Heading down? – Weekly Blog #730

In the midst of a never-ending pre-determined campaign, it’s hard to guess both the timing and the outcome. We are in this position today, and the best we can do is guess. Generally, there are two approaches to guessing. The first is to assess past contests and the second is to focus on current conditions. I will briefly do both, including two surprising differences.

Story

Every market and/or economic decline is different. Experts use labels for stock markets, such as market phase, correction, and bear market. Economic declines are divided into cyclical and structural. Neither is an accurate description, but it is somewhat useful in describing what happened, with some predictive value.

Stock market drop

A 20% drop from a former high is called a bear market, a 10% drop is called a correction, and a smaller drop is called a market phase. The problem today is that the three popular US stock indices can each be labeled with a different name:

DJIA -8.82% = Market phase

S&P 500 -12.28% = Correction

NASDAQ Composite -25.06% = Bear Market

The majority of the public and therefore politicians get their brief market information largely based on the DJIA. Securities distributors and small-staffed financial institutions use the SPX, while professional traders pay attention to the NASDAQ. No wonder there is confusion regarding the current state of the market and, to some extent, where it may go. Almost by definition, the bigger the drop, the sooner a bottom is reached. Long-term subscribers know that I often find the NASDAQ Composite to be a better predictor of the market than the other two metrics. The NASDAQ led both up and down. The reason for this is that the junior index has proportionately fewer passive (index) investors who make specific stock judgments.

If you accept this analysis, then we have reached the level starting a trough, as most troughs occur after a 25% drop. Therefore, NASDAQ followers may begin to believe that the bottom of this market is near. This view is supported by the level of trading on the NYSE and NASDAQ, as well as the number of new lows for the week ended Friday. On a year-to-date volume basis, the NYSE is +6.98% and the NASDAQ is -6.10%. Last week, the number of new lows on the NYSE was 649, compared to 1023 on the NASDAQ. (Analyzing NASDAQ, it’s important to recognize that tech stocks were the top sector, both up and down. (Long term, I think ‘tech’ stocks will be among the leaders, but not necessarily the same names.)

Cyclical or structural economic declines

Cyclical economic contractions are much more frequent than structural changes. Typically, cyclical contractions are caused by excessive growth in the money supply, which leads to too much borrowing and inflation.

Symptoms

We are currently experiencing these symptoms. The M2 measure of money supply growth is currently +13.21% on an annual basis, which clearly includes what politicians call stimulus and I call political kickbacks. Unsurprisingly, this led the JOC-ECRI to grow by +17.37% this year. (The good news is that the index fell 1.51% this week). Therefore, it is reasonable to speculate on a recession in our future.

The critical risk is that political leaders will turn a cyclical downturn into a structural downturn, as they did globally in the 1930s. This is not a prediction, but as a trained U.S. Marine, I am always on the lookout for a sneak attack and need to be aware of the risk. There are currently an unfortunate number of parallels to the 1930s. Despite general economic expansion globally, there is a vocal minority that can be exploited by politicians. (Remember, I believe Mark Twain said a politician’s job is to find a parade and get in front.)

The current leadership is becoming more autocratic in several countries. Small regional wars have the potential to become global wars, eg Ukraine>>>Black Sea >>>Asia Minor >>>>East versus West?

The French presidential election shows that a large part of the population votes against. This election is consistent with the idea that there are almost no popular governments, just more popular than the opposition. This in turn makes long-term plans difficult, which also makes investment judgments difficult.

What do you think?

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Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.