A Bottom, But Not THE Bottom



Earlier this week I posted two articles. The first discussed the possibility that this is just a correction within an ongoing bull market. The second delved into the possibility that a new cyclical bear market has begun. Only time will tell which is truly the case.

The bounce over the last couple of days has been met with "party hats" by the mainstream media as a sign that the bottom is in and the worst is now behind us. Historically such has not been the case as witnessed by looking at the 1987, 1998, 2010 and 2011 corrections that occurred within an ongoing bull market. In every case, the markets bounced off correction lows only to retest those lows several weeks later. As I stated then:

"The sharp 'reflexive' rally that will occur this week is likely the opportunity to review portfolio holdings and make adjustments before the next decline. History clearly suggests that reflexive rallies are prone to failing, and a retest of lows is common. Again, I am not talking about making wholesale liquidations in accounts. However, I am suggesting taking prudent portfolio management actions to raise some cash and reduce overall portfolio risk."

The esteemed technician Walter Murphy recently had some interesting commentary in this regard.

"Our sense is that the volatility of recent days is a sign that the S&P 500 is attempting to put a short-term bottom in place.

Nonetheless, the weekly and monthly Coppock Curves are down, with the weekly oscillator positioned to remain weak for at least another 5-6 weeks. In addition, there are no meaningful divergences. For example, the daily Coppock and RSI(8) indicators are at their lowest levels since August 2011.

Another indicator that may prove to be guideline is the S&P’s Bullish Percent Index, which is also at its lowest reading (22.4%) since 2011. During the 2011correction, the BPI initially fell to 20.4% in August, experienced a relief rally to 54.4% in September, and then fell to 21.8% in October. The October low was a bullish divergence because it was higher than the August reading even though the “500” recorded a lower low. This divergence was followed by the just-completed four-year rally. Thus, if past is prologue, we might (and do) expect a short-lived S&P rally that will be followed by renewed weakness to lower lows. The significance of those anticipated lower lows will be determined by the presence (or lack) of positive divergences."

Murphy-Correction-082715

There is a possibility that the October lows could turn out to be THE bottom for now. However, even if that is the case, many investors will wish they hadn't jumped in so quickly.

Then there is the possibility that the lows don't hold.

For investors, the real question should be what is the most dangerous: Missing out on a potential short-term rally in a very extended bull market, or catching the next big decline? That is for you to decide.

Fed Won't Hike In September

As I have repeatedly suggested since the beginning of this year, there was little ability, despite their incessant jawboning, for the Fed to raise rates this year....if ever. To wit:

"The Fed is slowly coming to realize that 'forward guidance', 'QE' and artificially suppressing interest rates does indeed boost asset prices and creates a burgeoning 'wealth gap.' However, since those programs only affect the top 20% of the population that actually has money to invest, it does little to create real prosperity across the broad economy.

But here is the real question: 'If, after six-plus years of economic expansion, the economy is not strong enough to withstand a hike in rates now, when will it ever be?'"

With global economic weakness now sweeping back into the US combined with a sharp decline in the financial markets, it was not surprising to see Bill Dudley, President of the New York Fed, in the media delivering a message.

"From my perspective, at this moment, the decision to begin the normalization process at the September FOMC meeting seems less compelling to me than it was a few weeks ago."

Of course, no rate hike means monetary policy remains accommodative for a while longer which sent stocks rebounding sharply following his comments.

However, the problem continues to be that despite the hopes and wishes of the Federal Reserve, both economic growth and inflation continue to be illusive. While Mr. Dudley current blames the lack of inflation on falling oil prices, it is only the latest excuse in a long series of missed forecasts. As I discussed in "Meet The Worst Economic Forecasters Ever..."

 When it comes to the economy, the Fed has consistently overstated economic strength. This is clearly shown in the chart and table below."

FOMC-Forecasts-GDP-031915

The problem now, despite their ongoing optimistic hopes, is the collapse in China's economic growth is creating a deflationary backwash on the U.S. This can be clearly seen in the breakeven inflation expectations in the bond market.

Inflation-5-10yr-Breakevenrates-082615

There is little ability currently for the Fed to hike rates in September. While most analysts are pushing the rate hike out to December of this year, the reality is that it could be much further out than that.

Earnings Recession Continues

While the lack of inflation and economic growth remains the Fed's nemesis for monetary policy, earnings are no longer the investor's friend. Political Calculations posted a good analysis about the ongoing deterioration in earnings. To wit:

"Today, we'll confirm that the earnings recession that began in the fourth quarter of 2014 has continued to deepen."

forecasts-SP500-ttm-EPS-2010-2016-snapshot-2015-08-20

"In the chart above, we confirm that the trailing twelve month earnings per share for the S&P 500 throughout 2015 has continued to fall from the levels that Standard and Poor had projected they would be back in May 2015. And for that matter, what S&P forecast they would be back in February 2015 and in November 2014."

With prices and valuations elevated, and earnings deteriorating, the backdrop for a continued "ripping bull-market" is at risk. The problem for the "perma-bulls" is that the deflationary backwash, combined with already weak economic fundamentals, continues to erode the ability for earnings to meet elevated future expectations. It is likely earnings will continue to disappoint in the quarters ahead and put further downward pressure on asset prices to close the current gap between "financial fantasy" and "economic realities."

Just some things worth thinking about.

David Stockman's Contra Corner is the only place where mainstream delusions and cant about the Warfare State, the Bailout State, Bubble Finance and Beltway Banditry are ripped, refuted and rebuked. Subscribe now to receive David Stockman’s latest posts by email each day as well as his model portfolio, Lee Adler’s Daily Data Dive and David’s personally curated insights and analysis from leading contrarian thinkers.

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