Is Mr. Market Patiently Setting Up His Next Heist?
The term “Mr. Market” is credited to legendary value investor Benjamin Graham. According to Investopedia (https://www.investopedia.com/terms/m/mr-market.asp), Graham first introduced Mr. Market in his 1949 book, The Intelligent Investor. Mr. Market is a hypothetical investor whose decisions are driven by alternating bouts of panic and greed.
Graham recognized that emotions are typically an investor’s worst enemy. His approach to investing emphasizes “intelligent” analysis of fundamentals, such as earnings and dividends. Warren Buffett, his disciple and most successful student, has amassed a fortune by applying Graham’s principles.
At Markonomics101.com, however, Mr. Market is NOT an investor.
He is a purely evil entity whose sole function is to relieve investors of as much of their wealth as possible.
Mr. Market is a combination of the “House” in Vegas, a “Career Politician” and a Mob Boss. He is the alpha of Sociopaths, and, like the Government, he wants what you have. It’s his form of taxation for those earnings that investors somehow managed to keep.
One can be certain of very little when it comes to any market by DESIGN! Anything that appears obvious is usually anything but. Like a magician, Mr. Market is a master of misdirection.
And yes, our Mr. Market is as hypothetical as Graham’s. Or, is he?
Bear Market Rallies Keep Investors Hopeful
Investors, however, are not as gullible as Charlie Brown. Therefore, he throws them a winner every so often to keep them “at the table”.
In this regard, Mr. Market is a lot like Benjamin Graham. He plays for the long term, realizing that whatever winnings he allows investors to enjoy will come right back his way eventually.
Mr. Market is a master of human psychology and behavior. He understands how prone investors are to making mistakes when emotional. He knows how to stoke Greed and how to generate FEAR.
Emotions ARE an investor’s worst enemy because they are counter-intuitive. Being “Drunk with Greed” is as incompatible with prudent decision making as just being DRUNK!
A brief refresher course on Investor psychology can be accessed here: “The Psychology of Investing” (https://markonomics101.com/2018/10/08/the-psychology-of-investing/).
Characteristics of Bear Market Rallies
The KEY characteristic of Bear Market Rallies is Volatility. Markets tend toward elevated volatility when perceived uncertainly rises and liquidity falls. Diminished liquidity means that it takes less money to produce bigger moves.
Market volatility is EXPLODING as the BEAR subtly takes over.
During August and September the Dow Jones Industrial Average (Dow) changed by 0.39% (either UP or DOWN) on average per trading day. In points, the mean deviation was roughly 100.
For the two months of October and November, the Dow gained or lost a staggering 250 points per day or 1%. VOLATILITY INCREASED BY A FACTOR OF 2.5!
This explosion of volatility is far more consistent with a BEAR MARKET, than a sustainable advance. Each strong “rally” serves to keep investor hope alive. It is nothing more than Misdirection by Mr. Market.
Historically, the largest percentage daily “up moves” have either occurred subsequent to the 1929 Crash or the 2008 financial panic (https://en.wikipedia.org/wiki/List_of_largest_daily_changes_in_the_Dow_Jones_Industrial_Average).
Additional background on Bear Market rallies can be found here: “Mr. Market’s Bear Market Rallies” and “Characteristics of Bear Market Rallies” (https://markonomics101.com/2018/10/14/mr-markets-bear-market-rallies/) (https://markonomics101.com/2018/10/17/characteristics-of-bear-market-rallies/).
Higher volatility is normally associated with declining prices. This has been corroborated by a number of academic studies (https://www.investopedia.com/articles/financial-theory/08/volatility.asp).
While rare, it is not unprecedented for markets to experience higher prices and volatility simultaneously. During the final phases of both the Dot Com Bubble and the Cryptocurrency Bubble, prices and volatilities exploded simultaneously.
Psychology of Higher Volatility
Higher volatility has a psychological component that is critical to Mr. Market’s success. When investors are “acclimated” to moderate levels of market fluctuations, they become more prone to “fear” when experiencing outsized daily losses. In contrast, once investors adjust to the exaggerated daily moves common with Bear Market volatility, they are less likely to react by selling early.
Every rebound rally, following a sharp decline, de-sensitizes investors to risk. Each rally sends the subtle message that declines are nothing but “temporary buying opportunities”. But are they now?
Bear Markets in Disguise
The charts in the slide show below show how time frames can affect perceptions. The first slide, of NDX for the last year is clear. NDX is still making LOWER LOWS and LOWER HIGHS. That’s the definition of a down trend, not a BULL MARKET.
The next slide of NDX is the “Big Picture” over 5 years. NDX is possibly forming the “Right Shoulder” of a long term “Head and Shoulders” Top Reversal. If that scenario is correct, the Pattern will require a few more weeks or months to complete. The only thing we can be certain of is the BEAR will emerge when no one’s ready.
The final 3 slides are of the Russell 2000. These show one technique for how Mr. Market disguises a BEAR MARKET as a BULL.
The 3 month chart reveals a short term “Rounded Bottom”, a pattern with BULLISH implications. But, on the 1 year and 5 year charts, the RUT looks to be forming an ominous Head and Shoulders Top. A BEAR disguised as a BULL.
The “Pattern” itself is much less important than the support levels. As long as NDX holds above support at 6300 and RUT above 1460, neither will be in “official” BEAR MARKET territory.
If those key support levels get breached, the equity markets will be at risk of a very severe “Waterfall Decline”. (https://markonomics101.com/2018/11/04/stock-markets-bounce-hard-above-the-waterfall-zone/).
Interest Rates Continue Lower and Partly Invert
Yesterday, interest rates continued to fall further. Three month T-Bill Rates broke an important uptrend line at about 2.3%. Yields on 5, 10 and 30 Year Maturities all fell a few basis points. The 10 year closed at under 3%, a key level.
More importantly, the Yield on 2 Year Maturities are now a touch MORE than those on 5 Year Maturities. The Benchmark Yield Spread between 2 Year Maturities and 10 Year Maturities is now only 0.14%. A negative spread, or “Inverted Yield” is a leading indicator of recession or economic slowdown.
A more detailed discussion of the causes and consequences of an “Inverted” Yield Curve were outlined Sunday. “Interest Rates In Sudden, Full Reverse” (https://markonomics101.com/2018/12/02/interest-rates-in-sudden-full-reverse/).
Risk continues to dwarf Return. A substantially weakening economy has NOT yet been fully incorporated into stock prices.
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