Dealing With Market Ambiguity

It was the clearest of signals in that first week of October 2018. The Dow Jones Industrial Average, S&P 500 and the Nasdaq Composite all could be labeled as having five complete waves at multiple degrees of trend, signaling the top of a 200 year bull market.

The importance of the signal is that, if the labeling is correct, this top, unlike the tops in 2000 and 2007, is far more serious and portends a much deeper, longer lasting bear market than anything anyone alive today has experienced. It should be a degree of magnitude greater than the Supercycle Bear Market of 1929-32. This one is expected to be a Grand Supercycle Bear Market. The previous one began in 1720 and the effects lasted nearly fifty years.

This bear market began right on schedule, dropping in two crashes with an intervening countertrend rally into a low on Christmas Eve. What should have followed was another upward reaction, followed by a further drop into a low of around DJIA 15,000 to complete the first leg down in a drop that is expected to get below 4,000. Then, after a retracement that could last a couple of years, another impulse wave taking the Dow down below 1,000 to a final low, probably 10-15 years from now.

Instead, an advance began on December 26th that has gone beyond a normal retracement, so the pattern is now something other than an impulse wave.

From here, I believe there are two possibilities. The bear market may continue irregularly in the way that the decline from 1986 to 1970 occurred. The problem with that scenario is that the 1986 drop was not a major bear market and it only dropped 37% before coming back to new highs. The second possibility is that this first drop is another pause in a continuing bull market which would mean new highs are ahead. The next phase of decline should give us a clue, and it shouldn’t take long to get underway, as the market is very overbought now.

How does an investor handle the situation? I look at the market now in terms of risk. It is the same as it was last October. It is extremely overvalued. Most investors have no real idea what they own, and are numbly complacent about it. A rational study of the present market condition clearly indicates that the risk, in historical perspective, has never been higher. Unfortunately, investors are never rational at market tops. They unconsciously cling to their stocks, driven by FOMO (Fear-Of-Missing-Out). It’s a hard emotion to beat.

The investment advisory industry is similarly bullish. Surveys of economists consistently indicate they are nearly unanimously optimistic. As counter intuitive as it may sound, major market turns always take place when the majority thinks a trend will continue.

In the futures market, the Commodity Futures Trading Commission’s Commitment of Traders Report on futures on stock indexes indicates a record long (bullish) position on the part of speculators, and a correspondingly record short (bearish) position on the part of the commercials. When extremes like these are reported, it is always the commercials that are right.

As long time readers know, I do not make recommendations. How you handle this information is your business. But I will tell you that my recommendation to Cindy is that she remain in 2 year Treasury Notes, even if the market were to go to another high. History tells us that you can’t make money in an expensive market and the risk today, in my opinion, is extraordinary.

Good luck,

Rod



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