The Chart That Sets the Stage for a Stock Market Correction

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Homespun wisdom…we’ve all heard it.

‘Expect the unexpected…’

‘The higher you climb, the further you fall…’

Homespun wisdom is simple — straightforward knowledge passed down from parent to child. Cautionary words to keep you on the straight and narrow.

If it was called ‘business-spun’ wisdom, it would sound something like this…

‘We expect things to improve next year. We never see a disrupting event in our future. We are programmed for growth, growth and more growth.’

Or:

‘Markets are riding high, but we see them going higher. Even though, by all historic valuation measures, this market is in another stratosphere, we see no reason to expect anything other than a rising market. Should there be any sort of “unexpected” correction, it’ll only be minor, and may result in a “soft landing”.’

‘Business-spun’ Wisdom

The acronym for ‘business-spun’ wisdom is ‘BS’. Which, as fate would have it, just so happens to be a very apt description.

These past few weeks I’ve read with interest (no pun intended) the ‘toing and froing’ on ‘interest rates’. What will, or won’t, the RBA do?

In The Australian Financial Review on 28 June 2017, we’re told that there are eight rate increases on the way:

Borrowers could be hit with at least eight consecutive official interest rate hikes in 2018 and 2019 if the economy rebounds as the Reserve Bank of Australia anticipates, says former central bank board member John Edwards.

Warning that the “time is coming to get back to normal” monetary policy, Dr Edwards said the current cash rate is “way below where it will need to be in years to come”.

As the economy returns to its normal pace of just over 3 per cent, inflation will return firmly to the 2 to 3 per cent Reserve Bank target range, raising pressure on policy makers to hike.

There are no ‘ifs, buts or maybes’ about why rates are heading up…the economy will be growing ‘just over 3 per cent’ and inflation ‘will return firmly to 2 to 3 per cent’.

Nothing unexpected in that outlook. And then the RBA minutes confirm what Edwards said a week earlier. Is that a coincidence or what?

The Australian, 18 July 2017:

The Reserve Bank of Australia says it estimates the neutral nominal cash rate would be around 200 basis points above its current level, adding monetary policy has been expansionary for about five years.

The RBA’s estimate suggests the cash rate target will need to rise from 1.50 per cent currently to 3.5 per cent over time.

But now, the markets are not so sure interest rates are going anywhere soon.

According to news.com.au on 1 August 2017:

CoreLogic head of research Tim Lawless said…

“However, rate hikes may be some way off as well,” he said. “Recent declines in the US dollar and strengthening commodity prices have placed added pressure on the Australian dollar, which may reduce export demand.”

Mr Lawless said financial markets were betting on an official cash rate hike sometime in late 2018.

Obviously, something unexpected — like a stronger Aussie dollar — has made the RBA rethink its expected return to 3% growth. Consequently, those expected interest rate cuts are pushed well into the future.

Expect the Unexpected

Based on ‘expecting the unexpected’, I expect the next movement in interest rates will be down — and sooner than most people realise.

Why? Complacency is writ large. The VIX (volatility index) is flat-lining around an all-time low. And then there was this in The Australian on 7 August 2017 (emphasis mine):

AMP Capital chief economist Shane Oliver said the weekend figures showed 209,000 jobs were created in the US in July and the unemployment rate was 4.3 per cent. He said the strong figures and low wages growth, of just 2.5 per cent, will result in the US Federal Reserve continuing its gradual tightening of monetary policy.

“So that combination of good growth but relatively low inflation is something the sharemarket likes. It’s almost like a Goldilocks economy — not too hot, not too cold, but just right,” Dr Oliver said. “Not so good for workers, but it’s good for the companies.”

When I read ‘goldilocks economy’, it sends shudders up my spine. Why? From Investopedia: ‘The U.S. economy of the mid- to late-1990s was considered a Goldilocks economy because it was “not too hot, not too cold, but just right.”

And we know how that ended… Goldilocks got mauled by the bear market of 2000–03.

No one expected the NASDAQ to lose over 80% of its value. No one expected 9/11. No one expected the US to invade Iraq. No one expected former Federal Reserve chair Alan Greenspan to keep rates too low for too long, inflating a US housing bubble in the process.

Read any mainstream forecasts and you’ll find they’re all the same. Everyone expects growth and inflation to gradually pick up. An expectation that keeps being ‘kicked down the road’.

The Australian, 4 August 2017:

Inflation in the Group of 20 largest economies fell to its lowest level in almost eight years in June, deepening a puzzle confronting central banks as they contemplate removing post-crisis stimulus measures.

For more than eight years, these economic quacks have tried to stimulate the economy. Never before in the history of money has ‘so much been done to produce so little’.

The only thing they’ve managed to inflate is asset prices. US stock prices and select capital city real estate prices keep going higher and higher.

But will these markets experience a hard landing?

According to BS wisdom, that’s not possible. Which only means it’s an odds-on certainty.

The chart below is compiled by US research house Ned Davis Research (NDR).

The chart — with the blue line only — was originally published in early 2017.

The chart was NDR’s prediction of what might happen in 2017 based on a ‘cycle composite’.

The blue line is a composite of the one-year seasonal cycle, four-year presidential cycle and 10-year decennial cycle. The data is based on daily price movements from 2 January 1900 to 31 December 2016.

The red dotted line is actually how the Dow Jones Industrial Average has performed in 2017.


Source: CMG Wealth
[Click to enlarge]

Thus far, NDR’s trend has been correct. But looks at what waits ahead.

The mainstream is not expecting this.

When, as I believe, the US share market falls hard from its historic high, shockwaves will be sent around the world.

Like Pavlov’s dog, central bankers will respond with something you can expect…lower interest rates.

Ignore the BS ‘wisdom’ and prepare your portfolio for a very hard landing.

Vern Gowdie,
For Markets & Money

Vern Gowdie

Vern Gowdie

Editor at Markets & Money

Vern Gowdie has been involved in financial planning in Australia since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners.

His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser magazine as one of the top five financial planning firms in Australia.

He is a feature editor to Markets and Money and is Founder and Chairman of the Gowdie Family Wealth and the Gowdie Letter advisory services.

Vern Gowdie

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