January Newsletter

by Stephen Kalayjian, co-founder of Knowvera Research and creator of Pattern Recognition 101 software. With the way January was progressing it was looking like it could be the worst January in the history of the U.S. equity markets. On January 9th I received a sell signal in the U.S. equity markets on the weekly charts when the S&P 500 futures closed below the 1956 level. On January 20th the Dow Jones Industrial Average traded down to a low of 15450.56. At that low the Dow Jones Industrial Average was down over 11% for the year and was in an extreme oversold condition. On the same day the S&P 500 futures traded down to a low of 1804.25. At this low the S&P 500 futures were about 146 handles below the 10 bar moving average on the daily chart, a significant oversold condition. From this oversold condition the Dow Jones Industrial Average has rallied over 700 points. As I write this newsletter the Dow Jones Industrial Average is at 16167 and is currently down about 7% for the year.

On January 15th the retail sales and producer price index (PPI) numbers were released. Retail sales cover the durables and nondurables portion of consumer spending and typically accounts for two-thirds of GDP. Retails sales is a key element in economic growth. After increasing by 0.2% in November retail sales decreased by 0.1% in December. The producer price index measures the price change in selling by domestic producers of goods and services and is one of the numbers the Federal Reserve looks at when measuring inflation. The producer price index decreased by 0.2% in December after increasing by 0.3% in November.

The Baltic Dry Index measures the cost of shipping raw materials across the globe. Due to an oversupply of shipping vessels in a time where global trade growth has slowed; the cost of shipping raw materials across the globe is the lowest it has been since records of the Baltic Dry Index began in 1985. Global trade was rising by an average of 7% per year in the decade before 2008. In recent years global trade growth has decreased to around 3%.

The data is showing a significant economic slowdown. We are seeing this slowdown worldwide, especially in China. As I write this newsletter the Shanghai Composite Index, China’s main benchmark, is at 2749.79 after closing down 6.4% overnight. This was the lowest close in the Shanghai Composite Index since late 2014. It is possible that these declines will continue. A chartist, who has been successfully predicting the moves in the index, is predicting a drop down to 2400.

On November 27th I first stated that if I was a long term investor and I owned mutual funds, exchange traded funds, and/or individual stocks I would look to sell and be 100% in cash if the Dow Jones Industrial Average gets into the 17800-18400 range. In the week of December 5th the Dow Jones Industrial Average traded up to a high of 17901.58 and never looked back. From that point the Dow Jones Industrial Average traded down to a low of 15450.56 on January 20th, a decline of over 2400 points.

I have never believed in the buy and hold mentality followed by most mutual funds. I don’t agree that one should just look at the long term and sit around and wait. One should not have to sit like a deer in headlights when the markets drop. The view that the markets will always bounce back is a flawed one. There are a significant number of opportunities to enter and exit the markets each year. I believe one can manage their own money by utilizing exchange traded funds with which one can buy, sell, and/or short the markets with minimal commissions. There are exchange traded funds which mirror the U.S. equity markets such as SPY (S&P 500), DIA (Dow Jones Industrial Average), QQQ (NASDAQ-100), and IWM (Russell 2000). One should question why they are paying management fees when they can trade exchange traded funds themselves. Mutual funds make their money from management fees; the more money they manage the more they make. Some funds charge anywhere from 2-5% whereas if you trade an exchange traded fund using a discount broker fees can range from 2.99-8.99 per execution.

When the Federal Reserve raised interest rates in the December meeting by 0.25%, it reflected their confidence in the U.S. economy. GDP was the lowest it had ever been at the time of an interest rate hike. Normally when interest rates are raised it is early in the cycle of a recovery, not seven years later. Years ago when unemployment was at 8.3-8.4% the Federal Reserve said they would start to raise interest rates once unemployment got down to 6.5%. They did not raise interest rates when unemployment got down to 6.5%, an opportune point in the recovery cycle to begin raising rates. When the Federal Reserve raised interest rates for the first time in nine years, after leaving rates at 0% for seven years, unemployment was at 5%.

The Federal Reserve met this week and, as expected, they did not raise interest rates or make any other changes to policy. I do not expect the Federal Reserve to raise interest rates in the first or second quarter of 2016. I don’t believe there will be an interest rate hike until possibly September of 2016, and even then a rate hike may be questionable. The Federal Reserve has maintained that they are data dependent and that they are expecting their inflation target of 2% to be met sometime in 2016. In their December meeting the Federal Reserve stated that they are potentially looking for the federal funds rate to reach 3.25% by 2018. I do not understand where they are getting their economic projections which would warrant interest rate hikes to that extent. If GDP was at 4-4.5% then one could argue that the Federal Reserve is accurate. In addition the Federal Reserve suggested that there would be 4 interest rate hikes in 2016???

A Federal Reserve official even said “Once oil prices stabilize, headline inflation should return to the Federal Open Market Committee's inflation target of 2 percent, although it may take longer than previously thought.” He also said it is worrisome that U.S. inflation expectations are falling. "Low inflation expectations may keep actual inflation lower, all else equal, making it more difficult for the Fed to return inflation to target." Another Federal Reserve official said that if the economy weakened they would consider negative rates. Negative interest rates would mean that depositors would have to pay banks to hold their money. This has never been done in the history of the U.S.

On January 20th crude oil traded down to a low of 27.56. For the first time that I can remember I saw heating oil trading at 85 cents. On January 26th the American Petroleum Institute (API) report showed much high crude oil inventory levels than expected. The report was expecting inventories of 3.5 million barrels and the number came in at a massive 11.4 million barrels, the biggest weekly build since May 1996. Many people are pounding the pavement that crude oil will hit 20 dollars a barrel at some point in 2016. Looking at the oil stocks and their performance, there are certain oil stocks which are now trading below a dollar, and one oil stock that I used to follow has actually been delisted. I think we will see more and more pain in the oil industry. Unfortunately this will lead to significant layoffs. There are reports that OPEC may look to cut production which would provide a boost to crude oil prices. I still think the overall trend in crude oil is down, however if crude oil gets down to the 21.50-25.50 range I think you will see a short term bottom in crude oil. If crude oil trades down into that range I believe we will see a very significant oversold bounce to somewhere 5-10 dollars higher.

I stated that gold had significant support at the 1040 level. On December 3rd gold traded down to a low of 1045.40. I was bullish on gold against the 1040 number and I did not think that that number would be penetrated. After the Federal Reserve raised interest rates in December gold sold off sharply. Gold started showing life and I got a buy signal on the daily charts on gold on January 6th when gold closed at 1091.90. Once I got this buy signal I had two great trades in gold on the long side. Watching gold trade the way it did showed me that the gold bugs did not believe the Federal Reserve would raise interest rates again anytime soon. As I write this newsletter gold is trading at 1120.20, a rally of close to 75 dollars since the December 3rd low. I am now looking for a pullback in gold to the 1078-1090 range where I would look to buy gold using a 1065 stop.

In summation there is a ton of overhead resistance on the weekly charts for the U.S. equity markets. For the markets to go back into bullish territory the S&P 500 futures need to close above 2021.45 on the weekly chart. That is currently 133 points from here, bringing the Dow Jones Industrial Average back to the 17300-17400 range. I do not think the downside is over and unless the Federal Reserve has another trick up their sleeve I expect further declines.


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