By Poly

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Cycle Counts


Cycle Count Observation Probable Outlook Cycle Clarity Trend
Daily Day 29 Range 36-42 Days – 2nd DC Bearish Green Failed
Investor Week 12 Range 20-24 Weeks Bearish
Green Failed
4Yr Month 76 Range 50-56 Months- 8th Investor Cycle. Bearish Green Up

It’s sad that equity markets continue to be so focused on the FED, and the liquidity support it may or may not provide. In my view, this is symptomatic of the entire bull market advance, and is evidence that the bull market is not built on secular economic expansion, as is both normal and healthy. Any market that is artificially supported is living on borrowed time. The current fixation with the FED is born from fear that the liquidity support will be removed.

I do not believe that the FED is as clueless as many investors want to believe. Rather, the FED has created an environment from which it is very difficult to exit. In 2008, with the economy facing a serious bout of deleveraging, the FED chose to push the problem into the future by papering it over. In doing so, they put their policies on the path of no return; at this point, the FED is so committed to easy money that any exit would be crushingly painful.

And this is why it’s ludicrous to think that the FED could have raised rates during the current business cycle expansion. Rate hikes are normally a tool to cool off an economy that is overheating, and that’s clearly not the case today. Although the economy is expanding and there are some bright spots, the expansion is clearly tepid and mixed across sectors. When we consider that both the Federal Reserve and the Federal Government have undertaken the most aggressive accommodative support for markets in world economic history, it’s clear that what little growth we have is the result of monetary intervention and not organic economic activity.

With low, liquidity-driven growth and an aging business cycle (it’s been six years since the last recession), the chance of a rate hike is almost nil. We should consider that there is a far greater chance of more quantitative easing being needed to keep markets propped up.

Although I’m not generally a fan of the monthly payroll number as a barometer of the current market environment, the downtrend developing in the numbers is alarming. And the report itself was dismal; the Labor Department reported an adjusted increase of 142,000 jobs in September, and also revised both July and August lower. On a three month basis, the trend is now lower and this is the first time we’ve seen back to back months with below 200,000 jobs created.

The lower job growth could be related to a clear – and alarming – slowdown in U.S. manufacturing activity. Even though the Services sector and consumption have fared the best during the current expansion, having all of the regional manufacturing indexes at contraction levels this late in the business cycle is an economic red flag. And it’s another reason that the FED will be unable to raise interest rates. With the business cycle where it currently stands, contraction in manufacturing activity is consistent with an economy slipping slowly toward recession.


10-2 Regional PMI

Many pundits seem to forget that the economy moves in distinct 5 to 7 year business cycles. The process of moving from recession to expansion to recession to expansion (and so on) dates back many hundreds of years. No government entity has the power to stop the business cycle, but intervention can alter the path of cycle moves. And that’s what has happened since 2008.

For some time now, the FED has been talking up the economy. And the Fed is now so invested in a narrative of economic expansion and the possibility of rate hikes that another round of quantitative easing is, at this point, impossible. It would destroy their remaining credibility. Before the FED can engage in additional overt QE, it will need very clear evidence of an economic downturn. And by the time they get it, a standard business cycle recession will be unavoidable. The FED is very reactive when it comes to policy shifts, and this should be highlighted in 2016 through another recession.

In terms of current equity market action, Friday saw a massive 50+ point reversal higher. The surge was directly related to the poor jobs number, and reflects widespread sentiment that the FED will soon be forced to provide additional monetary stimulus via QE 4. The below chart details both the strength of the move, and the fact that it is consistent with our expectations for a counter-trend bounce out of Tuesday’s low.

Although the move was expected in a framework that points to more downside, I want to caution the bears. The strength and ferocity of the buying near Friday’s close have introduced some doubt into my primary bearish outlook. I still believe that the strength of the bounce was simply due to aggressive short covering, and that it was a typical extreme, counter-trend bounce often seen after a hard selloff. But any strong move that ends at the high of the day on good volume should be a real concern for the bearish case.

I’ve highlighted the bullish scenario to make everyone aware of the possibility that the S&P could have put in a double bottom. This is not my expectation – the cycle count really doesn’t support it – but it is a valid alternative scenario. For the bullish case to hold, the S&P will have just seen an extremely short and unlikely day 25 Cycle Low. And because the August 24th low has not been breached to the downside, the ICL timing would be odd as well.

Netting it out, I still favor a decline into a late October DCL as my primary expectation, since the preponderance of the evidence supports that scenario. But it’s not as clear cut as it was before Friday’s pop.   I want to again stress that massive, daily moves, like that on Friday, should be ignored. Otherwise, you’ll likely wind up being whipsawed in and out of positions.


10-3 Equities Daily

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