Well that bounce played out much better than we expected! On January 9th, we suggested averaging in to your watch list because stocks had become so comparatively cheap. The market “crashed” down in late December when we first said NOT to sell. We were looking for another possible down turn, but it didn’t happen. Instead stocks went on a monster run, peaking on May 1, before coming back down to the 200 day moving average. Now we’re 5.5% off the highs, but the way people are reacting you’d think we were back down -20%. Below are a few gauges we’re looking at in deciding that this is a great new opportunity to buy in, if you haven’t already…
Exhibit A: AAII Sentiment Survey (a weekly survey of mom and pop investors). Note the excessive bearishness in comparison to the historical average.
Exhibit B: Yield curve inversion of the 10 year -3 month spread. 99% of you don’t know what this means, so check out our previous article for an intro. The 10 Year – 2 Year curve is the most popular indicator of a recession, but the most important thing to understand is that recessions are usually foretold about 18 months ahead of time. Right now we only see an inversion with the 10 year – 3 month, not the 2 year yield. It doesn’t matter though, most people who have heard a yield curve inversion signals a possible recession think it’s IMMEDIATE and think it signals a stock market crash, which it doesn’t.
Exhibit C: Seasonality. Without even looking at an indicator, the old adage is “sell in May and go away” Historically, stocks have made almost all of their gains between mid-October through early May. Summer has horrible returns. Why does this matter? If everybody is on board with thinking summer is a garbage time to own stocks, and they all sell-off after a fairly large drop, the market runs low on sellers. Remember last October through December? Horrible. It’s a fair bet to say that the last year may not stick to the old adages for season. A contrarian sees this as a good time to buy.
Exhibit D: The total put/call ratio. The options market is a great tool for contrarian ideas. Once again, when the majority is bullish or bearish, we know it’s close to a good time to buy or sell. Right now the amount of puts (bearish bets) is almost as high as it was in mid December, right before the market bottomed out. Meaning if not now, very soon we should be hitting a market bottom.
Exhibit E: Trump loves to say he has the upper hand in the trade war, but here’s the key to why he doesn’t. The primaries. Voting is starting soon, and he needs a strong economy in middle America where he gets the majority of his votes. The irony is that those areas are populated with people like farmers and coal miners. Guess who the biggest buyers of those economies are? China. All Xi Jinping as to do is hit middle America where it hurts to screw Trump and his votes are gone. This is just a theory on our part, of course. But when it comes down to it, we think that the pessimism on getting some kind of trade war agreement underway is way overblown. Something will pan out sooner rather than later in our opinion.
Verdict: We’re ONLY down 5.5% from the peak on May 1st at the moment. The McClellan Summation Index is still positive. The VIX is only bouncing around the 15-17 range. Yet we just outlined several examples of people reacting way too negatively. If you waited this last rally out, right now is a GREAT time to buy in. We may not be at the absolute bottom, but we would bet it wouldn’t be more than a few weeks off at the absolute max. Play it like we recommended back in December and January.
Now is not the time to be pessimistic.