Correction Is Over
As Bulls Jump Back Into The “Risk Pool.”
last week, retail investors didn’t step in right away to buy
the dip at the 50-dma. However, they did show up on Monday afternoon and
continued to buy through the rest of the week.
the market very oversold, a counter-trend bounce next week will not be a
surprise. However, if the market fails to hold the 50-dma, the risk
of a more substantial correction is likely.”
Notably, two essential things occurred this week. The market regained its 50-dma
and triggered our RIAPRO
Money Flow “buy” signal.
Both suggest that bulls have regained control, and we could see some
follow-through buying next week.
Over the past several weeks, in various forms, we discussed our reduction in
risk by rebalancing equities, raising cash, and extending our duration in our
bond portfolio. To wit:
“With volatility currently at the lows of
its recent range, a
pick-up in volatility would not be surprising. Over the last
6-months, corrections remain range-bound to the 50-dma which is currently 3%
lower than closing levels.While
such a decline is well within the norms of a correction in any given market
year, the low levels of volatility will make it ‘feel’ worse than it is.
With money flows
continuing to weaken and technical indicators setting up to produce
sell signals, we
reduced exposure a bit more this week by increasing cash and reducing our
financial holdings. “ – August
With the markets now deeply oversold on a short-term basis, we deployed some of
our cash throughout the week to rebalance the portfolio toward normal allocation
We don’t expect a
tremendous amount of upside, given the ongoing weakness of market internals, but
a retest of previous highs is not out of the question. Particularly since the
Fed “threaded the needle.”
The Fed Threads The
Needle On Taper
For weeks now, the Fed has been prepping the market for “taper
talk.” Stocks sold off a bit in anticipation of the announcement,
effectively “pricing in” a mildly
hawkish stance. Jerome Powell did not fail to deliver during his press
conference by announcing taper with no timeline.
With respect to progress towards taper, Powell commented, “In
my own thinking, the test is all but met”.
“I think if the economy continues to
progress broadly in line with expectations and the overall situation is
appropriate for this, we
could easily move ahead [with taper] by next meeting, or not…”
Again, with respect to a decision for November taper, “I
don’t need to see a good employment report next month; I just need to see a
decent employment report”. Powell is clearly signaling that Fed is
likely to announce taper in November barring an unexpected deterioration in
Powell commented that it may be appropriate for taper to conclude by
As expected, Powell left
a back door open in case taper doesn’t go over well. “If
necessary, we can accelerate or decelerate the taper”.
Fed has done a decent job of telegraphing when tapering is likely to begin
(most market participants believe the announcement will come this year), but
more importantly it’s because the asset purchase reductions are likely to be
trivial when seen in the context of how large the fixed income
markets are today, and how overwhelming the demand for income has become.” –
Rick Rieder, BlackRock’s CIO of Global Fixed Income
From the market’s perspective, a $15 billion reduction in purchases says the Fed
isn’t removing the “punch bowl.” However,
as shown in the table below, taper becomes an issue in 2022.
3-Signs Of The Next
I previously warned
that during the subsequent 5% correction, it would “feel” much worse
than it was. However, gauging by the number of emails asking about the “crash,”
why we weren’t heavily short the market, and we were crazy for “buying” the
recent lows, it is clear sentiment has gotten extremely negative.
The question I received the most was,“Is
this the beginning of a bear market?”
The answer is “no.”
Currently, bullish sentiment remains high, global liquidity flows are strong,
and stock buybacks are at a record.
While those issues
are supportive of stocks currently, they are also dependent on rising asset
So, for investors, there are 3-signs that will signal the next bear market or
recession is approaching, requiring a more defensive investment posture.
Inversion (Not Yet)
The yield curve is one of the most important indicators for determining when a
recession, and a subsequent bear market, approaches. The chart below shows the
percentage of yield curves that invert out of 10-possible combinations.
At the moment, given there are no inversions, there is no immediate risk of a
recession or “bear market. “
speaking, from the time yield curves begin to invert, the span to the next
recession runs roughly 9-months. However, note that yield curves are
currently declining, suggesting economic growth will weaken. If this trend
continues, another “inversion” would not
be a surprise.
Given the strong track record of predicting recessions historically, when the
subsequent inversion occurs, the media will quickly dismiss it just as they did
Such would not be a wise thing to do.
Fed Taper (Coming)
The issue of “tapering” is not as much
about the Fed’s actual reduction of bond purchases as it is about psychology.
“The key to
navigating Quantitative Easing and Fed policy in general is to recognize
that their effect on the stock market relies almost entirely on speculative
investor psychology. As long as investors get inclined to
speculate, they treat zero-interest money as an inferior asset, and they
will chase any asset with a yield above zero (or a past record of positive
doesn’t matter because investors psychologically rule out the possibility of
price declines in the first place.” – John Hussman
In other words, “QE” is
a mental formation. Therefore, the only thing that alters the effectiveness of
the Fed’s monetary policy is investor psychology itself. As shown,
there is a very high correlation between the expansion of the Fed’s balance
sheet and asset price increases.
Whether the correlation is due to liquidity moving into assets through leverage
or just the “psychology” of
the “Fed Put,” the result is
Therefore, it should also not be surprising that when the Fed starts “tapering” their
bond purchases, the market tends to witness increased volatility. The
grey shaded bars in the chart below show when the balance sheet is either flat
Notably, the period from the initial
tapering of assets and a market correction is almost immediate.
So far, the Fed is only TALKING about taper. November, however, could be a
Fed Rate Hikes (Not
The risk of a market correction rises further when the Fed is tapering its
balance sheet and increasing the overnight lending rate. Currently,
there is no expectation for rate hikes until late 2022.
What we now know,
after more than a decade of experience, is that when the Fed starts to slow or
drain its monetary liquidity, the clock starts ticking to the next corrective
Once the Fed begins to hike interest rates, market corrections occur quickly,
generally within 2-4 quarters. However, recessions and bear markets typically
take longer and have been extended due to ongoing interventions. Recent history
has moved the median time frame between the first rate hike and the onset of a
recession to somewhere between 24 and 36 months.
several primary indicators to follow to navigate market risk and potential bear
markets. While there is currently no indication of a recession or bear market,
the Fed starting to “taper” its asset
purchases will increase volatility.
Once the Fed begins to hike rates or yield curves start to invert, the time to
become much more defensive will become evident.
However, such could
all change quickly with the introduction of an exogenous event.
In the meantime, remain invested but don’t be lulled into complacency.
Changes in markets
always happen slowly, then all at once.
The views expressed by Lance Roberts are not
necessarily those of RetireEarlyLifestyle.com