We Need Capitulation

After a 10 year runup in stocks, everyone wants to be the correct prognosticator of the inevitable stock market crash.

It just can’t happen yet.

I hear talking heads of large fund companies pounding the table on buying stocks on the dips. They say that the fundamentals of the companies they own in their portfolios are sound. However, those who think that the economy is so strong that it can handle any number of interest rate hikes are just fooling themselves.

“Stocks are on sale” they proclaim.

That was the mantra for the last 10 years and they filled their coffers with tons of cash and built robust portfolios, albeit while most still trailed the major stock indexes.

However, things ARE different this time.

Despite two 10% corrections this year so far, investors have not yet realized the difference between buying on the dips in a bull market and the inevitable signs of a bear market. With no clarity of 2019, it is really hard to believe that buying the dips will be rewarding. The rules say to buy low – in a bull market. However, buying low in a bear market can wipe you out because stocks keep going lower.

During a bull market, prices trade above the long-term moving average. However, when the trend changes to a “bear market” prices trade below that moving average. Currently the “bull market” is still intact as prices remain above the long-term moving average. However, evidence continues to mount that support is at risk of giving way.

At this point, my mantra is that downside risk dwarfs upside reward.

In fact, I would be using any strength in the market to sell any laggards and I’m also not overweight in my stock allocations. Anything I bought that I want to hold for the long-term but overpaid for, I am selling for tax losses and looking to buy cheaper.

It’s funny because many of the stocks that I’d like to own are still not on sale in my viewpoint. While I do like to add to positions on weakness, I realize that being aggressively exposed to the financial markets provides less reward in this environment.

One of the things that frightens me most is the reality that the earnings growth touted by the pundits was indeed derived from tax cuts but also through the extensive use of share buybacks. While the mainstream media, and the Administration, initially rushed to claim that tax cuts would lead to surging economic growth, wages, and employment, such has yet to be the case. Instead, companies have used their tax windfall to repurchase shares instead.

Earnings growth not supported by strength is revenues and innovation of new products and services just isn’t healthy for the economy. This is an important point when you realize only a small percentage of total reported EPS growth actually came from increased revenues. While stock buybacks, corporate tax cuts, and debt-issuance can create an illusion of profitability in the short-term, the lack of revenue growth suggests a much weaker economic environment over the long-term.

In order to get excited about putting money to work in this environment, we need to see capitulation. The kind of selling that happens when everybody wants to throw in the towel and sell stocks. The kind of selling that gets rid of the weak holders of stocks.

Just remember, when the pundits tell you to sell, it is too late. All of the smart money has left which leaves you holding the bag.

Furthermore, since both fiscal and monetary policy tools were employed during the economic boom, it will only ensure the next recessionary drag will likely be larger, and last longer, than most expect.

Caution is the order of the day. Make sure you’re not the one holding the bag of over-weighted stock positions.

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