Although it’s just my own personal shorter term outlook, I’m currently making decisions under the macro assumption of a recessionary environment to come on the fundamental side of the equation and a bear market in equities as per financial market outcomes. Gutsy call, right? Hardly. Although I’ll save this for another discussion, the KEY issue for financial asset decision making right now centers on corporate profit margins and earnings outlooks. Margins are near historic highs and clearly vulnerable. I’m already seeing meaningful price competition appear in such mundane and theoretically stable industries as waste collection. Issue being, if there is significant risk in the macro earnings outlook ahead, margin compression will be the driver. Secondly, it probably goes without saying that at cycle peaks, overly optimistic Street earnings expectations are always and everywhere the norm. It happens every cycle. Potential for earnings contraction is always underestimated. And in the current environment of above average price volatility largely due to structural changes in the landscape and character of the market (HFT, prop desk liquidity diminished greatly and significantly reduced role of the specialist community – all speaking to reduced macro liquidity), earnings/margin surprises to the downside may result in a deeper than not cut of the financial market sword. Be prepared, especially as we receive “guidance” in 3Q earnings reporting commentary.
Again, you don’t need me to tell you this, but the potential for a very meaningful Euro banking crisis is indeed overshadowing a lot of the true fundamental outlook for the US economy and corporate results singularly. The very deep perceptual wounds of the US banking crisis (which is still ongoing, by the way) in 2007-early 2009 are wide open and far from healed. So it’s a bit of a tougher call on the economy and financial market outcomes specifically than would otherwise be the case. Personally, I’ve been arguing for a very shallow economic recovery over the past two to three years. In like manner, again outside of the Euro influence that can in no way be dismissed, I’d argue for a shallow recession. Why? One reason below is more than obvious.
Obvious bottom line comment being, at least for the historically meaningful influence that is the housing industry/market, there has been zero recovery in the current macro economic recovery cycle. Drop? From what, ground zero?
We can look at employment stats from here to kingdom come, but there is no way we can spin the fact that there has been no recovery. Auto sales? We’re still down 35% from peak cycle sales of the mid-prior decade period. Small business recovery? As I’ve documented ad neaseum since early 2009 there has been no recovery in any historical sense of the word. We’re in a macro deleveragng cycle, and that means shallow officially measured economic recoveries and shallow downturns. Both coming with a heck of a lot more frequency than we’ve seen since 1980. Will it be much more like what you see below? I think so, but we’ll just have to see what happens.
So as we step back a bit, we know we are confronting three major issues of the moment that will all have bearing on financial market outcomes. Again, near term issue number one is Euro area financial sector and sovereign debt reconciliation. Number two is the long wave US credit cycle reconciliation that in my opinion is still nearer its beginning than end. And finally it’s the character of the short term cyclical business/economic cycle. All three are colliding, and that makes for an incredibly elevated environment of uncertainty.
Do we crawl in a hole and simply come out some other day? Amidst all the emotion and volatility of the moment, danger lies all around us. But so lays opportunity I believe for those that can see the proper macro that is the collision of long term (perhaps generational) credit cycles with short term business cycles. Having said all of this, let me get to the point. Although I personally remain ever the fundamental observer, investment decision making simply cannot be accomplished without a technical overlay. Fundamentally, the collision of the long term credit cycle with the short term business cycle is my personal macro backdrop. And as wildly simplistic as this is going to sound, my technical macro, if you will, is to stay in harmony with the bigger picture “message of the market”. Again, to the point, I think it’s VERY important to remember perhaps one of the most simple bigger picture technical rules of the road. Bull markets for equities tend to witness persistence in overbought territory. In like manner, bear markets for equities tend to see technical conditions “linger” in oversold territory.
It’s just the opposite if we flip this rule on its head a bit. In equity bulls, trips into oversold territory are temporary at best. In bear markets journeys into overbought territory happen in the blink of an eye and its back to neutral or oversold ground. Although it’s just my perspective, I think this is a key differential fingerprint of macro bulls and bears from a technical perspective. Of course a few quick charts are in order. Have a look at the following weekly chart.
Again, I think keeping it simple and straightforward is the key here. Of course above I’m using the weekly chart of the SPX stretching back to the mid-1990’s. Look at the 14 period weekly RSI on top. Bears are characterized by a 14 period RSI below the 50 level. But the key is that bear markets “linger” below the 50 level as trips above that demarcation line are very short lived. In like manner during the bull market periods seen above, it’s trips below 50 that were short and sweet. Does it get any more simplistic than this? In a word, no. Amidst all the daily crazy “noise” of data immersion that characterizes life of the moment, something very simple and longer term in nature can absolutely help keep us on the right side of the major trend. Without belaboring the point, we see exactly the same “lingering” in oversold territory in looking at the weekly MACD calculation and Williams percent range indicator during the ‘00-early ’03 bear and late ’07-early ’09 bear. And the best part of all in terms of the “lingering” technical patterns? They happen in harmony. They corroborate each other. Lastly, as you can also see, these indicators spent the bulk of their time in what is typically considered overbought territory during historic bull periods.
So how do we use this to our best advantage? By changing our behavior and decision making in reaction not only to fundamental anecdotes, but also importantly to technical fingerprints. In bear markets, rallies into overbought territory need to be sold, or at the very worst avoided in terms initiating or adding to positions. If we “listen” closely enough and also keep it very simple, the markets will be obliging enough to reveal major trend fingerprints.
One more chart and a few final comments. The whole concept of “lingering” is again seen when looking at the history of NYSE new highs. For clarity, I’m using the weekly chart and a 12 week moving average of new highs to avoid all the wiggles and jiggles of a daily chart. My own “interpretation” of oversold is colored in green. In bulls, trips into the green are quick affairs. In meaningful bear markets? Not so much.
So, I know you get the whole concept here. It’s far from rocket science and about as incredibly simple as it gets. One tiny problem. The whole concept of “lingering” sure as heck looks really good in hindsight, no? Without question. Everything is 100% clear in hindsight. But we live in a world of foresight uncertainty in which we have zero luxury of waiting for hindsight. In other words, in hindsight you are fired. The weekly longer term charts are an invaluable help in staying on the right side of a trend. But we all know it can take weeks or months to move these charts. What the heck do we do in the meantime while we are waiting around for the weekly or longer term messages of the market to unfold before us?
From my perspective, we reach into the analytical tool box for more help in the paint by numbers exercise of making our way into the future. I’ve discussed this in the past so will keep this ultra short. Watching further macro weigh of the evidence indicators are key. I’ve used the interplay of the weekly 15 and 40 week exponential moving averages for decades. At least for the past few decades, this has been an invaluable help in my own decision making and risk management efforts. Invaluable. The current message is not bright. Neither good nor bad, it sets the tone for decision making and the most important investment exercise that is the management of risk.
Although this is miles from an exhaustive technical indicator list, helpful has been watching the cumulative advance decline line for the NYSE and its relationship to its own 200 day MA. Again, macro weight of the evidence in advancing versus declining issues. As you can see, we’ve just broken what historically has been this important line.
As always, technical analysis is the ongoing art. Weight of the evidence interpretation as opposed to individual indicator dogma has always been my personal approach. And right now, this whole concept of behavioral and character change caught in the concept of lingering in oversold territory again has my attention. Deserving of yours also? I hope it’s helpful.
