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Technically Speaking: The Goldilocks Warning

  • Written by Syndicated Publisher No Comments Comments
    December 3, 2015

    As we enter the final month of the year, stocks (as measured by the S&P 500) have made little progress for the year. Unfortunately, many hedge and mutual funds are lagging well behind on a year-to-date basis. As I stated recently:

    “Historical tendencies suggest a bias to the upside. This is particularly the case given the weakness this past summer which has left many mutual and hedge funds trailing their benchmarks. The need to play ‘catch-up’ will likely create a push into larger capitalization stocks as portfolios are ‘window dressed’ for year end reporting.

    Importantly, the traditional ‘Santa Claus’ rally does not guarantee the resumption of the ongoing ‘bull market’ into 2016. In early November, I laid out the expectation of a market decline back to support which would facilitate the year-end advance. Here is the updated version of that chart:

    SP500-MarketUpdate-120115

    So far, the expectation the strong October advance would experience a pull-back to support setting up the year-end push towards overhead resistance continues to play out.

    It is quite likely that over the next couple of weeks the markets will experience a higher degree of volatility as mutual funds begin their annual distributions of short and long-term capital gains, dividends, and interest. Following those distributions, the last half of the year should be more positively biased as managers position for the end of the year reporting.

    The forecast for the end of the year, however, does not carry over into 2016. With declining profitability, a weak economic outlook, surging inventories, a stronger dollar and a potential for higher rates there are may headwinds that currently exist. However, my biggest worry comes from the rising utterances of “it’s a Goldilocks economy.” 

    The Goldilocks Warning

    Just this year there has been a rising number of articles suggesting that we have once again entered into a “Goldilocks Economy.”

    America’s ‘Goldilocks’ Economy Is Here – CNBC

    The US In Still In A Goldilocks Economy – Quartz

    Fed’s Goldilocks Economy Just Right For Investors – NY Times

    There are plenty more, but you get the idea. The problem is that in the rush to come up with a “bullish thesis” as to why stocks should continue to elevate in the future, they have forgotten the last time the U.S. entered into such a state of“economic bliss.”  You might remember this:

    “The Fed’s official forecast, an average of forecasts by Fed governors and the Fed’s district banks, essentially portrays a ‘Goldilocks’ economy that is neither too hot, with inflation, nor too cold, with rising unemployment.” – WSJ Feb 15, 2007

    Of course, it was just 10-months later that the U.S. entered into a recession followed by the worst financial crisis since the “Great Depression.” 

    The problem with this “oft-repeated monument to trite” is that it’s absolute nonsense. AsJohn Tamny penned for Forbes:

    “A ‘Goldilocks Economy,’ one that is ‘not too hot and not too cold,’ is very much the fashionable explanation at the moment for all that’s allegedly good.

    ‘Goldilocks’ presumes economic uniformity where there is none, as though there’s no difference between Sausalito and Stockton, New York City and Newark. But there is, and that’s what’s so silly about commentary that lionizes the Fed for allegedly engineering ‘Goldilocks,’ ‘soft landings,’ and other laughable concepts that could only be dreamt up by the economics profession and the witless pundits who promote the profession’s mysticism.

    What this tells us is that the Fed can’t engineer the falsehood that is Goldilocks, rather the Fed’s meddling is what some call Goldilocks, and sometimes worse.Not too hot and not too cold isn’t something sane minds aspire to, rather it’s the mediocrity we can expect so long as we presume that central bankers allocating the credit of others is the source of our prosperity.”

    John is correct. An economy that is growing at 2%, inflation near zero, and Central banks global dumping trillions of dollars into the financial system to keep it afloat is not an economy that we should be aspiring to. Unfortunately, today’s “Goldilocks” economy is more akin to what we saw in 2007 than most would like to admit.

    Wages growth remains nascent while employment growth remains weak. Annual rates of growth in retail sales, core durable goods orders, imports, and exports are all suggesting the economy is far weaker than headlines suggest. Commodities too are suggesting that something is amiss with the economic landscape but are begin dismissed as a side effect of plunging oil prices.

    However, it isn’t just the economy that is reminiscent of the 2007 landscape.  The markets also reflect the same. Here are a couple of charts worth reminding you of.

    SP500-MarketUpdate-120115-1

    Currently, relative strength as measured by RSI on a weekly basis has continued to deteriorate. Not only was such deterioration a hallmark of the market topping process in 2007, but also in 2000.

    The same is true when you look at the NYSE advance-decline line.

    SP500-MarketUpdate-120115-2

    Another hallmark of the 2007 peak, and 2000 was the deviation in the markets from the longer-term bullish trend. Accelerations is price are typically late stage events as market exuberance exceeds underlying reality….hence the need for coming up with terms like “Goldilocks economy” to justify bullish outlooks. 

    SP500-MarketUpdate-120115-3

    Looking back in history, declines in price momentum have signaled both short-term corrections and major market peaks. Like 2007, the markets are currently suggesting that investor risk is extremely elevated.

    SP500-MarketUpdate-120115-4

    Even on a MONTHLY basis, both short and long-term signals are suggesting that the current technical backdrop is more akin to 2007.

    SP500-MarketUpdate-120115-5

    The problem of suggesting that we have once again evolved into a “Goldilocks economy” is that such an environment of slower growth is not conducive to supporting corporate profit growth at a level to justify high valuations.

    Such a backdrop becomes particularly problematic when the Federal Reserve begins to raise interest rates which removes one of the fundamental underpinnings of an overvalued market which was low interest rates. Ultimately, higher interest rates, particulalry in an economy with a deteriorating economic backdrop, becomes the pin that “pops the bubble.” 

    As Michael Kahn concludes in his article yesterday:

    Half of all S&P 500 stocks are trading below their major averages while the “market” is near its highs. It quantifies that the market is indeed narrow, and as history is a guide, in a very dangerous place.

    Of course, such conditions can last for weeks and months so we cannot say that things will head south tomorrow or even in a few weeks. But when the generals charge into battle and the troops do not follow it is probably not a good thing.

    With December nearly upon us, conventional wisdom says that the stock market is fully engrossed in the strongest half of the year. According to the ‘sell in May’ seasonal strategy, investors should have jumped back into the market in October.

    But this is the first time the Fed may actually start to raise rates in many years.Whether or not that is already baked into the market remains to be seen but the technical environment suggests big problems are already in place.”

    It is true that the bears didn’t eat Goldilocks at the end of the story…but then again, there never was a sequel either.

    Just something to think about.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of StreetTalk Live

    After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.
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