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Market Lab Report - Premarket Pulse 12/31/18 - Ho ho ho and a bottle of rum - Focus List Ground Zero

Our Focus List at Ground Zero

Well the Christmas crash has come and gone. Or has it? 

The Focus List having zero names on it starting in the fourth quarter of 2018, or what could be called 'Ground Zero' was the first time such had ever happened since we launched this site in 2010, indicative of the end of the decade-long QE-induced bull market which put major averages definitively under the -20% mark, unlike 2011 and 2016 when major averages only hovered around the -20% mark in the worst cases since 2009. Further, the carnal damage done to stocks has not been seen since 2008.

While it has been a nearly unprecedented occurrence, nimble timing on the short side for those who short has been immensely profitable. Meanwhile, those on the sidelines can say they didn't lose money when compared to most of the investment world. Keep in mind one does not always have to trade if the market is not trading in a manner which agrees with one's style of trade. For example, a choppy market seen much of this year was the cause of much loss. The Market Timing Wizards as a group once again have lost money this year, down several percent http://www.automated-trading-system.com/trend-following-wizards-november-3/. These are fund managers who have been interviewed in books such as Jack Schwager's Market Wizard series. In other words, prior to QE, they were superstars. But since QE began in 2009, they as a whole have faltered. Even the ones that outperformed the others in one year, fell behind as new market conditions arose. Indeed this past ten years has been unprecedented, offering up new challenges, requiring the trader and investor to stay in sync with changing markets.

Surfing the QE Waves (not to be confused with quantum electrodynamic ;o) )

Tried-and-true strategies as well as indicators collapsed one after another as the market served up waves not seen before. The profitably big waves followed by medium and little ones often observed in the 1980s and 1990s were long gone. Instead, we got waves that often looked to be building into big waves then suddenly collapsed and went back out to sea, leaving most traders dumbstruck, on both the long and short side. This started happening in early 2009 when the market looked as if it would fall apart a number of times throughout the year. Instead, the major averages rose in a vicious manner, resulting in loss to those attempting to short while the market would sell off just enough to push long positions to cash, then head higher. 

This pattern was repeated over the years in various forms with unexpectedly shallow floors that were created by quantitative easing. All the money generated by the U.S. Federal Reserve and global central banks found its way into the tallest standing midget, the U.S. stock market, preventing any correction that could be called a genuine bear market. Up until now. 

Bubble, Bubble...

As a result of QE, corporate buybacks soared to all-time highs, artificially boosting earnings, further distorting historical norms. Other bubbles have been percolating that I have discussed in prior reports. That said, we are not in the 1930s despite Ray Dalio's comparisons which I believe have their limits, and we are not in 2008 as there is no particularly massive omnipresent bubble waiting to blow apart.

Instead, we have a confluence of bubbles which, according to both Ray Dalio and Stanley Druckenmiller, both two of the  most successful fund managers with exceptional track records, will result in stagnating returns on the S&P 500 over the next few years of between 0-5%. Neither are suggesting a crash. Of course, this does not mean a crash cannot happen. We had no idea how far the market would fall from 2000-2002 or in 2008. We only knew to stay on the sidelines or short to protect or enhance capital.

Mainstream Media Fake News?

Nevertheless, the major news media would love investors to think things are never so bad since they are in the business of selling their services, thus don't want investors to get scared away from the market. They are often broken records of telling investors to buy the dips. Notice how mainstream media always finds an alibi to address falling markets? This happened in all bear markets such as 2000-2002, with the media attempting to justify why markets were oversold, or why now was the time to buy since prices were cheaper. Meanwhile, the NASDAQ Composite had its worst correction ever, falling -78% peak-to-trough. Our view is truth always wins out, even if it takes time, and sometimes a very long time, but for deeper reasons must always be told to the best of one's ability.

No Black Box

And while challenging conditions may mean having to adjust one's trading strategies over time, that has always been the way of the stock market. This concept is as old as markets themselves. At Virtue of Selfish Investing, those who have read our books will notice how our strategies continue to evolve over time, as there are no black boxes or get rich quick methods. Hard work, focus, and dedication are the key ingredients to success in any pursuit. In the last chapter of our first book, we have a chapter entitled Trading is Life; Life is Trading. It illustrates numerous parallels such as why charts are human nature on parade thus repeat. What repeats, or rhymes, can be profitable provided one has mastered their trading psychology to address weaknesses and acknowledge strengths. 

Weaknesses that cannot be overcome are not crippling to a trader as long as the trader recognizes them thus has exit rules to avoid such situations. In some cases, it is a matter of a trader adjusting one's strategy to align more closely with their trading personality. Some traders prefer shorter term, others longer term, some are willing to take high but acceptable risk, and others are more skittish. Indeed, trading is a path of self-discovery.

Way Forward Given Current Conditions

As for current conditions, shorting that continues to show possible profit opportunities will once again be in full swing though don't assume a new leg down. We could enter a choppy sloppy market environment much as we had seen earlier this year. Sharp bounces are typically followed by sharp retracements, as volatility remains elevated. For those who held short positions, your stops were probably triggered the last couple of days to lock in profits. Keeping stops tight has been key as a bird in the hand is worth thrice in the bush. And those birds typically fly off as any meaningful trends this year have been nearly non-existent.

Interestingly, those members who had taken issue with our VoSI Focus List not having enough names in August was the warning signal of what was to come. We were down to five names at that time, then by mid-September, down to just three names. While we sent reports on actionable names on a shorter term basis, no stock merited being added to the Focus List as Focus List stocks are considered to have larger upside rather than just a shorter term swing trade. Others observed rightly so that our Focus List can act as a market barometer of sorts in terms of the number of names on the list. Indeed, the unusually low number of names since August suggested serious underlying weakness in the general market.

This is a form of what legendary hedge fund manager Peter Druckenmiller calls the insides of the market. He uses such 'inside' indications to monitor market health which influences his market exposure. His first yellow flag has been cyclicals where he said in an interview he gave Dec 18 before the market was pushed into bear market territory, “Because if you look inside the stock market...front-end cyclicals show a completely different picture than the defensive parts to the market. Auto stocks are down 30%, they’re not 10% or 11%, building stocks are down 35%, banks...are down 25%...the Russell is down 20%, retail equities are down over 20%. How in the world can the S&P 500 be down only 10% or 11%?” That’s because utilities, staples and pharmaceuticals—economically defensive stocks — are up, he says.

Indeed, numerous other indicators which have been put out to pasture since QE began in 2009 are starting to carry more validity once again as global QE starts to slow and rates at least in the U.S. have been on the rise. That said, Druckenmiller urged the Fed to only quantitatively tighten should the data merit such action. He also was concerned the Fed could lower rates once again should stock market conditions deteriorate much further. This time, however, rates are still well outside historical norms thus limits the power of the Fed to stoke economy activity by reducing interest rates. 2019 should prove to be a most interesting year as we are just being introduced to a new bear market. No matter, as we have shown at Virtue of Selfish Investing, profit opportunities lie in wait regardless of what the market wishes to serve up. Happy New Year! 
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