Three charts that tell you the bear is back

Wednesday, 14 August 2019
Melbourne, Australia
By Greg Canavan

  • Three charts that tell you the bear is back
  • Three ways to strengthen your portfolio for a bear market

Hopefully, your portfolio is in reasonable shape. But if you’ve been playing around in the small and speculative space, then you’re probably feeling a bit beaten up right now.

The thing to understand is that in violent sell-offs like this, no one escapes unscathed. (That is, unless you’re all in on gold, which, despite my bullishness on the yellow metal, isn’t something I’d recommend from a portfolio/diversification perspective).

So when the market turns down violently like it did last week, there are only degrees of damage.

Markets go up, and they go down sometimes, too. We’re now entering a downward phase. My guess is that this is a continuation of the bear market that started back in 2018.

With that in mind, I want to discuss some options for how you might prepare for and handle the bear market, if that is indeed what is unfolding.

First, a little evidence to support this view…

The US–China trade war is obviously the main catalyst for the current correction.

The US is deadly serious about containing China. Watching the Death by China documentary, made by one of Trump’s trade advisers, Peter Navarro will give you a better idea of how the US thinks.

Their aim is to damage China economically and reshape the global supply chain. Technology supremacy is a major battleground.

In my view, the US will win the battle. China is vulnerable, both socially and economically. But the trade war will do some damage to markets in the meantime.

That’s because there is a larger, more fundamental reason underlying this trade war. I wrote about it in the three part report called ‘Trump’s Undoing Project’ at the end of 2018 for my Crisis & Opportunity subscribers. In short, I argued that Trump was dismantling the process we know as ‘globalisation’. This is something China has benefited from immensely.

I also argued that this unwinding wasn’t necessarily a bad thing.

In last week’s The Australian, Robert Gottleibson wrote a good article that touched on this issue:

We are watching an end to the globalisation system that we have been enjoying over past decades.

It was a rule-based system that saw a rapid increase in cross-border movement of goods, services, capital and people. China was the main beneficiary and, as a key supplier of raw materials to China, we rode the boom.

But mass globalisation created problems. The most obvious was that while countries like the US, UK and Australia enjoyed the benefits, in each country there were vast areas that missed out—often in areas outside the capital city elites.

In the UK those who missed out delivered Brexit and in the US they delivered President Trump and his clear trade war policies.

But if Trump is returned to the presidency next year, in my view the world is headed into an era that sees the disintegration of the rules-based trade system that has governed international commerce since the end of the World War II.

As I said, I don’t think this is a bad thing.

It might be to the detriment of the 1% who have become extraordinarily wealthy from the globalisation process. But in the long run, it will benefit the middle classes who have subsidised society’s ‘elites’ for decades.

And while any disintegration of the ‘rules based trade system’ will undoubtedly cause stock market volatility from time to time, longer term I think it will be bullish.

For now though, the odds suggest the bear is returning. The simple fact is that the business cycle is long in the tooth. Let me show you in a few simple charts why that is likely the case.

But first, the markets…

Markets

Overnight, the Dow Jones Industrial Average closed up 372.54 points, or 1.44%.

The S&P 500 closed up 42.57 points, or 1.48%.

In Europe the Euro Stoxx 50 index finished up 30.61 points, or 0.92%. Meanwhile, the FTSE 100 gained 0.33%, and Germany’s DAX closed up 70.45 points, or 0.60%.

In Asian markets Japan’s Nikkei 225 is up 207.64 points, or 1.02%. China’s CSI 300 is up 0.71%.

In Australia, the S&P/ASX 200 is down 1.50 points, or 0.023%.

West Texas Intermediate crude oil is US$56.32 per barrel. Brent crude is US$60.65 per barrel.

Turning to gold, the yellow metal is trading for US$1,502.58 (AU$2,214.37) per troy ounce. Silver is US$17.02 (AU$25.08) per troy ounce.

One bitcoin is worth US$10,564.40

The Aussie dollar is worth 67.85 US cents.

Three charts that tell you the bear is back

  1. The ASX 200: As you can see in the chart below, it spiked to a new all time high for one day ­— 30 July — before immediately turning back down. The rejection of the high was then confirmed this week by panic selling.



chart image
Source: Optuma
Click to enlarge

  1. The Aussie dollar: Last week, the Aussie dollar/US dollar exchange rate broke through the low from January 2016. It was at its lowest level since the financial crisis. The Aussie dollar is a good barometer of the health of the global economy, and China in particular. Last week’s moves are an ominous sign.



chart image
Source: Optuma
Click to enlarge

  1. The iron ore price: Recently, the iron ore price has plunged. This follows a 70% rally from the start of the year. Also, note in the chart below the volatility that occurred in June and July. This is a topping out pattern known as ‘distribution’. In short, it signifies an arm wrestle between the bulls and the bears. That’s what causes the volatility. As you can see below, the bears won…



chart image
Source: Optuma
Click to enlarge

That tells me there is increasing concern about China’s growth prospects. I’d expect to see a bounce in the short term, but longer term it looks like the bubble has burst. That will in turn put pressure on the big miners like BHP and Rio.

I could go on (like copper dropping to more than two year lows), but you get the picture.

So, what to do now?

Three ways to strengthen your portfolio for a bear market

  1. You should consider getting rid of the underperformers and keeping the outperformers.
  2. You should consider getting out of momentum stocks (stocks that everyone buys because they’re going up) with little to no earnings, and no dividends. These momentum stocks will probably underperform in a sell-off and outperform in a bounce. If I’m right about a bear market unfolding, you probably don’t want to be in these stocks over the next six months.
  3. Review and raise your stop losses. Make sure your stop losses are adequately placed. When volatility picks up, you actually want to raise your stop losses to preserve capital. I have reviewed and updated the stop losses in the portfolio below. There are a few I have left undecided for now.

Once you’ve reviewed your stop losses, you can sit back and let the market tell you what to do. There’s no need for anxious, emotionally driven decision making. If you get taken out, so be it.

Cheers,
Greg