Barometers, Thermometers And Recency Bias

As the month of October fades away and is replaced by the month of November, which represents the start of the "best six months of the year" for stocks, traders are all sharpening pencils, firing up slide rules and priming keyboards in anticipation of making some very bold calls on the pending "bottom" for the current market bloodbath. This weekend alone, the blogs and email inboxes are stuffed with glowing predictions of an imminent upturn and the number one reason for this is apparently the "incredible strength of the U.S. economy."

There used to be a famous newsletter writer/speaker/technician called Joe Granville who was universally hated by fund managers and analysts because he constantly referred to them as "chimps" and regularly had a trained monkey dressed up in a three-piece pinstripe suit on stage with him pretending to be reading the Wall Street Journal during speaking engagements. Granville often quoted Charles H. Dow as originator of the most-important term in stock analysis and the source of most serious portfolio errors over time: "The stock market is a barometer, not a thermometer" was his memorable phrase and especially today with so many CNBC analysts crediting the U.S. economy for stock market resiliency. From the book:

"Remember the difference between the thermometer and the barometer: the thermometer records the actual temperature at the moment just as the stock ticker records actual prices. But it is the business of a barometer to predict.

In that lies its great value, and in that lies the value in Dow Theory. The stock market is the barometer of the country's, and even the world's, business, and the theory shows how to read it."

As you all know, I credit the incredible stock market bubble as having two major causes: the first is the injection of trillions upon trillions in fantasyland liquidity into the financial system after 2008, and the second is the actions of the world's central bank trading desks which most times, if not all times, are simply the money-center banks around the world taking instructions from the policymakers. However, the MSM messaging services has every analyst in every medium pointing to the current temperature outside as proof positive that winter simply won't arrive and that a crashing barometer does not forbode a storm on the horizon. As a boater who navigates the Great Lakes, ignoring the barometer usually results in "bad things happening" and I would urge all of you to use the current market blowoff as a portent of those same "bad things happening." It is not "different" this time.

The worst fourth-quarter performance in recent memory was 2008 (sub-prime crisis), where the S&P dropped 38.5%, with other notables being 2002 (post 9/11 blues) and 2001 (dot-com crash). Those markets were basically without the invisible hand of intervention; stock prices were controlled by human emotion rather than elected officials and computer algorithms. The scary part about 2018 is that today there IS intervention and there IS the invisible hand and yet 75% of the S&P 500 is now officially in "correction territory" verging on full-fledged bear markets. The FANGS have one general left (Apple) to report earnings next week, and if it cannot avoid the "Sell the news" virus that crushed Netflix, Google, and Facebook (and Amazon), then 2018 will be up there in the chart when I post it in February with updated numbers. The daily RSI for the S&P is a hair above 30 but the weekly RSI is still over 36 so considering that in 2008, it took a minus 20 reading to even resemble a bottom, it took until 2009 March for the bear cycle to run its course.

Also, as bad as 2008–2009 was in terms of percentage decline and technical damage, it only lasted from the summer of 2008 until March 2009, so its nine-month duration was a picnic compared to the slow water tortures of 1973–1974 or 1981–1982 and even 2001–2002. The problem remains that most market participants have no recollection of bear markets because they are simply too young and are victims to a form of cognitive bias called "recency bias," where they are making investment decisions based upon relatively short-term historical time frames. This is what I glean from the number of interviews out there and the younger the speaker, the greater the bias.

For short-term traders, I don't doubt that a very short-term reflex rally could occur in November and possibly very early November as fund flows come into the markets spooking the shorts. I, for one, will not try to trade that rally because my greatest fear is that we are going to see the youngsters scramble to save their 2-and-20 bonuses by locking down profits (or whatever is left) and that means that there could be a serious liquidity problem for everyone.

Turning to gold and silver, I have spoken of this more than a few times since 2008, but for the precious metals all you need to watch is whether those that get margin calls are forced to cover. Large Speculators and Managed Money get margin calls; Commercials and Producers do NOT get margin calls. In 2008, Commercials were net short and Large Specs were net long and the Producers were net short while Managed Money was net long. As for the shares, they were massively over-owned by Managed Money and Large Specs. From the chart shown below, you can see that while the Large Specs are no longer net short, they are still carrying a very substantial short position so to add liquidity (cover margin) they will be buyers into any sort of stock market-related liquidity squeeze. Similar situation for the Managed Money gang including the CTAs, all of whom are now de-leveraging as fast as they possibly can.

In other words, the gap between the two lines shown below depicting COT positioning is illustrating an "Extreme Bottom" for gold. Those of you dumping physical gold and silver would be better off hedging the physical with the gold and silver miners if you see overall stock market weakness dragging the miners down with it. Remember, in 1987, the crash took physical gold up $80 but the gold miners got cut in half. Similarly, the long bond had the biggest rally in history at the time. Just sayin'.

There are a great many reasons to be cautious in stocks and bonds and leveraged real estate but I am simply unable to conjure up sufficient arguments against gold and especially silver as we close out the month of October 2018. As I finish this missive, the big new today is the announcement that Germany's Angela Merkel is standing down as chair of the ruling CDU party. This will be viewed as the ultimate dissolution of the glue that binds Europe together. I will have more on that later in the week but for now, the next two days are going to be VERY interesting as the month winds down and book-squaring accelerates. Today we have had a 600-point reversal to the downside and it is going to get even uglier by Wednesday.

Remember the last ten minutes of "Trading Places"? "I demand an investigation. Get those brokers back in here. Turn those machines back on! TURN THOSE MACHINES BACK ON!!!"

Retribution is the operative word for the day.

Originally trained during the inflationary 1970s, Michael Ballanger is a graduate of Saint Louis University where he earned a Bachelor of Science in finance and a Bachelor of Art in marketing before completing post-graduate work at the Wharton School of Finance. With more than 30 years of experience as a junior mining and exploration specialist, as well as a solid background in corporate finance, Ballanger's adherence to the concept of "Hard Assets" allows him to focus the practice on selecting opportunities in the global resource sector with emphasis on the precious metals exploration and development sector. Ballanger takes great pleasure in visiting mineral properties around the globe in the never-ending hunt for early-stage opportunities.