Farewell 'Summers's Last Hurrah,' 'Welcome The Winter Of Our Discontent'

What happened to fall? … Climate change, of course!

With all due respect to William Shakespeare and John Steinbeck, the inspirations for my title, reading the national news along with Barron's, and the front page of the Wall Street Journal, one would get the opinion we are about to slip into a cold winter market without experiencing the beautiful colors of fall. Barron's holiday cover greeted us with a menacing, almost maniacal, image of a long-expired bull... a grim reminder of a long-ago winter kill.

Scary cover art for the Labor Day Weakened 2017

A reasonable facsimile of Barron’s cover art

The Barron's article, aptly titled "How This Bull Market Will End," (subscription required) lists a plethora of things that might cause the current bull market to expire.

  • A Fed Mistake - Withdrawing support, too soon, too fast or too late.
  • Inflation - From presently unseen sources causing the Fed to have to raise rates rapidly
  • China - Blows up, taking us down with her
  • Antitrust - Actions against big techs like Alphabet (GOOG, GOOGL) and Amazon (NASDAQ:AMZN)
  • The end of QE - Unwinding the Fed balance sheet
  • Geopolitics - North Korea, the Middle East
  • Local Politics - Something simple like failing to pass a debt ceiling increase

According to Barron's Ben Levisohn, the most frequent cause of bear markets are recessions, which, interestingly, he sees no current signs of. One of the items listed above just might be a trigger for one. Levisohn goes on, "Time to freak out about the imminent end of this great bull run? We think not. Neither longevity nor high stock prices, nor political turmoil usually are enough to send stocks into a protracted slide. The culprit in nearly every case is recession. The mystery is what will cause the next one. Fortunately, there likely will be plenty of clues."

OMG! For this conclusion, you put a dead bull's skull on your front cover. Plus, all of the above concerns have been with us for years.

Big Guys Are Putting on Hedges to Protect Against the Market's Wiles

"Investors Hedge Their Bets Entering Choppiest Season for Markets," according to the Wall Street Journal in an article on September 4, 2017 (subscription required). The "choppiest season" referred to happens to be September, where market returns since 1950 have been slightly negative (DJII -1%, S&P 500 -0.7% and NASDAQ [since establishment in 1971] -1%). October is known for increased volatility and bad things happening (Black Thursday October 24, 1929 and Black Monday October 19, 1987).

Who knows? Maybe they will be right in their strategy this time around. Personally, as an investor in small and mid-sized businesses that I really like, I find it hard to play theses games. Staying the course, however, can lead to pain. Recently, I have felt such pain because of my preference for smaller-capitalization companies. In the period between July 25 and August 18, 2017, the Russell 2000 index, a proxy for smaller-cap companies, fell 7%. Meanwhile, the Dow and S&P only managed to shave off 2% and 3% respectively, peak to trough, both now hovering near new all-time highs, while the Russell is still 3% below its previous best close.

"Some are wagering groups that have struggled, like small-cap companies, will continue to post losses. Speculators' net bearish futures positions on Russell 2000 index stocks last month reached the highest level since 2008, data from the Commodity Futures Trading Commission show."

Part of the Russell's underperformance has been blamed on the lack of action on tax reform (smaller companies usually pay taxes at a higher rate than the larger ones, and thus, would have more to gain from a lower tax rate), and smaller companies are less likely to be exposed internationally, and therefore, not major beneficiaries of the weakening US dollar. But I think that there is more involved here.

Since July 1, we have seen a quiet but significant flight to safety

The US Treasury 10-year note has declined in yield from 2.39% to 2.12%, and gold has risen from $1211/oz. to 1236/oz. Meanwhile, as we've seen, small-caps have underperformed as money moved into presumed safer, larger-capitalization names. Also, public investor sentiment, which has been in the dumps, has deteriorated even more. For example, last month's report from the American Association of Individual Investors (AAII) showed a significant further decline in bullish sentiment to 25%, -3.1% from the previous week. An average historical reading on this metric is 38.5%.

Tuesday morning, September 5, we were greeted with the same old concerns.

The Dow opened down 100 points (closed down 234 points) as Korea tested another nuke and seems to be planning another missile test. Congress is facing another test as it prepares to tackle "the wall," hurricane relief and the debt limit. A Fed governor is out there warning against the dangers of raising rates too rapidly... "and the beat goes on." All of this is music to my ears. None of the above negative sentiment or willingness to make substantial negative bets against the market would be seen at a major secular bull market top. Could we correct? Absolutely. This may be a fall and "winter of our discontent." My feelings remain unchanged. We have much further to run before the bull turns into the skeletal remains depicted above.

What's your take?