A fortnight ago, (see: Why stockmarkets have further to fall), we came up with four key stock market indicators and likened them to The Four Horsemen of the Apocalypse. Since then, nothing has happened to particularly undermine or reinforce our view except, and this may be interesting, it is just possible we have arrived at that moment! Their time might have come!
Why late September is a bad time for stocks?
For what follows, I am grateful to David Gartman who writes every day the very highly regarded The Gartman Letter' (www.thegartmanletter.com). In his most recent issue, he told of work done by Paul Macrae Montgomery who is, he says, a genuine watcher of all things market-related, a student of market history and market psychology. Paul Montgomery recently wrote of the days between September 21st and 23rd, claiming that these dates have often been linked to major market turning points.
The legendary trader W.D. Gann reportedly claimed that capital and commodity markets tend to top out around September 22nd more often than any other day of the year. There is no apparently economic logic behind this reported observation... but... in as much as September 22nd happens to be the usual date of the Autumnal Equinox.... Initially, we never took such notions seriously. This was despite the authority of W.D.Gann, and even despite research from the Department of Neuroanatomy at Yale Medical School, which discovered that the human nervous system typically undergoes measurable perturbations during the late September time period.
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However,... we have experienced first hand the October Massacre of 1978; the October Massacre of 1987; the October 'Crashette' of 1989; the 1997Asian collapse; the 1998 Long Term Capital sell-off, etc. And remember the Great Gold Boom of the 1970's. While bullion peaked on January 21,1980, the Gold and silver stocks made their all time bull market highs on September 22, 1980. This day also saw the major peak in many oil stocks, which were enjoying a parallel bull market at the time. Also prior to the Great Crash of 1929, the last stock market index to make its then all time peak,the Dow Jones Utility Index, did so on September 21, 1929. Even as far back as 1873, such absolute panic struck, that the NYSE voted, on September 21st to temporarily close its doors.
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On rare occasions, markets bottom on the Autumnal Equinox. Soybeans made a major bottom on September 21st, 1984; and more recently, the market low after the infamous terrorists' attack on our country occurred on September 22, 2001....
Besides stock market moves, numerous currency market moves also have keyed off of this date. On September 21, 1931, for example, the British Pound sterling was devalued 28% overnightfrom $4.84 to $3.50. Also the now famous Plaza Accord of September 21st, 1985, which started a dramatic run in currencies, occurred on the... 54th anniversary of Britain's leaving the gold standard... And finally, recall that the historic 'Gould-Fiske Gold Corner Panic' also peaked exactly on September 21st-- the year was 1869.
Most of the world's major stock markets still appear to be carving out tops. So it will be very interesting to watch what happens to prices over the next few days.
Where are the Horseman of the Apocalypse now?
It is appropriate now to review the current whereabouts of The Four Horsemen of the Apocalypse and to briefly comment upon their progress each fortnight.
The VIX (Volatility Index). Two weeks ago this was stirring but has now fallen back close to its long-term lows. Complacency has returned, in spite of a coup d'tat in Thailand and open rebellion against the prime minister in Hungary, neither have, so far at least, disturbed the world's equilibrium. One thing we know for absolute certainty is that, at some time in the future, extreme volatility will return and with it, considerable adverse stock market activity. Not only might it be due now because of the date but furthermore, it is just too long since there was anything like a 10% pull-back and at least that much must be expected sooner or later.
The PHLX House Market Index. Consolidation continues at the recent low levels. News from the American House Market is not good. As we have constantly reported over recent months, the housing sector of the US economy is a key economic indicator. An indication of how fragile this market is 35% more homes were offered in July compared to July 2005 whilst 6.5% less homes were sold compared to July 2005. As a consequence, inventories are at sky-high levels. Logically, there is only one outcome which is not a soft landing but something much more unpleasant. Dan Tomnitz, of house builder D R Horton, recently said "We have never seen housing prices and demand slow as quickly as they have done during this downside". The IMF say that the slowing US house market is a key risk to global expansion.
The financial sector in the US relies upon the house market and not surprisingly, share prices of those directly connected to the house market mortgage lenders and the like have also been damaged. According to Barron's, one third of US corporate profits come from the financial sector. According to Fed data, more than 62% of banks' earnings are real estate related.
Dow Theory. The Dow Jones Industrial Average still fails to confirm the weaker Transportation Average, a condition that cannot persist. Recently, the Industrials have been heading north whilst the Transports have been heading south. Not just a case of non-confirmation but one of complete divergence. The fact that these are behaving in an opposite fashion implies important problems in the American economy. In the same way that we know that volatility will return to the market, we also know that these two averages will eventually behave similarly. The manner of that eventual change has dramatic implications for future strength or weakness.
Yield Curve. The US 30-year yield is 4.78% whilst the Fed's fund rate is 5.25%. In the UK the 15-year yield is 4.43% whilst the base rate is 4.75%. History tells us that an inverted yield curve can't continue without economic conditions deteriorating.
The seriousness of the situation is getting through, American householders' optimism is down; just under 50% expect the quality of life to be better in five years, this compares to 61% four years ago, the sharpest fall in forty years.
What the housing markets are telling us
In the UK and giving some comfort to the United States, the house market is surprisingly strong. The very point made by Kate Barker, a member of the Bank of England's Monetary Policy Committee, who said that "the strength of the house price inflation this year has taken the Bank by surprise". Alongside that, the Council of Mortgage Lenders report that affordability is at its worst ever. Average mortgages for first-time buyers in July were 3.24 x income, the highest multiple since records began in 1974. There is growing evidence of the increasing UK household debt crisis. The Citizens Advice Bureau report the scale of the debt problem is the worst since the last recession.
If our view of stock market conditions proves to be correct, then we have a number of stages ahead of us. Firstly, a general stock market decline is likely to be global. At some point, this will lead to new significant investment opportunities in the developing world and Japan, which we at RHAM plan to benefit from. During that process, bear fund investments will benefit inversely to the performance of the FTSE 100.
If it turns out that our view is not correct, then we will close the bear fund positions and in their place, reinvest much sooner in markets such as Japan, China and India. Our job in the meantime is to watch, wait and, when we think it appropriate, act.
By John Robson & Andrew Selsby at RH Asset Management Limited, as published in the Onassis Newsletter, a fortnightly newsletter that gives insight into the investment markets.
For more from RHAM, visit https://www.rhasset.co.uk/
