Columnists John Grace Opinion Uncategorized

ON THE MONEY: A crash of as much as 27% could be in the cards

Global bond markets are behaving as if major trouble lies ahead of the U.S. global economies. 

Global stock markets are behaving as if the economic skies will remain forever blue. The U.S. equity markets are repeatedly hitting new record levels and are trading at elevated valuations.

“Which financial market proves to have been the better economic forecaster will have a great gearing on the future course of the U.S. and world economies,” observes Seeking Alpha, a website content service for financial markets.

Are stocks about to break down sharply from here or go up dramatically? There is likely no middle path. Similar to the mini-megaphone pattern of higher highs and lower lows on the S&P 500 and Nasdaq, Dent Research has updated the data on the Dow.

The Dow finally tested a potential final E wave top in this evolving pattern. It moved just above the top trend-line to 23,999, with hopes that the Fed would cut rates by 0.5% instead of 0.25%, despite strong jobs number in early July.

But the markets aren’t so sure after that surge and they’ve fallen back just below that top trend line. The event that will cause a clearer break one way or the other is coming early next week, when the Fed decides to cut rates (and by how much) or not.

After so much pressure from President Donald Trump and a key leading indicator weaker than expected recently, it’s unlikely the Fed will sit on its hands. It’s more about whether they cut aggressively at 0.5% to head off a possible slowing, or play it more cautiously at 0.25%, submits Dent Research.

Dent Research asserts there will be a market dip before the announcement. Then, if we get just 0.25%, the markets may continue to sell off more and scenario No. 2 becomes more likely.

That could see as much as a 27% crash, taking the Dow down to 20,000-21,000 in the next few months. If the decision is a rate cut of 0.5%, then the markets should rally and we’ll likely get scenario No. 1. But they will still have to rally clearly above this top trend-line to confirm that we are heading into the next dramatic wave up, which should take us over 30,000 on the Dow and 9,000 on the Nasdaq… on the way to as high as 33,000 and 10,000, respectively.

According to me, too many investors have learned nothing from the past. Which means they could be destined to repeat it. We have addressed my 1-2 punch to help investors stay in the game.

First we recommend active management strategies that can move assets out of risky positions, be they at the time, stocks or bonds into cash or alternatives in a bad year. When volatility turns positive the same strategies move out of safety back into risk assets.

Savvy investors like to see how losses may have been limited to 20% or less in 2008, followed by gains of 25% or more in 2009. Instead of taking four or more years to get back to even, we can see the evidence that agile investors were back to their early 2008 values in two years or less.

The second piece to the puzzle is greater diversification.  It was this combination in the fourth quarter 2018 that the market was off 20% from Sept. 21 to Dec. 24, but investors with active management along with greater diversification were off about 6% at the time.

We can agree that getting back to even from a hole that is shallow is an easier job then when the minus advances to 20% or more. Please see the accompanying chart. 

You may count eight asset classes. And note, there are no big bets anywhere. Quite a difference to many investor’s composition of two asset classes with two big bets; 60% stocks and 40% bonds.

This isn’t a template. It is an example used to stimulate how you might increase the diversification in your portfolio.

I think we all like to learn from those smarter than we are. I believe success leaves clues. Clues for me and you, if you like, to follow and implement where appropriate.

John L. Grace is president of Investor’s Advantage Corp, a Los Angeles-area financial planning firm that has been helping investors manage wealth and prepare for a more prosperous future since 1979. His On the Money column runs monthly in The Wave.