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Market Lab Report - Never Let A Good Crisis Go To Waste

Market Lab Report / Dr. K's Crypto-Corner

by Dr. Chris Kacher

The (R)Evolution Will Not Be Centralized™


(click on image for hires version)

Human Innovation Always Trumps Fear

It just goes to show that human intelligence, creativity, and innovation has outdone fear in every case so far. In every crisis, certain industry groups get hammered in hugely oversold fashion so become deep bargains. All crises resolve to the upside. That said, while markets have always recovered, it can take years to breakeven if you bought at a peak. This is yet another reason why buy-and-hold is NOT a safe bet. 

Instead, it pays to find those stocks that are likely to outperform due to their cutting edge technologies or innovative services. Use technicals to time one's entries and exits. I have a saying. When it comes to finding the next stock with huge upside price potential, buy only if both fundamentals AND technicals show this potential upside. Sell only on technicals. Price will show whether you are right or wrong so always heed your sell stops! You can always reenter the position.  


Where to Focus

The top 20% of stocks and ETFs leave many clues as to the potential future leaders. Stocks that resist downtrends in markets are a sign of great strength. When the weight of the market comes off, these stocks often act like coiled springs and shoot higher. Eventually, both gold and bitcoin may be such candidates. The blue line in the image below is the S&P 500 while the gold line is gold. You can see how back in 2008, everything including gold was sold off hard. But by November 2008, gold started to trade sideways compared to the S&P 500 which was still in an overall downtrend. Recent signs as I pointed out in the last webinar show bitcoin has been the first to bounce. Whether it can sustain its bounce is of course in question as another wave of panic selling which is likely for reasons cited later in this piece would probably push all assets including bitcoin and gold lower.


Another focus point are the stocks performing in the bottom 20%. Such poor performers enables one to pinpoint which industry groups and stocks have been greatly oversold that may offer a huge upside. That said, with any major shift, some industry groups may not come back or stagnate so buyer beware. It takes much research and contextual analysis to separate the wheat from the chaff.

No One Knows The Future

When the legendary William O'Neil was ever asked in interviews where the market would be in the future, his response was always the same. "How should I know?" The point is that each day brings new information. The wise trader and investor assimilates the data then acts accordingly. It is a real-time approach. Predictions are subject to great error. Those who stake their reputations on predictions often find themselves psychologically wedded to such predictions. Therefore should one make a prediction, one should always be ready to change their view on a dime. Price dictates such actions. If your stop is hit, you might be wrong. Move onto the next opportunity or circle back if a second or multiple entry points arise while the risk/reward remains favorable. The trade of a lifetime often comes every few weeks, especially near market lows. Stay nimble and open to all possibilities. 

Change is the Only Constant

The only constant when it comes to markets is change. Quantitative easing, or QE, was one of a number of material changes introduced to the markets which destroyed a number of variables that had once carried predictive value. Thus being able to pivot in a timely manner has always been critical to the few successful investors who have remained successful.

If we analyze a century worth of data, we will see that all crises were followed by major averages bottoming then moving higher which brought major buying opportunities.

Some examples:

2008-2009 - Crash, bounce, retest, new highs


In 2008, markets were rescued by QE thus 2009 was the start of the decade+ bull and one of the best years for stocks. Gold was the first to reach new highs in a matter of months. It had lost about 1/3 of its value but this was a sign of strength relative to most all other industry groups which had lost roughly half or more of their values. Car rental companies came roaring back as their breakup value, ie, the value of their automotive fleets alone, far exceeded their stock price lows. Other groups followed. But try to pinpoint the bottom is a fool's game. It is best to monitor a range of industry groups, both leading and lagging, to get a sense of when markets make a major bottom. In the case of the NASDAQ-100, it bottomed in Nov-2008 then retested lows in Mar-2009. It was then off to the races. The S&P 500 undercut prior lows, then zoomed higher. A number of stocks in the top and bottom 20% zoomed higher. Pocket pivots and buyable gap ups were numerous as well as undercut & rally formations enabling one to get quick exposure to the nascent bull market.

New bull market due to: Quantitative easing (QE1) which kicked off this "Era of QE".

qqq 2009
Courtesy of https://allstarcharts.com/u-s-stock-market-bottomed-2008-march-2009/ 


1962 - Crash, bounce, retest, new highs

This bear was caused first the President John Kennedy's standoff against the steel companies which began in the spring of 1962 then by the Cuban Missile Crisis in October.

New bull market due to: Both issues resolved. Economic stimulus spurred growth.


(Courtesy of https://www.investing.com/analysis/how-the-recent-stock-market-crash-is-just-like-1987-200371419 )


1987 - Crash, bounce, retest, new highs 

This crash was brought on by a number of factors including a badly timed interest rate hike. Computer program-driven trading models that followed a portfolio insurance strategy as well as investor panic spurred the crash. No trading curbs existing in those days. There was also a takeover-tax bill, sent around several days before the crash to see how the measure would be received. Some believe this was the straw that broke the camel’s back in an environment that was already appearing to be a perfect storm for some kind of tumble.

New bull market due to: After the crash, trading curbs and circuit breakers were put in place to prevent such recurrences. In a statement on October 20, 1987, Fed Chairman Alan Greenspan said, “The Federal Reserve, consistent with its responsibilities as the Nation's central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system." Behind the scenes, the Fed encouraged banks to continue to lend on their usual terms. The Fed’s response to Black Monday ushered in a new era of investor confidence in the central bank’s ability to calm severe market downturns. Unlike many prior financial crises, the sharp losses stemming from Black Monday were not followed by an economic recession or a banking crisis due to the Fed's fast response to provide any needed liquidity via easy money policies. Former Fed Vice Chairman Donald Kohn said, “Unlike previous financial crises, the 1987 stock market decline was not associated with a deposit run or any other problem in the banking sector."


(Courtesy of https://www.investing.com/analysis/how-the-recent-stock-market-crash-is-just-like-1987-200371419 )


1998 - Crash, bounce, retest, new highs 

This bear was brought on by the "Asian Contagion". After the bear ended, the top performers in late 1998 were the first to hit new highs. This included YHOO, EBAY, and AMZN. EBAY left an important clue in that it had first mover advantage, yet came public during the 1998 bear market. It promptly lost over 1/3 of its value but when the weight of the market came off, it created a U-turn pattern. Within a matter of days, it had eclipsed its IPO price by gapping to new highs. I called Bill O'Neil and told him this is your buy point. Of course, I bought a sizable position in the institutional account I was managing.

New bull market due to: Containment of the crisis. The Fed also had easy money policies in place to prepare for Y2K which was seen as potentially disastrous. Easy money created one of the most powerful bull market rallies in 1999 which created the dot-com bubble.


(Courtesy of https://www.investing.com/analysis/how-the-recent-stock-market-crash-is-just-like-1987-200371419 )

(https://www.macrotrends.net/stocks/charts/EBAY/ebay/stock-price-history )


2011 - Crash, bounce, retest, new highs 

This near-miss bear with averages down roughly -20% was brought on by the end of the second iteration of quantitative easing, or QE2. The Federal Reserve had no choice but to reinstate QE as came to be known as Operation Twist.

  • QE2: November 2010 - June 2011.
  • Operation Twist: September 2011.

New bull market due to: Operation Twist


(Courtesy of https://www.investing.com/analysis/how-the-recent-stock-market-crash-is-just-like-1987-200371419 )

2000-2002

Post dot-com bubble, markets headed lower. Y2K turned out to be no issue so the easy money policies had to be undone. Furthermore, because dot-coms were in a bubble with most having deficient business models, the bubble blew apart. Without the easy money in place, recession hit by 2001. This prolonged the stock market correction. Markets did not recover until early 2003 as many internet companies between 2001-2002 (Webvan, Exodus Communications, and Pets.com) went bankrupt. An outbreak of accounting scandals (Arthur Andersen, Adelphia, Enron, and WorldCom) was also a factor and investor confidence suffered. The September 11, 2001 attacks also contributed heavily to the stock market downturn, as investors became unsure about the prospect of terrorism affecting the United States economy.

New bull market in early 2003 due to: Easy money, ie, low interest rates.

(https://www.macrotrends.net/2015/fed-funds-rate-historical-chart )

Most of the weaker dot-coms had also been weeded out by then. This allowed the strongest ones (EBAY, AMZN, YHOO, etc) to thrive in the low interest rate environment. All issued strong buy signals in March 2003 as they had been outperforming the general market averages.
(https://www.macrotrends.net/2324/sp-500-historical-chart-data )

(https://www.macrotrends.net/stocks/charts/AMZN/amazon/stock-price-history )


1929

Roosevelt's crippling polices via the New Deal from 1933-1939 prolonged the depression, despite the big bounce in the major averages from 1932-1937, turning it into The Great Depression. From October 1929, the Dow Industrials lost 90% from peak to trough, bottoming in June 1932 after which it had its strongest up years on record with a gain of about 100% in 3 months off lows in 1932, then after a pullback, another 100%+ gain in 1933.



(https://newworldeconomics.com/the-federal-reserve-in-the-1930s-2-interest-rates/ )

Back then, bank lending was more stringent, at least not on an overnight basis. Most of the overnight lending was to brokers, for margin loans. Margin was big in those days, up to 1930, as it was unregulated and people used leverage up to 10x on stocks. 

In the chart below, the discount rate jumped toward the end of 1931 due to the devaluation of the British pound in September 1931. The British pound was the world’s premier gold standard international currency in those days. It set off turmoil everywhere, including dozens of “echo” devaluations since the British pound was also the premier reserve currency. This caused another wave of panic selling. But as can be seen in the chart above, rates were quickly brought back down, this time to 0% or near 0% where rates stayed, except for early 1934 when markets had a correction, then were quickly brought back down where they stayed near 0% until early 1937 when the Fed tightened causing a -50.2% plunge.


(https://newworldeconomics.com/the-federal-reserve-in-the-1930s-2-interest-rates/ )

New bull market beginning June 1932 due to: Super easy money policies. Low interest rates such as 0% or near 0% Treasury bill rates from mid-1932 to early 1937 not only pulled the stock market out of its downtrend, but the Dow Industrials and S&P 500 had their strongest market rallies in history.

1973-1974

The oil embargo of 1973 skyrocketed prices and crippled economies. A deep recession resulted as shown by the wide shaded area below.
(https://www.macrotrends.net/2015/fed-funds-rate-historical-chart )

New bull market beginning late 1974 due to: Numerous rate cuts, ie, easy money policies.
(https://www.macrotrends.net/1320/nasdaq-historical-chart )


2020

President Trump and global central banks have been providing record levels of stimulus, even beyond what was provided in the 1930s. I do not expect to see a prolonged bear market though steep corrections in the major averages beyond 50% would not come as a surprise. That said, easy money has never been easier. Tax cuts, low oil, and numerous economic incentives as well as helicopter money all work to potentially minimize the length and depth of any recession. In other words, despite everything going from bad to worse, major averages could find their lows, even if deep, sooner than we think. "Buy when there's blood in the streets" has always and still applies.

The first panic selling wave was due to the exponential rise in coronavirus cases. The second panic selling wave will likely be due to the massive amount of damage done to the economy due to lockdowns, quarantines, and supply chain disruptions. A third wave of panic selling could be due to the infection rate not leveling off as the weather turns warmer. Since the virus is brand new, Harvard Medical School's coronavirus resource center said, "At this time, we do not know whether the spread of COVID-19 will decrease when the weather warms up." https://www.nih.gov/news-events/news-releases/new-coronavirus-stable-hours-surfaces

Currently, gold miners, precious metals, bitcoin, hotels, airlines, and logistics companies should be watched for potential entry points but only once the major averages have found their bottoms. This could still be months off as the economic standstill is likely to induce a recession which could easily push major averages 50% or more below their all-time highs. That said, markets are forward looking and hate uncertainty, so once more data in the coming weeks can dispel much of the uncertainty, that may very well represent a major bottom in markets. Since information travels much faster today than in the 1930s or even in the early 2000s, the bottom could come sooner than later, even though it may be quite a sharp drop due to further panic selling.

The damage being done to the global economy continues to be greatly underestimated. New York Empire State Index and Germany's ZEW both made history, plummeting even well beyond the revised estimates. Hotels have experienced so far a 53% plunge in business. Economists are bracing for a once-in-a-lifetime surge in jobless claims. Goldman Sachs expects 2.25 million claims, but Trump's incentives for SMEs could reduce this number.

While the Fed's Bullard says the coronavirus shutdown of economic activity is not a recession but an investment in survival, he is saying that this is essentially a massive $4 trillion investment to keep things from getting worse, as opposed to investments that are supposed to help grow an economy. Such an onslaught of capital will further debase fiat thus gold, stocks, and bitcoin should benefit.


Will We Have A Recession?

It is highly likely. The question remains as to its severity (length and depth). As we can see from the numerous key examples above, easy money policies always rescued then jump started the economy. Most bear markets were short, sharp shocks of the "Crash, bounce, retest, new highs" type. The few prolonged bear markets were due to reasons such as restrictions on bank lending (1930-) and devaluation of the world's reserve currency at the time (1931) or the oil embargo (1973) or the slew of exogenous events from 9/11 (2001) to accounting scandals (2000-2002) and of course the dot-com bust which took a couple of years to unwind (2001-2002). Still, in all three cases, low interest rates were the key to helping stock markets find major bottoms. 

Keep in mind the stock market can have declines of 20% or greater without a recession. This happened in 1962 (-28%), 1987 (-33.5%), 1998 (-21%), and 2011 (-20%). The massively stimulative measures could spur growth that could cushion or at least shorten the length of a recession even if it comes as a sharp panic-stricken shock based on any additional waves of panic selling discussed above.

Average 3 year nominal returns when buying a U.S. equity sector down x% since the 1920s:

Down 60% = 57%

Down 70% = 87%

Down 80% = 172%

Down 90% = 240%

Will continue to monitor the situation. Stay tuned. 
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This information is provided by MoKa Investors, LLC DBA Virtue of Selfish Investing (VoSI) is issued solely for informational purposes and does not constitute an offer to sell or a solicitation of an offer to buy securities. Information contained herein is based on sources which we believe to be reliable but is not guaranteed by us as being accurate and does not purport to be a complete statement or summary of available data. VoSI reports are intended to alert VoSI members to technical developments in certain securities that may or may not be actionable, only, and are not intended as recommendations. Past performance is not a guarantee, nor is it necessarily indicative, of future results. Opinions expressed herein are statements of our judgment as of the publication date and are subject to change without notice. Entities including but not limited to VoSI, its members, officers, directors, employees, customers, agents, and affiliates may have a position, long or short, in the securities referred to herein, and/or other related securities, and may increase or decrease such position or take a contra position. Additional information is available upon written request. This publication is for clients of Virtue of Selfish Investing. Reproduction without written permission is strictly prohibited and will be prosecuted to the full extent of the law. ©2020 MoKa Investors, LLC DBA Virtue of Selfish Investing. All rights reserved.
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