Bull market tops are long, drawn out processes, often lasting 18 months, give or take. But they are predictable. They happen when the central bank decides that enough is enough.
I warned in 2017 that when the Fed started talking about balance sheet reduction, the process of ending the bull market and beginning a bear market would be at hand. Indeed, the Fedheads started discussing it publicly that summer, and in September, they made it official. They began balance sheet “normalization” in October of that year.
What that meant, in short, was that the Fed would begin to – literally – pull money out of the banking system and extinguish it, month by month. The Fed published a schedule of reductions that would ratchet up from $10 billion per month in October 2017 to $50 billion per month in October 2018.
Under Quantitative Easing (QE), which was supposed to be an emergency program to prop up the financial system as it was collapsing during the 2007–2009 crisis, the Fed bought U.S. Treasury bills, notes, and bonds, and mortgage-backed securities (MBS) directly from Primary Dealers. The Fed ballooned its total assets in its System Open Market Account from $800 billion to an insane $4.5 trillion.
That “emergency” program turned into a long-running scheme to inflate bubbles in the stock and bond markets. It lasted from late 2008 until late 2014. The Fed then undertook a program of rolling over its Treasury holdings and buying just enough MBS to keep its total assets at that inflated level.
The Fed got what it wanted: massive asset bubbles in stocks and bonds, plus an echo bubble in U.S. housing prices.
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It decided that enough was enough in September 2017 and announced its program to “normalize” both the size of its balance sheet and the level of interest rates. “Normalize” was just a euphemism for shrinking the balance sheet.
I saw that as the death knell for the bull market. And now it’s playing out.
Tops Take Time, but They Are Predictable
The process of the Fed pulling cash out of the system would be simultaneous with the Treasury also drawing massive amounts of cash out of the financial markets to inject into the U.S. economy. It was a double-whammy that I expected would ultimately trigger a bear market. I warned you about that. In fact, I did so it so long and so often that you probably thought that I was “the boy who cried ‘wolf!'”
So my outlook is for the market to top out slowly, then head down slowly at first. Complacency will rule the markets in this first phase of the bear. But as the Fed tightens the screws, conditions will devolve into a bear market with lower highs and lower lows, probably later in 2018.
The Fed will not realize that it has lost control until it is too late.
Throughout the fourth quarter, I recommended selling on rallies to get to a goal of 60% to 70% cash by the end of January. The market regularly rallied to new all-time highs through January. The warnings seemed ridiculous; who wants to hear a message like that?
Then came the February market break, and suddenly the warnings I had been posting didn’t look so silly…
That is, until the next rally, a maddeningly persistent one that lasted from April until September. I thought it would end in July, but the Trump administration had inserted a couple of gifts in the new tax law that would result in the extension of the rally.
The corporate tax cut rewarded companies for repatriating cash to the United States. They used it to buy back their stocks in a massive wave. The law also gave corporations a tax break on their pension fund contributions made before Sept. 15, 2018. That drove more money into the market. One of your fellow Sure Moneyans brought this little-known feature of the tax law to my attention, for which I am eternally grateful.
The summer blow-off was the result. I found this rally so alarming, I recommended raising cash to at least 80% to 90%. For me, the blow-off only increased the risk of a devastating crash.
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The rally left a demand vacuum in its wake. We have experienced the initial impact of that over the past two months. It has been ugly and painful, especially for the formerly beloved tech stocks. They’ve seen crushing losses.
But it’s only the beginning.
I had given you the caveat that bull market tops take a long time. For example:
History tells us that bull markets take time to top out. Rounding top patterns often take a year to a year and a half to roll over. First they struggle to make new highs. Then six to nine months down the road, there’s a rally that fails to make a new high. That’s when it’s time to be out of the market, if not completely, substantially so. Because the next decline will break the lows of prior corrections, and the bear will begin to take his pound of flesh.
This Chart Shows You What to Expect, and Suggests What to Do About It
We are now on the verge of that next decline that breaks the lows, if not this month, then in the next couple of months. On the theory of a picture being worth a thousand words, let’s look at my long-term cycle chart of the S&P 500.
I have drawn a green ellipse around what the evidence suggests is the bull market top pattern. Many stocks topped out at the January high. Even more did so at the September peak. That’s when I believe we will look back and say that’s where the bear market started.
It’s clear that the 2,600–2,530 area is critical support. I do not believe that that area will ultimately hold. Both the momentum indicators and the cycle oscillators on the Long-Term Trend, the 3- to 4-Year Cycle, and the 10- to 12-Month Cycle are on sell signals and weakening. Those indicators portend a breakdown.
The monetary environment remains extremely bearish, as we’ve discussed ad infinitum all year. I don’t need to rehash that for you if you’ve been reading Sure Money for a while. If you are new to these reports, please read a few earlier posts. That will give you the gist of it.
Everything points to this support level breaking down, leading to a really big and lasting decline. We should see a bounce or two from that 2,530 area. Those would be places where I would take shots for profits on the short side. I like the idea of keeping most of your capital in T-bills – interest rates are skyrocketing – while using a small portion of your cash as trading capital. I like the idea of buying short-term, near-the-money put options to profit from declines in the SPY or individual stocks.
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The post This Chart Shows You What To Expect As The Market Top Nears Completion appeared first on Lee Adler’s Sure Money.
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