After Wednesday's market spike reaction to the midterm elections, institutional investors began to taper back on their buying Thursday and Friday, given overbought conditions that have developed.
As I have been stressing to you, fundamentals are deteriorating, in spite of what you might be hearing on the news. With oil prices still dropping, this is going to surprise investors with a sharp pullback in earnings growth for the fourth quarter.
Notice how this is manifesting itself in the Canadian Composite Index (TSX), which is a leading market index given its exposure to energy and mining companies ahead of economic contractions.
The Canadian Stock Exchange has also rebounded recently, but notice it is still in a bear market and the tell on this index is that it has recently had a "death cross" where the 50-day moving average is now trending below its 200-day moving average. This is very bearish for our markets because it warns that this entire sector is about to fail. With oil prices having fallen recently from $76 a barrel to $60 a barrel and oil prices also trending in bear market territory - watch out!
All of this I have forewarned would happen, have I not?
Now notice what is happening to the Russell 2000 ($RUT) index that measures U.S. small-cap companies. It too has recently rallied but is also on the verge of a "death cross" on the charts. This represents significant resistance for investors - especially with the Fed about to raise interest rates again.
The key point to understand as investors is that while the midterm election has excited the market, creating a bit of a domino effect with hedge fund managers in realignments, it changes nothing in terms of an approaching economic slowdown. This means any rallies are suspect and likely sucker plays. Investors should use this as a huge selling opportunity and raise cash ahead of growing economic weakness.
Risk management should be your top priority!
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One play you might also want to consider is shorting the Russell 2000 index, with a "small" portion of your portfolio - using an ETF fund like ProShares UltraShort Russell 2000 (TWM). As long as the Russell 2000 50-day moving average is trending below its 200-day moving average as it is about to do, hold your short position with a small portion of your portfolio to hedge any excellent value plays you want to hold onto as well.
Remember, the key here is the economic cycle is rolling over, with the Fed tightening via its monetary policy and there is no indication that the tightening is going to end until a recession is induced.
This is why you must think very carefully about risk and capital preservation now, because both fundamentals and the technical underpinnings of the market are eroding rapidly, as I have forewarned, because of rising interest rates and the full impact of trade tariffs that are about to hit soon.
We are likely to see investigations into President Trump's businesses, his tax returns, many members of his cabinet, and perhaps even eventual movement toward impeachment. CEOs of banks and large financial management services will be subpoenaed and investigated by the House, as well. There will also be investigations of the administration Republicans, as the House Committees seek to inflict damage on "capitalism" and make their case for greater "socialism."
For a while, the markets are likely to mildly celebrate that Democrats lost so handily in the Senate. But the subpoena powers of the House via Democrats will be used to damage the presidency of Donald Trump and in return become a foil for Trump to beat upon, much like he has the press.
The market does like a split government, though, and perhaps knowing that the next two years are going to be filled with gridlocked legislation means that the financial markets will be left on their own. (Putting lipstick on a pig, I am afraid)
I suggest that we might get a relief Santa Claus rally going into the end of the year, but nothing has changed my opinion that the equity market has peaked and will still be at the mercy of the Federal Reserve's tightening policy, perhaps even stronger with a companion foe in the House of Representatives.
We should expect to see the House battle against the tax cuts and certainly vote against any further tax cuts proposed by the Trump administration, meaning that economic stimulus from Republican policies will be thwarted to a great degree by a Democrat House bent on bringing Trump down and seeking payback for its 2016 presidential loss.
In some ways, it makes me wonder why so many House Republican representatives chose to retire in this election - 39 Republicans compared to only 18 Democrats - no wonder the Democrats took back the House. It is almost like it was a Republican (think "Trump") strategy to lose the House to the Democrats in the midterms so that the next two years the Republicans, i.e. "Trump", can campaign against the terrible obstructionist Democrats in the House, making a strong case for his re-election and for turning the House back to Republicans in the 2020 presidential election - so as to resume policies for a stronger economy in his second term.
Lose to win, huh?
To your wealth,
Dennis SlothowerEditor, Stealth Stocks Daily Alert and Wall Street's Underground Profits
Dennis Slothower has been leading a small but profitable group of investors to some extraordinary profits in both good markets and bad over the course of a 38+ year investment career, starting as a stock broker in 1979. In 2011 Dennis was named the top performer by Hulbert Financial Digest for avoiding the Crash of 2008. Now, he is bringing his extensive experience to the public through Outsider Club, Stealth Stocks Daily Alert, and Wall Street's Underground Profits. For more about Dennis, check out his editor page.