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Market Lab Report - Premarket Pulse 1/14/19 - Government Shuts Down- So What? Retest of major lows ahead?

Fed Futures Down On China's Trade Growth


China imports and exports for December came in weak, underpinning worries of a slowdown in the global growth engine. Exports rose 7.1%, customs data showed Monday, down from the 7.9% reported earlier for 2017. Import growth declined to 12.9% from the previous year’s 15.9%. The data adds pressure on Beijing to resolve its costly tariff battle with Washington. While exports to the U.S. held up through late 2018 despite President Donald Trump’s tariff hikes on Chinese goods, forecasters say American orders are set to decline sharply.


On Government Shut Downs


Government shut downs rattle markets but are irrelevant as far as determining the general direction of the major averages. In 1996, when the Republicans had just won back a majority in both houses of Congress after four decades, we had the longest government shutdown in history at 21 days which was a non-issue, though it makes for great headline scares. In actuality, there have been 19 shutdowns since 1976. If you take the timeframe from a week before the shutdown since rumors can push markets lower, to a week after to account for any bounce back, the S&P 500 returned on average +1.51%, countering expectations. 


Interestingly, when some governments have shut down for prolonged periods, the respective country's economic growth has improved. In other words, in some countries, no government can be a better alternative. Spain is one such example where by October 2016, its government had been shut down for 10 months, yet as a consequence, it became one of the fastest growing EU countries while its unemployment fell: https://www.forbes.com/sites/timworstall/2016/10/27/spain-has-no-government-for-10-months-economy-grows-unemployment-falls-to-18-9/#42269553b62c. Activist governments that get out of the way of the people and let natural dynamics take over often find various economic metrics improving. Government intervention often is paved with overregulation which, as Ed Seykota wrote in his book Govopoly, is the beginning of the end of a regime when time and money spent on onerous regulations exceed the levels of productivity. Inevitably, some form of massive transformation is often the result. As I've asked before, if we take the situation to the more extreme, animals don't need formal governing but instead exist on communal governing, so why do human beings need such staunch rules in place? Of course, one could argue the other extreme and suggest a cabal could create biological weapons to wipe out a good portion of the planet. But I digress.


Fed Says What The Market Wants To Hear

The Fed meeting minutes were released on Wednesday. As expected, more members want to keep rates on hold to keep the bounce alive. They are obviously nervous about the recently observed bear market correction thus have to soft-talk the markets.  The GDP and unemployment numbers have been suggesting the economy is strong, but as we have pointed out in prior reports, the distorted CPI values potentially push GDP into much weaker or even negative growth while the rest of the world remains hamstrung, thus no global central bank can even begin to think of hiking rates which remain at record low levels. The U.S. has hiked 9 times now, each time 25 basis points, yet the 2.25-2.5% is well below historical norms of 5-5.5%. Powell recently said the Fed would be willing to "adjust" policy if it disrupted the market or created adverse financial conditions, thus basically giving a market reassurance that rates could go higher, stay at current levels, or even go lower if necessary. This has sustained the bounce at least for now.


Retest of Recent Market Lows Likely?


That said, on a monthly chart of the S&P 500 dating back to the early 1990s as shown below, each time the market has had a sharp correction, it retests and undercuts prior lows. This has happened in 100% of the cases: 1998, 2002, 2009, 2010, 2011, and 2015. The corrections in 1996 and 1997 were sharp, but less than -15%, so perhaps not sharp enough to require a retest of prior lows. 



Nevertheless, the current correction suggests a retest of prior lows within the next 2-3 months at the time if the last 6 cases are any guide. Keep in mind that today's environment is more unique than prior market environments, so using history as a guide can be less reliable.

With the Fed controlling interest rates, they will do what they can to achieve a successful retest to avoid a new downtrend that plunges the market into more deeply bearish territory. But rates remain well below historical norms. As we have said many times, the Fed may have painted themselves into a corner with respect to interest rates which have traditionally been the fuel to spur the economy out of recessions.
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