of the Core” where momentous misperceptions and market mispricing have become deeply entrenched. It’s the “Core of the Core” that has attracted enormous amounts of “money” over recent years. It’s also here where I believe leverage has quietly been used most aggressively. Over recent years it became one massive Crowded Trade. Now the sophisticated players must contemplate beating the unsuspecting public to the exits.

“Fed Chair Janet Yellen will be forced to either acknowledge labor market tightening as reason to continue with the four-hike schedule for 2016 or risk her credibility, belittle job market stability and sound a warning about the risks of lower oil prices and cheap gasoline (sacrilege to regular Americans) by slowing the hiking pace after a single 0.25 percent increase last month. If she gets it wrong, things could get ugly fast."

JPMorgan's 2016 Outlook for the S&P 500 Index favored a continuation of a broad and volatile range into the first half of the year, below 2,100 and above 1,820-1,870 longer-term range support. While the unexpected early-January weakness has not violated the Oct 2014 and Aug 2015 lows and other support parameters near that area, the nature of the current decline raises some concern for what has been a constructive longer-term view.

The first week of July 2013 was the last time the Russell 2000 traded at these levels. That is 30 months of buy-and-hold for no return. Despite the constant clammer from "Small Cap fund managers" that they are the plaxce to be for protection against a soaring USD (since they are dominantly domestically focused), it seems the fact that small caps are much more sensitive to credit market conditions is the real reason and that market is carnaging.

The beaten-down Russell 2000 Small-Cap Index has reached a confluence of significant potential near-term support levels. Should this level fail to provide as much as a speed bump and the Russell 2000 slices right through it, then perhaps a more devastating market decline is already at hand.

"After suffering the worst start to a new year in history, the U.S. stock market has entered correction territory which is defined by a drop of 10% from its old high. The following "hateful eight" charts pretty much speak for themselves... This doesn't bode well for U.S. stocks which are now in the riskiest position since the bull market started seven years ago."

A lot of people were expecting some really great things to happen in 2015, but most of them did not happen.  But what did happen? A global financial crisis began during the second half of 2015 threatens to greatly accelerate as we enter 2016. This is what the early stages of a financial crisis look like, and the worst is yet to come.

According to ScGen, the Fed is widely expected to start tightening policy on Wednesday and adds that "after the BoJ and ECB, we see a risk that the market will be wrong-footed for a third time, and that extreme positions built ahead of tightening will be reversed.... In particular, we are short US small cap equities vs large via being short Russell 2000 vs S&P 500.... As the Fed tightens and the market enters into a lower-liquidity environment (and higher-volatility regime), we think the premium on small caps is no longer justified."

In the end, we are just human. Despite the best of our intentions, it is nearly impossible for an individual to be devoid of the emotional biases that inevitably lead to poor investment decision making over time. This is why all great investors have strict investment disciplines that they follow to reduce the impact of human emotions. Take a step back from the media and Wall Street commentary for a moment and make an honest assessment of the financial markets today. Does the current extension of the financial markets appear to be rational? Are individuals current assessing the "possibilities" or the "probabilities" in the markets?

"It is our humble belief that the consensus at the Fed does not fully understand the magnitude of the problems in corporate credit markets and the unintended consequences of their policy actions."

"... As the tide of leverage goes out, the full extent of irresponsible lending becomes apparent. The previously virtuous cycle between risk spreads and fundamentals goes into reverse, with lower prices, defaults, and downgrades forcing leveraged investors to sell, leading to even lower prices."