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Comstock Partners, Inc.
The Case For A Triple Top
March 14, 2013

Whenever the vast majority of investors, pundits and the media agree on the direction of the market, they are usually wrong.  In the past few days as the indexes have either broken or approached new highs, an apparent wave of euphoria has been evident.  The “experts” cite the gains so far in 2013, the Fed’s willingness to keep its foot on the gas for however long it takes, a perception of improvement in the economy, rosy earnings forecasts and reasonable stock valuations.  The still significant major problems facing the market are now being mostly ignored.

The market’s positive beginning to the year is far from unique, and is not much different than the start of each of the last three years.  2010 began with a gain in the S&P 500 of 9.2% only to be followed by a 15.6% correction.  Similarly, the next year started with an increase of 8.4% and then corrected by 19.4%.  Early last year the market gained 13.1% before dropping 10.5%.  So far this year the market has jumped 9.6%, similar to the gains of the prior three years.  With investor sentiment extremely high and serious domestic and foreign  problems still unresolved, we think that not only are the chances for a major correction quite high, but that the entire market rise since March 2009 may be coming to an end. 

Economic growth has been staggering along at barely a 2% annual growth rate, and recent economic numbers give us little reason to believe that the pace is increasing. Although February retail sales jumped 1.1% from a month earlier, the number appeared at odds with the non-seasonally-adjusted figure, which was down 0.4%. This was the first time in three years that unadjusted February retail sales were below a month earlier.  In 2012, unadjusted sales were up 4.5%, yet resulted in a seasonally-adjusted number of plus 0.7%.  Over the last seven years on average, unadjusted February retail sales were 1.8% below January.  This translated into minus 1.2% seasonally adjusted.  We will therefore have to wait and see whether retail sales really rebounded strongly last month or whether it was a statistical quirk as we suspect.  Consumers are still burdened with excessive debt and barely increasing wages, while the savings rate in January was already back down to 2.4%.

In addition, the economic numbers available to date do not yet reflect the tightening fiscal policy resulting from the agreement to avert the fiscal cliff and the failure to stop the sequester from going into effect.  The sequester will continue to slowly affect the economy with the passage of time as various aspects of the program are put into place.  It is estimated that the sequester can result in the loss of anywhere from 500,000 to 700,000 jobs.  In the event that the sequester is cancelled by a so-called “grand bargain” (which looks less and less likely), the result will be a combination of spending cuts and tax increases that would similarly reduce economic growth.  

It is also noteworthy that none of the above reflects the recession in much of Europe, the uncertainty created by the recent Italian elections, the probable re-emergence of European financial instability, China’s problems with both inflation and slowing growth, the Japanese recession and serious economic problems in the other BRIC nations.  The real potential of geopolitical turmoil (Syria, Egypt, Iraq, Iran, Afghanistan, Mali) is also being ignored.

It seems to us that the failure of the last dip in the market to accelerate on the downside has drawn in the last of those looking to put money in the market and that the prevalent view is that the market has nowhere to go but up.  Sentiment is at historically high levels while the number of daily new highs has been dropping during the advance.  Insider transactions are heavily on the sell side and volume has been drying up.  In addition we doubt that retail investors will come to the rescue.  They’ve been badly burned twice in the last 13 years and have no stomach to do it again.  It will take the rise of a new generation before retail investors become comfortable with the market again. In our view there is a strong possibility that the S&P 500 makes an approximate triple top with the intraday highs of 1576 in October 2007 and 1553 in March 2000 with a major cyclical downturn to follow. 

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