Considering what is happening in the markets, I wanted to share with you a letter that I sent out to my clients this morning.
As a review, let’s take a look at what is happening in real time. First the S&P 500. We have been watching this channel as the market has gone back and forth between the two blue lines since last November. As I stated in past letters, the S&P 500 should break out of that channel with vengeance. It has done so to the downside. Keep in mind, the last two bull markets have ended in this same pattern. 5 of 5 of the worst bear markets in history have been preceded by some variation of this pattern.
Now the Dow Jones Industrial Average
As written about, the Dow is in a 13 year megaphone pattern. You can see on the chart it is going through the same pattern as in the 70’s. We would be at point 5 if this continues to play out. Point 5 in 1973 produced a -45% decline. 1973 just like today was a Shemitah year. The reaction in point 5 is telling. Thus far, the market has started a big decline at point 5.
Crash or Correction or Bear Market?
The Dow Jones opened this morning down over a 1,000 points. Typically, when the market opens with that much loss it recovers throughout the day. The key is what happens in the afternoon. If the selling returns, it could get out of hand quickly. As I write, the market is trying to recover. Keep an eye on it.
A normal correction in a bull market is a loss of 10 to 20%. A loss greater than 20% is a bear market. It is way too early to tell what we are dealing with. However, the following should point to caution.
Psychology – Investors are not accustomed to normal losses. A 5% loss will feel like a 10% loss. The media is already blowing this way out of proportion. Investors are also more risk adverse than ever before. Year to date, investors have liquidated 78 billion dollars of mutual funds. I don’t think that today’s investor is going to stick around.
Mutual Fund Cash – Mutual fund money managers have the lowest amount of cash on hand in history. Thus, if investors are selling their mutual funds, mutual fund money managers have to sell their stocks to create cash. This adds to the domino effect.
Margin Debt – Investors have foolishly borrowed against their investment accounts to purchase more stocks. We have more margin debt than any time in history. AS stocks decline, brokerage companies will issue margin calls requiring investors to pay down their debt. That also adds to the selling
So, I don’t want to get too far ahead of myself forecasting what is to come. We just need to take it day by day. This first 30 days of selling will tell us a great deal. The losses in the Chinese stock market during the first 30 days were as great as the losses during the first 30 days of the 1929 US bear market crash. We are witnessing deflation playing out. It hit the gold market. Then it hit the oil market. It hit China’s stock market with a vengeance. Now it appears to be hitting our stock market. It was only a matter of time.
If the deflationary waive stays consistent, the losses in the stock market could be deep and could occur quickly defying what anyone would think could happen. Then again, we could be off to new highs before you know it. This market has been very unpredictable!