Volatility Is Here to Stay

On the most recent segment of the Financial Sense Newshour’s Smart Macro, Cris Sheridan got an update from Financial Sense Wealth Management’s CIO Chris Puplava. Chris shared his thoughts on last week’s market decline, explained why he thinks we won’t retest the March 23 lows and told listeners why he’s maintaining a neutral position. See below for excerpts from Smart Macro on the Financial Sense Newshour.

For audio, see Trillions of Cash Waiting on Sidelines Earning Zero Percent, Says Chris Puplava.

What are your thoughts on the market decline we saw, and what are your big picture takeaways?

If you look at the market, we were actually getting pretty euphoric. Sentiment data, like put call option data, was starting to show a lot of complacency. Another thing that's becoming a hot topic is the amount of Robin Hood accounts, the free online trading brokerage account platform, that saw a surge of new accounts opening. It’s almost akin to what we saw in China back in 2015, if you looked at and watched the number of brokerage accounts being opened in China when they were going through their bubble.

I think there's a lot of hot money that's coming to the market pushing things higher, but this decline while it's painful, overall, it's healthy. You never want to see the market go straight up because it will often go straight down.

I am surprised a little bit by the magnitude of the decline. I was expecting some kind of pullback and some sideways action in the market but not as dramatic as we saw Thursday. I think we're just still dealing with the pandemic. There's a lot of angst in the market. I think people are very quick to get in and get out. So, I think volatility is here to stay. Doesn't matter what market, it could be equities, fixed income or currency, I think we're going to see elevated levels of volatility going forward.

Do you still believe we won’t retest the March 23 lows?

I do believe that. You might have read about this in some of my past articles, I took a look at every bear market since WWII. I wanted to delineate new bull markets from dead cat bear market bounces. In the study, I had the requirement that you’d gone through an official bear market where you’d fallen at least 20%. Then we studied what happens after, when you've at least recovered half of that decline.

We found that of the 12 bear markets, there were 11 out of the 12 that did not retest the lows, it was actually the low. After WWII, I think in the late 1940s, we did see a revisit of the lows and actually slight undercut, but that was the only case. When we look at the markets in which the market recovers at least 61.8% of the retracement, there was no exception. The bottom was in and there was no revisit of the lows. And we've gone well beyond the 50% and even the 61.8% retracement level.

I wanted to see after we got past that level, if we don't revisit the lows, can we still expect some significant corrections. So, I took all of those cases and looked at the average path, the best case and worst case and then plotted that from the starting point of the 50% retracement to see how we're acting and literally from that level which was in mid-April, when we had the 50% retracement, all the way through I would say late May, we were literally hugging a little bit above and a little bit below the average path of prior bull markets.

But beginning in late May, going into the early part of this month, the market really took off. And at one point a couple days ago, we were actually above the best case that we have seen of all the other prior bear market bottoms. So, for the market to come back, that would put us at about the average path. If we follow the average path, then we would be looking at around 3000 on the S&P. So, at about another hundred points lower, we would still be at the average path of the prior bull markets since WWII.

I always think studying history really helps put things into context, as the noise from the news day to day can really shake you, and sometimes you have to step away. Rather than looking at the daily news stories, look at the historical precedents we've seen. From what I can see, even the worst-case scenario after the S&P retraced half of its bear market, we’ll be roughly around 2600 on the S&P. If we maintain above 2600, we still would not be the worst-case scenario, we would still be in the realm of prior precedent.

I think that helps to frame the context that things were getting a little bit frothy, just like the extreme in March, when the markets were selling off precipitously. I was telling clients, if the Dow continues to fall like this, it's going to be at zero in a matter of weeks. And we know that's not possible. And likewise, if the S&P and the NASDAQ and the Dow continue to rally like this, I mean, we're talking Dow 50,000 by the end of the year. So, we can't go straight up and straight down.

This is healthy, but I will say I'm shocked by the speed of the decline last week. To me, that shows this is a very trigger-happy market in which we can rise and fall very rapidly as people move from fear and greed rapidly. But overall, I do think these are still constructive and we're still maintaining a bullish outlook.

Outside of COVID-19, what are you looking at that’s making you maintain a neutral position?

We do have a neutral stance toward the stock market; we’re slightly underweight fixed income at the expense of commodities. If you look at the amount of fiscal and monetary stimulus that has been applied, from my vantage point, I think we're going to see the US dollar weaken over the coming year. As protection against that currency debasement, we have moved into precious metals, first into gold, and then more recently into silver.

So, we have shifted the allocation in our accounts by under weighting fixed income where there's virtually no yield into commodities, where we're basically hedging against future current debasement. But we are neutral and the reason for that is a massive amount of uncertainty. You know, we haven't experienced anything like this ever before, not since the 1918 Spanish flu. So clearly, there's a lot of warranted conservatism around that.

But at the same time, we also have the reaction to this in terms of monetary and fiscal authorities, unlike anything we have ever seen. The U.S. Fed is on the path of doubling its balance sheet in just the next one or two months. The Fed now has a balance sheet greater than $7 trillion. It is staggering, when literally just going back to September of last year, the Fed's balance sheet was under $4 trillion. It was reducing its balance sheet until last September when it began to expand it once more.

It’s not just the Fed’s balance sheets. If you look at the amount of money that is in money markets, we are nearing $5 trillion in money market assets. And when you look at that plus other categories, like the amount sitting in commercial bank deposits, that has surged. We're seeing things we haven't seen before. For example, in the last six months, the amount of growth in money market assets has gone up by more than 30%.

Even at the peak of the financial crisis in 2007-2009, never had we seen the surge in money markets by more than 30% over a six-month timeframe. The data that we have goes back to the late 1980s. We have never seen anything like this, and even further, we've got data on commercial bank deposits going back to the early 1970s. At no time in history have we ever seen a vertical spike in the amount of deposits sitting at banks, and over the last six months, commercial bank deposits have grown by 16%.

There's a massive amount of money on the sidelines. The Fed has massively expanded its balance sheet. So, from my vantage point, when you've got all of that money sitting earning zero percent, we know investors aren't going to sit in cash forever, you can't retire on zero percent interest rates, you can't live on that.

For that reason, you know that money will come back. We don't know where, obviously it could go into other assets like real estate and so forth. But I do feel that there is somewhat of a limited downside to the market with all that money on the sidelines. If that money was not there, sure, we could have more downside as investors raise cash. But I think there are a lot of people who raise cash and have not gotten in.

So, if you are an investor who sold near the bottom, you're probably beating yourself up over the last several months. And if the market begins to pull in here, you know, the Dow up a couple more thousand points, the S&P a couple hundred points, you're probably looking at an entry point.

The other thing too that we've seen, is the Fed has really very little tolerance for any kind of market weakness. Essentially whatever market is declining, the Fed’s going to start going in there. I mean, we went from Treasuries and mortgage-backed securities this time around to municipals, to investment grade corporate bonds and even junk grade corporate bonds.

So, I do think the Fed is going to limit things. And as they stated this week, they're keeping interest rates locked at zero, and their forecast is through 2022. We've got years of zero percent interest rates ahead, and I have a hard time believing all of that money is going to be sitting on the sidelines.

To listen to the full Smart Macro segment and to find out if Chris Puplava sees any warning signs in the market, click here. For an archive of past shows, visit our Financial Sense Newshour page.

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