No June Swoon, Bye Bye in July?

Mr. Market (S&P 500) keeps hitting 2,100, only to pull back. That level is a psychological magnet, drawing investors closer. Failure to hold and advance above it means a top.

You need to be concerned that the market hasn’t moved up in over a year because there is immense buying pressure that makes everything bullish.

The modern stock market began back in the 1980’s when an obscure tax rule (the 401k) was noticed and put into play: the common man had a way to dodge taxes on income. By the early 90’s, the world of 401k’s took off and the stock market went parabolic and has remained in ridiculous territory ever since.

Read We're in a Global Bear Market, Says Leading Technician

When people argue that the market is overvalued based on historical price-to-earnings, that’s immaterial. Old PE multipliers need to be ignored. As long as tens of billions of dollars are pouring into the market each month, prices will be bid up. The biggest buying pressure will be on S&P 500 companies because the large cap stocks can absorb big orders without tipping the hand.

If a mutual fund wants to buy 0M in stock, they have to target companies that trade billions every day, or risk being exposed.

To net it out: the market is inherently bullish because 401k’s have created massive, institutionalized buying. It’s rigged to be bullish: the standard company-offered 401k plans never include short funds or alternatives. In essence, the market should always be rising because all that money has to go somewhere, and it’s usually buying stocks via mutual funds.

Warning Sign #1: It’s been over a year, nearly a trillion dollars of new 401k money has poured into the market, but the market hasn’t moved. Why should it advance? The latest payroll figure (38K jobs added) was dismal. It was also incredibly consistent with the rest of the macroeconomic data that has been signaling a loss of growth momentum.

That consistency of signal is important. I was on a radio show recently (I believe it was Financial Sense with Cris Sheridan) and I pointed out that when we get to inflection points in the economy, the data starts to get noisy. That is, one data will point up, while another will point down. That contradiction in signal – to me – is actually a comforting confirmation of an inflection point.

Read also The Single Most Important Chart to Understand Where We Are Today

Well, we’re past the point of conflicting signals. Instead, all macro signals are conclusively screaming recession. In fact, Cris cornered me and asked about why I was predicting a recession later this year when folks from Bloomberg said everything was champagne and roses. Frankly, I was wondering what data these folks were looking at.

The reason is that too many folks depend on backwards-looking data. For example, June’s payrolls track labor activity that ended May 12th. By the time it gets analyzed, it’s already more than a month old at best. Since that data release, JP Morgan (NYSE: JPM) and other banks started to join the Zatlin bandwagon and declared that a recession in 12 months was more likely than ever. That is a conclusion based on the latest-but-already-obsolete payroll data.

We can do better than that. We can use more current and much better predictive data.

A Fundamental View of What Comes Next

  1. Bye bye in July: Once we get past Brexit, attention will turn to earnings season. The case can be made that conditions have stabilized, but it’s far from the recovery or rebound narrative story that experts are spinning. Plus, after a straight upsurge of 15%, the market needs to consolidate, a process which is underway. The S&P 500 needs to base at 2,100 before it can go higher, and earnings season will either give it the powder to charge ahead… or not.
  2. Market dumps big in September: The backbone of this economy is the consumer (especially with the industrial recession biting hard). Well, the consumer is going to be very unhappy in the autumn because they are about to take big hits to their wallets.

Most summertime spending has already happened – camps and vacations have already been paid for – but fast forward to August. A lot of spending gets concentrated in the last few months of the year: back to school, Halloween, holiday shopping, and winter vacation. Add to that rash of spending a lot of inflation, especially in healthcare. The reality of higher health care costs will hit in September.

Meanwhile, in the face of rising costs, incomes are dropping. Not only are raises pretty unimpressive (a key means by which companies are meeting margin targets), bonuses will be lower than last year.

Before you say that bonuses are a November or December event, remember that most companies want to set employee expectations and will telegraph the scale of bonus much, much earlier. Like… September.

Another reason for September doldrums is that earnings will be right around the corner. Earnings will trigger some corporate maneuvers. If layoffs are on the way, they will be announced in October in order to get the benefit on the earnings calls AND in order to actually get employees off the books by year-end. Again, employees can tell when companies are in trouble and layoffs are in the air. They will recognize the preliminary corporate frugality for what it is.

Taken together, we have all the ingredients for consumers to belt-tighten: less money, more expenses, and gloomier sentiment about the future. So let’s find the silver linings in those clouds.

  • You can exit the market in full or partially. (I moved my 401K into cash recently.)
  • You can rotate into the usual bear market investments (utilities, for example).
  • You can rotate out of equities into other assets – although I am not sure what. I am not a gold bug, for example.
  • You can play the downturn via short ETFs.
  • You can buy some long-dated, out-of-the-money puts on the market. SPY (a very liquid S&P 500 ETF) is trading at 0. Going out one year to a June 2017 expiration date, the 0 put options are . You pay today for the right to sell the ETF for 0. While it’s true that you would make money once the S&P 500 goes under 1,880, practically speaking there may be profit if the market looks like it’s heading there, especially if it happens well before June. That’s profit if the market tanks more than 11% by June OR if it tanks ~5% by February. That is a lot less than what happens if we see a recession between now and then in which markets would dump 15%-20%. A 15% move by June equals a 100% return. Some folks would argue for different flavors of puts, but you get the idea.
  • Bonds: Fed chair Janet Yellen just signaled that she is open to negative interest rates.

Turn bad news into good news.

Still Up With the Moneyball Trader

In May, the market was determined to be bullish, regardless of actual results. Our LONG calls published in our Moneyball Trader advisory were 67% accurate (6 out of 9 correct).

Companies we tracked who reported weak earnings weren’t penalized by the market.

By the way, that’s another reason to expect a pullback – divergence from underlying fundamentals is just too high.

So far in June, The Moneyball Trader is up 10% cumulatively.

More information about The Moneyball Trader advisory can be found here.

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