Suspension of Logic

After every market correction like we are seeing right now, we get to see the same S&P 500 prices we saw in 2014, which is a total suspension of logic in many ways. It is up just 2% since November of 2014. If Trump wins the election, it will most likely go below that point. This ends up being a virtuous cycle because the market being down actually is predicting a Trump victory. The market’s 3 month performance prior to elections has predicted every election since 1984. The chart below shows the market has predicted the correct election result for replacement candidates 86% of the time since 1944. With the market currently down, the indicator is pointing towards Trump. A down market predicts a Trump win which will cause a down market.

bloomberg

The movements in the stock market do not alter my perception of where it is going. Unless there is a major correction, I will stay bearish. However, since I have debated many bulls, I know that they are very focused on the price action. If it matters to some investors, I have to focus on it whether it changes my mind or not. What tends to happen is I provide a cogent argument as to why stocks are overvalued and the response always surrounds how the market has done well in the past. Even bears have made this argument. Bill Fleckenstein said on CNBC on September 22nd that you can’t short the market because it has done so well. (The market is down 3% since then). More people are focused on price then you’d think. It’s tough to fight a rising market even if the facts are on your side.

The reason I focus on the bulls is because the market won’t fall because people with my though process are bearish. We’ve been bearish for quite some time. I need to figure out what will cause the bulls to change their minds. I believe the match that will light the flame of a major correction is the price action.

The best way to win arguments versus the bears is to ask why interest rates are at crisis levels if the economy has recovered. They never have an answer to this basic question. Some say the Fed should raise interest rates because the economy has recovered. I wonder if they believe this argument because I can provide data that disproves this. The second counter point made is that the Fed will keep rates low forever and will never allow a correction. This is in disagreement with the others, but it is much more intellectually honest because it acknowledges the market’s heavy reliance on the Fed. Given the inherent impossibility of this policy keeping stocks up forever, which the first group of bulls would agree with, it doesn’t hold any water in predicting where stocks will go in the next 12 months.

As much as the truth hurts the bulls, it is the reality we have to deal with. The best expression of this reality is shown in the chart below. This economic recovery has not been real because the government didn’t let the economy heal in 2008. As you can see, the manufacturing economy has grown only after the Fed has come to the rescue. If interest rates were normalized, none of the positive numbers we’ve seen would exist. The chart shows a mini-cycle within the larger economic cycle. There shouldn’t be this much weakness in the midst of the growth part of the cycle. The next mini downturn will coincide with the rolling over of the larger cycle which may exacerbate the situation.

ism

The chart below of construction spending illustrates the possibility that this heightened weakness could be hear sooner than later. October’s construction spending showed a year over year decline for the first time since the last recession. The mini-blip lower we saw in late 2006 coincides with the oil market collapse this cycle. Housing construction’s decline preceded the last recession. This time the energy and mining industries preceded the current crash as they showed weakness in late 2014.

construction

The final chart I have, shows the Fitch aggregate index of the credit market. The credit cycle showed signs of peaking in 2004 and 2010. This cycle has been more elongated than the last one, but it clearly shows the economy nearing a recession. The current rating is -3; it was -5 when the last recession started. The blue lines represent the credit default swaps outlook. It is at the worst possible rating of -10. It hit this rating in Q4 2007 in the last cycle.

fitch

Conclusion

The economy is weak according to the credit market, manufacturing, and construction. The only thing that keeps the bulls’ argument together is the price action. With the market correcting back to 2014 levels, this argument is questionable. The Russell 2000 and the NYSE still have yet to reach their 2015 highs.

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4 Comments

  • David

    November 1, 2016

    I am a wannabee Elliottician. My reading of the tea leaves says we could easily see a sharp drop in the market (W5000, QQQ, IWM, $DJI, RUT, /ES, SPX, SPY) NO MATTER WHOM IS ELECTED. I can easily be wrong, but it sure seems that way to me. The run-up nearly eight (8) years and fundamentals are very weak also. Rots o' Ruck!

    • John Galt

      November 2, 2016

      Everyone on TV is a wannabe electician. Especially Karl Rove.

  • Donald Groce

    November 2, 2016

    Your column is very aptly named if Donald Trump is elected. 600 reasons why this guy should not be president have been given by Repblicans as well as Democrats. Yet here he is. Standing at the door step of the White house. The primal crisis of our time got maybe 3 words in this election cycle. Yeah, Trump tell those miners in WVA and Kentucky to keep digging coal. In doing so they are digging the grave of civilization. Ignorance is curable, stupidity is fatal.
    Don

    • John Galt

      November 2, 2016

      So I'm guessing you're not a supporter. hahaha