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What to expect next?

I’ve been very quiet in the past month. The reason is that I was intensively working on a new product I will announce in the near future. Sometimes you just got to lock yourself in a room if you want to get things done. Focus is so underestimated thing nowadays. It’s just impossible to deliver a high quality product if your mind is all over the place.

Anyway, more about that when time is right. I want to discuss the market with you. Since my post Is it over? the stocks rallied a lot and most have already forgotten we’ve seen a mini crash in Q4. However, the problem is that, while I think there’s a good chance the bottom is in, the current action does not look like a Typical bottom. So, what to expect next?

The market is behaving very constructive as of late and it’s not far fetched to say the S&P 500 could continue going higher to above of its 200d or up to somewhere 2,800 level – the purple area.

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Typical bottom

People love picking tops and bottoms. I understand where this comes from, some just have the urge to prove they know more, they know better. While this might be a viable strategy, one needs to know where the market is currently and if a low has a chance of becoming the bottom. Are we in a 8-12% consolidation phase, a 20-30% cyclical correction or a 35+% secular bear market?

We’re seeing a good 10% bounce from the Xmas lows and it’s easy to feel stupid if you dumped your stocks then but now watching the market go up without you. It’s also as easy to feel victorious if you didn’t sell then, but what if we get a retest, or worse, what if it’s not over yet? Can you withstand that?

I prepared a chart pack of 16 bottoms that occurred since 1962. They might help you navigate through the cycles and picking the bottoms. One very common characteristic in bear markets is that we often see a multiple double digit counter trend rallies, the same goes for rallies near market bottoms.

I bet you’ve heard the old saying that tops are a process and bottoms an event. The following charts prove that bottoms are a process too, even though sometimes shorter in length! There are no V type bottoms really, a much more common bottom is the one that fakes people in believing it’s not over yet, like a double bottom or a low undercut bottom or a bear trap bottom. Let’s go through them one by one.

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Dollar breaking down

I bet you found yourself being a bit early on the market on a few occasions. This can be very risky, because there’s a thin line between being early and being wrong. Having a sound risk management one can prevent losing (too much) money, however one must remember that there are two dimensions of a good trade, time and direction. If either of them is wrong, you risk losing money! Thus I don’t trade on my macro views until the tape confirms them.

I wrote a post Euro to repeat 2017 move? three months ago. Clearly I was early, but now it looks US dollar is finally breaking down, thus confirming euro and other currencies could appreciate versus the dollar.

Let me start with a monthly chart of Trade Weighted US Dollar Index of major currencies by FRED. The broad index looks more bullish too be fair, but it does not offer that much history, so below I will show you an equally weighted index against emerging market currencies too.

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Is it over?

I’m not one of the guys who like to scare others with a repeat of 2008 or 1929 crisis. I don’t think that’s very useful. In my mind this is one of the reasons why the working class stay under invested throughout the bull runs and usually buy the top. They’re too scared to buy until the peak euphoria comes when is already too late.

However, one must not be complacent. We need to respect risk, we need to respect the market, we need to use stop losses. This is why they were invented. And this is why in Q4 I was warning you we could see a correction in the market. If you didn’t pay attention you could be down as much as 40% if you were invested in Apple or even more, if you were invested in some of the other stocks.

Could we see a 2008/1929 style crisis? Absolutely, but I don’t think this is the highest likelihood event. I still believe we’re in a secular bull market and that this is a cyclical correction only, but I’m staying open minded to any outcome. Like I’m opened to a scenario that the worst is over and that the market will start a process of forming higher highs and higher lows.

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Commit to a process and stick to it

The start of a new year can mean a new beginning for some. Hope, resolutions, more hope. But a few are willing to do the right thing, this mostly means ditching hope and replacing it with work, solutions and processes.

The market doesn’t care what we hope for, a retirement plan, a new house, or a hot stock tip. The market is a redistribution machine. It transfers the money from many to a few. Trading and investing is not that much about stock picking than it is about risk management. 2018 was nothing like 2017. In 2017 most forgot about risk management, many didn’t use it, and they were handsomely rewarded for their complacency. But then 2018 came. It was the total opposite year. It was a tough year, especially for those who forgot what the term stop loss means.

I’m not mocking anyone. The same day I think I know more than others the market smacks me straight in the face. And I get humbled down. What I’m trying to achieve is to make you a bit more aware of the current situation. Have we seen the bottom yet? If not, are you ready for another leg lower? Can you take it? Will you handle it? Most complacent people who answered yes to the questions above will most likely sell the bottom.

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Banks are rolling lower!

Since early October I’ve given so many warnings about the stocks market it’s almost making me sick already. No, not because the market might correct or even crash, but because I must be starting to get annoying to all of you. The intention of my warnings is to make you aware that there are risks and that you do everything that’s in your power of protecting your wealth (see Do NOT underestimate the risk). This is why we’re here, aren’t we? Making money is important, but protecting it, this is an even more important task in my opinion. 

Let’s take a look at a banking sector. I wrote a post about financial sector a few weeks ago and that we are looking to short it under the right conditions (see Sectors on the watch to short). I was also going on about yields falling or bond prices rising in the intermediate term (see From yield curve inversion to bond squeeze?). 

What if the FED hikes for the last time this December and pauses with rate hikes next year? What if the natural consequence is that the banks suffer in the same period? And when banks are trading lower it is never a good sign for the stock market in general!

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Do NOT underestimate the risk

I am not one of those guys who were warning you of a stock market crash for the past few years. They totally missed the bull run we had an opportunity to enjoy since the second part of 2016. But some of them will still claim they successfully called the crash! While in fact I was very bullish US stocks until early October this year when I gave a warning something has changed. A warning about emerging markets was given out even earlier.

I am not joining the doom and gloom camp, I am just trying to be rational and am giving a cautionary heads up, because the risks and stakes are getting bigger by the day. This does not mean the market can’t continue going higher over time if the underlying fundamentals and flow improve. But should they not we’re facing a serious market crash risk.

I am one of those who rather takes some of the risk off when events are not in favor and potentially misses a few per cent of the upside than risks additional losses of your capital. With a wise portfolio management it’s much easier to catch up with those few per cent when things improve than it is trying to get back to break even and trying to fix the damage that’s been done. 

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From yield curve inversion to bond squeeze?

Yesterday we got the first US yield curve (3 and 5 year) inversion since 2007. Usually a recession follows within two years but I don’t want to scare you with that. Firstly, it doesn’t have to happen immediately and secondly, if you read any of my posts lately you know that getting defensive is not something we should fight against and in that case you’re well prepared for a case of a downturn.

The point of this post is to point out that we could see a flight to safety, that is into treasury bonds. A lot of people are expecting inflation and interest rates to rise over time, meaning bond prices to fall, including me (see Bond breakdown?). But it looks too many got ahead of themselves so it would be irresponsible to ignore the intermediate term risks in the market. Let me present what I think could happen.

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Keeping a perspective

After G20 meeting when stock indices are gapping up it’s very easy to lose sight. It’s as easy to get excited as it had been easy getting depressed two weeks ago. In this kind of environment one needs to keep perspective. Often the best way is to take a deep breath, zoom out and take a more long term view. Usually the longer you go in the past, the more you will understand the present and the easier you’ll prepare yourself for any possible outcome in the future.

So I would like to share with a longer term chart of the S&P 500 index dating back from 1900 to the present day. 

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Shorting German auto industry

German DAX30 stock index has been one of the weakest so far this year. I’ve been arguing for the past couple of months that if the price of DAX is falling it’s hard to be bullish on stocks as an asset class (see Winter coming?). Many people are refusing to accept that we could see a deeper correction. The same goes to the perma bear camp that refused to accept higher prices until the end of this September.

I, on the other hand, like to keep an open mind and if prices are falling, why not shorting them. They’d fall anyway and it doesn’t do me any good if I’m observing on the sidelines. However, long or short, bullish or bearish, one must respect risks and be willing to accept things could change in a heart beat. Like we did in the first week of October this year. 

Like the US FAANG stocks, the bread and butter of their equity market, the German blue chip companies, their auto industry, could be facing turbulent times going forward.

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