Stock markets around the world have been crushed in the past five or six trading days. Gains that had been accumulating during January through July have been wiped out in most markets. The biggest question on everyone's mind is "what happens next?"

Are markets about to crater as they did in 2000-2001 and 2007-2008? Or is this a more normal 10-15% correction within an ongoing equity bull market? We will attempt to provide some answers in this newsletter and guidance on what we intend to do with each of our model portfolios. But before we do, lets review a bit.

On July 21, 2015 we wrote, "We have made it clear recently that we fear more weakness is U.S. stocks and therefore we have been raising cash in ORCA and Mendocino. Today and tomorrow Cape Lookout takes its turn in the rebalancing barrel."

During that time we took the cash allocation of the Cape Lookout model from about 12% to 30%. Both ORCA and Mendocino are currently more than 60% in cash. We raised more cash in ORCA and Mendocino today as the market bounced this morning. These are our highest allocations to cash since fall of 2007.

The large cash allocation has helped to stem losses in all three portfolios, but given the recent violent move down in stock prices it would have been fun, and more defensive, to be allocated entirely to cash. Cape Lookout, Mendocino and ORCA are all now down on the year, as are most major stock market indexes.

The good news is that Mendocino is down only a fraction at this point. Cape Lookout is down more, but less than the overall market. ORCA has taken a larger hit because it owns several very speculative stocks, particularly in the biotech arena. These stocks have become volatile as weak hands have run for the exits.

The custom bond accounts (formerly known as Pt. Reyes) are holding up very well. All the accounts we sampled in the past two days are now positive on the year.

As stocks were climbing earlier this year and interest rates were rising our custom bond accounts were looking pretty weak. They were falling in value as rates were rising. As of this week their fortunes have totally reversed. Bond prices are rising, yields are falling, and our custom bond accounts are looking pretty good.

Dividend Diamonds is experiencing the largest losses since the model was started. Remember this model is allocated entirely to equities and its primary purpose is rising income. Since it is 100% allocated to stocks it is going to feel some pain in any serious market correction. It's dividend income has risen every year since inception. Goal #1 continues to be accomplished for Dividend Diamonds, even though it has experienced "paper losses" year to date.

That brings us to present day. Stocks started the day with a rally that completely fizzled.  With no further ado let's outline what we think is happening.

It is too easy to point exclusively to a slowdown in China as the single cause of the global equity downturn. We believe economic growth is slowing around the world.

Most people are focused on the equity collapse of the past few days. U.S. stocks actually started to correct after May 21st. That day was the high of the market so far this year.

The violent correction in China also started in late May.

The Nikkei Average in Japan peaked in May.

Stocks in Germany, Russia and various emerging markets peaked in April/May.

We just looked at the long term charts of stock markets in all G20 countries. The G20 nations represent approximately 67% of global population, 85% of global gross domestic product, and 75% of global trade.

Thirteen stock markets are now BELOW their 2007 highs. They include:
Argentina, Australia, Brazil, Canada, China, France, Italy, England, South Korea, Russia, Saudi Arabia, South Africa, and the European Union.

In the U.S. most major averages are still above their 2007 highs. However the NYSE Composite and the S&P 100 have fallen BELOW their 2007 peaks.

Mexico is a mixed bag. Their BOLSA index ($MXX) is still UP. The I Share Mexican MSCI Index is DOWN.

The two major stock indexes in Turkey are UP from 2007 highs, but they have both been trending down since late 2012.

The India Bombay 30 Sensex has been a real winner since 2007 but it has been "flat to down" since mid-2014.

The German $DAX has also been a huge winner since 2007. It is now flat for 2015.

Major markets in Indonesia and Japan are hanging onto small gains since 2007.

Frankly, it is pretty amazing that G20 stock markets have not done better since the market peak in 2007. Central banks in many of these countries have dumped trillions of stimulus dollars/euros/yen/yuan/pesos/etc into markets and these economies.

The EEM (I Shares MSCI Emerging Markets ETF) is an exchange traded fund that represents a broad cross section of stocks from emerging market countries.

It has been treading sideways in a consolidation pattern since 2011, searching for direction and momentum. It recently broke to the downside. This too seems amazing and quite bearish, given all the stimulus around the globe.

It is hard to make a case for a global equity bull market when so many markets are below their 2007 highs. It is even harder to make that case while watching many of these markets breaking down in real time.

We have argued since May 2013 that U.S. equities were in a new "secular bull market". The recent violent correction has not yet changed that technical picture which is still intact, but it does raise some doubt about the theory.

We are asking ourselves the following question, "Is it possible for the U.S. market to decouple from global markets and outperform in 2015?"

That is what happened in 2011, which was the last time we experienced such a violent correction around the world. The S&P 500 finished up a fraction at the end of 2011, while the average decline for G20 equity markets was -22%. We have always said that it was a harder year to manage through than 2007-2008.

In our last newsletter we suggested two possible outcomes for a U.S. market in correction mode. One possibility was that a correction would be followed by a move to new highs for U.S. stocks. The other is a more ominous return to a bear market.

Here is the same chart of the S&P 500 that we showed you in our last newsletter. This chart spans 1996 through July 21, 2015.

The first two vertical blue lines (from left to right) mark the beginning of the collapses of 2000-2002 and 2007-2009. The point of this chart is to show you that several technical indicators are lining up just as they did on those two previous occasions.

Several of our favorite technical analysts are creeping into the camp that the U.S. stock market is about to roll over again and that it may retrench by up to 50%. That theory is portrayed by the red arrow on the right.

John Murphy (Stockcharts.com) thinks the market is in a bullish formation represented by 5 "Elliott Waves" that will eventually make new all time highs. But before doing so it will experience a correction of some magnitude.

In Elliott Wave Theory the market moves from its low to its ultimate high in 5 complete waves. Waves 1, 3 and 5 are advancing waves. Waves 2 and 4 are corrective waves. John suspects we are now in corrective wave 4, which could be followed by wave 5 that takes the market to new heights.

The correction we have recently experienced could be the "Elliott Wave" correction. If that it the case it really needs to end right about NOW. John recently pointed out that the market lows of October 2014 need to hold for his theory to remain viable. The NYSE composite bottomed at 9886 last October. It reached 9692 today. The S&P 500 bottomed at 1820 last October. It closed at 1867 today. If these averages close on Friday at levels below 9886 and 1820 it is quite reasonable to assume that John's theory is "out the window" and that U.S. equities will go lower.

Another troubling sign has been the speed of the correction. The U.S. market has dropped much faster than it did at the start of the 2000-2001 and 2007-2008 corrections. There has been very little respite and no place to "get short" if you weren't already short this market coming into the correction.

We used the pop upward in the market this morning to sell more stocks in ORCA and Mendocino. We raised additional cash by selling four more positions in each model portfolio. Both models are now over 60% in cash. 

WHEN WILL IT ALL STOP AND REVERSE?

We have said at least a 1000 times that no one can project the timing or depth of corrections accurately all the time. All technical analysis has some subjectivity to it.

We can tell you that this one looks and feels like it has more room to run on the downside before it ends. We can certainly entertain the idea that the market will bounce. It may bounce substantially, but the charts are telling us, and our guts are telling us that this correction is probably not over. That is our now our "base case".

WHAT DO COMMODITIES HAVE TO DO WITH IT?

We suspect that commodities are the "canary in the coal mine" this time around. Most commodities keep breaking to new multi-year lows. It is hard to imagine that equities will get their footing back until commodities do. 
 
The $CRB commodity index is a basket of commodities. The index has been around since the mid 1950's. It has been revised several times. It is currently made up of
19 commodities: Aluminum, Cocoa, Coffee, Copper, Corn, Cotton, Crude Oil, Gold, Heating Oil, Lean Hogs, Live Cattle, Natural Gas, Nickel, Orange Juice, Silver, Soybeans, Sugar, Unleaded Gas and Wheat.

This index is fast approaching its low points of 1999 and 2002. It is well below its bottom in 2009.

We need to see the $CRB hold the lows of 1999 and 2002 in order to get some confidence that stocks can find a bottom too. The chart above shows the index back to the 1980's. In the 50's, 60's and early 70's commodity prices broke much lower. It is not out of the question that could happen again.

There are MANY opinions on the future price of $WTIC oil. We are in the camp that it could go as low as $20 per barrel; down from $39 today.  Here is a chart that shows the path for $WTIC from 1997 to present day. After completing 5 waves up it now appears to be deep into a 3 wave correction (A,B,C). No one knows for sure how low it will go but our favorite analyst has a $20 price target. We defer to him on this one as he is more often right than wrong (by a lot).

The technical condition of U.S. and global equities is broken. The sell off in commodities is intimidating. We will take it one step at a time and we do not want to leap to conclusions.

Our base case is that U.S. and Chinese equities should bounce. China may bounce a lot tomorrow due to short term technical conditions. Our current inclination would be to raise more cash and/or short indexes for our models that can do this. (ORCA, Mendocino, and Cape Lookout).

Our current "base case" is that the S&P 500 will seek the 1573 level. It represents very significant support at the 38.2 Fibonacci retrace of the entire move up from 666 in 2009 to a peak of 2134 this year.

The old market high, from 2007, is 1576. A move down to this level would also be a "back test of the breakout" from that level that occurred in 2013. We have written many times over the past two years that a back test of that level should be expected at some point.

The target of 1573 is about 15-16% lower than today's close.We would have preferred that a "back test of the breakout" had started a long time ago from a lower level.

WHAT ABOUT GOLD AS A SAFE HAVEN?

We have been expecting gold to reverse and start to move back up again as investors flee other assets. That has not happened yet and there are no imminent signs that it will. It is not relevant at this time.

WHAT IS GOING TO HAPPEN WITH INTEREST RATES?

We said in our original market outlook for 2015 that we did not expect the U.S. Fed to raise rates in 2015. We still don't. Futures markets are predicting about a 24-27% chance of a rate hike in September. If it happens we believe it will be a tiny hike which will be irrelevant.

Long term rates are showing NO signs of rising. That is also consistent with our observations throughout the year.

Here is the path of the 10-year Treasury yield for the past 35 years. It is DOWN, and it is showing no signs of changing trend yet. It may be starting to consolidate, but it is not rising. We suspect that clients invested in the custom bonds accounts can rest easy for the rest of 2015.
 

All the best,

 

Paul Krsek
MANAGING MEMBER & CHIEF INVESTMENT OFFICER  
5T Wealth Management
(707) 603-2672 Office
(707) 486-7333 Cell
Paul@5TWealth.com  

Disclosure and Disclaimer - Updated last on July 23, 2012 by Paul Krsek:
ELLUMINATION is the proprietary newsletter written for clients, friends, and affiliates of 5T WEALTH MANAGEMENT .

Paul Krsek is the sole author of ELLUMINATION. While the views and representations found in the newsletter generally reflect the attitudes and opinions of the 5T WEALTH MANAGEMENT members and staff, Krsek writes without editing and therefore is solely responsible for the content and opinions contained in ELLUMINATION.

ELLUMINATION does not represent the opinions of Fidelity, Fidelity Institutional Brokerage Group, NFS or anyone employed by Fidelity in any capacity. Neither Fidelity, Fidelity Institutional Brokerage Group, nor NFS, nor anyone employed by Fidelity in any capacity has participated in the creation of ELLUMINATION and they are not responsible for the contents or distribution of ELLUMINATION.

ELLUMINATION is written to provide general information to clients, friends, and affiliates. The contents of ELLUMINATION are not to be taken as individual investment advice. No investment decisions should be made based on the opinions or information offered in ELLUMINATION.

5T WEALTH MANAGEMENT does not represent that the information in ELLUMINATION is accurate or complete and it should not be relied upon as such. Opinions expressed herein are subject to change or modification without notice.

The investment portfolio models or management services mentioned in ELLUMINATION may or may not be available in some states, and they may not be suitable for all types of investors.

5T WEALTH MANAGEMENT manages accounts with various histories and investment objectives. Various accounts may be managed differently from time to time.

Krsek makes frequent reference to the model portfolios called Hatteras, Mendocino, Point Reyes, Diamond Head, Cape Lookout and Dividend Diamonds as well as our Fund of Funds Portfolio. During 2005 Paul Krsek was appointed Chief Investment Officer of 5T WEALTH MANAGEMENT, and as such is responsible to make all trading and management decisions for all client accounts which are being managed according to a specific portfolio model. A description of each of our models can be found on our website at http://www.5twealth.com/prd_port_signup.cfm.

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From time to time 5T WEALTH MANAGEMENT receives requests from clients to purchase securities that are not included in the model portfolio to which they are assigned. Effective May 24, 2006, 5T WEALTH MANAGEMENT has encouraged clients to hold such securities in a separate account for the client. Because 5T WEALTH MANAGEMENT is a "fee only" registered investment advisor" it charges its normal management fee for monitoring such securities in the separate accounts in which they are held.

5T WEALTH MANAGEMENT makes every effort to exclude securities that are 'requested by the client' from the modeled portfolio accounts.

The investment objectives of various accounts and models may be substantially different from one another. Therefore topics or investments mentioned in E-Ellumination may or may not apply to specific managed accounts and/or models.

Trades or adjustments to accounts mentioned in ELLUMINATION may or may not happen in every account managed by portfolio managers at 5T WEALTH MANAGEMENT.

If you are not satisfied with the investment results in your account it is your responsibility to inform Krsek to discuss possible changes that can be made to the account to accommodate and satisfy your needs.

The assets held in managed accounts at 5T WEALTH MANAGEMENT may include stocks, bonds, cash, commodities, foreign exchange or mutual funds or exchange traded funds (ETF's), money market accounts or limited partnerships that represent the same. They are subject to market fluctuation and the potential for losses. The assets are not insured. The value and income produced by these investment products may fluctuate, so that an investor may get back less than they initially invested.

The portfolio managers at 5T WEALTH MANAGEMENT do not guarantee results.

Past performance should not be considered an indicator of potential future performance. If you do not consider yourself suitable, either emotionally or financially, to experience volatility and/or losses in financial markets, you should not invest.

From time to time Krsek lists the simple annual returns of the six model accounts in this newsletter. These accounts are "models" and do not represent the actual results accruing to individual accounts. Simple annual return does not represent "time weighted return" as reported individually to clients in their quarterly reports prepared using Centerpiece.

This document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy any securities or other instruments mentioned in it.

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