The last few months have been a rollercoaster ride, with the S&P 500 dropping 34%, then rocketing up 31.4% in 3 weeks. Then dropping -3.7% in the past two days.
I have followed a series of economic and stock market indicators in order to avoid significant losses in the stock market in 2020. These indicators have been put together during 2018-2019 and are comprised of a series of measures that are proven to be correlated with the stock market.
Why is it possible to time the market during moments like this?
The problem is in the detail: this stock market is rigged. If you don’t believe me have a look here and read about how hedge fund billionaire Bill Ackman said that “hell will be coming” right before he made a massive short wager on the market (to make money). At the same time as making that prognostication he prepared to profit from the sell-off over the coming days, only to then pocket the money and run for the hills.
He turned $26 million into $2.6 billion. Bill Ackman literally made money off of your stock market fear. What do you think of that? Now he’s patting himself on the back about how smart he was here.
One graph that makes me sit up and think
For me there is a simple illustration of how the “Great Lockdown” compares against other bear markets:
The “Corona Crash” or “Great Lockdown” simply hasn’t had enough time to develop, because the average length of a bear market with a recession is 10 months. We have only been through less than 2 months.
So what should you do?
The opposite of what everybody else is doing, which is feverishly buying stocks!
That’s the problem here: in a rigged market you simply are not going to make money by following what everybody else is doing. Just like in December, January, and early February it didn’t make sense to follow everybody and buy stocks. You lost real money if you were 100% or 80% invested at that time.
People who really understand how the economy works like Mohamed El Erian, Robert Shiller, Jeremy Siegel, Jeff Gundlach, Warren Buffett and Charlie Munger, among others, were telling us to sell stocks in January 2020. And apart from Jeremy Siegel nobody is rushing to tell you to buy at today’s levels.
I follow the experts, and above all else I follow the set of indicators that I know these experts use.
A simple rule – Market Timing Model
The really simple but challenging rule is this: you need to be fearful when others are greedy, and greedy when others are fearful. You’ve probably heard the saying.
What I want to add to it is another important component part – there are ways to quantify fear and greed. So rather than just trust your gut, you need to use the same measurements that economists and fund managers and hedge funds use to inform your decision making.
Here’s a summary of the Market Timing Model:
Short Term: -1 [Neutral / Downtrend]
Medium Term: -7 [Bearish / Sell]
Long Term: -7 [Bearish / Sell]
Short Term Indicators – Market Timing Model – Neutral/Sell
The short term indicators change daily and they are subject to the volatile vagaries of the stock market. Until recently they were mostly green and showed that investors had got ahead of themselves in planning for a quick recovery. Here is a summary of where we are today:
The un-weighted stock index dropped 4% triggering a sell. We’re still below the 200 day moving average and the S&P 500 will shortly drop below the 50 DMA, triggering another sell. Volatility (VIX) which is a strong indicator jumped considerably. If it continues to track higher than this is very bearish for stocks.
Next week I will be running the Market Timing Model daily, to see whether short term sentiment erodes further. I expect that it will if the “China trade war” narrative continues along with lacklustre corporate earnings.
Medium Term Indicators – Market Timing Model – SELL
Turning our attention to the economy, we find that the situation and indeed the measures we use to determine where we are now sit at historic lows. Here is where the medium term market indicators sit today:
Warren Buffett’s favourite measure is the “Market Cap to GDP” ratio and that is currently very high, suggesting future returns for stocks (long term!) will be closer to -2% at today’s levels.
The 30 year treasury yield is another indicator to watch. Until it starts climbing (like it did in past recoveries) expect stock markets to remain subdued.
The only upside is a decrease in credit risk in the bond market. Bond King Jeff Gundlach watches these three measures quite closely, and when they are on an upward trend it means that there is trouble in credit markets. And believe me that spells bad for stocks. Right now they are coming down from elevated levels.
Long Term Indicators – Market Timing Model – SELL
Again there is not a lot to write home about here. Valuations are still sky high and don’t seem to match where we are in the economic cycle. If you read the news or look outside you’d realise that today – 1st May 2020 – the economy has virtually come to a standstill. Yes, we are preparing to go back to work soon; and yes there will be an uptick in activity. But we are not returning to normal imminently.
Counterbalance this against historically high valuations for stocks and equities:
You’ve got a recipe for disaster until we see better economic data coming out of the US. Unemployment levels are shocking, however, they do not historically tend to return to lower levels very quickly. The US may never return to 3% unemployment levels.
The Kansas City Financial Stress index has peaked up and we expect that it might be even higher at the next reading towards the end of May 2020. Don’t expect a recovery in asset prices until this has peaked and started coming down. The last peaks we saw in these figures were in 2000, and 2008. Just sayin!
As we advocated last week in 3 graphs that show why I am “fifty fifty” about this stock recovery, anybody who thinks they know exactly how the next 6 months are going to play out is kidding themselves.
There is not going to be a v-shaped recovery. Data coming out of the US and EU this week and next should re-affirm the fact that we are entering a very painful recession, which will make the Global Financial Crisis look like a flesh wound.
To survive this bear market we advocate buying quality, cash generative businesses. The rest of the time we suggest that investors take a serious look at their risk tolerance and ensure they have enough cash on hand to buy serious dips in the market. Volatility is coming back baby, and it’s coming for a stock portfolio near you!