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With a Bang or a Whimper?

Investors can be forgiven if they’ve got a swimming feeling in their heads as they read financial market news.  Journalists no longer use the words “rise” or “fall” to describe market direction but rather “plunge,” “plummet,” “nosedive,” or “soar,” skyrocket,” and “rip higher.”  To say the markets are merely up or down is too tame a description to keep our attention these days, so writers have become well-versed in hyperbole to keep us unwittingly fixated on short-term market moves.  The prevailing narrative is shifting so rapidly that even seasoned professionals are losing their perspective on market behavior.

Of course, part of the confusion is Wall Street’s analytical bias toward prediction, at which it is notoriously inaccurate.  But the obsession with what the markets “should do” frequently overwhelms the perspective on what it “is doing.”  The predictive crowd is populated with highly educated and experienced voices, lending credence to the idea of following expert opinion as a guide for the Main Street investor.  Unfortunately, these are the same experts that advised buying cryptocurrencies at their red-hot peak, shunning oil, gas, and other commodities right before Ukraine was invaded, and claiming throughout 2021 that inflation was “transitory” and under control.

There has been no shortage of hyperbole these last few months as market pundits claim the bear should end with a “bang” of buying mania, while others note it should end with a “whimper” when downtrodden investors lose interest and apathy reigns in the markets.  But rather than focus on how the bear “should” end, objective investors can look to time-tested tools to observe whether or not the decline “is” ending or continuing.

For a view of what the market “is doing” we turn to our old friends the NYSE Bullish % and the NYSE advance/decline (a/d) line.  The message from these should give hope to the bulls.

The NYSE Bullish %, compiled by Investors Intelligence ( has given a buy signal as of early August.  The Bullish % measures the percentage of stocks on the NYSE that are on buy signals as measured by their point-and-figure (p&f) charts.  By their nature p&f charts provide unambiguous buy and sell signals for stocks, mutual funds, and ETFs, including funds and ETFs of bonds.  Thus, their signals are easy to identify as buys or sells, and tally into a percentage format.

A falling proportion of buy signals implies a weak, or bearish, market and is reflected in a NYSE Bullish % that trends down.  This is exactly what has been happening since late 2021, pushing this indicator down to oversold lows of 26% (74% of stocks on sells).  The recent summer rally has been fairly broad, lifting many stocks up to buy signals and thus raising the NYSE Bullish % by enough to generate a buy signal at 46%.

A second positive for the bulls is a buy signal given by the NYSE a/d line in late July.  It is also a measure of breadth, as it is a cumulative tally of the net number of stocks rising in price daily.  The NYSE a/d line has been a good barometer of market direction with timely buy signals at lows and similarly timely sell signals at important highs.  The a/d line is an egalitarian indicator, meaning each stock is given equal weight in the calculation.  The indexes (e.g. S&P 500) themselves are highly influenced by the biggest stocks and so often do not reflect the direction of the majority of its components.  The a/d line is much more democratic, and its buy signal indicates that the summer rally is including many more stocks than earlier failing attempts of this year.

To complete the bull’s wish list we are looking for a buy signal in the weekly a/d line (not shown).  While that signal is close, it has not happened yet.

It takes a lot to turn these measures around, and once reversed, they tend to persist in the prevailing direction of their p&f signals, which is now “up.”  With these key indicators in positive modes, combined with generally depressed investor sentiment, investors should look for reasons to be bullish.

This is not to say investors should throw caution to the wind.  Companies reporting earnings disappointments are seeing their stocks mercilessly sold off as investors still embrace a shoot first, ask questions later attitude.  The potential for missteps is high, and security selection remains key to avoiding “accidents.”

Moreover, this low is lacking several key characteristics of major secular bottoms.  First, while stocks have gotten cheaper in this bear market, they have not gotten “cheap.”  Classic bear market lows have been characterized by very low price/earnings and price/sales ratios, and high dividend yields.  We are not there yet, and investors would be wise to remember that earnings continue to be under pressure from supply chain constraints and persistent inflation in labor costs and raw materials.

Second, recessionary fears continue to haunt the markets.  This can be seen as a positive as stocks often bottom in the midst of recessions, so maybe we are witnessing a replay of the traditional playbook.

The U.S. just recorded its second consecutive quarter of negative GDP (i.e. the economy shrank in size) which has been the generally accepted definition of recession.  We would be more sanguine about the market lows but for some unique elements of today’s recessionary environment.

There is no escaping the fact that Europe is going to be hit hard by their current energy crisis.  The continent gets much of its oil and gas from Russia, commodities that are now pawns in the conflict between Russia and the west.  Vladimir Putin has slowed the flow of energy to Europe to a trickle, and industrial firms are in a panic.  Being cut off from these vital raw materials may tip Europe into a depression rivalling the early 1970s when OPEC first flexed its muscles.  With no resolution to the Ukrainian war in sight, and energy being Putin’s primary leverage with the west, it is hard to see our European trading partners bouncing back quickly.

Our other key trading partner, China, is facing twin dilemmas of its own making.  By adopting a “zero covid” policy, China has imposed draconian lockdowns on large swaths of its population.  This has been repeated in many cities during 2022 as covid keeps reappearing, resulting in a stop-start pattern to consumer demand and industrial production.

Second, real estate, China’s domestic growth engine, is in a depression, with sales of properties continuing to fall by 30-40% using year-to-year comparisons.  Large developers such as Evergrande have declared bankruptcy as their cash flow has dried up, and the still solvent ones are seeing their bonds trade at 25 cents on the dollar, a sign of deep skepticism about their future.  Now households have taken matters into their own hands, refusing to pay on mortgages on yet to be finished apartments.  Add to this the rising political tensions between China and the U.S. over Taiwan, which are exacerbating trade barriers rather than reducing them, and you have a recipe for subdued growth for the foreseeable future.

Finally, one cannot blindly accept the idea of a bear market bottom without considering the Federal Reserve’s monetary policy.  Hemmed in by persistent inflationary pressures they once believed were transitory, the Fed has found itself far behind the interest rate curve.  In an attempt to play catch-up with inflation, monetary policy is tightening (i.e. interest rates rising) at a time when the economy looks to be entering a recession.  This is exactly the opposite of a typical business cycle, where the Fed would be easing monetary policy to cushion a business slowdown.  This monetary constriction is reflected in the Fed’s own data showing that banks are tightening lending standards for industrial, commercial and consumer loans just when demand could use a little stimulus.

Have investors gotten ahead of themselves and rallied stocks prematurely?  Is it possible we are witnessing just a large rally in the context of a longer bear market?  There have certainly been instances when both the NYSE Bullish % and a/d line have turned bullish, only to be reversed as the bear marched on.

The most recent example was in 2007-08.  After brokerage Bear Stearns went bust in March 2008, the Fed reassured investors that the worst of the mortgage worries were over.  Stocks rallied in the spring of 2008 generating buy signals in both the Bullish % and a/d line.  By late summer, however, the reality of the depth of the mortgage debacle became clear, and stocks started down again to their final lows of March 2009.

Recent buy signals in the NYSE Bullish % and advance/decline line are welcome news to this year’s demoralized bulls, and clearly indicate what “is” happening in the markets.  European and Chinese economic concerns, along with the Fed’s hapless monetary policy, are worries that can’t be lightly dismissed, and could derail the bullish message from these key indicators.  We will keep readers apprised of changes to the Bullish %s and daily and weekly a/d lines.

The best approach investors can take to these bullish developments is exemplified by Ronald Reagan’s description of the 1987 nuclear arms agreements with Russia: “Trust…but verify.”