You can’t predict, but you can prepare – Part I

May 14, 2021No Comments

You can’t predict, but you can prepare

Welcome to the Smart Money Dumb Money Show.

We’ve got a little bit of a treat for you over this week and next week.

I’m going to do a bit of a two-part video where we talk about the current markets and the correction which I had been predicting on my blogs, for those who read my blog regularly, I have been talking about the market being overbought and likely to pull back and I’m going to talk about a couple of the factors that led me to that conclusion and how far I think the market will go down. We’ll talk about that today and then next week we’re going to be talking about what happens if the market goes lower than my predicted levels and what if this market turns into a genuine bear.

I’m going to present a few slides that I showed to the Canadian Society of Technical analyst at a conference that Brook Zachary and myself were involved with on Thursday the 12th, last week.  I’m going to cover some of the charts that I covered at that conference as well as a few extras.

What I want to start off with is a chart that I actually used on my blog the other day and I told the story on the blog of when I was a relatively younger Investment Advisor, at that time I was not a Portfolio Manager. I started in the business in 1990, and even around the late 1990s, the markets were really rewarding technology shares, and in fact, the NASDAQ, which is the poster boy for technology shares, was on a bit of a tear.

Now, what happened is that it started to arc off of its trend line that had started since the previous bear market of the 1970s. So the bull market that led us into the 2000 top, 2001 top, was led out- of after a consolidation period during the seventies and eighties. And it was really almost a 20-year bull. It was about a 17-year bull.



So this green line on the chart shows you that it was a nice 45-degree angle on the chart. Now, what happened was, this is a NASDAQ chart, it is not the S&P 500, what happened there was a couple of research analysts who I befriended and was following. One man’s name was Gurney Watson. He was writing a number of reports and he was talking about how the market had a geometric problem and not an arithmetic problem. What he meant by that was he was talking about the extent of the rise on the NASDAQ and he was really the first person who introduced me to the concept of looking for angles of the ascent of chart trendlines to determine if a market is, in fact, healthy or parabolic.

Now, another fellow at the time who was with Merrill Lynch and Gurney was with Merrill Lynch Canada, and another analyst out of the American side of Merrill Lynch. His name was Don Kapetanakis, and Don also was writing reports and Don noted in and around 1999 when the NASDAQ was about 3000, that it was very overbought and it was likely due to a correction. Now, he wrote a second research report a little bit later, and when the NASDAQ hit 4000, and he was even more clear about his prognosis of an overbought market.

Well, what happened is, is that from his original report somewhere around 3000, which I note in the chart here, the market ended up going to around 5000, which when you think about it, is about a 60% gain off of the original parabolic point that he was identifying. So, he was calling the market out here, and it went on to here, which was 60% higher.

So it was Don wrong and was Gurney wrong about being late in the party for the NASDAQ?

Well, they did appear to be wrong at first, but we know history now, and we know what happened to the NASDAQ. And the NASDAQ after peaking at around 5000, fell like a brick and eventually fell right back down to about 1300, which was well below the old trend line. So, I guess you could say that Don and Gurney were wrong for a bit and then very right in the end of the day, but it’s hard to get out of the market and then watch it go up another 50 or 60%. Even if at the end of the day, selling out of 3000 ended up saving you almost two-thirds of your money.

So I decided at that point that using factors like Gurney and Don, we’re using such as chart angles and momentum indicators and Gurney was actually the very first person I had ever heard of using sentiment indicators and he was a big influence in my life because he was talking about the smart money dumb money indicator, but he was more of an hourly guy when it came to the smart money dumb money that aside.

I decided that I wanted to be able to identify a little bit more accurately when a parabolic market might end, and I want to point out that this red line represents the bear market is sort of the bull market that began after 2009.  And you can see it’s a nice 45-degree angle, just like it was during the eighties and nineties. We’re marking off of that trend line in a parabolic way, very similar to what happened then, so that the less discerning, I might say its parabolic all the factors are there. It’s an overbought market we should get out. But clearly, the market can remain wrong longer than you can remain solvent as Mayor Kane’s once said.

So let’s go on to the next chart and let’s take a look at what the more likely scenario is for the time being.

And that is that. So this is a chart that I’ve been showing on the blog lately and I’ve been talking about how we are, our king off of a long-term trend line and if you look at traditional momentum mitigators and this is a monthly chart, so it’s a pretty long looking chart, you’ll see that Mac D and R C are very overbought that indicates that things are likely to pull back. And in fact, more importantly, in my mind, one of the things I follow is the 200-day moving average.

Now take a look, now the market is corrected since I posted this chart, but take a look at how far the S&P, for example, S&P 500 was above this red line, which is the 200-day moving average. In fact, a couple of weeks ago, that level was about 15 or 16% above its moving average.

What I have found is that anything on a market index, not an individual stock, but a market index, a widely traded market index, that is too much over 10 and particularly reaching into the 15% range over its 200 days almost invariably correct. And you can see that here. And you can see that here, and you can see that here, and you can see that here, all of these times were above 10 over the moving average. Now, in some cases, it will correct below the moving average. In some cases, it typically will just fall to or close to the moving average. In this case, fell to the moving average, fell to the moving average, fell to the moving average there. Here we were within about 3% of the moving average.

So your guess is as good as mine as to how far the market would fall but my suggestion is it won’t likely correct below the 200 days moving average. And at the time of this chart, the moving average was somewhere just below 3800. I think it was around 3770.

How low could the S&P go? I think it could test very close to 3800 or maybe just above that. If it gets a typical 3% correction, we may have already seen the damage because it came very close to 3 or 4% off of that moving average this week.

So, what happens though if we move beyond a minor correction?

Well first of all, how do we identify a bubble versus time for a normal correction? And this is a chart that I posted on my blog and I’m also I’ve also put it in my upcoming book on Contrarian Investing and I just list a number of factors that on the outside can give us an idea of what is a bubble market. And these are factors that a gentleman named Jason Goepfert, who is the publisher and creator of the research service called and he’s probably the world’s greatest expert on sentiment. He said just on the high-level view a market bubble is usually led by these factors which is a high level of optimism, very easy credit, a lot of I. P. O. Is being issued in secondary offerings, risk stocks like Bitcoin and whatnot, outperforming boring stocks like consumer staples and whatnot and very stretched valuations. And I don’t need to bring you through every one of those that you would probably identify that every one of those conditions exists right now.

So when we start looking at market sentiment over-optimism one of the most readily and followed sentiment indicators out there is the American Association of Investment Advisors. Now I usually don’t talk about this indicator because it’s not part of my bearometer but it’s still a good way of looking at the market and you can see right up until recently it was in that too few bears.

This particular indicator is just tracking the bears, it’s not looking at the bulls. And the percentage of bears amongst their association, The American Association of Individual Investors, is likely to go down to about 20% of their population of investors that participate in this survey.

Typically when levels get that low, you can see markets tend to correct. There’s just before the early 2020 crash and then, of course, the bears come out of hiding when after the fact, right? So there was a lot of bears after the market crashed in March of 2020. Over and over this happens in 2018. Too few bears just before the end of the year. So that’s an indicator, we have a little bit of enthusiasm.



This is included in the bear-o-meter. Now, officially, it’s not into my bear zone. My bear zone has to get around 12. You can see that many times when it has gotten down to 12 like here before the 2018 correction or before the 2015 correction or before the big bear market of 2008 and on. And of course, before the Tech Bubble, The C can get very low. And in fact, even before the 2020 crash the VIX was at that 12 level. We’re not at the 12th level, but it’s heading that way.

So again, another factor of enthusiasm out there that worries me that we could be in a bubble condition.

But remember the first chart I showed you when the two analysts I mentioned? They were identifying these very things that I’m talking about right now and they were saying the market’s overbought, it’s likely to crash. But the market can keep going as we saw eventually, by the way, if these conditions carry on, the market will likely crash. But you could miss out on another 50% upside before it actually decides to crash. And particularly with the Fed being on board to stimulate the market.

The final indicator, I just want to show you is something that is in my bear-o-meter and that’s the new high, new low indicator.

And I was interested to see this recently, which is the number of new highs versus the number of new lows has just skyrocketed to levels not seen actually in the past 20 years. So you can see, it’s just extraordinarily high. So this is a number of new highs versus new lows on the New York stock exchange and it’s very, very high and, and anything above 300% is bearish and it’s in the 500% level right now. So it’s, it’s really moved and that tells us that optimism is excessive right now. So conditions are a little scary.

Sentiment trader publishes this study of smart versus dumb money.

You can see the dumb money meaning retail investors, mutual fund flow E. T. F flow, make up this index. The enthusiasm, the optimism is very high. Money flowing into equity, for example, in those areas is very, very high. Meanwhile, the blue line is what’s called smart money, this tends to be institutional investors, commercial hedgers, and of course, people like pension managers and whatnot, and their optimism is lower quite a bit lower. And when what we find is when the two are complete opposites like this, it often leads into reversers movements.

For example, the smart money institutions were very bullish at this bottom back in 2020. You know, the correction in March of 2020. Meanwhile, retail investors hated the market, but the retail investors loved the market just prior to the crash and the smart money hated the market prior to the crash.

So we’re kind of in that condition now, we’re not quite as deep into the woods as we were back in that, that time period. But it’s another sign that optimism is very high.

And for my last comment, if markets continue to be this optimistic, we may be in for a bear market. So finally, and this is the last point I’ll make before we go on to doing my next video next week, which is my bear-o-meter measures a lot of these factors we just talked about. It moved from most of the past year in a neutral to bullish position and it moved to three, which is not outright bearish, but cautious on the verge of being bearish. So, it doesn’t surprise me again that given how much over the market was over its 200-day moving average and what the momentum indicators were signaling and all that stuff that we got a correction and maybe we get some more, maybe we don’t. But we’re not yet deeply into bear territory according to my bear-o-meter. However, as we just saw were starting to head that way, so the next video, and I encourage you to tune in next week, will cover what happens if we do enter into a bear market, how do we protect ourselves?

Thanks for watching and I’ll leave you with one final thought.

And that is that you can never predict exactly what’s going to happen but you can prepare. And that line comes from Howard Marks, the Great Co-Manager of Oaktree Capital Management and it’s one of my favourite lines: you can’t predict, you can prepare.

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