Path Toward Prosperity

Is this the beginning?

Global Valuations and Future Proabilities

Risk Management

Is gold ready to breakout or breakdown?


Are We In the Early Stages of the Next Bear Market?

This is THE question on many people's mind.  You wouldn't be normal if you didn't wonder the same thing. Over the past six months, the global stock market has become much more volatile.  According to FactSet, 2018 was the worst global investment performance since 2008.  The only positive major asset classes were cash and short-term U.S. Treasuries. It has begun to test investors' patience, strategy, and intestinal fortitude.

Here are the results of Google Searches for the term recession over the past five years.  You can clearly see the spike in searches over the past six months culminating with late December.  As more volatility creeps into the global stock market, investors begin to contemplate if the recent run has come to an end...and if so, what if anything to do about it.

I will start off by saying, I have no idea if this is the start of a bear market or just a blip in a seemingly neverending bull market.  The key is to make sure you have an investment strategy that you understand, are disciplined with and will stick with no matter what comes our way.

That being said, I think it is important to look at history as a guide.

Thanks to Steve Blumenthal, Tom Bowley, and for these charts. Below is a chart from 1999-2000 as the Technology Bubble was beginning to burst.  You can see from the chart below, the S&P 500 began to churn sideways in late 1999 into September 2000 before falling in the initial decline of that bear market.  The initial decline ended when the volatility index, (VIX) spiked in early 2001 to a level of 34.  That marked a short-term bottom and a 21.7% rally ensued over the following 2 months.  That was the final opportunity to reduce risk if one wished before the bear market took hold.


This next chart is the beginning of the 2007-2009 Bear Market.  As you can see the market churned sideways in the summer of 2007 before the initial fall into the Spring 2008 low.  That too coincided with a spike in the volatility index (vix) that twice registered readings above 34.  Those intermediate bottoms preceded two separate 10+ plus rallies that again gave investors an opportunity to reduce risk ahead of the major decline to come.  Each of these bounces ended when the volatility index (VIX) fell back into the teens.



Here is a current chart of the market.  The market swoon that started in October culminated with a volatility (vix) reading on December 24th of 36.  That coincided with the short-term low.  We have since seen a bounce of just over 17% that resulted with the volatility index(vix) dropping below 20 over the ensuing month.  Could this be the calm before the storm?


Global Valuations and Probabilities

As you may know, I have a background in economics and a love of statistics.  As a self-professed math geek, I enjoy looking deeper into numbers.  Further, I put a lot of weight in probabilities.  While we have no idea what will happen in the future, I do believe we can put the odds in our favor if we know the probabilities.  Anyone can and sometimes does get lucky but the probabilities are what can make for long-term success.

As an example, maybe you have been to a casino before.  Have you watched or played Blackjack?  That is a game where the experienced players are disciplined and play the odds.  Once in a while, someone will sit down at the table, maybe a little tipsy and place a wager.  They may be dealt a 19 while the dealer is showing a six.  Despite solid odds in their favor to stay, they decide to hit.  You say, "Are you sure?".  They respond, "Of course I am".  They hit and receive a 2 for a blackjack!  You can't believe it.  The lucky player turns to you and says, "See, I told you".

Despite 85% odds that he would bust, the player won the hand and became even more confident despite the fact, that playing the probabilities, that was a horrible decision.

The same scenario can occur in the financial markets. Even when the odds are stacked against you, you can end up winning.  Conversely, even with the odds in your favor, you can also lose.  There are no guarantees.

However, if you consistently invest with a disciplined strategy that tilts the odds in your favor, you have a much better chance of a successful outcome. 

After a sustained bull market that shunned the overvaluations that have existed in the past few years, it is popular to say that valuation is not a good indicator of adding to or reducing exposure to markets.

While it may be a very useful tool in understanding the prospects for future returns over the next 7-10 years, valuations have little impact on short-term returns.

While I firmly believe that valuations and business fundamentals are the drivers of long-term market performance, in the short-term, I believe that emotion and sentiment drive the primary market trend.

In my opinion, technical or trend analysis can be extremely helpful in understanding the short-term dynamics in the markets.  However, because trend analysis only takes into consideration price movement it can over or underestimate potential moves.

By combining valuation analysis with trend analysis one can potentially create a more robust long-term strategy.  For instance, investing in cheap stocks that are in a strong downtrend may be foolish based on the principles of technical analysis which suggest those trends will continue.  Conversely, investing in stocks trading at their most expensive valuations but in an uptrend may not be suitable for the long-term investor.

The ideal scenario, in my opinion, is to invest in a cheap market that is in an uptrend.  Conversely, investing in a historically expensive stock market that is also in a downtrend can potentially be the worst of all possible environments.

Currently, by almost any valuation measure we are in one of the most expensive U.S. stock markets if not the most expensive market in U.S. history.  Additionally, we just entered a new downtrend as shown above, (as defined by price relative to its 200-day moving average).

Here is a chart of the current valuation ratio as measured by Nobel Laureate Robert Shiller's CAPE ratio which isn't encouraging on a valuation basis.




In my opinion, based upon the preceding it makes sense to maintain a long-term focus but proceed with some caution here.

While I never think it is smart to move completely into or out of the stock market, I do think that turning the risk dial up or down based on market trend and valuations can make sense.

For those investors who are closer or in retirement, you may want to consider using the current market bounce to reduce risk.

For those investors who are younger but maybe are a little out over their skis according to their risk profile, it may make sense to use the current market bounce to reduce risk.

For those investors who are more aggressive, it may make sense to accumulate some dry powder to pounce on potential investment opportunities.

If you have a sound, long-term strategy and a level of risk that is appropriate for your personal situation, then the good news is the suitable course of action may be to do nothing.

If you would like to discuss your portfolio in more detail, please don't hesitate to reach out and schedule time for a comprehensive discussion.

Inflation Hedges

One of the widely followed inflation hedges is the price of gold.  Over the long-term, gold can be a diversifier for an investment portfolio.  It has little correlation to the stock market.  Meaning, gold tends to move independently from the direction of stocks.  They can move up together, down together or both move inversely.

I recently saw this chart from Cornerstone Macro technician Carter Worth on the long-term movement in Gold.  The precious metal is up roughly 10% from its August low and has now moved into a positive trend above the 200 day moving average. (While the stock market has been heading in the opposite direction).  The "wedge" or "triangle" that has formed in the price of gold the past few years has been a push and pull between bulls and bears.  Most times, this wedge is resolved with a significant move one way or the other.  It will be interesting to see how this shakes out

Triangles are popular chart patterns used in technical analysis since they occur frequently compared to other patterns. Symmetrical triangles occur when two trend lines converge toward each other and may signal only that a breakout is likely to occur but not the direction. The wedge pattern is a reversal or, less commonly, a continuation pattern that's similar to the symmetrical triangle but slants upward or downward. Rising wedges are bearish chart patterns that occur when trend is moving higher and the prices are converging and the prevailing trend is losing momentum. Falling wedges are bullish chart patterns that occur when the trend is moving lower.

Additionally, a "wedge" or "triangle" has formed on the shorter-term chart as well.  It looks as though gold may be set up for a significant move after a substantial amount of time moving sideways.  Only time will tell which direction that move is....



















No strategy ensures success or protects against a loss.



Colin B. Exelby
Celestial Wealth Management

Important Disclosures
  • Past performance is not necessarily a guide to future performance.
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