I'm not bringing this up to 'scare' anyone. This post is in regards to the fact a few sources I read on a daily basis have started to align in their market analysis very closely. This is a first and I think it's my "duty" to at least give you guys the information to judge for yourselves. cthree and myself both more or less 'called' a go to cash position within the last month in preperation for a 5%+ decline. It just happened recently. This is the next step.

I'm going to make this as clear cut and straightfoward as possible. I'm a nerd economics guy but I'll spare you the gibberish except for those that want it.

Much of this I will regurgitate from John Mauldin's free* newsletter and John P. Hussman, Ph.D.; however I will get to the point.

Fact-if investors chose to invest [long positions] in the many times in history in which the market indicators were like they are currently-they would lose money, substantially.

Fact- 10% market losses have typically occurred more than once every 2 years, and bear market losses (generally 25-35%) occur about once every 4-5 years. This isn't like saying because an NBA player misses 20 free throws in a row he's got to make the next shot, it's saying if you aren't prepared for this decline when it comes, you are a fool. Not if, when. The longer it goes [this is the 2nd longest in history btw, the harder the fall].

Fact-"There is in fact zero correlation between year-over-year changes in earnings and year-over-year changes in the S&P 500. Rather, low and expanding risk premiums are at the root of nearly every abrupt market loss."
[laymen's terms-the growth of companies and consistent earnings do not correlate to market collapses which is what most people look at as the indicator of the market's health]

Fact-"Credit spreads and credit default swap spreads are surging. While we haven't observed the spike in short-term spreads (e.g. 6 month commercial paper versus 6 month Treasury yields) that would indicate near-term recession risks, we are now seeing a "tiered" widening of credit concerns. For example, note that high yield (junk) securities have experienced upward yield pressure since early June. In recent weeks, we've seen a spillover into credit spreads on investment grade securities. Again, we're not observing this in short-dated spreads, which would be a signal of imminent recession risks, but it's already clear that low risk premiums are being pressed decisively higher.
[the common market internals that have been POSITIVE for the last few years just turned NEGATIVE at the time the market sustained the 500 point loss. This is good and bad-good from the standpoint we know what we are dealing with and recession may not be as abrupt-bad from the standpoint most indicators suggest we are getting near the end of the run]

Fact-"The DJIA hit a record high while declining stocks overwhelmed advancing stocks by a 2:1 margin (remember that last week?). That divergence has never before occurred in market history, though again, lesser divergences have typically been characteristic of weakening markets."
['typically' is a bit generous IMO, the stronger divergences but weaker than the 2:1 margin usually represent time periods just before major* drops in equity values]

What to look for-The double-top: This has occurred only 6 times in 80 years. "Those instances, and the subsequent market losses were: October 1929 (-86.2%), May 1946 (-28.8%), February 1969 (-36.1%), January 1973 (-48.2%), September 1987 (-33.5%), and April 1998 (though followed by an 18% market correction by October 1998, the subsequent recovery produced a third "shelf" in the Coppock Guide by 2000, and the market lost nearly half its value between 2000 and 2002)."
[The "tops" are a measure of price momentum based on the 10-month "smoothing" of the averaged 14-month and 11-month rate of change in the S&P 500].

Ok-let's say you didn't absorb that too well. BOTTOM LINE-3 major and reputable asset managers I follow daily have just recently adjusted to become nearly fully hedged against the market. 2 of the 3 will lose $ if the market continues upwards.

The market could continue without a correction for sometime, don't sell all your assets tomorrow in a panic. The above men are paid to be nervous. But if you aren't at least eyeing some Proctor and Gamble or defense picks you are a sitting duck. A major* indicator will be if the fed cuts rates. If the fed does nothing, it's going to be sooner than later. If the fed cuts rates, it could prolong a large drop by as much as 6-12 months, if the fed raised interest rates by some oddity, it would probably be catastrophic but expected.

If you are thinking of using puts on your risker plays, it's probably a good idea from here on out. I personally am 80% "cash" and am reinserting it in to recession proof stocks with decent upside, besides some tech stocks I know very well.

"when someone says it's going to be different this time, that's when you need to be most scared"-jim cramer's real money

 

I'm not going to say I agree or disagree, frankly it's a lot of mumbo jumbo but one thing I can agree with wholeheartedly is that risk in the market is much higher than it was. In June you could have said that it didn't matter which stocks you invested in almost all were going higher. That's not true anymore.

I don't think you should panic. The DOW is at 13300 and topped at 14000. We are going to 14000 again with absolute assurance. There are risks however when we get there and you need to recognize them and hedge against them. I don't think you should short the market. Once we get some traction up we are going up 700 DOW points.

The risk is that we get to 14000 and get stuck. This is the "double top". Previous support forms future resistance and it is very hard for a stock or index to achieve "higher highs". If the DOW sails past 14000 then it's off to the races but until that happens it's a crap shoot as to whether it will. If it fails it could easily fall right back to where we are.

I would recommend (and am doing this myself) looking over your portfolio and using some sort of hedging strategy to defend your positions at times of elevated risk to normalize it. That can be in the form of buying a put spread or selling out of the money calls or some other strategy which works for you. You can short index ETFs as well. You'll trade off any gains while you're hedged but you'll preserve your capital in time of uncertainty.

Risk is real. If you have profits take them or at least protect them. Stay diversified and hedge your portfolio when the markets are volatile. Good advice.

PS: Beyond passing 14000 on the DOW is the China risk ahead of the Olympics. You don't want exposure to China going into the games. Again just another risk to the market you need to take seriously but not something which should cause you to panic.

 

Good posts, guys. Thank you.