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Since we issued our last warning Signal at the end of September 2019, Equity markets and the US equity market in particular recorded new all time highs with a heavy concentration in very few large cap stocks such as Apple and Microsoft.

However, this is happening in an environment where :

. Even if earnings expectations have been carefully massaged down by analysts and astute CFOs, the fats and figures show an earnings recession

. The FED sent a clear message that it will not lower rates again

. Bond yields have started backing up sharply and panic seems to be taking hold in the CLO space

. Donald Trump’s impeachment looks more and more like a real possibility

. There is strictly no guarantee that a phase 1 resolution of the Trade war will take place as the Chinese will not charge their stance at all while Donald Trump is under pressure to get a deal done

. The troubles are escalating in Hong Kong to the point where a military intervention of the Chinese army is a real possibility.

Investors have pinned their hopes on a partial resolution of the Trade War and on a resumption of global growth and we are of the view that both are potentially wrong, even if a partial deal is achieved.

The US leading economic indicators point to a CONTINUATION of the weakness ahead, regardless of the outcome of the Trade War and China’s economic data remains weak while the government is hesitant to stimulate more the economy in the face of the Trade War uncertainty.

Moreover, there is a dangerous disconnect between Wall Street optimism and Main Street pessimism which usually has always proven Main Street right

US CEO’s are the MOST pessimistic they have been even before 2009

There is strictly NO reason why the earnings decline should stop here now that the effects of the tax cuts are fading away.

All this to say that equity markets are rising on hot air and bullish expectations that may prove to be quashed severely

Technically, we are getting some very nasty signals

Volatility Guauges are at levels that usually precede a MAJOR move

For the first time in several months, two technical warning signs triggered on the Nasdaq exchange.

A couple of disasters are making comebacks. On the Nasdaq exchange on Wednesday, both a Hindenburg Omen and Titanic Syndrome triggered.

These warnings started to trigger in mid-July, and ended up preceding a pullback. At the time, they were clustering on both the NYSE and Nasdaq. So far this time, it’s only on the Nasdaq.

There has not been a cluster, and they haven’t triggered on the NYSE, but even a single day with both warnings triggering has preceded consistently poor returns for the Nasdaq Composite. What makes it even more rare (and worse) is that both of them triggered on consecutive day

The last time this happened was before the December 2018 correction

The divergence in sentiment between professional investors and individual investors has never been that large

Never in the past has professional investors been so pessimistic and never in the past has individual investors been so optimistic. usually this precedes a MAJOR correction in equities.

Breadth and Participation are Exceptionally low

Another warning signal is the “participation problem”.

Over the past 7 sessions, the S&P managed to show a gain, but breadth on the NYSE was negative 6 of the 7 days. Negative breadth, in this case, simply means more declining than advancing securities, i.e. an Up Issues Ratio below 50%.

This really means that the ENTIRE rally is concentrated in only a very few stocks, the MEGA caps and that it usually indicates the last leg of the bull market with a massive reversal in this large caps when the turning point happens.

Investors have been driving some of the biggest stocks in the US to new highs, stretching their valuations to the highest level in decades. That has caused them to become out of line with the rest of the market.

The Wall Street Journal  notes that some of the largest stocks in the S&P 500 are tilting the valuation of the index to a high level relative to the rest of the companies in the index.

The forward price/earnings ratio of the equal-weighted S&P 500 index is now below that of the capitalization-weighted index by the largest degree in a decade.

In Conclusion

October 2019 has been an uncomfortable ride for anyone who is short or hedged in his portfolio,

However, all the indicators are pointing to a very sharp move ahead and that move is most probably on the way down.

The very low level of cash in global portfolios and the very concentrated participation in only a few stocks will make the correction a very drastic one.

It is time to be on the safe side !