ISM Manufacturing, PMI: Danger, Will Robinson! Danger! by Tony Sagami, Mauldin Economics
Danger, Will Robinson! Danger!
— Robot, Lost in Space
Oh, the pain, the pain.
Seth Klarman: Investors Can No Longer Rely On Mean Reversion
"For most of the last century," Seth Klarman noted in his second-quarter letter to Baupost's investors, "a reasonable approach to assessing a company's future prospects was to expect mean reversion." He went on to explain that fluctuations in business performance were largely cyclical, and investors could profit from this buying low and selling high. Also Read More
— Dr. Zachary Smith, Lost in Space
We all have our favorite childhood TV shows, and Lost in Space was one of mine. I’m really not trying to insult your intelligence by quoting fictional TV characters, but I do see some serious stock market danger ahead, and the Lost in Space robot may be more right about 2015 than the high-paid experts on Wall Street.
I hope the 320-point plunge on Monday followed by the 130-point fall on Tuesday got your attention, because I believe there is a lot more pain left to come.
I could list dozens of reason why caution is in order, but here are four serious warnings signs just from last week.
Danger Will Robinson #1: ISM Manufacturing Index. The December index of the US manufacturing sector came in at 55.5, below the forecast for 57.5 and the weakest reading since May. The New Orders component of the Index dropped to the worst level in seven months.
The culprit is the strong dollar, which hurts US exporters, and a general slowdown of the global economy.
Danger Will Robinson #2: ISM Non-Manufacturing (Services Sector). The December figure of 56.2 was well below the expectations of 58.0 and a big drop from the 59.3 in November.
Moreover, the services index has dropped three out of the last four months and saw the largest one-month fall in six years!
Danger Will Robinson #3: Construction spending. The Commerce Department reported that Construction Spending fell 0.3% in November, which was (again) below expectations of a 0.4% increase.
Danger Will Robinson #4: Chicago PMI. The Index fell to 58.3 in December, below the 60.0 expectation, as well as November’s 60.8. According to the report, “The slowdown in the pace of activity exhibited since October’s one-year high of 66.2 has been marked. It was a disappointing end to the year with the pulse rate of our business panel slowing noticeably in December.”
The below-the-headline details paint an even drearier picture:
- prices paid fell;
- new orders fell;
- supplier deliveries fell;
- production fell; and
- order backlogs fell.
Those four warnings signs don’t mean that the bear market will start tomorrow morning, but the growing laundry list of economic warnings signs combined with rough start to 2015 tells me that you need to prepare for some stock market trouble.
There are three basic options:
Option #1: Do nothing—get clobbered. Most people think they can ride out bear markets. But the historical reality is that most investors, professional and individual alike, panic and sell when the pain gets to be too much.
Option #2: Hope for the best, prepare for the worst. Have some sort of defensive strategy in place. That could be some type of simple moving-average discipline or a more complex technical analysis. At minimum, I highly recommend the use of stop losses.
Option #3: Portfolio insurance. Buy some portfolio insurance with put options or inverse ETFs. That is exactly what my Rational Bear subscribers are doing, and I expect those bear market bets to pay off in a big, big way.
Whether it’s next week, next month, or next year, a bear market for US stocks is coming, and you’d better have an industrial-sized bottle of Pepto Bismol to help you stomach the pain or have some rational, methodical strategy to protect your portfolio.
30-year market expert Tony Sagami leads the Yield Shark and Rational Bear advisories at Mauldin Economics. To learn more about Yield Shark and how it helps you maximize dividend income, click here. To learn more about Rational Bear and how you can use it to benefit from falling stocks and sectors, click here.