If anyone has not noticed, the market has changed from rewarding buying the dips to rewarding selling the blips.
Selling the blips is how smart money leaves markets. Smart money is also big money. There is too much of it to fit through the exit door at the same time. That is why market crashes rarely occur in a day (August of 1987 was an exception) or even short periods like a month. Even the Great Depression took multiple years for the stock market to reach its ultimate bottom.
Why Wall Street Is Always Positive Regarding Markets
Maintaining positive market psychology is always pushed by Wall Street. In good times optimism drives markets where the big money wants them to go — up. In bad times, Wall Street may or may not recognize what is happening but it pays for them to be bullish nevertheless. Optimism tends to keep naive investors in markets which cushions the declines. This optimism also produces upward blips which are used by the smart money to exit with much of their profit intact.
Market Declines
Markets rarely go straight up or straight down. To rise markets need liquidity or additional funds. Quantitative easing provided this need quite nicely. Its sustained use provided the market advance seen in the chart below. Supplementing the liquidity infusion was the financial repression policy employed by the Federal Reserve. While they were flooding the system they were also driving interest rates to near zero, forcing monies into equities because it became the only game in town.
The chart below is SPY, an ETF that mirrors the performance of the S&P 500 index. Each bar represents monthly data. SPY bottomed in April of 2009 at around 67. This drop was from about 157 reached in November of 2007. It took about a year and a half for this decline of about 55% to play out.
QE ended near the end of 2014. That’s when the market leveled off. Shortly thereafter, Forbes [9] reported:
It should not be forgotten that U.S. QE is over. What we are seeing in the market is in large part caused by this change. A trillion dollars a year of credit easing, asset support and indirect motorization is over.
The dollar has therefore rallied hard. Anything that amounts to being the anti-dollar has been crushed. The obvious anti-dollars are gold and oil. This is why they have slumped.
Beware narrative that personalizes market moves. People want to blame people or groups directly, but when the cause is systemic instead of using abstract explanations, finger pointing at personifications is a natural instinct. However, it’s misleading.
For comparison purposes, the peak to the trough period for the Dow in the previous decline is shown in this chart (each bar represents weekly data):
There were several weeks during this decline where people were buying the dips because that had worked in the prior several years. Note also that almost six months into this decline SPY had only dropped 15 – 20 points from its high, roughly 2o – 25% of the loss that would ultimately be incurred. Things got really nasty over the next 12 months, especially during October and November of 2009. 70 to 75 points were lost in this 12-month period.
Recent Activity
For comparison purposes, recent weekly data of the period from our recent high are shown below:
These charts are history. History does not tell what will happen in the future. For those who believing buying the dips is always a winning strategy, perhaps they will instill some needed caution. In the end, buying the dips or selling the blips will have been judged to have been the correct strategy. Unfortunately, there is no way of knowing which one in advance.
Why Selling The Blips Makes Sense
My opinion is that there are very strong reasons to not be buying the dips:
- The economy today is hollowed out, arguably worse than it was in late 2009.
- There is unlikely to be any more QE (or if there is it will be ineffective).
- The entire world is in dire straits with regard to their debt and economic problems. It is difficult to see where growth is occurring or what could change that scenario short of a world-wide depression.
- The geo-political situation is as bad or worse than it was prior to World War II.
- If there is any upside at all in the stock market, it likely is in the ten percent range.
- The downside is probably 50% from these levels.
- The perceived imbalance between upside and downside potential is not one to be buying into.
More Quantitative Easing
The economy is a mess. Inordinate amounts of QE failed to create a recovery (as non-Keynesians predicted). However QE was very effective in driving the valuation of financial assets to levels that are inconsistent with the moribund economy. That will not change. Whether it will be used again in an attempt to re-energize the stock market would not surprise. Politics and not economics is dictating policy and a failure of the stock market unmasks all the BS that has been acclaimed about the economy.
Personally, I don’t think the Fed will raise interest rates this month. Doing so would likely create a massive sell-off. There is no way to avoid the sell-off regardless of what the Fed does. Better that it happen without it occurring with a rate increase. That would be the politic thing to do. Better that the arsonist is not there when the fire is discovered.
The political unrest in the populace is palpable. There is a good chance that the Fed will re-institute more QE before the ultimate collapse.
Regardless of how this plays out, manipulation can change prices but does not affect underlying values. Valuations eventually come in line with values and values seem a lot lower than current valuations.
