What Does “Bearish J.C.” Look Like?

by JC Parets  -  October 15, 2018

Some of you guys may have read my work for over a decade. But I understand I’ve got many newer readers here, so I think it’s important to address what’s going on in the markets after last week’s volatility.

I’ve been called a permabull many times for over two years now, meaning that others in the markets believed I just always had a bullish bias towards stocks.

The truth is that while so many were eager to pick a top during this entire rally, I’ve been consistently bullish because the weight of the evidence pointed that way.

But this is no longer the case, and our approach has had to adapt over the past week to a new environment.

We’re fortunate to have been accurate with our risk levels. As soon as small-caps broke $169, things got bad. THERE WAS NO REASON TO BE IN THEM if we were below that in the Russell 2000 ETF (NYSEArca: IWM).

Large-caps broke our levels early last week and things got progressively worse after our prices were breached. That’s why we set them.

That’s the good news. The bad news is that I’m confident this is just the beginning.

I believe we’re entering, at the very least, a period of consolidation.

I think we’re lucky if it’s another 2015.

That wasn’t so bad and markets recovered quickly to begin one of the greatest runs in history.

I hope you enjoyed it.

Things Have Changed

The big issue now is that we’ve broken a lot of important levels. This makes any strength vulnerable to overhead supply.

In other words, instead of the infamous BTFD (Buy The Freakin Dip), the old STFR (Sell The Freakin Rip) is most likely to rule moving forward.

I’m sure Howard and my friends at STOCKTWITS will have a lot of fun with this one.

That’s just the environment we’re in now.

Either we resolve through much lower prices and get it out of the way quickly, like 1987, or it’s a drawn out process that could take six to 12 more months.

Both of those scenarios would be perfectly normal and I think it is what is most likely going to occur. Personally, I’d rather it be 1987 where we lose a cool 20%-plus overnight and then we just get rocking again.

Some firms will go out of business, journalists will have the time of their lives and it gives us all another story to tell in the future.

Think about it, DO YOU EVER HEAR ABOUT 1953? No, you hear about 1929 and 1987. But why can’t we be in 1953? And no one will ever talk about it again. Sideways and boring and then ripping higher afterwards?

A 2015 or 1953-style market is probably the best outcome. Although a frustrating environment for trend followers (because there is no trend), if you can trade a range successfully, there’s a lot of money to be made.

We’ll see similar sector rotation and there will be opportunities to buy near the bottom of ranges and sell near the top of them.

This is no longer an environment where we just want to be buying the strongest stocks in the strongest sectors.

With a new environment comes new strategies. “Adapt or die.” That’s the sort of mentality we want to incorporate. It’s a new era.

What sparked this new bearish regime for stocks is the failed breakouts we just got in the S&P 500 and Dow Jones Industrial Average, among many other indexes and sectors.

You can see a few of my favorites here from the past:

[CLICK TO ENLARGE]

There was a reason I’ve pressed that $2,875 is the line in the sand in the S&P 500. A neutral approach to stocks below that level has been and still is essential. Anything else is irresponsible in my opinion.

This $2,875 level was the January high and would present an epic failed breakout. The same neutral approach to small-caps was in order once IWM broke $169. It was the first one to go and levels got destroyed from there.

Here is the S&P 500 level failing to hold. This is From Failed Moves Come Fast Moves, Exhibit A:

You can see the exact same thing in the Dow Jones Industrial Average. These are not bullish setups, far from it:

The levels were $26,600 for the Dow and $2,875 for the S&P 500. These were simply the former highs. Technical analysis doesn’t have to be hard.

The problem for bulls now is that those were “support” levels. Now they are “resistance” levels.

That means there are bag holders up there ready to unload to you at any opportunity.

This is the “overhead supply” you hear me talk about. For a while, there has not been much overhead supply in anything.

Most of the stocks we did the best with the past few years had been making all-time highs. We haven’t wanted to mess around, just buy the best of the best.

We’re no longer in that environment. I think heavy cash positions are still best. I just really think we can be patient and open to all possibilities.

Remember, it’s not that it’s different this time, it’s different everytime. I’ve been down this road before. You’ll see all sorts of statistics about how it’s the biggest this, or longest that, or highest this… Ignore it.

In many cases, whoever is saying that is so desperate for attention that they’ll even quote the actual points instead of percent changes. They are the ones that worst intentions of all.

You’ll see asset managers and financial advisors ride this all the way down as low as it goes. Many don’t have a plan. Kudos to you who do, and I know many that do.

We have a lot of financial advisors who rely on our researchand have done very well. I know for a fact they’ve incorporated our risk-management measures over the past two weeks because they’ve emailed and told me! We’re all in this together.

It’s a regime change, not just for the market but for other “types of people” out there.

Commodities Rule?

The gold bugs are likely to have their turn. We’ve been bullish this group since last month and I still think they’re going higher.

Commercial hedgers have on their most bullish position in precious metals of all-time. You can fight that one if you’d like and buy stocks instead. My bet is that metals keep outperforming moving forward. And probably commodities in general, too.

I like the recent relative strength in energy as well. The difference is that if stocks become a shit storm, oil will probably get hit too and gold won’t. But for the most part, I think commodities rule here.

Interest rates are going higher. You’re seeing higher commodities pricing that in. I think both of these continue. The risk with the rates story is once again the possibility of that stock shit storm.

If that does happen, and I’m not saying it will, then bonds should get a flight to safety bid. Rates will fall in that type of environment.

I’m really interested in seeing how this plays out because I still think we need to be bearish Treasury bonds. It’s been working all year.

Speaking of safety, part of the picture I tried to paint last month of what a bearish environment for stocks would look like involved Yen strength.

Forget gold and bonds, money goes to Yen when it’s scared. Look how the Yen is up every day since the Dow peaked.

If you want to know how bad things are going to get for stocks, I think strength in Yen is the tell:

Here is Yen from afar. Look familiar?

A break below $111.50 and holding below that in USD/JPY, meaning a Yen breakout, would signal that there’s much more risk out there than people are expecting right now.

What to Expect

What does this mean from a trading perspective? Well, I think we’re going to have rallies and we’re going to get selloffs.

We’re going to have some of the greatest rallies of all-time, especially if we get a lot more downside in price. If it’s just a sideways grind for six to 12 months, then those counter-trend rallies will be less explosive.

It’s funny, as I’m writing this I’m thinking back about some of those epic days in the fall of 2008. I’ll never forget it. Those were some great lessons for sure.

So what else should we expect in this environment? Longs and shorts. More gold exposure. We’ll see about bonds, I’d like to see how that one plays out.

What’s curious is the euro strength. You would think the U.S. dollar would be more of a safe haven, like it was in 2008 to 2009. You see? Not every cycle is the same.

The dollar falling and euro rallying is clearly having no impact on U.S. stocks and instead has been positive for precious metals and gold and silver stocks.

I don’t see any reason not to expect those trends to continue, along with lower for longer for stocks.

I’m probably going to be just as obnoxious. I don’t think I’ll be any more aggressive than usual, probably about the same.

I’m always going to tell you how it is, whether it’s what you want to hear or not. I’m not here to tell you bedtime stories about the Fed or Trump or whatever the gossip du jour might be.

We’re going to analyze the behavior of the market every day and make the best choices we can based on the weight-of-the-evidence.

This is in up markets, down markets or sideways markets.

The one promise I will make it you as that I’m going to give it to you straight.

So what if I’m wrong? What if last week was not the high for this cycle? Could that even be possible? Yes, it is entirely possible. Anything is.

As I’ve mentioned before, nothing in this market will ever surprise me again. I’ve seen too much. But that’s the bet we’ve made. And I’m confident that we’re not just going to bounce back here and pretend like nothing ever happens.

It would have to take S&P back above $2,875 and Dow above $26,600 to invalidate any of these bearish implications, and I don’t believe that’s the smart bet to make.

This is going to most likely take time to repair and/or price, as I mentioned 1987 before.

That would be my preference, but I don’t get any say around here.

Let me know what you think at bigmarkettrends@charlesstreetresearch.com.

To wise investing,

J.C. Parets