In last weekend’s newsletter, I discussed the “round-trip” move of the market following the Fed’s latest announcement to NOT hike rates.
“It is not surprising the Fed once again failed to take action as their expectations for economic growth were once again lowered. In fact, as I have noted previously, the Federal Reserve are the worst economic forecasters on the planet.
As shown in the table/chart below, not only are the expectations for economic growth now the lowest on record, the Fed has given up on 2% growth for the economy with the long-run economic projections now at just 1.9%.”

“This should surprise no one. The Federal Reserve has continued to hope for the last several years that extremely ‘accommodative’ monetary policy, and near zero interest rates, would spark stronger levels of economic activity leading to a rise in broad-based inflationary pressures. Unfortunately, this has yet to be the case.
With the Fed holding still on hiking rates, with a promise to now hike in December (**cough****bullshit****cough), traders came rushing back into the market pushing prices right back into the trading range of the last month.”
The chart below shows the “round-trip” from complacency, to panic, and back to complacency.

As I noted on Thursday, the Fed non-announcement gave the bulls a reason to charge back into the markets as “accommodative monetary policy” is once again extended through the end of the year.
Of course, it is not surprising the Fed once again failed to take action as their expectations for economic growth were once again lowered. Simply, with an economy failing to gain traction there is little ability for the Fed to raise rates either now OR in December.
However, it was the docile tones of the once again “Dovish” Fed that saved market bulls from a “bearish” rout. The recent test of the bullish trend line from February lows combined with a move back of the 50-dma clears the way for the markets to retest, and potentially breakout, to new highs.

With economic data remaining extremely weak, and leading indicators continuing to roll over, the “bad news is good news as the Fed stays on hold” scenario continues to play to investor’s favor….for now.

The question that remains, of course, is when does the reality of the weak economic environment begin to impact the fantasy of stock prices.
It was interesting that Janet Yellen mentioned “commercial real estate values” in her latest comments to the press. To wit:

“Yes.

Ironically, last week I titled last week’s reading list “Market Stasis” with respect to the 43-days of sideways market action with relatively minor price fluctuations. That publication marked the respective end of that complacency.
This past week has been anything but complacent as the volume in volatility trades have exploded simultaneously with wild swings in market price from spectacular declines to surging rebounds.

This corrective action, which I have warned about repeatedly over the last month (see here) may be different than the standard “buy the dip” correction. The market has already violated both initial supports (the bull trend line and previous highs) which brings into focus the bull trend support line from the February lows. A violation of the latter will likely see the markets retest the 2020 level on the S&P 500.

One thing the sell off this week showed investors is what happens when correlations across asset classes become extremely high. When the selling begins, there is no “safe place” to hide. As my partner, Michael Lebowitz, noted earlier this week:
“The truth of the matter is that blind diversification does not work simply because it does not take into account the effects of volatility on asset prices.

“
Wishful Thinking

The confusion at the Fed continues as Federal Reserve Bank of San Francisco President John Williams painted an upbeat picture of the U.S. economy in a speech on Tuesday. This, of course, comes despite recent disappointing data on both the employment and economic fronts.
“The economy is in good shape and headed in the right direction. As a result, it makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.” 
Of course, the Fed’s Williams is once again “jawboning” the media and Wall Street, as despite their best efforts over the last several years, economic growth has continued to slow to ever lower growth rates. This is clearly shown in the chart below which shows the Fed’s “predictions” versus actual outcomes.

However, despite Mr. Williams hopes of stronger economic growth in the months ahead, the data currently doesn’t suggest this will be the case. Let’s start with the manufacturing and service data.
In June, I discussed my Economic Output Composite Index (EOCI) which is a very broad measure of economic activity consisting of not just manufacturing data, but services as well as leading indicators. (The chart below compares the EOCI to both GDP and the Leading Economic Indicator Index. The EOCI is comprised of the CFNAI, Chicago PMI, LEI, NFIB, ISM, and Fed regional surveys.

On Tuesday, I noted the end of summer and the entrance into one of the weakest months of the year statistically speaking.
“We can confirm BofAML’s point by looking at the analysis of each month of September going back to 1960 as shown in the chart below.”

“As shown, the average return for all months of September is -.70% with a median return of -.42%. More importantly, the statistics for September are universally negative. The number of losing months outweighs winning months by 31 to 25 which gives September a 55% chance of being negative historically speaking. While the “average and median” losses are less than 1%, this analysis obscures the fact that many September months registered losses of greater than 3%.”
As Donald Trump would say: “Not so good. Not so good.”
This past week has failed to break the current consolidation process that started over a month ago. As shown in the chart below, however, the “bulls” are currently facing a very important test.

The GREEN dots at the bottom denote when the market is oversold AND on a momentum buy signal. The combination of these factors has subsequently led to a rise in the markets. However, the RED dots denoted when the markets were on a momentum sell signal and oversold. This combination of factors has generally led to further declines.

With roughly 97% of the S&P 500 having reported earnings, as of the end of August, we can take a closer look at the results through the 2nd quarter of the year. Despite the exuberance from the media over the “number of companies that beat estimates” during the most recent reported period, 12-month operating earnings per share FELL from $98.61 per share in Q1 to $98.33 which translates into a quarterly decrease of 0.2%. While operating earnings are widely discussed by analysts and the general media; there are many problems with the way in which these earnings are derived due to one-time charges, inclusion/exclusion of material events, and outright manipulation to “beat earnings.”
Therefore, from a historical valuation perspective, reported earnings are much more relevant in determining market over/undervaluation levels. It is from this perspective the news improved modestly as 12-month reported earnings per share rose from $86.44 in Q1 to $86.99, or 0.6% in Q2. However, despite the improvement in reported earnings for the quarter, the trend remains clearly negative.

Always Optimistic

There is one commodity that Wall Street always has in abundance, “optimism.” When it comes to earnings expectations, estimates are always higher regardless of the trends of economic data. The problem is that the difference between expectations and reality have been quite dramatic.

By Michael Lebowitz, CFA

Volumes have been written on behavioral finance and the seemingly “irrational” decisions investors tend to make to avoid straying from the herd. This article examines a current example coined “FOMO” (fear of missing out), in today’s texting parlance. Through a better understanding of the psychological dynamics of bubble mentality, we hope to help investment managers better grasp the complex role they must play when their concern for poor expected returns and higher levels of risk  are pitted against their client’s fear of not keeping pace with the market.
Candid Camera

Allen Funt and Candid Camera filmed a famous episode designed to show how humans tend to behave like each other, regardless of the logic in doing so. In their experiment, an unknowing man entered an elevator, followed shortly by a few Candid Camera actors. After entering the elevator, the actors faced the rear of the car. The man, clearly befuddled, slowly turned around and faced the rear of the elevator. In a second skit, another man not only followed the actors and actresses facing backwards, but then proceeded to rotate back and forth with the crowd. As the skit goes on, he also removes his hat and puts it back on following the actions of the actors and actresses.

While the world has been focused on the Federal Reserve, the markets, and the upcoming election, few have noticed the expansion of the deficit in recent months which is now in excess of $667 billion up from a recent low of $530 billion. The chart below shows the history of U.S. surplus/deficit:

During the financial crisis, the deficit ballooned to a record of $1.35 trillion as tax revenue declined as Government spending swelled. Importantly, the Federal Deficit was approaching 10% in 2009, a historical record for the U.S., but still remains at levels associated with weaker economic growth rates and recessions.

The decline in the deficit was artificial in many ways as it was primarily due to the reforms from the “2011 Budget Control Act” which including tough spending cuts and a big tax bite that impacted a large majority of the middle class. Much of that “austerity” has now been reversed.
Tax The Rich

The surge in tax revenues was a direct result of the “fiscal cliff” at the end of 2012 as companies rushed to pay out special dividends and bonuses ahead of what was perceived to a fiscal disaster and higher tax rates. The large surge in incomes was primarily generated at the upper end of the income brackets where individuals were impacted by higher tax rates. Those taxes were then paid in April and October of 2013 and accounted for the sharp decline in the deficit.

As Yellen spoke on Friday, the markets surged back into the trading range that we have been locked into for the past few weeks. Despite GDP being revised lower and economic data continuing to remain weak, the hopes for a strengthening economic recovery from the Fed remain. Here are Yellen’s key points:
YELLEN SAYS RATE-HIKE CASE `HAS STRENGTHENED IN RECENT MONTHS’
YELLEN SAYS ECONOMY NEARING FED’S EMPLOYMENT, INFLATION GOALS
YELLEN: FOMC NOT ACTIVELY CONSIDERING ADDITIONAL TOOLS
YELLEN SAYS GROWTH NOT RAPID BUT ENOUGH TO IMPROVE LABOR MKT
On those headlines, the market rallied as the expectations for a September rate hike dissolved.
Remember, raising the Fed Funds rate is a tightening of monetary policy which withdraws liquidity from the financial markets. With fundamentals and economics weak, the only supportive argument for higher asset prices, and for “yield chasers” paying 3.5x sales for a 2.5% dividend, is continued accommodative policy. 
But it was this statement that sent the markets surging higher:
“On the monetary policy side, future policymakers might choose to consider some additional tools that have been employed by other central banks, though adding them to our toolkit would require a very careful weighing of costs and benefits and, in some cases, could require legislation.

As summer begins to fade, and kids return to school, the focus once again turns to the annual event of Central Bankers in Jackson Hole, Wyoming. However, if you only looked at the market as a gauge as to the excitement of the event, well it must have been one pretty boring after-party.

The current action is aligning more closely with a normal corrective event from an extreme overbought condition. During such a “normalized” market correction, the market should pull back to the most recent support, hold that support level and turn higher if the current bullish trend is to remain intact.
However, with all other indicators now pushing extreme levels, a correction from current levels could be somewhat larger than currently anticipated. As I discussed recently:
“However, there is a more than reasonable chance, as I laid out at the end of July,  for a deeper correction in the next 60-days.  The chart below shows the potential drawdowns from current levels.”

“Here is the point. It would take a correction from current levels to break 2000, which is very important support for the markets currently, to even register a 10% correction.
Given the current bullish exuberance for the market, this is probably unlikely between now and the election.Therefore, even a ‘worst case’ correction currently would likely be an 8.5% drawdown back to major support.

“
Would Another $4 Trillion In QE Work?

Just recently, David Reifschneider, deputy director of the division of research and statistics for the Federal Reserve board in Washington, D.C., released a staff working paper entitled “Gauging The Ability Of The FOMC To Respond To Future Recessions.” 
The conclusion was simply this:
“Simulations of the FRB/US model of a severe recession suggest that large-scale asset purchases and forward guidance about the future path of the federal funds rate should be able to provide enough additional accommodation to fully compensate for a more limited [ability] to cut short-term interest rates in most, but probably not all, circumstances.”
In other words, the Federal Reserve is rapidly becoming aware they have become caught in a liquidity trap keeping them unable to raise interest rates sufficiently to reload that particular policy tool. As I have discussed in recent weeks, and below, there are an ever growing number of indications the U.S. economy is currently headed towards the next recession. 
He compares three policy approaches to offset the next recession.
Fed funds goes into negative territory but there is no breakdown in the structure of economic relationships.
Fed funds returns to zero and keeps it there long enough for unemployment to return to baseline.

As another week comes to a close, we continue to wrestle with a market that remains detached from underlying economic data and clings to recent levels of over overbought, overextended and low reward/risk outcomes. Of course, in the final stages of a bull market, this is what has historically been the case.

As I stated last week:
“The problem for individual investors is the ‘trap’ that is currently being laid between the appearance of strong market dynamics against the backdrop of weak economic and market fundamentals. Ignoring the last two to chase the former has historically not worked out well.”
There was an excellent article by John Authers for the Financial Times on Friday to this very point:
“Markets are extravagantly confident that brokers are too bearish, and that their profit forecasts for US companies are too low. The multiple of 18 times next year’s projected earnings at which the S&P 500 currently trades, according to Bloomberg data, allows little other interpretation. It is at its highest since 2002, outstripping any level it reached during the credit bubble, or when the Federal Reserve was pumping up asset prices with QE bond purchases.

Yesterday, we got the release of the minutes from the FOMC meeting in July. Not surprisingly, we see a Fed just as confused as ever as to what monetary policy actions should be taken. To wit:

FED OFFICIALS SPLIT IN JULY ON WHETHER RATE HIKE NEEDED SOON
A COUPLE FED OFFICIALS BACKED JULY RATE HIKE
FOMC VOTERS AGREED TO WAIT FOR MORE DATA TO GAUGE ECONOMY
SEVERAL FED OFFICIALS CONCERNED OF FIN. RISKS FROM LOW RATES
SEVERAL FED OFFICIALS SAW AMPLE TIME TO ACT IF INFLATION RISE
FOMC VOTERS DIVIDED ON WHETHER JOB-GAIN PACE WORRISOME

As I wrote previously, I think the Fed is making a major policy mistake.
“First, with the markets making new all-time highs, there is a ‘price’ cushion available for the markets to absorb a rate hike without breaking important downside support.
Secondly, with Central Banks globally flooding the markets with liquidity, a further ‘shock absorber’ is currently engaged in softening the impact of a rate hike.
Lastly, the economy is likely going to show a bit of ‘strength’ in upcoming reports, with slightly stronger inflationary pressures. This pickup in economic strength will be another inventory restocking cycle following several months of weakness. As has been in the past, it will be transient and that strength will evaporate as quickly as it came.
If I was Janet Yellen, I would hike interest rates by .

On Monday, the markets hit new “all-time highs.” That’s the good news.
The bad news is that such is occurring on a rapid decline in volume as shown in the chart below.

While volume by itself is not a great indicator from which to manage money by, it does lend credence to the level of participation in the market’s advance. Volume, like volatility which we will discuss in a moment, is most useful in denoting turning points in the market. Historically, volume tends to begin increasing just prior to, and during, a market decline.
While declining volume does not suggest the current advance is over, it is worth paying attention to when it turns higher.
Furthermore, with the extension of the market now 7.5% above the 200-day moving average, a reversion at some point in the not-s0-distant future becomes much more likely. This is particularly the case given the current overbought conditions combined with weakness in price momentum from high levels as denoted by the red circles below.

But such “bear markings” seem to provide little worry to the “bulls” which brings me to my point for today.
A Bull Market In Complacency

In this past weekend’s newsletter, I touched on the volatility index stating:
“The level of “complacency” in the market has simply gotten to an extreme that rarely lasts long.
The chart below is the comparison of the S&P 500 to the Volatility Index.

Yesterday, media headlines rang out:
“The Markets Just Did Something It Hasn’t Done Since 1999.”
It’s pretty amazing when you think about it for a moment. All three indices hit simultaneous new highs at a time when earnings, profitability, and economic data are deteriorating.
While much of the media analysts continue to suggest there remains a bearish attitude towards stocks, price action of the markets as compared to fundamental data suggests quite the opposite.
The chart below compares the current S&P 500 to both earnings and the annual ROC in GDP.
Notice any similarities?

Despite a “belief” that “This Time Is Different (TTID)” due to Central Bank interventions, the reality is that it probably isn’t. The only difference is the interventions have elongated the current cycle, and has created a greater deviation, than what would have normally existed. What is “not different this time” is the eventual reversion of that extreme will likely be just as damaging as every other previous bear market in history.
But, of course, “TTID” is the old Central Bank driven mantra, today it is “There Is No Alternative (TINA).” As stated, regardless of what you call it, the results will eventually be the same.
Let’s review where we stand currently.
Chart updated through Friday’s open.

Despite deteriorating economic data, the market continues to cling to recent levels of over overbought, overextended and low reward/risk outcomes.
The problem for individual investors is the “trap” that is currently being laid between the appearance of strong market dynamics against the backdrop of weak economic and market fundamentals. Ignoring the last two to chase the former has historically not worked out well.
As David Rosenberg penned for the Financial Post:
“Okay, this really is one weird market.
I’m quite sure I have not seen such levels of confidence on one hand, and cognitive dissonance
Maybe they think the Fed goes, but it will be a mistake and send the economy back into a deflationary downturn.
But how can that be the case when this same ‘smart money’ crowd has built up a net speculative long position in the S&P 500 to the tune of 28,809 futures and options contracts?
The “greed” factor is also highly evident on the Chicago Board Options Exchange (CBOE) where net speculative shorts on the VIX have reached 114,603 futures and options contracts, a level reached only once before. The bull market is in complacency.

“

In this past weekend’s newsletter, I reviewed the current state of the market and the problem for Janet Yellen holding off on hiking rates given the recent strength of employment data on the surface. I say on the surface, because if you dig just a little you will find the inherent problems as I noted.
“The +85k unadjusted number also confirms the trends of fixed and non-private residential investment. Businesses hire against the demand for their products and services. This is why, as shown in the chart below, the historical relationship between employment and fixed investment is extremely high….until now.”

“Importantly, there are two takeaways from this data:
Currently, the markets don’t care about what is really happening in the economy, but whether the data keeps the“punch bowl” available. Liquidity is key to supporting asset prices at current levels.
However, eventually, the markets WILL care about this data when the economy slows to a point where recessionary forces are no longer deniable.
For now, we are not at the second point as of yet. Therefore, the bullish bias remains intact as long as Central Bankers remain accommodative and keeps interest rates suppressed. Of course, the ongoing liquidity push is distorting market dynamics to a point that will lead to some very bad things in the future.

It is not surprising that after one of the longest cyclical bull markets in history that individuals are ebullient about the long-term prospects of investing. The ongoing interventions by global Cental Banks have led to T.I.N.A. (There Is No Alternative) which has become a pervasive, and “Pavlovian,” investor mindset. But therein lies the real story.
The chart below shows every economic expansion going back to 1871 and the subsequent market decline.

This chart should make one point very clear – this cycle will end.
However, for now, the bullish bias exists as individuals continue to hold historically high levels of equity and leverage, chasing yield in the riskiest of areas, and maintaining relatively low levels of cash as shown in the charts below.

There are only a few people, besides me, that discuss the probabilities of lower returns over the next decade. But let’s do some basic math.
First, the general consensus is that stocks will return:
6%-8%/year in real (inflation-adjusted) terms,
plus or minus whatever changes we see in valuation ratios.
Plug in the math and we get the following scenarios:
If P/E10 declines from 25X to 19X  over the next decade, equity returns should be roughly 3%/year real or 5%/year nominal.
If P/E10 declines to 15X, returns fall to 1%/year real or 3%/year nominal.

Editor Note: Michael Lebowitz of 720 Global Research is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  He is a regular contributor to Real Investment Advice.
On Friday July 29th, 2016, the Bureau of Economic Analysis (BEA) released the second‐quarter GDP figures and revisions for prior quarters. At a disappointing annualized growth rate of only 1.20%, second quarter GDP widely missed consensus expectations of 2.50% growth. Coincidently the current 1‐year average growth rate has risen at the same 1.20% and that annualized growth rate has declined for five quarters in a row.
For the most part, the recent bout of stagnant GDP data has not caught the attention of the media or the markets. As consultants to those who manage wealth we believe this data is vitally important, regardless of what others may think. Accordingly, we provide some context around this data to help you better grasp its magnitude.
The graph below plots average 1‐year GDP growth on a quarterly basis going back to 1948. The
blue shaded areas represent periods deemed recessionary by the National Bureau of Economic
Research (NBER), and the red dotted line facilitates the comparison of the current 1.20% reading versus those of the past.

“

In this past weekend’s newsletter, I reviewed the current state of the market and the risks of an August/September correction from a statistical standpoint.
However, the important point was the stagnation of the market over the last couple of weeks following the breakout above previous resistance levels to all-time highs despite rampant concerns about the effect of the “Brexit.”  This, of course, has been the result of a rapid response by global Central Banks to push enough liquidity into the system to offset any potential negative impact from the vote. 

As I have noted over the past couple of weeks, the market is in the process of digesting an extreme overbought condition. As I stated this past weekend, there are two ways to accomplish this:
“Importantly, there are TWO ways to solve an overbought and overextended market advance.
The first is for the market to continue this very tight trading range long enough for the moving average to catch up with the price.
The second is a corrective pullback, which is notated in the chart below. However, not all pullbacks are created equal. 
A pullback to 2135, the previous all-time high, that holds that level will allow for an increase in equity allocations to the new targets.
A pullback that breaks 2135 will keep equity allocation increases on ‘HOLD’ until support has been tested.

Since I was traveling on vacation last week, and did not write a weekly report, I want to use this opportunity to update the previous analysis and model positioning for the current environment. This is particularly important as we enter into what has historically been two of the most dangerous months of the year. 
First, why do I say that? The chart below shows the historical return patterns by month for the S&P 500.

The months of August and September have a higher rate of corrections that other months with both standing at 42.37%. Furthermore, the rise of computerized trading, as shown in the chart above, has led to a substantial increase in volatility of point gain/loss during these two months. However, notice the polynomial trend line has trended more negatively in recent years reinforcing my concerns heading into the next two months.
Then there is this tidbit:

We’re about to step into seasonality ditch: lowest 3-month returns Aug-Oct for S&P going back to 1928
source: BoA ML pic.twitter.com/Q5S5JSQdvr
— Babak (@TN) July 29, 2016

It is not just historical statistics that suggest caution, but primarily it is the current extension of the market itself. As I discussed two weeks ago:
“This week, I am adjusting the model allocations up to 75%. Review last week’s missive for the individual sector analysis for recommendations leading up to the model change.

This week, the headlines have been dominated by the Democratic National Convention pushing Janet Yellen’s latest FOMC non-action to “page 6.”
Of course, it was not surprising to hear yesterday Janet Yellen has once again “flip-flopped” on hiking rates. This tweet from HedgEye sums it up nicely.

In honor of Summer, we’re breaking out #Fed flip flops:
Hawkish DEC
Dovish MAR
Hawkish MAY
Dovish JUNE
Hawkish JULY pic.twitter.com/wK7Cxk7tS9
— Hedgeye (@Hedgeye) July 28, 2016
As I noted a couple of weeks ago:
Come July, Janet Yellen and the FOMC are going to once again ‘punt’ hiking interest rates in favor of waiting for ‘global instability’ due to the ‘Brexit’ to subside. However, as stated this is a mistake for a couple of reasons.
First, with the markets making new all-time highs, there is a ‘price’ cushion available for the markets to absorb a rate hike without breaking important downside support.
Secondly, with Central Banks globally flooding the markets with liquidity, a further ‘shock absorber’ is currently engaged in softening the impact of a rate hike.
Lastly, the economy is likely going to show a bit of ‘strength’ in upcoming reports, with slightly stronger inflationary pressures. This pickup in economic strength will be another inventory restocking cycle following several months of weakness.

Last night, President Obama took the stage at the Democratic National Convention to throw his support to Hillary Clinton in her bid for the Presidency. He also took the opportunity to take a victory lap for his economic achievements while in office.

With the 2016 Presidential Election fast approaching, this was one of the final chances the President will have to try and divert attention away from Hillary’s “trustworthiness” problem following continued revelations surrounding Benghazi, email scandals and the Clinton Foundation which is now under investigation by the IRS.
The problem for the Democrats currently, following a rather severe beating at the polls during the 2012 mid-terms, is the broad loss of faith in “hope and change.” With Donald Trump and Hillary Clinton virtually tied in the majority of polls (within a margin of error), it is imperative to regain those voters. Not surprisingly, since voters tend to “vote their pocketbook,” it wasn’t surprising to hear the President spin a decisively positive economic picture during his speech. He hopes that by pointing to falling unemployment rates, economic growth and higher confidence levels; it will give voters a sense of confidence in the President’s accomplishments and be convinced the expect the same for Hillary.

Editor Note: Michael Lebowitz of 720 Global Research is an investment consultant, specializing in macroeconomic research, valuations, asset allocation, and risk management.  He is a regular contributor to Real Investment Advice.

Pondering the state of the global economy can elicit manic‐depressive‐obsessive‐compulsive emotions. The volatility of global markets – equities, bonds, commodities, currencies, etc. – are challenging enough without consideration of Brexit, the U.S. Presidential election, radical Islamic terrorism and so on. Yet no discussion of economic and market environments is complete without giving hefty consideration to what may be a major shift in the way economic policy is conducted in Japan.
The Japanese economy has been the poster child for economic malaise and bad fortune for so long that even the most radical policy responses no longer garner much attention. In fact, recent policy actions intended to weaken the Yen have resulted in significant appreciation of the yen against the currencies of Japan’s major trade partners, further crippling economic activity. The frustration of an appreciating currency coupled with deflation and zero economic growth has produced signs that what Japan has in store for the world falls squarely in to the category of “you ain’t seen nothin’ yet.

Last week I was on my annual family vacation which didn’t afford me the opportunity to publish my normal weekly commentary and portfolio model updates (subscribe for free e-delivery). What is interesting, however, is that relatively little has changed during that time frame.
For continuity, let me begin this week’s “Technically Speaking” update from where I left off previously.
“As shown below, the market is currently 3-standard deviations above its 50-day moving average. This is ‘rarefied air’ in terms of price extensions and a pullback is now necessary to provide a better entry point for increasing equity allocations.”
Chart updated through Monday’s close

“However, as I have noted, there is a difference in pullbacks.
A pullback to 2135, the previous all-time high, that holds that level will allow for an increase in equity allocations to the new targets. 
A pullback that breaks 2135 will keep equity allocation increases on ‘HOLD’ until support has been tested. 
A pullback that breaks 2080 will trigger “stop losses” in portfolios and confirm the recent breakout was a short-term ‘head fake.’”

Over the past week, as shown in the chart above, the market has failed to make any significant movement as traders anxiously await the next Fed meeting.

Well, my annual family vacation at the beach is coming to an end and soon I will be winging my way back to Houston. While I do love taking time out of my normally busy schedule to focus on those that I most adore, it is always comforting to return home.
However, since I am flying all day tomorrow, I will not be writing my weekly newsletter this weekend. Therefore, I wanted to update a couple of points from last week as we continue to manage risk in portfolios.
While the markets have indeed broken out to new highs, as I addressed earlier this week, it has done so without a significant improvement in the fundamentals. However, the breakout, such as it is, should not be dismissed or ignored. The technical underpinnings have improved enough to warrant an increase in equity related exposure given a proper entry point in the days or weeks ahead. Such an entry point would require a relaxation of the extreme short-term overbought conditions that currently exist. But a violation of critical support would negate the breakout and return the market back to a more bearish posture.

The potential for such a pullback is extremely high. As Tom McClellan noted recently, the “14-day Choppiness Index,” which tracks the path of a short-term trend, suggests Wall Street’s “uptrend is getting tired.

“.
Today’s “Thoughts From The Beach” picks up on a couple of articles I read over the last few days. With the markets breaking out to new highs, the bull market commentary has been expanding quickly. As you know, I have increased equity allocations in models with the breakout, but this is a tactical position only. The fundamentals by no means support the rising risk levels in the market currently.  Let’s take a look at a 3-Things worth considering.
Money In The Mattress?

Here is a myth that just won’t seem to die: “Cash On The Sidelines.”
This is the age old excuse why the current “bull market” rally is set to continue into the indefinite future. The ongoing belief is that at any moment investors are suddenly going to empty bank accounts and pour it into the markets. However, the reality is if they haven’t done it by now after 3-consecutive rounds of Q.E. in the U.S., a 200% advance in the markets, and now global Q.E., exactly what will that catalyst be?
However, Clifford Asness summed up the problem with this myth the best and is worth repeating:
“Every time someone says, ‘There is a lot of cash on the sidelines,’ a tiny part of my soul dies. There are no sidelines. Those saying this seem to envision a seller of stocks moving her money to cash and awaiting a chance to return.

“
Yesterday, I discussed the importance of risk management and reviewed the 15-rules that drive my portfolio management discipline. I needed to lay that groundwork for today’s discussion of why those rules need to be implemented right now.
As shown in the chart below, the market has currently surged nearly 9% from the “Brexit” fear lows driven by a massive increase in Central Bank interventions.

The problem, as I have pointed out previously, continues to be that while prices are increasing, that increase in price is coming at the expense of declining volume. While volume is not a great timing indicator for trading purposes, it does provide insight to the “conviction” of participants to the advance of the market.
But do not be mistaken about the importance of the drivers behind the advance. As Doug Kass recently penned:
“Global economic growth’s weak trajectory and Washington’s stark partisanship have combined to produce fiscal inertia. This puts the responsibility for stimulus on central banks, which have in many cases taken interest rates into negative territory. This has disadvantaged savers and put investors and traders on an arguably dangerous path of malinvestment in a search for yield.“
The current market extension has currently extremes which are more normally associated with short to intermediate term-corrections.

Here we go again. Another Friday. Another attempted breakout above the 2100 level on the S&P 500. Over the last couple of months, as shown below, this has become a regular occurrence.

While the market is once again extremely overbought on a weekly basis, the employment report on Friday which showed a historically abnormal surge in June jobs growth, despite a weaker than expected wage increase and further negative revisions to May’s report, sent investors scrambling into the market. That push on Friday was enough to trigger a short-term buy signal and set the market up for a push to all-time highs.
However, don’t get too excited just yet. There are several things that need to happen before you going jumping head first into the pool.
We have seen repeated breakout attempts on Friday’s previously which have failed to hold into the next week. Therefore, IF this breakout is going to succeed, allowing us to potentially increase equity allocation risk, it must hold through next Friday.
The overbought condition on a weekly basis needs to be resolved somewhat to allow enough buying power to push stocks above 2135 with some voracity. A failure at that resistance level could lead to a bigger retracement back into previous trading range of 2040-2100.

You have to admit it is really quite amazing. Two weeks ago, Central Bankers and leading politicians were exclaiming that if Britain left the E.U. it would be a catastrophic economic event on the magnitude of a “Lehman” moment. However, despite all of the “hand-wringing,” if you had been asleep over the last month, as shown in the chart below, you wouldn’t know something had happened.

Of course, it was the “rapid response” team of the Federal Reserve, Bank of England and ECB that provided “bulls” the fuel to push asset prices back to recent levels as I discussed last weekend.
For now, Central Banks have seemingly accomplished the rescue of the entire global financial system by one again lofting asset prices higher. The problem, however, remains the underlying fundamental issues of weak earnings, slowing economic growth and a collapsing Chinese economy.
There is a point, unknown to anyone currently, where the failure of monetary policy will occur. The resulting impact will likely be one of the worst financial disasters in human and financial history. But that is a topic for later.
For now, here is your reading list for the weekend.

“Things are shaky and feeling dangerous.”  – Jeff Gundlach

BREXIT BIOPSY

Brexit: Breaking Bullish or Bearish? by Dr. Ed Yardeni via Dr.