CAMS Weekly View from the Corner - Week ending 8/9/24
August 12, 2024
In a recent edition we addressed the historical issue of Fed rate cutting cycles and stock market behavior. A knee-jerk expectation from most is when the Fed begins to cut rates the stock market is given an all clear signal. The contrary is the more typical experience.
Rate cutting cycles lead to questionable stock market behavior that many times, in particular in this 21st century, leads to a challenged stock market environment.
Generally speaking when the Fed is cutting rates they are striving to push back recessionary developments.
Recessions and stock markets get along about as well as oil and water. The economic landscape recessing in its growth trajectory brings with it a challenging business environment which can easily impact a large swath of stock market listed companies via reduced sales and profits.
Reduced sales and profits, particularly if they develop into a trend of such inspires collective market participants to hit sell buttons on stock market listed company shares resulting in reduced share prices on a trend basis.
The challenging part, as is always present for stock market prices is they rarely move in a straight line – be it up or down.
When moving down in trend they do so intermittently, an ebb and flow process, to include large headline grabbing up moves that easily inspire a collective belief that all is good again and prices are ready to trend onward and upward.
Just as these large moves appear to offer the downside is over a new resurgent downside in prices emerge thereby moving lower than the general price levels experienced in the previous down cycle. That previous low can be from days, weeks or even months ago.
The longer the time frame since the previous low existed the more confident the consensus is that stock market lows had been put in and the resurgence is real and trustworthy, i.e. it is a trend you can believe in and importantly, deploy capital into.
Then, yet again, as confidence is built and capital is deployed prices find a way to ultimately move even lower than what was previously viewed as the new low point in prices.
This process unfolds into what is known as a bear market. A trend, noise aside, of market prices consistently finding a way to move lower.
The Bull Trap
The above general descriptive process can be viewed as a series of bull traps. Such a trap is as it suggests – as you deploy capital into the above market process you believe downside price action, on a trend basis is over.
With your newfound bullish view (market will now trend higher view) the market moves upward with one of those previously offered headline grabbing up days offering surely this is the beginning of a trend to the stars.
Then, X days/weeks/months later the market works its way lower leaving you and your capital trapped in your previously bullish view, i.e. bull trapped.
False Breakouts Often Mark the Starting Point
Bull traps, downtrends, bear markets, series of bull traps etc. are often marked with the beginning point of a false breakout. A false breakout is as its name implies as well.
The price of a stock or index breaks out to a higher level inducing many to believe a higher trend trajectory has begun. Just as the consensus determine this is the case said stock or index turns tail on their consensus belief and collapses to the price point of its breakout and then worse, to even lower prices not seen in X days/weeks.
The false breakout has occurred and the first bull trap has been set and sprung courtesy of collective market participants quickly rethinking and re-pricing their initial view that all is well out in market/econ land.
For those not as quick to the draw (think sell button) or choose not to draw at all they get, or said more accurately, their capital gets caught in the bull trap.
All of the above offers a general descriptive view of how markets unfold during downtrends/bear markets. We are raising awareness to this in light of the tremendous market based expectation of rate cuts by the Fed near-term.
With this, as implied at the outset of this edition, it is time to increase focus on market operations and discipline. This is nearly the opposite of what a knee-jerk expectation would offer with the onset expectation of Fed rate cuts. “The Fed will cut rates and the markets will be easy,” rethink such a mindset if you have it.
Rather, increase focus and prepare for turbulence is a more appropriate mindset, using history as our guide.
False Breakouts are Prevalent
We move off the general descriptive historical scenario as shared to this point and move to real-time current day. The above is meant to set the stage for what has begun to unfold in recent weeks. We are seeing false breakouts all around from X market index down to sectors and on down through to sub-groupings within sectors.
Importantly, this does not guarantee market issues from here with a bear market heading right for us.
What it does, in particular with the wealth of false breakouts presenting themselves is to offer to the market operator/tactician a tap on the proverbial shoulder to be focused, trust little in terms of price trend attempts that may be bull traps in disguise and execute buy/sell discipline strategies without excuse.
For the assets under our care the above is how we are mentally posturing at this stage. Again, history is our guide and history offers Fed rate cutting cycles can be challenging.
This is not Healthy Market Behavior
Above is a chart depicting the previous twelve months for a Russell 2000 small company index vehicle. Our red horizontal line highlights the previous high points that acted as price ceilings whereby an uptrend via a breakout higher was unable to occur.
For the bulk of 2024 (about 2/3rds of the chart) this index traded in a range moving sideways but no trend in 2024.
Per our left black arrow we see a powerful breakout to the tune of an 11% upturn in just several trading sessions. Then after waffling around it turned tail hard south and immediately erased its moves, its gains and its breakout thereby creating a false breakout.
The above is representative of a wealth of false breakouts that have developed across many areas of the stock market. We selected this as a representation only as it certainly is not an isolated case.
This can be reduced to Simplicity
All of the above does not have to be hard, complex and confusing. If the market landscape is going to be just fine in the upcoming Fed cutting cycle, assuming we have such a cycle, then the market should be able to display healthy behavior. Keep it simple – healthy behavior = healthy market.
For example, false breakouts should disappear and should not enter the market landscape again. Prices themselves when attempting to move lower just cannot seem to do so and then they seemingly find a way to move higher. This is the opposite of our general bear market description at the outset of this edition. (In bear markets they just always seem to find a way to move lower.)
Sensational headline grabbing upturns will disappear and then fail to exist because there was no previous notable downturn to erase. As offered, keep it simple - healthy behavior consistently displayed equals a healthy market backdrop.
To be certain, current day we do not have healthy behavior hence our focus and the subject content for this edition.
For now, stay focused – be disciplined - our in-house mantra for assets under our guidance in particular when market behavior begins to act questionable such as it is now.
This is subject to change which if it does will show up in changing market behavior to a more healthy acting market backdrop. We will share observations on this front accordingly as the near-term unfolds.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
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