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And They Crawl Out Of The Woodwork

You know it's coming and it won't be any easier to take than when you were small and your Mother said "I told you so".  The blogisphere will now erupt with the force of an annoying snaggle tooth emphatically screaming "I warned you" and "I said it was coming.........now buy my plan so you're prepared"  and ca-ching, you cough up the coin like a kid at the carnival freak show.   Every smidiot and hack will now attack your inbox on how they could have prevented your losses and how (via in their premier plan) you would have benefited this week.......if you had only listened.

Puhlease

Markets correct.  On occasion, they correct more than mere pullbacks but the essential thing to remember is, they recover.  

No, it's not a master plot against Donald Trump.  His over-swept hair is safe and........seriously?  Who would even dream up that scenario (smh) but the heavy-selling picture last week certainly backed up a Dow sell-signal and have many wondering, just where we'll stop or is the bull run dead.  Are the men out there stating we'll see an enormous crash in October have a leg to stand on?  Then again some have much more credibility than others, calling the top and sitting back.  Those are the ones to watch.

fwiw I see next support at the 100 week EMA near $1945, assuming that Friday's low doesn't hold.  We're oversold daily and (just about) on the weekly.  Will it hold?  We shall see.

Still looking around at all of the emails and blogs, I felt TheStreet actually did a good job of sorting out what has occurred around the globe and taking a view of what may lie ahead.........no fee required young man.

A number of conditions have been developing for a few months that have conspired and have formed a toxic cocktail that led to this week's risk aversion and market schmeissing.  Risk happens fast.  As some of these conditions were much different than the past events, during which selloffs were modest and contained, we should be concerned.  Below are the adverse developments that led to the sharp market drop -- and in italics is a look forward to possible outcomes over the balance of the year and into early 2016:

1.) Technical Deterioration: The first development that we have to be mindful of has been the  narrowing market leadership and market divergences -- a consistent theme and concern of mine. Transports had already fallen despite lower oil, and, of course, cyclical (especially of an energy kind), commodities based companies and industrial stocks already had entered their own bear markets. The recent stunning upheaval in media stocks, threatened by fundamental business threats, has been a nail in the market's coffin this week and turned many great charts -- e.g., Disney (DIS) -- into very bad charts. The technical erosion has recently accelerated. As BTIG's Dan Greenhaus noted in his commentary last evening, "Among the S&P 500, nearly 30% of the index is now down 20% or more from respective 52- week highs ... while a staggering 57% of stocks are down 10% or more. Less than half the index is now above its 200-day moving average."

The bad news is that with many broken charts it will take time for a base building. The good news is that the decline in industrials and cyclical could be entering the final phase -- at least judged by the magnitude of the drops and what seems like a discounting of a global recession. A recovery in the stocks that are already in a Bear Market will be dependent upon global economic growth expectations.

2.) The Increased Role of Momentum-Based Portfolio and Trading Strategies and ETFs: Trend-following strategies and leveraged ETFs took the market to new heights and are now taking the market to recent lows. They care not of balance sheets and income statements and are agnostic as to where value lies. They aren't greedy, don't panic and pain is unknown to them -- they simply accentuate and exaggerate market trends and direction. 

It is near to impossible to forecast when the quants reverse direction as they are totally dependent upon price momentum. As I have written, "Kill the Quants Before They Kill Our Markets."

3.) Widening Credit Spreads: Credit spreads widened dramatically. High yield has moved from about 225 over to 525 over Treasuries. We shouldn't lose sight that the investment-grade and high-yield markets have had record issuances in recent years and the substitution of debt for equity has been an important fuel for corporate share buybacks. That window of issuances -- or more costly issuances of debt -- have closed some of that window and was the basis for my "Peak Buybacks" thesis . 

I suspect the widening of credit spreads will subside with greater confidence in global economic growth.

4.) China, the Engine of Global Growth, Has Stalled: We didn't need another weak purchasing managers index (as was released last night in China) to stoke concerns that an ongoing and sharp deceleration in the rate of growth in that region is at hand. And so is the speculative character of the Chinese stock market. Russia, Brazil and Venezuela are experiencing recession, and Greece, Italy and Spain are not far behind.

In the case of China, that country has more tools to halt the economic slide --and I wouldn't be surprised if some "shock and awe" is introduced over the coming weekend. Other areas of concern around the globe are either doomed or will extend and pretend, but Europe's manufacturing data last night could provide some relief. 

5.) Slowing Global Economic Growth Prospects: With overall global economic growth prospects diminishing, the chasm between the real economy and financial asset prices has grown ever wider. This led to this week's selling.

I remain concerned that global growth expectations are still too optimistic, but the consensus is now moving toward more realistic forecasts after being high for the last few years. Moreover, the sharp dive in commodities should, at some point, fuel an improved economy. 

6.) Slowing Profit Prospects: Until recently the market has ignored a material lower revision in S&P earnings-per-share expectations for 2015 (from $134 a share to about $115 a share).

The good news is that most of the forecasters have now adjusted their expectations down to more reasonable levels. Investors are now paying less for growth (as described by Jim "El Capitan" Cramer this morning). And, while the commodities' schmeissing hurts some important components of the S&P, lower rates and lower commodities could sustain profit margins and profits.

7.) Confidence in Central Bankers Has Been Waning: Enough said.

The good news here is that, again, there is growing recognition that the Fed and its brethren have done all they can accomplish for now.

8.) Bullish Investor Sentiment Had Moderated: Retail investors have consistently shed investments as outflows have continued.

While individual market enthusiasm has been muted, corporations (through buybacks) have taken up that slack. Retail investors will likely continue to shun stocks, but corporations should provide continued market support, albeit perhaps not as enthusiastically as in the past.

9.) The Bull Market in Complacency Has Been in Full Force: Again, enough said.

Up until recently investors have been complacent-- as measure by a low volatility index -- but the recent market drop, which has been severe in many sectors, have increased the recognition that (1) not all dips are buys, and (2) that a larger correction is possible. The later was something not considered prior to this month. The good news is that the VIX rose by more than 25% yesterday as complacency has been attacked. The CNN Fear Index is back to 2009 levels. In other words, we are now seeing the early signposts of possible capitulation.

10.) A U.S. Rate Rise is Imminent: Stop us if you've heard that one before.

The debate over Fed uncertainty has become a bit hyperbolic. My view is that the erosion in financial conditions coupled with current market chaos and uncertainty have provided the ammo for "one and done" in December is in place. That's probably a good thing.

Bottom Line

Where do we go from here?  I am less than certain, and those with extreme and self-confident views are "attention getters, not money makers."

While a lot of damage has occurred and some groups are likely close to bottoming, much will depend on the evolving economic data around the world in the time ahead.

As I have consistently written, the only certainty is the lack of certainty, and rarely have there been so many possible economic and market outcomes, many of which are aren't good. 

On a more positive note, with the S&P flirting with 2000 we are already closing in on my Fair Market Value Calculation of 1995. Here is the basis of this calculation:

  • Scenario #1: Economic Acceleration Above Consensus (Probability: +10%) – +3% Real U.S. GDP growth, +2.0% to +3.0% inflation and +8% to +12% profit growth. Stocks climb by 7.5% over the next 12 to 18 months. S&P target is 2245.
  • Scenario #2: Status Quo (Probability: 25%) – +2% to +3% Real U.S. GDP growth, +1.5% to +2.0% inflation and +5% to +9% profit growth. Stocks climb by 5% over the next 12 to 18 months. S&P target is 2195.
  • Scenario #3: Muddle Along (Probability: 25%) – +2% Real U.S. GDP growth, +1.5% inflation and +3% to +5% profit growth. Stocks climb by 0% to 5% over the next 12 to 18 months.  S&P target is 2140.
  • Scenario #4: A Garden Variety Recession (Probability: 25%) – Negative Real U.S. GDP growth, less than +0.5% inflation and a decline in profits: Stocks drop by 13% to 17% over the next 12 to 18 months. S&P target is 1775.
  • Scenario #5:  A Deep Recession (Probability: 15%) – Negative Real US GDP growth, deflation and a large drop in profits: Stocks drop by more than 20% over the next 12 to 18 months. S&P target is 1625.

When I combined the scenarios' probabilities against my S&P targets for each scenario, I come to a "Fair Market Value" for the S&P at about 1995 compared to Friday's close of 2090 – a decline of about 5% from current levels.

--Kass Diary (August 2015)

My guess is that somewhere between Scenario Three and Four (above) is the most likely scenario for the economy and markets over the next six to nine months.

This would be consistent with my view that a broad and important market top was indeed put in place during the first six months of 2015.

I still see a "saw tooth" pattern lower as my baseline expectation.

However, some stocks and sectors -- many of which have been shattered in recent months and have already experienced a Bear Market -- are now moving towards reasonable value and more attractive buy levels.

As to the broader market: For now I prefer to pay heed to Warren Buffett's thoughts of waiting for the right pitch, as stated at the beginning of today's opening missive.

We can never pick (with certainty) where the market's drop will stop and it is unreasonable to expect to buy at the bottom.

Though it might be still too early to significantly raise long exposure as reward versus risk is still unattractive, I can envision a developing opportunity in the months ahead.  For as The Oracle wrote, "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

There will be a time to go shopping as (stock) merchandise will likely be on sale over the next three to six months.

A number of conditions have been developing for a few months that have conspired and have formed a toxic cocktail that led to this week's risk aversion and market schmeissing.

Risk happens fast.

As some of these conditions were much different than the past events, during which selloffs were modest and contained, we should be concerned.

Below are the adverse developments that led to the sharp market drop -- and in italics is a look forward to possible outcomes over the balance of the year and into early 2016:

1.) Technical Deterioration: The first development that we have to be mindful of has been the  narrowing market leadership and market divergences -- a consistent theme and concern of mine. Transports had already fallen despite lower oil, and, of course, cyclical (especially of an energy kind), commodities based companies and industrial stocks already had entered their own bear markets. The recent stunning upheaval in media stocks, threatened by fundamental business threats, has been a nail in the market's coffin this week and turned many great charts -- e.g., Disney (DIS) -- into very bad charts. The technical erosion has recently accelerated. As BTIG's Dan Greenhaus noted in his commentary last evening, "Among the S&P 500, nearly 30% of the index is now down 20% or more from respective 52- week highs ... while a staggering 57% of stocks are down 10% or more. Less than half the index is now above its 200-day moving average."

The bad news is that with many broken charts it will take time for a base building. The good news is that the decline in industrials and cyclical could be entering the final phase -- at least judged by the magnitude of the drops and what seems like a discounting of a global recession. A recovery in the stocks that are already in a Bear Market will be dependent upon global economic growth expectations.

2.) The Increased Role of Momentum-Based Portfolio and Trading Strategies and ETFs: Trend-following strategies and leveraged ETFs took the market to new heights and are now taking the market to recent lows. They care not of balance sheets and income statements and are agnostic as to where value lies. They aren't greedy, don't panic and pain is unknown to them -- they simply accentuate and exaggerate market trends and direction. 

It is near to impossible to forecast when the quants reverse direction as they are totally dependent upon price momentum. As I have written, "Kill the Quants Before They Kill Our Markets."

3.) Widening Credit Spreads: Credit spreads widened dramatically. High yield has moved from about 225 over to 525 over Treasuries. We shouldn't lose sight that the investment-grade and high-yield markets have had record issuances in recent years and the substitution of debt for equity has been an important fuel for corporate share buybacks. That window of issuances -- or more costly issuances of debt -- have closed some of that window and was the basis for my "Peak Buybacks" thesis . 

I suspect the widening of credit spreads will subside with greater confidence in global economic growth.

4.) China, the Engine of Global Growth, Has Stalled: We didn't need another weak purchasing managers index (as was released last night in China) to stoke concerns that an ongoing and sharp deceleration in the rate of growth in that region is at hand. And so is the speculative character of the Chinese stock market. Russia, Brazil and Venezuela are experiencing recession, and Greece, Italy and Spain are not far behind.

In the case of China, that country has more tools to halt the economic slide --and I wouldn't be surprised if some "shock and awe" is introduced over the coming weekend. Other areas of concern around the globe are either doomed or will extend and pretend, but Europe's manufacturing data last night could provide some relief

5.) Slowing Global Economic Growth Prospects: With overall global economic growth prospects diminishing, the chasm between the real economy and financial asset prices has grown ever wider. This led to this week's selling.

I remain concerned that global growth expectations are still too optimistic, but the consensus is now moving toward more realistic forecasts after being high for the last few years. Moreover, the sharp dive in commodities should, at some point, fuel an improved economy. 

6.) Slowing Profit Prospects: Until recently the market has ignored a material lower revision in S&P earnings-per-share expectations for 2015 (from $134 a share to about $115 a share).

The good news is that most of the forecasters have now adjusted their expectations down to more reasonable levels. Investors are now paying less for growth (as described by Jim "El Capitan" Cramer this morning). And, while the commodities' schmeissing hurts some important components of the S&P, lower rates and lower commodities could sustain profit margins and profits.

7.) Confidence in Central Bankers Has Been Waning: Enough said.

The good news here is that, again, there is growing recognition that the Fed and its brethren have done all they can accomplish for now.

8.) Bullish Investor Sentiment Had Moderated: Retail investors have consistently shed investments as outflows have continued.

While individual market enthusiasm has been muted, corporations (through buybacks) have taken up that slack. Retail investors will likely continue to shun stocks, but corporations should provide continued market support, albeit perhaps not as enthusiastically as in the past.

9.) The Bull Market in Complacency Has Been in Full Force: Again, enough said.

Up until recently investors have been complacent-- as measure by a low volatility index -- but the recent market drop, which has been severe in many sectors, have increased the recognition that (1) not all dips are buys, and (2) that a larger correction is possible. The later was something not considered prior to this month. The good news is that the VIX rose by more than 25% yesterday as complacency has been attacked. The CNN Fear Index is back to 2009 levels. In other words, we are now seeing the early signposts of possible capitulation.

10.) A U.S. Rate Rise is Imminent: Stop us if you've heard that one before.

The debate over Fed uncertainty has become a bit hyperbolic. My view is that the erosion in financial conditions coupled with current market chaos and uncertainty have provided the ammo for "one and done" in December is in place. That's probably a good thing.

Bottom Line

Where do we go from here?  I am less than certain, and those with extreme and self-confident views are "attention getters, not money makers."

While a lot of damage has occurred and some groups are likely close to bottoming, much will depend on the evolving economic data around the world in the time ahead.

As I have consistently written, the only certainty is the lack of certainty, and rarely have there been so many possible economic and market outcomes, many of which are aren't good. 

On a more positive note, with the S&P flirting with 2000 we are already closing in on my Fair Market Value Calculation of 1995. Here is the basis of this calculation:

  • Scenario #1: Economic Acceleration Above Consensus (Probability: +10%) – +3% Real U.S. GDP growth, +2.0% to +3.0% inflation and +8% to +12% profit growth. Stocks climb by 7.5% over the next 12 to 18 months. S&P target is 2245.
  • Scenario #2: Status Quo (Probability: 25%) – +2% to +3% Real U.S. GDP growth, +1.5% to +2.0% inflation and +5% to +9% profit growth. Stocks climb by 5% over the next 12 to 18 months. S&P target is 2195.
  • Scenario #3: Muddle Along (Probability: 25%) – +2% Real U.S. GDP growth, +1.5% inflation and +3% to +5% profit growth. Stocks climb by 0% to 5% over the next 12 to 18 months.  S&P target is 2140.
  • Scenario #4: A Garden Variety Recession (Probability: 25%) – Negative Real U.S. GDP growth, less than +0.5% inflation and a decline in profits: Stocks drop by 13% to 17% over the next 12 to 18 months. S&P target is 1775.
  • Scenario #5:  A Deep Recession (Probability: 15%) – Negative Real US GDP growth, deflation and a large drop in profits: Stocks drop by more than 20% over the next 12 to 18 months. S&P target is 1625.

When I combined the scenarios' probabilities against my S&P targets for each scenario, I come to a "Fair Market Value" for the S&P at about 1995 compared to Friday's close of 2090 – a decline of about 5% from current levels.

--Kass Diary (August 2015)

My guess is that somewhere between Scenario Three and Four (above) is the most likely scenario for the economy and markets over the next six to nine months.

This would be consistent with my view that a broad and important market top was indeed put in place during the first six months of 2015.

I still see a "saw tooth" pattern lower as my baseline expectation.

However, some stocks and sectors -- many of which have been shattered in recent months and have already experienced a Bear Market -- are now moving towards reasonable value and more attractive buy levels.

As to the broader market: For now I prefer to pay heed to Warren Buffett's thoughts of waiting for the right pitch, as stated at the beginning of today's opening missive.

We can never pick (with certainty) where the market's drop will stop and it is unreasonable to expect to buy at the bottom.

Though it might be still too early to significantly raise long exposure as reward versus risk is still unattractive, I can envision a developing opportunity in the months ahead.  For as The Oracle wrote, "Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.' Whether we're talking about socks or stocks, I like buying quality merchandise when it is marked down."

There will be a time to go shopping as (stock) merchandise will likely be on sale over the next three to six months.

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