A Noteworthy Warning

Obviously, during a bubble one cannot get timing advice from John Hussman, and certainly not from us either (our guest author Frank Roellinger and his strict trend-following system are probably far more useful for this purpose- see 'The Modified Davis Method' for details). We can only provide some background information on money supply growth trends and the occasional update on technical conditions. Apart from that, we are frequently wont to pointing out that risk in the market seems quite large – but there is no telling when this risk will manifest itself. What we feel fairly certain about is that when it does manifest itself, it will catch many people unawares, and a lot of the gains that have been made will be given back in a lot less time than it took to attain them.

However, there is another man who is probably worth heeding regarding timing questions, namely Jim Stack. We say this because Stack turned very bullish early on in the recent bull market, and correctly stayed bullish even when the euro-land debt crisis made it appear in 2011 as though the market was on its way back down. We therefore noted with interest that according to a recent press report, Stack is very cautious at the moment:


“One of the first independent advisers to call the current bull market is now raising a cautionary flag. James Stack, president of Stack Investment Research, warns subscribers to his newsletter, InvesTech Research, that the 5-year-old bull is aging rapidly. Although he hasn’t recommended selling stocks just yet, he says risk is rising and has one eye on the exits.

Attention must be paid. Early in his career, Stack, along with the late, great Marty Zweig, predicted the 1987 stock market crash. Twenty years later, in August 2007, he wrote: “We are taking steps to reduce exposure as warning flags increase.”

But unlike some perma-bears who never know when to quit, Stack turned bullish again in early 2009. I remember a conversation at a conference in Orlando that February in which he made the case for a new bull market while I was still very doom-and-gloom.


In a telephone interview from his headquarters in idyllic Whitefish, Mont., last week, Stack pointed out that 2013’s nearly 30% gain in the S&P was the 10th largest in the last 85 years. “I don’t think anyone who was positive on the outlook for 2013 could have expected the size of the advance we’ve seen…,” he told me. Meanwhile, he said, economic trends are “all entering 2014 in strong fashion,” presenting “little probability of a recession in the first half or three quarters of the year.”

But, he wrote in his most recent newsletter, “a strong economic outlook doesn’t negate the possibility of a bear market. The stock market leads the economy, and market peaks precede the start of recession by 5.5 months on average.”

All in all, he told me, “both macroeconomic and technical [indicators] still support more bull market highs in 2014.” But he’s getting worried. “Technically we’re about 15% above long-term historical valuations,” he said. The S&P 500 trades at 19x trailing-12-month earnings, vs. an average of 17x trailing earnings. And then there’s the calendar, particularly the four-year presidential cycle, which is of great interest to technicians and market historians. “The middle two quarters of a midterm election year are historically the weakest,” he said.”


(emphasis added)

Given that Jim Stack is a veteran of the markets and has made a number of quite prescient calls in the course of his career, we certainly agree that 'attention should be paid' to what he is saying. Interestingly he mentions the presidential cycle – we recently showed a chart of the average performance of the US stock market during mid term election years as well (i.e., the second year of the president's term). As a reminder, here it is again:




The average mid term election performance of the SPX from 1928 to today (blue line) vs. the 'average of all years' (red line), via Mike Burk – click to enlarge.



Below is a weekly chart of the SPX over the past three years. What is noteworthy is the wedge-like shape of the advance, as well as the recent multi-month divergence of the NYSE McClellan oscillator. Similar divergences were in evidence at previous market peaks.

As an aside, Stack may be right when he states that there is still time, as the market has a tendency to retest its highs or even make a new high in April in mid-term election years. Note also that a fairly weak January performance is apparently normal. Keep in mind though that it is not likely that the market will follow the template precisely.

One very notable historical market peak actually occurred in January, namely in early January 1973. This is worth mentioning because at the time the market had also just broken out to new highs and sentiment was almost as unanimously bullish as it is today (we say 'almost' because it was probably not quite as extreme as nowadays. At the end of 2013, new record highs in bullish sentiment were recorded in several indicators, but many of these indicators didn't exist in 1973, so a direct comparison is not possible). Even Alan Greenspan said two day before the 1973 peak that “there is no reason to be anything but bullish”.  :)



SPX, weeklySPX weekly over the past three years: a large wedge-like advance, accompanied by a notable breadth divergence since the middle of last year – click to enlarge.





Charts by: Mike Burk, StockCharts



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5 Responses to “US Stock Market – Jim Stack Grows Cautious”

  • Aka77:

    Dear Pater,

    Thanks for your excellent work.
    I have two questions about money supply growth and the stock market.
    Firstly,you mentioned in many of your articles that currently bank credit growth is almost non existent and that most of the inflation comes from the Fed QE program, via banks creating deposits to buy treasuries that they then pass over to the Fed. I recall reading Rothbard say that the business cycle can occur only if credit is expanded to businesses, otherwise credit to consumers/gov cannot create the business cycle (as it finances consumption and does not distort the production structure). Can you help me reconcile these two facts? Maybe banks do indeed create money to buy treasuries, but then this money finds a way to drift into the business sector (maybe through record bond issuance etc.)?
    Secondly, I get your point that in order to have a bust a slowdown in money supply growth is necessary and yet if I look at a chart that compares TMS YoY growth to the SPX, I see that this relationship seems to have worked only since the 2000 bust: http://research.stlouisfed.org/fred2/graph/?g=r74
    As an example the huge slowdown that occurred in the mid 90s did not bring about any meaningful stock market crash. Am I missing something or is there another way to look at this that confirms your point(which I find theoretically very sound)?

    • Aka77:

      I’ ve been looking into this a bit more and maybe my initial suspicion is right.Maybe the apparent breakdown in the relationship between TMS growth rates and the stock market is due to the fact that sweeps were introduced in the 90s and if I am not mistaken the formula you generally use to calculate TMS (which is the one I used in the above chart) does not account for this fact.

  • roger:

    While the record is undeniably excellent, it’s strange he could time the market so well by while holding the contemporary falsehood that is “the stock market leads the economy”. This is one of the falsehood that was refuted convincingly a while ago in one of your articles.

  • Hans:

    I am looking to short the market, gold and oil in the next sixty days.

  • No6:

    I would not be surprised to see this crash in Feb.

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