Volatility returns... More bad news from China... Why you shouldn't worry about China... 'Serious damage has been done'... What to do now...
The "calm" didn't last long...
Following a quiet start to the week yesterday, investors woke up to another global selloff this morning.
Most major markets in Asia and Europe closed down 2% or more. U.S. stocks, as represented by the benchmark S&P 500 Index, fell nearly 3%.
The U.S. dollar weakened 0.4%. Most commodities – including oil – declined. After an incredible three-day rally of 27% - the biggest rally in at least 25 years – West Texas Intermediate (WTI) crude oil plunged nearly 7% back to around $45 per barrel.
Volatility – as measured by the CBOE Volatility Index, or "VIX" – surged12% to close back above 30 (though it still remains below its recent highs of more than 40).
Outside of a handful of individual stocks, only a few notable assets defied the trend: the euro (which tends to trade opposite the U.S. dollar), 10-year U.S. Treasurys (which often act as a "safe haven" asset)... and gold.
Gold closed up 0.7%. Silver was up more than 2% at one point, but closed unchanged.
Today's selloff is being blamed on new data suggesting that the Chinese economy is slowing. From an article in the Wall Street Journal...
China got another poor picture of its economic health on Tuesday, as an official gauge of manufacturing activity in August slumped to a three-year low, while the usually strong services sector showed new weakness.
Meanwhile, private gauges of both manufacturing and services activity also showed a similar pattern of less-than-stellar activity despite government efforts to bolster the economy.
Analysts said, however, that some of the weakness could be temporary, as the latest slip in manufacturing may have been aggravated by temporary factory closures aimed at controlling pollution around the nation's capital ahead of celebrations marking the 70th anniversary of the end of World War II.
The Journal noted that it isn't just that China's economy appears to be slowing that has some investors worried. The Chinese government's attempts to intervene also don't seem to be working...
"We believe that the clock is ticking toward further negative surprises," Rabobank strategist Michael Every said about the data in a note to clients.
He said that policy responses from China aimed at encouraging stability had so far failed.
Chinese authorities have been trying to stabilize the domestic stock market since late June, cutting interest rates for the fifth time since November, and pledging to support the market by buying stocks.
Despite the ineffectiveness of China's government so far, it's not giving up just yet...
According to reports this week, the government will "encourage" public companies to do more to boost China's stock market. From an article on Bloomberg News...
China will encourage listed companies to conduct mergers and acquisitions, buy back shares when prices are low, and pay higher cash dividends as the government extends efforts to boost share prices.
The steps are aimed at increasing the investment value of listed companies and promoting stable and healthy growth of capital markets, the China Securities Regulatory Commission said in a statement posted on its Website on Monday.
"Regulatory departments stepped onto the only right path, that is to increase the return for investors," Li Daxiao, an economist at Yingda Securities, said in a Weibo post after the statement. "This is a very correct direction!" he said.
In the meantime, the Chinese government is cracking down on "market manipulators." More from Bloomberg...
Chinese authorities have imposed limits on wagering against stocks, known as short selling, amid a rout in equity markets. The campaign against market manipulation has snared senior executives at Citic Securities Co., China's largest brokerage, as well as a journalist at business magazine Caijing.
As the Shanghai Composite Index has slumped about 38 percent since a selloff began in June, authorities in China have repeatedly blamed market manipulators and foreign forces for the rout. In July, the Ministry of Public Security said it would help the China Securities Regulatory Commission investigate evidence of "malicious" short selling of stocks and indexes.
"They're sending out an even stronger signal that people in China cannot short sell the market, or even long sell the market," said Steven Leung, an executive director at UOB Kay Hian Ltd. in Hong Kong. "The signal is not good for the future development of China's securities market."
While the latest news from China isn't positive, there is a "silver lining" for U.S. investors.
Despite what you might hear from the financial media, the Chinese economy has almost no connection to the U.S economy. Former "permabear" David Rosenberg, chief economist and strategist at wealth management firm Gluskin Sheff, explained in a recent article in Canada's Financial Post...
This gets very little attention because the media and Wall Street analysts know full well that bad news always sells better than good news – take this from a former bear.
China's economy has a grand 16% correlation with the U.S. economy, knock-on effects and all. In other words, it's insignificant, though there are some sectors such as automotive and scrap steel that are affected.
China represents the grand total of 0.7% of U.S. GDP...
Rosenberg compared today's worries about China with similar worries about Japan in recent decades...
Before China, Japan was the world's second-largest economy from 1968 to 2010. When I started in this business in the mid-1980's, Japan was all we talked about. Go take a look at the movie Black Rain, starring Michael Douglas – we feared them.
Japan drove the markets, and that included commodities since they have none of their own (outside of rice) – and, get this, over the past quarter century of its No. 2 GDP status, Japan was in recession nearly 40% of the time.
I don't recall that this unleashed recessionary forces globally. Indeed, in a show of just how domestic the U.S. economy and market are, the U.S. was in a bull market and robust economic growth through most of this period.
Rosenberg noted that the U.S. recessions in 1990, 2001, and 2008 had nothing to do with Japan. And he doesn't think the recent turmoil in China will have a significant influence on our economy or markets today.
We agree... But as we've discussed, there are plenty of other reasons for caution. Today, we'll share one more...
Our friend Dr. Richard Smith sent us a new warning about the market this morning.
Regular readers may remember Richard is a mathematics Ph.D. – and former Stansberry Research subscriber – who built the excellent TradeStops trailing stop loss software we often recommend.
As we mentioned last month, Richard has been quietly working to transform TradeStops from a simple trailing-stop tracker (which it still does incredibly well) to a full-featured portfolio-management system.
One of the new tools Richard developed is called "smart" trailing stops. We explained how they work last month...
The technology behind these stops is proprietary, but understanding how it works is simple...
Rather than choosing a 20% or 25% trailing stop for a position (which our research shows is already surprisingly effective), Richard's smart trailing stops factor in the expected volatility – what Richard calls the volatility quotient – of that particular stock. In other words, it helps distinguish normal fluctuations from moves that suggest a real change in trend.
Richard tracks "smart" indicators for hundreds of stocks and major market indexes. And following the recent selloff, his TradeStops computers are warning that "serious damage has been done." From Richard...
Everywhere I look, technical damage has been done – and it's like nothing we've seen since 2008. Here's an update on the dozen or so charts I've been following for the past month.
All three U.S. stock market indexes – the Dow Jones Industrials, the Nasdaq 100, and the S&P 500 – have moved beyond their normal volatility ranges for the first time since early 2009.
All three indexes have penetrated their smart trailing stops. Additionally, the smart moving averages are also rolling over in all three cases.
In addition to the three major U.S. indexes, Richard says every one of the major sector exchange-traded funds (ETFs) he follows – such as materials, energy, financials, technology, etc. – dropped below their smart trailing stops.
While the recent rally quickly pushed all three indices and most of the sectors back above those levels, Richard notes that this isn't "normal" action...
Of course, anything can happen, but I'm increasingly concerned about the damage that has been done and the complacency I'm seeing in the media. I'm personally happy to see my stops getting hit and giving me the opportunity to move some capital to cash.
Like us, Richard believes this is a reason for caution. But he says there are still some good opportunities out there...
Not everything is gloom and doom in the markets. Believe it or not, there are many opportunities that are performing well.
I've recently put together a list of 300 different equities and ETFs that I monitor with my SSI toolbox (re-entry rule, smart trailing stops, and low-risk zone indicators). The lists covers stocks from the S&P 100, Nasdaq Composite, and a group of about 100 ETFs such as the above sector-focused ETFs. Some equities are still performing incredibly well.
It's important to keep in mind that these signals aren't necessarily a reason to sell individual stocks. Not all stocks trade similarly to the major market indexes, and as Richard noted, some stocks are still doing well.
But it is one more reason to be careful today.
Our advice remains the same: Stay long your "winners," selectively put new money to work in high-conviction opportunities, and consider selling some stocks short to "hedge" your portfolio... But just in case, keep your catastrophe-prevention plan in place.
And if you haven't checked out the new TradeStops, we urge you to take a look now. TradeStops makes tracking and following your trailing stops as effortless as possible, but Richard's new features will open a whole new world of investing to you.
Not only will his new smart trailing stops tell you when to sell any individual position, but his new "re-entry rule" tool will alert you when it's safe to buy back in to those positions after you sell. You can get all the details on the new TradeStops, right here.
New 52-week highs (as of 8/31/15): none.
In today's mailbag, one subscriber says stop losses are for "suckers." Send your thoughts to feedback@stansberryresearch.com. Please note, we can't answer every e-mail, but we read them all.
"DUH, Have you heard of and understand FLASH crash or do you understand that it can happen again and again, The sucker investors with stop loss orders get taken out by computers and then the price goes back sort of to fair value and you sucker are just suckers what else can I say? It should be obvious by now that it can happen with high frequency programed trading and ETF selling that has no real market at the instant You will probably not use this advice because it seems more appropriate in selling newsletters to retail subscribers who you can tell are protected against losses (which is just BS IMHO). STOP LOSS ORDERS ARE A big fish SUCKERS order and will guarantee you a loss in a flash crash." – Paid-up subscriber Phil
Brill comment: Perhaps you should actually read our recommendations before you criticize them. We repeatedly emphasize two key points about trailing stops:
1. We recommend using closing – not intraday – prices for your stops.
2. NEVER enter your stops with your broker. It makes it too easy for market makers to pick you off. It's like playing poker with your cards showing.
Regards,
Justin Brill
Baltimore, Maryland
September 1, 2015
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