Date: October 17, 2018

Was It “A” Bottom or “THE” Bottom? Don’t Get Comfortable Just Yet!

As you know, I had been calling for a mid to upper single digit decline in stocks since late September. That pullback has certainly come to fruition this month with the major stocks market indices down between 7% and 10%. Last Thursday brought short-term panic readings in some indicators and that served to mitigate more weakness, at least for now. Usually when these conditions occur, the bulk of the price damage has been done for the time being and at this point, I don’t think this time is any different. As such, we redeployed some of our dry powder back into the stock market late last week.

Just because the odds favor most of the price damage being done, it doesn’t mean that the volatility is over. As I wrote about last week, I believe the markets will see heightened movement in both directions through early November and the mid-term elections. In other words, the market has now shifted to a short-term time horizon or a trader’s market where weakness should be bought and perhaps, in limited situations, strength should be sold.

This is all in the context of an ongoing bull market. Usually during declines, the same group of gloom and doomers email or tweet me that the bull market is over and armageddon is upon us. If I had time, I would go back and see just how awful this group was at forecasting. I would bet that they typically contact me within a day or two of a bottom. Anyway, regarding the end of the bull market, I will publish a full canaries in the coal mine next week. But in the meantime, bull markets do not typically end with stocks going from all-time highs to multi-month lows in a period of a few weeks. As you may recall, bull markets tend to work sideways and roll and roll over time. The first decline does not generate much in the way of panic. More on this next week.

What’s next for stocks?

As I said, volatility reigns. However, there are lots of instruments worth buying or putting on your shopping list. While stocks have bounced from the lows last Thursday, I do think there is a scenario or even two where those levels will be breached over the coming few weeks. Stay closely tuned. I keep watching the parade of pundits who advise buying right now. Those are the same pundits who never saw the decline coming in the first place and were fully invested. So how can they “buy” when they were fully invested throughout?

This morning I watched an interview with Larry Fink, CEO of Blackrock, one of the world’s largest asset managers. Fink has been one of those pundits who is habitually on the wrong side of market moves. I often find that pundits who are wrong have a higher degree of being wrong than those are who usually on the right side of markets. Today, Fink didn’t give so much of an outlook as he did an explanation of why stocks went down. Hedge funds. Yes, he said hedge funds. There have been a number of funds liquidating and returning money to investors and Fink believes they caused a 7%+ decline in stocks. Incredulously, I just shook my head. What hedge fund manager with the vast majority of their net worth in the fund is just going to hit the sell button all at once or over two days? The answer? NO ONE! It was an absurd explanation. Unless a fund is forced to sell because of some type of margin call, they would liquidate in an orderly fashion over a period of weeks or longer.

As I pick this back up in the evening, I am now in Baltimore for a few days visiting with clients and stocks have exploded higher, led by technology and small caps. Why? Because initial snapback rallies usually see the most beaten down, rally the hardest. During the decline, it seemed like there were way too many pundits talking about the charts and technical indicators. All of a sudden when fundamentals failed to explain the decline, the masses had to turn elsewhere. But don’t worry. As soon as a rally really gets moving, they will abandon the technical rationale and go back to spewing about the economy and earnings. It happens every time. Rinse and repeat.

Summing it all up, the downside objective of the mid to upper single digit decline I forecast last month has been met, but I am not yet ready to declare an all clear. The vast majority of the damage should have been done for now, but stocks are in need of some repair which can be accomplished with time passing.
While a 7% pullback usually recovers in a few months, seeing the indices head right back to all time highs in straight line fashion would be very atypical and cause me to have the most concern since the bull market began in March 2009. That scenario could even lead to the end of the bull market like we saw from the August 2007 low to the October 2007 peak.

Paul Schatz, President, Heritage Capital