Wealthbuilder.ie Stock Market Brief 19th. July 2018.

No two recessions are ever the same.

One of the best indicators of a possible recession on the horizon is the inversion of the American
Treasury interest rate yield curves. Inversion means the yield on short term rates are abnormally
higher than long term rates. With Jerome Powell, the FED chairman, publically committed to
another two .25% interest rate hikes this year, it is highly probable that by year end the 2/10 year
yield curve will have inverted. (Currently the spread between the 2 year and 10 year yield is only
.26%). In the recessions of 2000 and 2008 the American economy experienced severe recessions
within 22 months and 24 months, respectively, upon yield curve inversion.

With this perspective in mind I hear a lot of punters saying they are not too worried, short term,
believing that there is plenty of time to exit the market and protect the wonderful profits made
during this bull market. However, given the mature nature of this stock market (it commenced in
March 2009) and taking cognisence of the potential interest rate inversion I have advised student
clients, particularly those with substantial funds, to take a sizable percentage of their capital out
of this market and place it in cash and I have told those folk nearing retiremnt to go totally to
cash, should inversion actually occur as expected.

My main reason for maintaining this view is due to the changed nature of the market as a result
the explosive popularity in “basket investing” through exchange traded funds. This I reckon will
be a recurring “mantra” of the next recession, for recessions are never the same and always have
their unique “footprints”. The defining feature of the next recession, I think, will be multi flash-
crashes due to collapsing market liquidity and the “sameness” of ETF investment portfilio
structure. In the circumstance of flash-crashes sell-stops will be of little benefit. There wil be
severs gap-downs, with no actual market to fill sell-stop trigger points. The lack of traditional
“market makers”, quant trading, high frequency trading and algorithim trading will all exacerbate
the problem. Due to the fact that technical analysis programming has become so ubiquitous
everybody, (or to put it more honestly, every trading computer bot), will “desire” to sell the same
basket of equities, contained in the same popular ETFs, all at the same time. Result: no market,
period.

However, there is a sunny side to this historical observation. I have always told students that
recessions are wonderful things for any investor who is prepared. Being prepared means having
a cash position to take advantage of market price action once the panic is over and prices have
stabilised. Warren Buffit exemplified this concept in a recent Berkshire Hathaway Newsletter.
To paraphrase him he said: “in recessions when valuations fall and value becomes evident we do
not go out investing with a spoon, we use a bath tub”.

Technical Picture.
The market is solidly repairing the damage done by the New Year “correction”. The NASDAQ
and the Russell 2000 have reached new highs and the S & P 500 has finally taken out the July
highs. The Dow industrials and the Dow Transports have not done so yet but are making a strong
effort to follow suit.
The 14 day and 28 day stochastics we are giving over bought reading, thus it would be
reasonable to get a pullback of some degree but I think technically the markets are building up
for a strong year end.

The one important negative factor to bear in mind is that the VIX is hard on the floor of its
trading range, so an explosion upward is fairly likely at some stage thus bringing with it strong
volatility and price contraction. The important thing is that it that when this occurs the technical
damage is contained. If not and similar breakdowns occur like that of February last what with
rising interest rates, a strengthening dollar, quantitative tightening, escalating trade wars and
potential Brexit chaos growing in Britain, Ireland and greater Europe, a short-term bear trend
could easily morph into something more destabilizing.

Chart: Dow Industrials: Daily.

Chart: Dow Transports: Daily.

Chart: NASDAQ: Daily.

Chart: S & P 500: Daily.

Chart: Russell 2000: Daily.

Chart: VIX: Daily.

Charts: Courtesy of StockCharts.Com

© 19h July 2018 Christopher M. Quigley.