The Emperor Has No Clothes

"I truly believe that the first 100 days of my Administration has been just about the most successful in our country's history," President Donald Trump said in his weekly address on Friday (April 28th), a day ahead of the closely watched 100-day milestone. 

If the U.S. stock market is used as the gauge for measuring President Trump's "success" in his first 100 days of office, then the above comment is completely accurate. Wall Street investors certainly believe the rosy business scenarios coming out of the White House and NO ONE can argue this point. The International Center for Finance at Yale School of Management regularly surveys retail and institutional investors for their views on current valuations and one-year-ahead expected returns. In its latest survey, 99% of those surveyed now believe that U.S. stock prices will be higher in one year's time. 99% ! Wow !!

In the interest of full disclosure, I am not included among this 99% group. In fact, as part of the 1% who are "non-believers", I am significantly short both the S&P 500 Index and the Russell 2000 Index. Here are just a few noteworthy negatives facing U.S. stock prices immediately ahead:

1. Since 1950, U.S. stock prices have advanced approximately 7.5% on average during the period November 1st through April 30th. From May 1st through October 31st, the average gain is just 0.3%! (Negative seasonal bias: "Sell in May and go away!")

2. The latest monthly NYSE Margin Debt report (for March 2017) revealed a record $536.9 billion in customer borrowing to buy stocks, up more than $91 billion over the last 12 months. If a stock market correction does begin in earnest, it won't take long for those who have bought stocks on margin to seriously consider exiting their positions. This exodus from the margin buyers will then accelerate the overall price decline in most major stock market indexes.

3. The Trump Administration's much anticipated "Tax Reform" package was introduced last week, and it's a complete non-starter (and has no chance of passing in either the House or the Senate). While Trump spoke the truth when he declared that a "massive tax cut" proposal would be forthcoming, the package that was presented last week was just a "massive" tax cut for the wealthy that early projections strongly suggest will inflate the National Debt by as much as $7 trillion (or 35%) over the next 10 years. While there may be a minor cut in corporate income taxes during President Trump's term in office, no significant tax reform legislation can be expected this year, and maybe not even next year!
4. According to Bloomberg, total loans at the 15 largest U.S. regional banks declined by about $10 billion to $1.73 trillion in the first quarter, compared with the previous three-month period, the first drop in four years! All but two of those banks missed analysts’ estimates for total loans, as a slump in commercial and industrial lending directly impacted results. Is it possible that bank lending standards are tightening? Yes indeed!

5. The cold winds of economic recession are already being felt nationwide and globally. Gross Domestic Product grew by just 0.7% in the first quarter this year (as announced yesterday, Friday, April 28th), and expected continued central bank tightening in the U.S. and China, already underway, will stymie any significant economic growth for the rest of this year and maybe even into next year (despite optimistic forecasts to the contrary).

6. A daily chart sell signal was triggered by my computer trading system this past Friday, April 28th, in the Nasdaq Composite Index (which traded above 6,000 for the first time in history last week). See chart below.

7. After posting a record high last week, the Russell 2000 Index fell sharply (-1.18%) on Friday, April 28th. This closely watched index of small-cap stocks tends to be a leading indicator for the general market. The Russell 2000 Index is currently trading at 104 times trailing 12-month earnings (according to Birinyi Associates), an unsustainable level of valuation.
8. The Dow Jones Transportation Average, often another excellent leading indicator, is already down 5.62% from its record high posted on March 1, 2017. Please see DJTA Weekly Chart below (with multiple computer-generated sell signals reflected).

Bottom line: A major stock market correction in the U.S. looms immediately ahead. The S&P 500 Index and the Nasdaq Composite are both projected to lose at least 20% over the next 6 months, and the Russell 2000 Index is projected to sustain an even greater loss over the same time period.

Nasdaq Composite Index Daily Chart with Computer-generated Buy & Sell Signals

Russell 2000 Index ETF (symbol IWM) Daily Chart

Russell 2000 Index Weekly Chart with Computer-generated Buy & Sell Signals

Dow Jones Transportation Average Weekly Chart with Computer-generated Buy & Sell Signals

Russell 2000 Index Monthly Chart with Computer-generated Buy & Sell Signals

End Game For U.S. Stocks

Last week's rally in most major U.S. stock indexes served to abort preliminary monthly chart sell signals that were triggered the previous week in my computer trading system. Please see last week's column to gain more insight into the mechanics and potential ramifications here.

So where do we stand now?

In the interest of full disclosure, despite last week's rally I am still short the S&P 500 and the Russell 2000 in my managed accounts. Monday's gap down opening (on 032717) was a meaningful trading low, but I remain convinced that a major stock market top is forming and that the next big move will be to the downside.

Here are just a few potential negatives on the immediate horizon:

1. The Trump Administration's tax reform efforts will meet with the same fate in Congress as its attempt to repeal and replace "Obamacare".

2. The "Russian Story" and all its implications relating to the 2016 Presidential Election and potential ties to the White House is NOT likely to disappear anytime soon. In fact, the current investigations by the Congress and by the FBI are likely to expand in size to dwarf and undermine almost every attempt by the Trump Administration to enact meaningful legislation across the board.

3. The current U.S. economic recovery, which dates back to 2009, is now on borrowed time, and a fairly significant slowdown lies immediately ahead. While the upcoming recession is not expected to result in negative GDP for more than two or three straight quarters, there are possible scenarios that could unfold where the negative economic consequences would be much worse.

4. Central bank tightening in the U.S. and China right now doesn't bode well for the so-called "reflationary" trade which has served to create historic bubbles in financial asset prices, especially in the United States.

5. Evidence of a major top in bank stocks is clear (see official monthly chart sell signals in March for US Bancorp (USB) and Wells Fargo (WFC) below.

6. Official monthly chart sell signals in March for Amgen and CSX don't bode well for two major sectors of the U.S. economy (biotechs and railroads - please see monthly charts below).

7. Populist political movements throughout the world, especially in Europe, increase the odds of harmful government protectionist economic policy actions that will almost certainly doom financial asset prices on a global basis.

8. I worry most about a potential "Black Swan" event relating to a major terrorist strike in one of the G-7 countries, which might then trigger a massive over-reaction by one or more of the major global military powers with probable involvement and support from the Trump Administration and the U.S. military.
9. Saudi Arabia's Aramco IPO is expected to be the largest IPO in history at potentially more than 4x the record-sized Alibaba offering. Early reports indicate a $2 trillion valuation for Aramco. If a 5% stake is offered, then this IPO would total $100 billion as compared to the $25 billion Alibaba offering. While this massive negative "liquidity event" is not expected to unfold this year, Aramco could be listed on the NYSE as early as Q-1 in 2018.
10. And the most important potential single negative for financial asset prices immediately ahead relates to recent comments from two key U.S. Federal Reserve officials regarding the Fed's $4.5 trillion balance sheet. In 2008, the Fed's balance sheet held less than $1 trillion. Since then, several "quantitative easing" measures have resulted in open market bond purchases by the Fed of more than $3.5 trillion. While the Fed claims it hasn't expanded its balance sheet since early last year, all funds from maturing bonds and interest payments received by the Fed on its massive bond portfolio have been regularly reinvested in the marketplace. Influential NY Fed President William Dudley said recently that the Fed is now considering NOT reinvesting these funds which would then result in a natural draw down of the Fed's balance sheet. And St. Louis Fed President James Bullard recently went one step more aggressive here with a suggestion that the Fed may actually begin outright liquidation of its bond portfolio! In my view, the financial markets have yet to discount the staggering negative liquidity ramifications of ANY plan to downsize the Fed's massive balance sheet and its $4.5 trillion bond portfolio.

Bottom line: Don't fight the Fed! Potential U.S. Tax Reform from the Trump Administration is doomed! The Russian Story will dominate the news for President Trump's entire term! Current record high valuations in U.S. share prices fail to discount the increasing probability of a "black swan" event that could easily result in an overnight downside gap of 5% or more!

CSX Monthly Chart with Computer-based Buy & Sell Signals

Dow Jones Transportation Average Monthly Chart with Computer-based Buy & Sell Signals

US Bancorp (USB) Monthly Chart with Computer-based Buy & Sell Signals

Wells Fargo Corp (WFC) Monthly Chart with Computer-based Buy & Sell Signals

AMGEN (AMGN) Monthly Chart with Computer-based Buy & Sell Signals

Russell 2000 Index ETF (IWM) Weekly Chart with Computer-based Buy & Sell Signals