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Jeff Cooper Asks: Is it Safe?


Current markets are parrallel to what we've seen before. History is repeating itself.

"There can be few fields of human endeavor in which history counts for so little as in the world of finance."
-J.K. Galbraith

After the crash of 1929, the market had a nice recovery. By April 1930, the market was up 41% from its low on November 13, 1929. Many believed the worst was over.

One of those who did was Benjamin Graham, the father of security analysis and Warren Buffet's instructor at Columbia University.

Benjamin Graham was also a great investor in his own right.

Nonetheless, in 1930, Graham was 36 years old and on the threshold of becoming a millionaire (that was when being a millionaire meant being rich). He had already enjoyed a lot of success in the markets. About that time, he met with a successful, retired 93-year old businessman named John Dix (this is when being 93 meant having experience).

Graham was full of smug self-confidence, as he would later confess in his memoir.

Graham found Dix surprisingly alert as Dix peppered him with questions.

Then Dix asked him how much money Graham owed to banks and Dix was horrified by what he heard.

That's because Graham used a lot of debt in his investment fund to finance stock purchases. This was not like today when we have leverage on leverage. When Dix heard this, he then gave Graham a serious warning:

Dix said, "Mr. Graham, I want you to do something of the greatest importance to yourself. Get on the train to New York tomorrow; go to your office, sell out your securities; pay off your debts, and return the capital to your partners. I wouldn't be able to sleep one moment at night if I were in your position in these times, and you shouldn't be able to sleep either. I'm much older than you, with lots more experience, and you'd better take my advice."

Graham didn't take the advice. He even wrote in his memoir that he "thanked the old man, a bit condescendingly."

Of course, Dix was right, and the worse was yet to come.

"I have often wondered what my life would have been like if I had followed his advice." Graham subsequently suffered terribly in 1930, his worst year ever.

After 1930, he did unwind the debt he held in his account and he did much better thereafter in what was a cruelly difficult market.

Given that Graham's partnership had 44% of its assets financed by debt going into 1930, just pacing the market would have wiped him out.

Irving Kahn, another old investor and student of Graham', wrote of the ordeal in the 1930's: "Keeping the fund alive was a great achievement. His small losses of 1931 and 1932 were especially impressive."

Graham's big mistake was using too much debt, just like the Profligates of today. That's why Dix told him he shouldn't be able to sleep at night until he got rid of his debt. Dix appreciated just how dangerous all of that debt could be. The inspiration to take from Graham's story is that he fought his way back and went on to earn high returns in the market in later years.

In some ways, the story is reminiscent of that of my father's told in my first book Hit & Run Trading. He retired at 45 after selling his textile business, moving the family to California from Pennsylvania.

He was not into the country club scene.  He got into the stock market and eventually, brokers persuaded him that margin was the way to really make money.

In May 1962, my dad was on full margin and at the hospital with my mother who was having an operation. He had left instructions with his broker that if his positions started to sell off, to protect his account by liquidating one stock to backstop the others.

For whatever reason, the broker failed to follow my father's instructions. Instead, each of his positions went down, getting hit with a margin call in the process.

My dad lost more money that day than he had to his name.

I never saw him get emotional about it.

We moved back east where he started over in the textile industry.

He eventually sold another business and got back into the market, this time with a plan. He fought his way back and ultimately, he made substantially more than what he had lost on that one day in May 1962.

After his comeback, my dad would tell me "stocks don't move, they are moved."

It is inevitable that even in using the best of investing methods, the markets will hand out punitive lessons, one of which should be that markets occasionally hand out punitive lessons to EVERYONE. It would not be logical to think otherwise.

Life is a cycle of lessons.

True character is shown only at times of adversity. It is easy to have character when things are going swimmingly.

The lesson which Graham learned is a lesson that we have had to learn over and over in every investment cycle. Looking at the calamity in 2008 it is clear that our enormous debts one again produced a great debacle.

In spite of the market's recovery, the world's government debts are rising to previously unthinkable levels.

Whereas in 2008, the 'cancer' was in the banks, now it seems to be in the sovereigns.

That may be the reason why the market bounces back from every setback of late. It seems the powers that be will do whatever it takes to hold on to power.

We know that trees don't grow to the sky and that there is a bear market out there... somewhere.

Because we are in unchartered waters and because the powers that be are doing whatever it takes, the top prior to the onset of the next bear market may be that much more difficult to identify.

It may mean the harder the top, the bigger the top. It may mean the bigger the top, the bigger the fall.

As the brilliant market participant W.D. Gann observed: "For every action, there is an equal and opposite reaction."

Bull runs based on hope and impulsiveness are just the opposite end of the spectrum of despair and panic.

Likewise this is true of extended legs within bull and bear markets: reactions are the function of emotional excesses in a market on all time frames.

Recently, we've had historic moves in the dollar and oil, and in the bigger picture, persistent advances in equities and bonds.

Major moves/changes have been taking place in several asset classes and they will reverberate across the board.

This is where the stock market finds itself after a wide and loose 4 month trading range: the SPX reached a record high of 2093 on December 29, 2014 and on the last day of April 2015 close at 2085.

Thursday, the market was taken to the woodshed and Monday's Key Reversal Day was well on its way to turning into a Key Reversal Week when we got a barn burner of a rally, albeit on meager volume.

Obviously, the fundamentals had changed between Thursday and Friday -- just like they have through 2015's abrupt swings.

It feels like someone is protecting the SPX baby at 2080, lest a little Rising Wedge lead to a break of the really big multi-year Rising Wedge.

Will we get a follow-through finally?

It seems the short straw that players would rush into the market in front of this Friday's big jobs report... but it is also out of the normal to get a big reversal on an UP open (Friday) on the heels of a large distribution day (Thursday).

But we saw this same thing play out as recently as 4/20. That led to a nominal new high. Will Friday's move perpetuate a big breakout or just another nominal new high -- assuming we see follow through.

We have walked through a cluster of major time/price cycles which hit last week (Monday to be precise), and have a second hit this week.

As you know, 2145-2150 SPX satisfies several technicals milestones including a 100% advance of the major higher 2011 October 1075 low.

So another bull trap to a marginal new high could be in the cards.

The thing is that turning points can be accelerations too.

So just when it looked like we've been up so long it looked like down, the talented Mr. Market may have pulled an inside straight.

To be sure, at major turning points, Mr. Market plays his cards close to his vest, keeping the vast majority of players wrong-footed.

Conclusion. 2015 has seen a masquerade of misdirection days and a barrage of reversals. Time studies tell me this should be ending. The question obviously is one of direction and amplitude.

In the movie Marathon Man, the question is asked, "is it safe?"

"I don't know what you mean. I can't tell you something's safe or not, unless I know specifically what you're talking about."

What we're talking about is debt.

Are stocks safe skating on top of a sea of debt?

My work suggests that a generational bond market rally has culminated and a 50% decline in bonds is ahead.

Against that back drop, this time frame and the current pattern in stocks should be pivotal -- not precluding another pirouette higher.

Twitter: @JeffCooperLive

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