Stocks set up for ‘ugly decline’ as early as Thursday

MARKET  TIMER  TOM  MCCLELLAN  SEES  STOCKS  SET  UP  FOR  'UGLY  DECLINE'  AS  EARLY  AS  THURSDAY 

By Tomi Kilgore 

Aug 18, 2015 5:18 p.m. ET

McClellan is bullish today, but he expects definitive peak in stocks between Aug. 20 and Aug. 26

Tom McClellan expects ‘nothing good for bulls’ the rest of the year

Tom McClellan loves doing what financial advisers tell you not to do. He tries to time the financial markets — to the exact day, if his charts align just right.

At the moment, they are telling him to be bullish on the stock market for all of his trading time frames, including those that trade every few days, weeks and months. But bulls should be ready to flee, as soon as this week.

That’s because McClellan said his timing models suggest “THE” top in stocks will be hit some time between Aug. 20 and Aug. 26. He expects “nothing good for the bulls for the rest of the year,” he said in a phone interview with MarketWatch.

McClellan doesn’t have a strong view on how far stocks could fall, just that it will probably be an “ugly decline” lasting into early 2016. The good news is that his models suggest it should not be as bad as the 2007-to-2009 bear market, when the S&P 500 Index SPX, -0.26%  plunged as much as 57%, or the 2000-to-2002 selloff when the index plummeted 49%. 

“I try to get the direction right, and I let the magnitude take care of itself,” McClellan said.

From his home in Lakewood, Wash., about 10 miles outside of Tacoma and nearly 3,000 miles from Wall Street, McClellan scours over what seem to be hundreds of charts covering the stock, commodities and bond markets, and even those following weather patterns, architecture billings and sunspot activity.

The West Point grad and former Army helicopter pilot also relies heavily on the widely used technical indicator that bears his surname, the McClellan Oscillator (MCO). 

Developed in 1969 by his parents, Sherman and Marian McClellan, that indicator can be used to determine overbought and oversold conditions and gauge the flow of money into and out of the market, according to the Market Technicians Association’s Knowledge Base.

He’s always looking for patterns that could help him predict the direction and the timing of future market moves. Then he writes about those patterns in daily and bimonthly newsletters, as well as in a weekly notice on one chart in particular.

Currently, McClellan sees a number of bearish patterns warning that the big one is likely to hit Wall Street very soon, he reported. For one, the advance-decline line, which tracks the number of stocks participating in a trend, started declining nearly four months ago.

The NYSE’s advance-decline line has been falling since April

 

Meanwhile, the S&P 500 came within a fraction of a record high as recently as July 20. Basically, that suggests the index is being propped up by fewer and fewer stocks, making it much more vulnerable to a shock.

And one reason he expects a big selloff to start as early as this week is a chart showing that liquidity in the financial markets is about to dry up, as investors prepare for the Federal Reserve’s inevitable interest-rate hike.

Drops in smart-money long positions in eurodollar futures suggests liquidity is drying up.

 

Eurodollar futures reflect investors’ bets on where they see three-month borrowing rates down the road. 

Commercial traders are known as “smart money,” because their trades reflect what’s actually happening in the underlying cash markets, as opposed to noncommercials, who tend to trade futures to speculate.

Some may question the predictive ability of any chart, set forward by one year. McClellan’s response: “You don’t have to understand the physics of something to accept and profit from it.”

Combined, he feels the charts’ message is pretty clear.
“We are already seeing confirming signs of liquidity problems in the weakening [advance-decline] line, which topped back in April and appears to be setting up for a major divergence [from the S&P 500], similar to 2000 and 2007,” McClellan wrote in a recent newsletter.

Other charts supporting the bearish view include the leveling off of Treasury and mortgage-backed securities held by the Federal Reserve after the end of quantitative easing, and the high level of taxation relative to gross domestic product.

End of QE could start weighing on stocks — soon

Warily bullish

But if he’s so sure that “a major price top” is coming, why is he still bullish for his short-, medium- and long-term trading styles? “If the top is still out in front of you, you don’t want to exit yet,” McClellan said. In other words, you don’t wear a raincoat today because a storm is coming tomorrow.

A rise in tax receipts to 18% of GDP has always led to recessions in the past

Many argue that trying to time the market so precisely not only increases risk, by raising the odds of being whipsawed — buying high and selling low, or vice-versa — but also fails to beat the more passive buy-and-hold strategy espoused by financial advisers.

“My mother used to say [that] everyone times the market,” according to McClellan. “Some people buy when they have money, and sell when they need it. Others use methods that are more sophisticated.”

You can decide whether you’re going to buy or sell, but you don’t get to set the price. “The timing [of a trade] is the only thing you have control over. Why abandon the only thing you have control over?” McClellan asked.

The bottom line is that, while it might seem counterintuitive, data provided by MarketWatch’s Mark Hulbert, editor of the newsletter-tracking Hulbert Financial Digest, shows that over the past couple of years, McClellan has helped his readers make money while also reducing risk.

Since Oct. 1, 2013, McClellan’s short-term timing signals have produced an annualized return of 14%, compared with a buy-and-hold return of 14.6%.

But the Sharpe ratio, used by modern portfolio theorists to gauge how much return they’re getting for the risk they are taking, was 0.54 for McClellan’s short-term signals, which was better than the risk-adjusted return reading of 0.47 for a buy-and-hold approach.

The Sharpe ratio for McClellan’s intermediate-term timing signals was also higher than for a buy-and-hold strategy, while his long-term signals came up a bit short.

He declined to comment on the growth of newsletter subscriptions over the years, but he did say he makes “a comfortable living” doing what he loves.

McClellan didn’t always love the stock market

The McClellan Oscillator started gaining acclaim when Tom was a child, but he didn’t become interested in his parents’ work until he grew up. “It’s only when I got older,” said McClellan, “that my parents got smarter.”

He took over the family business in 1995 after 11 years in the Army, and quickly started modernizing the process. When he published the first newsletter on a PDF file in 1997, McClellan said he had to call “several hundred subscribers” to explain how to download the software they needed to read it.

While technology has made his job easier over the years, the demands of a daily newsletter can still be daunting. During a recent so-called vacation in Guatemala, he had to break away every afternoon to work on his reports.

The only time he has taken off was when he had some guest writers, including his father, fill in for a few days while he had hip-replacement surgery. That’s when he realized, as demanding and emotionally taxing the daily commitment to analyzing and writing about the financial markets can be, he didn’t want to do anything else.

“I missed writing. I missed the daily involvement,” McClellan said. “It’s a challenge. But I love to work with indicators. I love my job.”

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