Much of what is thought and believed about the stock market is based upon fallacy and a lack of understanding, which was easily seen in the comments section of one of my recent articles. It seems that many investors felt quite strongly that a long-term bear market is simply an impossibility. And, they attempted to outline their reasoning in the comments section of my latest articles. So, I am going to discuss the issues they brought up in a series of articles over the coming weeks.
I will be breaking the discussion down into six general topics raised in the comments section. Due to the areas of discussion I am going to cover, I am going to split this discussion up into three articles, as it would be too long for just one article. These are the topics which will be covered.
1 – “You need to take a more balanced approach incorporating fundamental analysis such as corporate earnings and economic data”.
2- “Big banks are swimming in cash”.
3- “The Fed will provide liquidity to keep us out of trouble”.
4- “We do not have the same conditions as 1929”.
5 – Outright disbelief in the potential for a long-term bear market.
6- How does one approach investing during a long-term bear market?
Since we are dealing with financial markets, which are non-linear and uncertain environments, I want to make it clear up front that a depression is obviously not a foregone conclusion. Therefore, I will end this series of articles outlining what I will need to see over the coming two years to tell me whether we are indeed heading into a 13-21 year bear market. And, if the market takes the path I lay out over the coming two years, then it will make a long-term bear market a high probability. Until such time, I am going to be taking my cues from the market action week by week and month by month, and will not likely take on an extreme bearish posture until I see strong confirmation in the next year or two. But, I will likely be raising a lot of cash in the coming months.
So let’s get started.
1 – “You need to take a more balanced approach incorporating fundamental analysis such as corporate earnings and economic data”
Those that have followed my analysis over the last 13 years know that I have caught most (but clearly not all, as we are not perfect) of the major turns in all the assets I cover. While I really only cover the SPX and sometimes the metals publicly over the last several years, our clients that have been with me for over a decade know how well we have done. In fact, this was recently said by a client who has been with me for a bit over a decade:
“The number of different markets, i.e., TLT, Metals, Oil, IWM, SPX etc., that you have absolutely nailed over the years is legend.”
Yet, those new to my analysis view it as some form of voodoo, and often complain that it lacks substance since I do not use fundamental analysis in my prognostications of the overall market direction. In fact, many of our members come to us with a very skeptical view of what we do, until they actually learn the details in greater depth:
“For too many years I thought it was voodoo…. Not anymore . . . I know I fought this.. but damn it works . . . My accounts are killing it.. returns I did not think possible.”
As I have explained in many prior articles, I was born and raised in the early part of my investing career on fundamental analysis, using earnings, economic data and many other factors to assess the stock market. However, as I progressed in my investing career, I learned that much of that was actually noise. And, when I tuned out that noise and began to place a greater focus on market psychology and investor mass sentiment, it made me a much better investor, who was ultimately less surprised by many of the moves the market takes (despite it surprising most other market participants). And, I have imparted the same to my subscribers and clients, who convey the same perspective:
“I used to read news articles that backed up the trade I was in. Until I found Avi and his team and he said ignore the news and only pay attention to the price. That’s when I actually started making money – 11 years ago.”
With regard to earnings, I will simply state my view that earnings lag stock price. If you look closely at historical trends, you will see earnings are usually at their worst at the bottom of market negative trends, and they are usually at their best at the top of those trends, with the markets and stock prices turning well before we see them in the earnings of companies. Therefore, earnings often lag market turns.
In fact, this is what one of my clients noted about earnings:
“Having worked for many listed companies and regarded as an insider with access to company confidential information, I have sometimes struggled to understand the correlation between business results and the share price.”
I wrote an article discussing this exact issue and explaining the reasons as to why this is so. And, if you are interested in reading more of my in-depth view on this matter, you can feel free to read it here.
Now, as far as using market fundamentals, well, while I will view fundamentals as being important in smaller companies, I see them as being much less so in larger companies. In fact, I see them as wholly useless when it comes to the market as a whole. And, yes, I have written about this in the past as well, and you can read further details on this here.
Along the same lines of this discussion, one person proposed in one of my recent articles that “at the center of sentiment trends lies the perception of what fundamentals are!” I am sorry, but this represents purely circular reasoning which says absolutely nothing other than their misguided and unsubstantiated feeling/belief that fundamentals are controlling.
But, if you read the articles I have cited with an open mind, you will reasonably understand why this is a complete fallacy. In the overall stock market, fundamentals lag price, not lead it. Moreover, consider how negative fundamentals are even ignored during an uptrend, whereas positive fundamentals are ignored during a downtrend. There is a significant amount of evidence to prove that fundamentals are not controlling market direction, but are more coincidental to the market direction.
If you need further discussion of this perspective, feel free to read this article as well.
As we become more mature in our understanding of how markets work, we will gain greater understanding through psychological studies of markets and market participants, which will explain why fundamentals are not as important to the general market movements as many currently believe.
In a paper entitled “Large Financial Crashes,” published in 1997 in Physica A., a publication of the European Physical Society, the authors, within their conclusions, present a nice summation of what drives the overall herding phenomena within financial markets:
“Stock markets are fascinating structures with analogies to what is arguably the most complex dynamical system found in natural sciences, i.e., the human mind. Instead of the usual interpretation of the Efficient Market Hypothesis in which traders extract and incorporate consciously (by their action) all information contained in market prices, we propose that the market as a whole can exhibit an “emergent” behavior not shared by any of its constituents. In other words, we have in mind the process of the emergence of intelligent behavior at a macroscopic scale that individuals at the microscopic scales have no idea of. This process has been discussed in biology for instance in the animal populations such as ant colonies or in connection with the emergence of consciousness.”
Even more mind-blowing is a study that suggests the market would move as we normally see it move, even without any news or fundamentals at all. In 1997, the Europhysics Letters published a study conducted by Caldarelli, Marsili, and Zhang, in which subjects simulated trading currencies. However, there were no exogenous factors that were involved in potentially affecting the trading pattern. Their specific goal was to observe financial market psychology “in the absence of external factors.”
One of the noted findings was that the trading behavior of the participants was “very similar to that observed in the real economy.” This is just one of many studies which support the proposition that fundamentals are not nearly as important for market direction as many currently believe, as markets would work in the same manner with them or without them.
Interestingly, I challenge all my clients to turn off the television and stop reading much of what is written about the market, and just focus on price patterns. These are the typical comments I get from those who take me up on that challenge:
“I’ve only been here about a year and a half and although I have degrees in accounting and finance, I’ve always found them useless in actually making good trades. Once I found Avi it really improved my results.”
“Personally, I am a fundamentals meet technicals kind of guy…..but when it comes to markets that Avi & team analyze…I have not seen anyone come close in my 25 years of observation. Avi for me is a financial Myth buster.”
And, yes, I have received thousands more similar comments through the years.
So, while many of you may view what I am about to say as arrogant, I think it needs to be said anyway. If I am able to identify most of the twists and turns in the market quite accurately by focusing on price through our analysis method, and most tell us that we are more accurate than most analysts out there, why would I consider tarnishing that by adding what I have learned from experience and market studies is extraneous noise? While you may believe that my analysis is lacking, our long-term track record suggests otherwise.
And, what reinforces that perspective is when we get similar feedback from our almost 1000 money manager clients:
“The entire team is masterful and their technical analysis far supersedes any fundamental analysis I’ve ever seen.”
“We’ve never spoken, but I have been a member for about 19 months and I just want to say thank you for the work you and your team do. This service has changed my entire perspective on the markets in a positive way. For some context, I am the Chief Investment Officer of a boutique Wealth Management firm with approximately 1.5B in AUM, so your knowledge and expertise touches every one of our clients, and for that I am extremely thankful. Thank you again! Kind regards, John”
In conclusion, while many of you may still view my analysis as lacking due to the exclusion of what you deem important, market history, market studies, market experience, and our track record all combine to strongly suggest otherwise. And, if you still consider it lacking, then I clearly understand if you will cease to follow my work. But, before you do, may I remind you of the wise words of Isaac Asimov:
“Your assumptions are your windows on the world. Scrub them off every once in a while, or the light won’t come in.”
Let’s move on to our next area of discussion.
2- “Big banks are swimming in cash”
One of the segments of the market which concerns me greatly if we are heading into a major bear market is our banking system. And, after the financial crisis of 2008, those in charge of the banking system have placed a really nice band-aid on the system and have come out to tell us just how strong the system is now to make us feel better and be able to sleep at night.
For example, back in the summer of 2017, Fed Chair Janet Yellen said that the banking system is “very much stronger” due to Fed supervision and higher capital levels. She then followed that up with what I believe will be a history-making statement. Yellen predicted that because of the measures the Fed has taken, another financial crisis is unlikely “in our lifetime.”
Yet, as we have all experienced during the market decline into October of 2022, there were a number of banking issues which came to light. And, those issues negatively impacted some very large banks. Yet, it still only represented a small fraction of the entire banking system, which is why the issue was within the ability of those in charge to handle and contain. However, if you look at the balance sheets of many of the largest banks, you will see we have a ticking time bomb. We only saw the tip of the iceberg with the recent banking failures.
Unfortunately, even though a number of banking issues have come to light of late, these are some of the comments regarding banks that were posted to a recent article I wrote, which evidence the outright ignorance of most to these issues:
“no banking crisis in sight / nothing like GFC”
“Banks are well regulated today, so well that some politicians are calling for a more relaxed regulation. There is no way a catastrophe like 1929 is going to happen . . .”
While the 2008 financial crisis was focused upon one issue (for which the great majority at the time also said “no banking crisis in sight”), the banking system currently has multiple large issues residing on its balance sheets. The banking system is not “much stronger,” despite Yellen’s claims. In fact, there are greater hazards sitting on those balance sheets now than there were in 2007. We have taken the liberty of highlighting many of those we have found on the balance sheets of the largest banks in the United States over the last year and a half. And, you can read our public articles on the matter, as they are compiled here.
Now, I know many of you believe the FDIC is backstopping all your bank accounts. But, consider that there is a limitation to the FDIC’s ability to backstop. In fact, one can even consider the FDIC as a warm blanket which allows everyone to feel secure about their bank accounts when they are sleeping at night.
However, another commenter made an astute point in one of my recent articles:
“The FDIC has about 1% of total US bank deposits available. The FDIC is capable of handling a bank default or two here and there, but a widespread default will gut the FDIC quickly.”
Consider that in the third quarter of 2010 (after we were already coming out of the 2008 financial crisis), the FDIC’s contingent loss reserve was drained by $6.2 billion, which brought the Deposit Insurance Fund deficit in 2010 to over $21 billion. Furthermore, by that time, the FDIC had already burned through its entire 2010 assessments.
Now, from time to time, someone from the banking industry tries to tell me that I am wrong in my perspective and that they know better because they work in the industry. But, consider how many of those working in the financial industry were still surprised by the 2008 financial crisis?
In February of 2009, Paul Volker, former Fed Chairman, said regarding the financial markets: “It’s broken down in the face of almost all expectation and prediction. Even the experts don’t quite know what’s going on.”
In May 2009, the Wharton Business School noted regarding the financial community that “[i]t’s not just that they missed it, they positively denied that it would happen.”
So, are these the people we are to rely upon in providing us with assurance that the banking industry is healthy? Should we rely upon Ms. Yellen’s assurances? Should we rely upon those that proclaim they know better simply because they ‘work in the industry?’ History suggests otherwise.
In 2009, the overall market stabilized, which took the pressure off the banking industry before more bank holdings were destroyed. But, consider what would happen if we went into a protracted bear market which would place a greater strain upon our financial system, rather than the year and a half crisis we faced around 2008. (And, if you believe that it was the Fed that saved us from further pain, you will want to read my upcoming articles – so please withhold any comments about how the Fed saved us before you read that next article).
Even if you have thought me to be eccentric or a complete crackpot (which I, my 8,000 subscribers, and almost 1,000 money manager clients can assure you I am not), please consider the items I am discussing in these missives with an open mind. Those that have done so have seen their ability to navigate our financial markets much improve. But, you must keep an open mind to consider these matters seriously. Ultimately, my goal is to help those willing to open their minds protect themselves from what I believe can be a very difficult financial environment over the coming decade or two.
Next week, we will discuss the 3rd and 4th issues highlighted at the start of this article.
Housekeeping Matters
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