The markets changed in February.
The magic of the longest bull market in living memory changed its personality and broke its involatile trend.
You might call this a bear market or you might consider the market at the beginning of a crash. You could think it's just a correction and now is the time to buy the dip. Whatever you think now is the time to have an investment thesis and to keep testing it against what you see the market doing.
I am not an optimist and have written we are in a crash, I have also written we may be in a managed period of sideways trading for 2-3 years as the Federal Reserve pushes and pulls the levers of reverse-QE and QE.
In these liquidity driven markets the financial powerhouses of the central banks can moderate the markets reactions and that is their brief these days. Crashes risk systemic damage and the purpose of central banks is to avoid systemic disruption.
However it used to be thought that you can’t beat the market even if you are a central bank. That belief has faded, but it is still probably true and will be tested going forwards.
My thesis is we are in for a crash that will be moderated by the Federal Reserve into a long period of violent swings. Meanwhile the market will on aggregate go sideways, as it did during the Dotcom crash. The strategy is to let economic growth replace the mountain of Federal Reserve liquidity that has bloated the Fed’s balance sheet. The Fed wants to get back to a much smaller balance sheet and to do that it has to take money out of the system. If it does it too fast the market will disintegrate, if it does it too slow it may get stuck with its gigantic balance sheet for good. You can argue whether they should want to shrink but the fact is they do and are.
This Federal Reserve delivering is a mighty drag on the world economy and already developing markets and economies are taking a very painful hit from the global supply of cheap money drying up. Now it’s the turn of the stock markets to feel the pain.
That pain is relieved when the Fed reverses its reverse-QE and this seems to happen when the market is in trouble. Cheap money pushes into yield paying equities which pushes the market up. Liquidity is a powerful financial drug.
This is the dynamic I believe we are in. But if something bad strikes the market will crash. There is only so much support that can be put under a market and history says in the end a market will crash however much support is there.
So this sideways action will be a major element of this bear market and it’s highly likely to lead to a crash before the Fed has its balance sheet right sized and the economy replaces the lost liquidity.
Sadly as I realised recently the scenario even if the Dow goes sideways through a cycle of corrections and support rallies, is worse than I at first realised. While the Dow had support during the Dotcom crash the Nasdaq came off its rails entirely.
Liquidity tweaking by central banks will not save the Nasdaq from a crash.
No amount of central bank liquidity saved the Nasdaq in the Dotcom crash and that was because it was a bubble.
Can anyone honestly say the Nasdaq chart is one of a bubble?
So in my current thesis the Dow will swerve around, correcting and rallying in a 10-15% range and the Nasdaq will crash and possibly crash horribly with a change the DOW will also crater at some point too.
This scenario seems to be playing out right now. The markets rallied after the October Shocktober but only the Dow really came back strong with the European and Nasdaq market limping along behind it.
Yet theories are not fate, in the coming months passivity may be doom. If you are going to be vest in this environment it is time to draw up your plans.
I hope the buy the dip folks get it right as I still hold a rump of my very best conviction stocks and if the market does trade sideways buying the dips could turn a nice profit.
However if the Nasdaq goes below 7000, or certainly much below February's lows, I’m out the last 25% of my portfolio because a Nasdaq crash will punch a hole below the waterline of most global stock markets of the world.
Markets crash, they always have and they always will. The trick is to be out near the top and back in near the bottom.
In terrible markets there is one asset that is normally uncorrelated and that is cash.
If you think this is the proverbial ‘it’ then cash is the only asset to hold and right now if my thesis holds that we are in the next ‘big one’ then ‘in cash,’ waiting for the inevitable bottom.