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S&P 500: The Calm Before The Storm

The S&P 500 (SP500)/SPX is at a crucial inflection point. On Friday the SPX closed right around 2,950, a critical resistance level. From a fundamental standpoint, key economic data has been worsening dramatically lately. Manufacturing and non-manufacturing data, employment indicators, as well as various other important economic indicators are pointing towards a possible recession in the U.S. in the near future.

Moreover, it appears that the Fed may be behind the curve. Also, the market may be overly optimistic on the measures the Fed is prepared to take to support the U.S. economy, the S&P 500, and stocks in general. Thus, it appears likely that SPX and stocks in general have much more downside risk than upside potential from here.

Furthermore, the combination of a slowing economy in the U.S. and the possibility of limited near term Fed action, continued trade disputes, and other factors will likely put additional strain on the U.S. consumer. This phenomenon could be enough to tip the U.S. economy into a recession within the next 6-12 months, and we may be in the early stages of a bear market (in stocks) already.

Technical View: Very Bearish

SPX 1-Year Chart


If we look at the SPX’s 1-year chart, we see that the S&P 500 recently bounced off 2,850 support, filled the gap-up at around 2,950, and as of writing this article S&P 500 futures are down by around 0.5%.

What is very troubling from a technical perspective is the RSI. We see that at prior peaks the RSI went well above, or at least touched the 70 level. However, during the latest peak the RSI only reached about 60 before reversing and declining. This likely indicates weakening technical momentum, and a loss of appetite for risk assets amongst market participants.

 Moreover, the SPX attempted to breakout above the 3,025-3,030 resistance level several times during its latest peak. The breakout attempts were unsuccessful, and moreover, the SPX put in a short-term double top as well as a longer-term double top simultaneously. Also, the upside-down black hammer candle before the latest selloff is a very bearish technical indicator.

It seems probable that the SPX will fail at 2,950 resistance, will trade down to 2,850-2,825 support, and will likely brake lower to retest the 2,725 level, unless the Fed brings out the “bazooka” soon (this seems doubtful in my view).

Regardless, a decline from 3,030 to 2,725 would be a textbook 10% correction. However, if SPX breaks below this level we could trade down much lower, and the odds of a bear market materializing appear to be increasing significantly.

What's Changed from Q3

Speaking from a macro point of view, the economy has worsened due to trade tensions, a recession in manufacturing, a slowdown in the services sector, questionable monetary policy from the Fed, and multiple other factors.

ISM manufacturing PMI has come in below 50 for two months in a row now. Moreover, the numbers have been far worse than analysts had anticipated. So, the U.S. manufacturing sector is clearly in recession now.

Now, the services sector appears to be closing in on contraction mode as well. ISM non-manufacturing PMI came in at just 52.6, vs an estimated 55, and far lower than last month's 56.4.

Let’s Take a Closer Look at Those Employment Numbers

The employment numbers are also coming in worse than expected lately. For instance the latest non-farm payroll report appears "not that bad", but if you look closely at the numbers, it was quite disappointing.

Firstly, the decline in the unemployment rate to 3.5% is insignificant at this point. In fact, the "official" unemployment rate typically hits bottom right before every recession starts, at least going back 60 years or so. You can read more about this trend and other bearish indicators here.

Furthermore, the real unemployment rate in the U.S. is likely closer to 7-8% than it is to 3.5%. This is due to millions of "discouraged" workers who have stopped looking for work and are simply not included in the official unemployment rate statistics.

What is important, and what is really troubling are several factors. First, we see that average hourly earnings were expected to grow by 0.3% MoM, but they came in flat at 0.0% MoM. Also, average hourly earnings grew by just 2.9% YoY, vs an expected 3.2% rise.

Furthermore, if you notice, private non-farm payrolls came in at just 114K vs the expected 133K. This is a significant miss and it indicates that the employment picture in the private sector is much worse than was anticipated and is being advertised. In fact, the only reason the overall jobs numbers didn't miss by an extensive number was due to more government jobs being created.

This certainly is not good news, as government jobs ultimately have to be payed for by the tax payer. Given that average hourly earnings are not rising as they should be, the economy is at or near maximum employment, this will put even more pressure on the consumer going forward.

Putting the Pieces of The Puzzle Together

There are a great deal of moving parts and pieces to the overall macro puzzle. However, if we focus on just a few, like the recession in manufacturing, worsening private employment numbers, much worse than expected services sector data, etc., we see that the U.S. economy may be like a house of cards, standing solely on the back of the U.S. consumer.


U.S. economy house of cards

Sooner than later, the U.S. consumer will very likely buckle, and as about 70% of U.S. GDP comes from consumer spending we can probably expect a recession coupled with a bear market fairly soon. In fact, I believe that there is a higher probability that we are in a bear market already, than that we are still in a bull one.

Thus, the Fed will need to act regardless. In fact, it's acting already, steadily lowering rates, recently "giving" big banks $100 billion. This is just another form of QE by the way, and I am sure there is a lot more to come in the next several years.

But what if the Fed doesn't lower its funds rate in October?

After all, there is about a 20% probability that the Fed won't act at all at this month’s meeting. I believe these chances are much higher, especially if the stock market remains around current levels or goes higher between now and the end of this month. In fact, the Fed will likely only lower the funds rate later this month if the stock market deteriorates further from here.

Regardless, it appears that the Fed is behind the curve. Whether it is intentionally, or unintentionally, remains a topic for debate. Ultimately, the Fed may not be able to prevent the recession for much longer no matter what it does, as its recent actions seem to have a very limited effect on the economy.

Albright Investment Group's Q3 Portfolio Performance

Despite a few difficulties, primarily in the Bitcoin/cryptocurrency basket of our portfolio, Albright Investment Group AIG, had a very successful quarter.

A few highlights:

The stock and ETF portion of our portfolio (including non-physical metals) which made up roughly 45% of total portfolio holdings returned about 4.5% in Q3 vs the S&P 500’s roughly zero return. Moreover, other major averages like the Nasdaq, Russell 2000, and the NYSE composite finished the quarter firmly in the red.

Some top performing sectors in the quarter included gold/silver/miners (GSMs), up by over 6% in Q3, and defensive staples, which also returned around 6% in Q3 (this is not including dividends or covered call dividends, CCDs).

Technology was down by roughly 2% in the quarter, most other segments were relatively flat, and energy was the big underperformer delivering a loss of roughly 9% in the quarter.

Fortunately, we were able to minimize losses and maximize gains in many areas of our portfolio, including in energy by trading around positions throughout the quarter.

YTD Performance

Our stock/ETF portfolio outperformed all major averages in Q3. YTD (Q1-Q3) AIG’s stock/ETF portion of the portfolio was up by about 37% vs the S&P 500’s 17% gain. Basically, our stock and ETF portion of AIG’s portfolio more than doubled the S&P’s returns.

Our overall portfolio, including cryptocurrencies, cash, bands, physical metals, stocks and ETFs returned 30.54% YTD (Q1-Q3), beating the S&P 500 by roughly 80%.

The Takeaway

We can see that many of the top performing stocks are related to sectors such as GSMs, consumer staples, some top-quality technology, and other “safe-haven” sectors. I expect this sort of rotation and trend to continue throughout the rest of the year.

On the other hand, the worst performing stocks appear to be high multiple/high flying names in technology as well as in other sectors. Moreover, we see that energy names had an atrocious quarter in Q3. However, this could present an opportunity in quality energy and oil services names to recover significantly in Q4 if WTIC/crude oil goes and stays above the $55-$60 level.

In this environment, high multiple names may continue to underperform. However, high quality and grossly oversold energy names may see a rebound, especially if we see WTIC stabilize above $55 and proceed to move higher. On the other hand, if WTIC breaks down below $50, expect more downside in oil related equities regardless of “how cheap” they seem.

Bitcoin and the Cryptocurrency Complex

Despite a “difficult” Q3, AIG’s cryptocurrency basket is up by over 40% YTD. Moreover, we are likely at a time when it is advantageous to accumulate digital assets, as they have declined a great deal, and the market seems to be overreacting to recent news (noise).


What We are Doing with Our Portfolio Today and Why

We’ve decreased our non-GSM (gold/silver/miners) stock and ETF holdings to roughly 24%. This is because we see increased risk of a recession on the horizon, and the stock market likely has far more downside risk than upside potential from here.

We have about 12% in cash. This is to have some dry powder ready to add to positions when necessary. This may or may not be positions in stocks, depending on future market dynamics.

Ultimately, the Fed will likely need to bring the funds rate down to zero and introduce a great deal of QE to keep the economy from stalling or crashing completely. However, before and while this is happening corporate profits will very likely decline and there should be a grizzly bear market in stocks coming up shortly. That is why we are very cautious on most equities going forward.

However, assets like gold, silver, gold mining companies, Bitcoin and some systemically important digital assets are great instruments to hold as the Fed lowers rates, increases its balance sheet, and balloons the monetary base.

Bitcoin and other mineable coins are inflation proof, as there are only a certain number of coins that can ever exist in circulation. Gold and silver are classic hedges against inflation and monetary base expansion.

In fact, if you compare gold's rise relative to USD monetary base expansion since then President Nixon decoupled the world's monetary system from the gold standard, their (gold's and U.S.’s. monetary base) expansions percentage wise have been nearly identical.

Thus, we have about 22% of our portfolio allocated to the GSM segment. This figure will likely rise going forward to about 25% of portfolio holdings.


gold

Also, as the Fed will very likely continue to bring medium and long term rates down to or close to zero. Thus, we should see trading instruments like TLT, IEF and others alike do extremely well as they appreciate in value as U.S. treasury yields decline.

Now, we have accumulated a sizable Bitcoin and digital asset position, which may seem excessive to some people. However, this is the future of currency, and digital store of value. I view Bitcoin and other systemically important coins as enterprises and not just currency/payment systems.

In fact, I believe a fair comparison to blockchain, Bitcoin and other important coins would be the internet in the early 1990's and key companies like Microsoft (MSFT), Intel (INTC), Amazon (AMZN), etc. These companies that sprung out around the internet at the right time and filled their intended market positions became dominant market leading companies in the process.

It appears that a similar phenomenon may be taking place in the blockchain, Bitcoin, digital asset market right now. Therefore, I am quite confident these assets are going much higher over the next 5 - 15 years.

Nevertheless, I do not advocate investors to risk more than 20% of their portfolio investing in digital assets as there is still a lot of regulatory uncertainty surrounding the space. I general suggest market participants hold roughly 7.5%-20% of portfolio holdings in assets like Bitcoin, Litecoin, Dash, Zcash, etc.

Thank you for reading my article, and all the best to everyone navigating these choppy market waters. Our investment and trading strategies will morph and change throughout these uncertain times, but I am very confident Q4 will be another great quarter for our AIG investment community.