Why the Market is Really in Trouble

What an ugly start to the year. Some may want to start praying (it definitely wouldn't hurt). Some may just want to cry after another terrible week. The Nasdaq lost a whopping 6.3% for the week and blew out its November low, putting the Nasdaq in a bear stance.

The S&P blew out its 80-week moving average, an average that has held up over the last four+ years, and has signaled previous recessions. The DJI is only 75 points away from its November low and below the August close. The warning signs are all over the place and the trend is down.

Cash is king for risk adverse investors. If you don't want to go to cash for buy and hold or tax reasons, then at least spend some money to hedge your positions. Working the dark side can also be very profitable for cowboys like me. In my opinion, the market has another 10% down to go and that is assuming that the Fed will cut rates another 100 basis points. If they don't, then we could see years of churn and a situation most current investors have never seen.

Why am I so negative? Another 10% down? The Fed changes the dynamic, but they are behind the curve. So far, they have demonstrated that they are worried about the wrong thing - inflation. They failed to move aggressively in 2001 (when they did, it was too late) and they have possibly already missed the point of no return this time around.

Is it a recession? I really am not sure. Using traditional technical terms, I think not, but the stock market will react the same. It is currently pricing in a recession. My hope is that the Fed gets off its butt, realizes it, and gives us a V-bounce and not a slow painful churn.

Yes, the technical support broke down, but Technical Analysis in my opinion is only a tool and not gospel. The fundamental economic conditions are different that they were in February, August, and even November last year. Of all the economic data released by the Government, the jobs report is my #1 focus.

It is a trailing indicator (as compared to others), but there is usually enough uncertainty within the stock market that any correction is "under control" until jobs data show weakness. Good stocks (with volatility) usually hold up well against the other depressing data that are identified prior to an increase in the unemployment rate, thereby restraining major losses. However, when jobs go south, I head for the sidelines hedging against the worst.

The October jobs report was dismal, but there was a feeling that it would be revised (it was) and that it would spark the Fed to move aggressively (it didn't). I stayed with the market long through the November decline because I believed that the Fed would save the day with aggressive rate cuts. It killed my returns for the year and made a good year into an average year.

My current thinking is that we are looking at a stock market situation like what happened in 1990. The economic conditions are different, but it was the last serious housing recession that we went through and housing was the drag. Inventories are better than they were in 1991 and valuations and rates are better. This is all good news. I am not debating a recession (or lack of one). What I am focused on is the historical price action of the stock market during that timeframe.

Lets look at the stock market in 1990. An S&P monthly gives us some perspective:



The two downturns in October of 1989 and February of 1990 look very much like August and November of this year. The 80 week moving average (at 335) was undercut in August and the market went down another 10%. Let's look at the daily historical chart:



Bear runs are typically very steep (fear is very powerful) and a bottom was put in at 308 and was retested five weeks later. This test failed and the actual bottom was eventually put in at 295. Another retest happened 10 days later and the index put in a double bottom that held. It is worth noting that the market stayed below its 200-day ma for six months, but there were plenty of rallies throughout the process.

Those that bought and held theoretically didn't lose any money after six months, but the Fed got on the case and got aggressive. Without the Fed, the market may have had prolonged pain.

I think that today we are right at that point in August of 1990. We had a great run in the 1980's and the economic numbers were sliding, but the Fed reacted well and the pain for stocks was fairly shallow.