On August 18th, 2015, after a period of relative calm very similar to what we’ve recently seen, I wrote a post Warning Bells Scream in Silence. U.S. stocks followed that period of calm with two sharp declines of about 12%-ish:
At the time I highlighted the following headlines that belied the complacent backdrop for U.S. stocks:
At this stage of the bull market and economic recovery, after 7 years of unprecedented monetary and fiscal easing the world over, the global economy appears weak at best. As for the evidence, there is no shortage in the financial press on a daily basis:
Europe: Weak eurozone data underline fragile recovery from FT.com 8/14/15
Brazil: Brazil’s Political Crisis Puts the Entire Economy on Hold from Bloomberg 8/17/15
China: China Turned to Risky Devaluation as Export Machine Stalled from NYT 8/171/5
Russia: Russia struggles to shrug off China slowdown from FT.com 8/17/15
U.S.: US economic growth gauge takes a tumble from CNBC.com
At the time I also highlighted Crude Oil, which was about to make a new 7 year low at $42, the 10 year Treasury yield which was banging along the bottom at 2.18%, copper at 5 year lows at 229, and of course the Chinese stock market bubble that was in the process of bursting.
What about now? Crude is a good bit higher now near $52. the 10 year Treasury yield a tad higher at 2.47%. copper a little higher at 270, and Shanghai Composite lower at 3230 (from 3800) at the time. That’s minimal progress.
On August 18th, 2015 the S&P 500 (SPX) was at 2100 on its way to 1867 in a matter of days, and back to 2100 in a matter of months. It then reversed and made a new low at 1810 by early February 2010. What’s interesting is that despite the reversal of a lot of the headlines listed from the period (that clearly spooked investors at the time), the SPX is only up 14% from Aug 18th, 2015.
What’s that mean? Investors are correct for now, stocks were a coiled spring. The economy is improving (mildly) and there’s an assumption that market friendly policy like corporate tax cuts and deregulation will happen and market harmful policies like trade wars and border taxes won’t.
So this breakout could continue, and who knows where it reverses and what’s the catalyst. But I suspect a lot of things need to go right in the coming months in an environment of rising interest rates and policy that already seems priced in. If we don’t see an improving economy to go along with the market’s anticipation of one we would undoubtedly see our first correction in some time. And to my eye, the 2100 level in the SPX is where we are going if investors all head for the door at the same time. And that 2100 is about 12% from current levels, similar to the corrections we saw in 2015:
I know that sounds preposterous, a re-test of the November 2016 lows, given what appears to be improving economic data the world over. But if you’re adding new capital to a breakout here you have to be a couple chess moves ahead on what you would do if you get trapped. (We’ve been highlighting defined risk stock alternatives in breakout names all year with that idea, participate in upside, define risk when it reverses).
A quick 4% decline back to the nice round number of 2300 is very realistic. And the question if the February breakout level doesn’t hold is whether it would turn into a proper sell-off to the nice round number of 2200, the November 2016 breakout level. And of course if that doesn’t hold, then back to 2100 for a pull your hair out sort of test, reversing all of the post election gains. Those are the levels to target for hedges:
Warnings bells are not screaming the same way this time around, but complacency is similar. And yesterday’s 1.3% move broke a historically long period of the market unable to move more than 1% a day. As we’ve pointed out recently, we’re starting to see the VIX up some days when the market is higher, and down, when it’s lower. (yesterday and this morning is a good example) The higher we go now, the harder we fall. It’s that simple.
We may be in a situation where an improving economy and a sideways market for the past few years is about to have kerosene poured over it. And the breakout could get absurd. But have a plan if it doesn’t. Because a lot has to go right for this to be sustainable.
As as the Boss once said, “blind faith in your leaders, or in anything will get you killed!”