Sell-off has likely not run its course so cash is still king

NEW YORK, NY - OCTOBER 26: Traders and financial professionals work ahead of the closing bell on the floor on the New York Stock Exchange (NYSE), October 26, 2018 in New York City.
Drew Angerer | Getty Images News | Getty Images
NEW YORK, NY - OCTOBER 26: Traders and financial professionals work ahead of the closing bell on the floor on the New York Stock Exchange (NYSE), October 26, 2018 in New York City.

In January, the stock market went on a tear, prompting many analysts to upgrade earnings estimates and raise price targets on the stock market's major averages, despite some looming warning signs on the horizon.

Some observers, like Charles Schwab's Liz Ann Sonders, or myself for that matter, suggested that investors rebalance their portfolios and wait until later in 2018, or beyond, to find a better buying opportunity for stocks, particularly those that had experienced rather substantial gains.

By September, the advice among the most cautious among us appeared off-the-mark, as the economy gathered steam, corporate profits remained strong and consumer spending accelerated.

The things many worried about most, from interest rate risk, to political risk, to foreign policy risk, were virtually ignored by the financial markets.

A little more than a month ago, the Nasdaq Composite index hit a new all-time high, soon followed by the Dow Jones Industrial Average and the S&P 500 index.

It was hard, at the juncture, not to capitulate to a market that had rebounded so sharply and recommend everyone get back into the pool.

However, in flash, the major averages are now down 10 percent, or more, from their recent highs in one of the worst Octobers since the financial crisis in 2008.

And the bricks in the "wall of worry" are still there and solidifying.

Interest rate risk remains as the Federal Reserve has insisted it plans on continuing its rate hikes as GDP accelerates, but rate-sensitive sectors of the economy, like housing and autos, slow down.

President Trump has raised the specter of imposing even more tariffs on China, on everything China sells to the U.S. That certainly got the market's attention on Monday.

Europe is looking to impose taxes on the revenues, not profits, of large technology companies, a new idea that comes at a time when corporate profit growth, and profit margins, may be peaking. The global economy, most notably in China, is slowing appreciably. Trade war risks are making it worse. Political divisions at home and growing nationalism abroad, witness the latest election results in Brazil, and it's hard to predict where the world is headed.

The underlying technical deterioration of the stock market has been evident all month. The Advance/Decline Line has rolled over while the number of new 52-week lows has exploded as the market sold off in October. The Dow Transportation Average is down more than 6 percent, year-to-date, a technical divergence that suggests demand for manufactured goods may be slowing in the U.S.

The transports deliver things. The industrials make things. When the deliverers turn down, not only is that an indicator that the economy could be slowing, but also could trigger one of the oldest technical sell signals in stock market history.

Now, it could be that we were simply overdue for a short, sharp and scary correction often occurring in the month of October.

Growth may have peaked

It hardly seems, however, that this market looks healthy enough to mount a meaningful rally in the days and weeks ahead.

In January, the major averages jumped sharply, reflecting the hope that the recently passed tax cuts would boost economic growth, corporate profits and consumer spending.

That did happen. But Wall Street may now see that as old news.

Growth may have peaked. Capital spending has curiously rolled over of late, despite generous tax incentives to invest in new plan and equipment. Consumers appear to be doing fine. The economy, corporate profits and consumer spending may have been on a "sugar high" in the first half of the year an could slow noticeably in the year ahead.

There are armed forces heading to our southern border in the days leading up to the mid-term elections, now only a week away. Democrats could retake control of the House of Representatives, throwing a monkey wrench in the President's plans to further cut taxes and further deregulate business.

There are too many variables in the weeks and months ahead to make a confident prediction about where the economy and market go from here. However, had investors listened to those savvy strategists, having recommended raising cash levels all year, they would be breathing easier today as cash has been among the best performing assets this year.

Pattern recognition is a key component in dealing with market cycles. Many of us have seen this pattern before and would likely bet that the most negative component of this particular pattern has not yet run its full course.

Cash is king until further notice.

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