For me, the most difficult part of trading is dealing with the fact market moves always last way, way longer than anyone expects (or maybe just much longer than I expect). Much to my detriment, I am always too early, and then when it finally turns my way, I continually make the same mistake of assuming it has run too far too fast the other way. Like Lindsay Lohan at a Hollywood vodka launch party, I struggle with this problem incessantly. They say admitting you have a problem is the first step to recovery, so maybe this post will prove cathartic for my trading. If Lindsay can get sober, maybe I can actually ride a trend for more than a week or two before I am already thinking about fading it.
For those suffering with a similar addiction, it might seem like the current stock market sell off is one of those cases where it has gone down too far too fast. But I am here to remind you to stay strong; don’t feed the powers of the addiction. Yes, it might feel good for a little while when we get the inevitable dead cat bounce, but that pleasure will prove fleeting and more importantly, a poor risk reward.
Even though the bears are well acquainted with all the reasons the US stock market is overvalued and due for a decline, the bulls are just waking up to this realization. For the longest time the Federal Reserve’s easy money policies have made the bears look like brain dead chicken littles, but have a look at what has happened since the Fed has stopped expanding its balance sheet:
The Fed’s balance sheet leveled out in 2014, and since then, the stock market has gone sideways. But here is the real kicker; although the Fed’s balance sheet is not scheduled to decline, the non-traditional tools like reverse repos and issuance of interest bearing deposits the Fed is using to manage their tightening monetary policy campaign, have the same effect as a balance sheet decline.
There are a ton of other reasons why the US stock market is overvalued, but unless you believe the Fed’s QE program had no positive effect on equity values, then the synthetic reversal of this balance sheet expansion should cause the stock market to decline. It’s as simple as that.
But the most important part of this theory is that it is no longer just a theory. For the first time in a long time, market action is reflecting the bears’ concerns. The stock market is trading heavy, with little ability to muster rallies of any real consequence. Suddenly the path of least resistance is down, not up.
Even market darlings like Apple computer are sagging. For the longest time, this company could do no wrong. Everything was interpreted bullishly. Colossal flops like the Apple Watch (Zoolander edition</a>) were quickly glossed over and unrealistic growth extrapolated forever into the future. Yet have a look at the chart lately:
Apple has been struggling. And it is about time the stock market took notice to the poor company performance. It took forever, but the market can no longer ignore the bad news (from the Nikkei Asia Review):
Apple is expected to reduce output of its latest iPhone models by around 30% in the January-March quarter compared with its original plans, a measure that will deal a blow to Japanese and South Korean parts suppliers.
The U.S. company had initially told parts makers to keep production of the iPhone 6s and 6s Plus for the quarter at the same level as with their predecessors — the iPhone 6 and 6 Plus — a year earlier. But inventories of the two models launched last September have piled up at retailers in markets ranging from China and Japan to Europe and the U.S. amid lackluster sales. Customers saw little improvement in performance over the previous generation, while dollar appreciation led to sharp price hikes in emerging markets.
I don’t want to spend too long discussing individual stocks, or even the general stock market valuation level. All those make for interesting discussions, but at the end of the day, are just opinions.
But what are not opinions are the red and green marks next to everyone’s P&L. And my main message today is the red marks are adding up for the bulls. They haven’t panicked yet. In fact, few have even entertained the idea they might be wrong. Yet as the red ticks add up, they will be forced to admit it is not going as they planned.
Over the years, every cycle I have witnessed has gone to levels I felt were too cheap only to rebound to valuations I felt were crazy. We have been perched up at QE artificially induced stratospheric valuations for so long market participants have been conditioned to believe this is normal. It isn’t. And now that the Federal Reserve is intent on trying to get back to normal, there is no reason to expect stocks to stay up here.
Before this new downward move is over, I will be long, cursing at myself for being such an early fool and begging for all the optimistic bulls to return. But we are miles from that point. In the mean time, make no mistake – we are entering a down cycle for US stocks. And that cycle is just starting, not ending.
As long as the Fed keeps its foot on the brake with their aggressive tightening policy, there is absolutely no reason to own US stocks. The market is just waking up to that fact. Say no to the temptation of trying to buy the dips. Rallies are to be sold, not the other way round.
Thanks for reading,