The markets seem to be marching to the script pretty well with the healthy rebound off the lows of last Tuesday. We sent out a special notice on Wednesday indicating that strong probability given the extreme oversold condition. Now we are at an important inflection zone again.
What You Should Really Care About Now
As we’ve said repeatedly since our annual meeting last October, gains will be earned not given. That means, we all need to be more tolerant of market volatility more so than the years prior to 2014, if we want to “earn” our returns. The easy money is behind us and has been since October of 2014. Now we have seen exactly what that means and feels like with the near vertical decline in the last two weeks of August when the markets lost almost 13% (intraday) in only four days. Actually, if one were to get really granular, you’d say that the markets lost nearly 13% in a total of about 2.5 hours of heavy selling much of which happened in overnight trading during those four days. For anyone trying to manage risk is such an environment, you might have felt some frustration. Selling or profit taking had to be done well in advance of any actual price declines if one was to have completely sidestepped these four days. We certainly did some selling in June, July and August, which helped limit losses, but it’s never enough for an event like that right?
Right now, all investors should be paying attention to their market exposure on a total portfolio basis. We believe our net exposure positioning in close to correct with roughly 50-60% still held in select investments that are still showing good relative strength to the markets. This applies to all Tactical Equity and Blended Asset strategies. Income models have been 80-90% in cash for months and are now pending an increase in exposure to high yield and emerging market bonds now trading at more attractive levels. Net exposure analysis is a strong form of asset allocation if we consider cash as a viable (short term) asset class. When all things begin to rise and fall with almost perfectly corrected moves as we’ve seeing since mid August, the only thing that matters is how much you have on the table. Once we get back to a more healthy market and correlations among sectors and asset styles (growth, value, large and small) drops, then we can rebuild a more exposed and diversified portfolio again. But for now, it’s all about exposure to the market.
Inflection Zone
Take a quick look at the short-term daily chart below of the S&P 500 ETF – SPY from August 10th through today’s close.
We see the very nasty decline that began on the 20th of August around $205 and hit a panic low on the morning of Monday the 24th marking a significant low around the $182.50 level. Now, five trading days later, the index is angling back up to the breakdown point which was discussed in last Wednesday’s commentary as a high likelihood. That level is roughly 2044 on the S&P 500 or $204.50 on the chart above. On the chart, you see two horizontal red lines. If the US market can hold above the lower red line in the next day or two, then we’ll likely see another run up to the upper red line at 2044. We have now entered an Inflection Zone for the more important market trend. What does that mean? It means, in this zone, sellers will be given a very ripe opportunity to cut exposure again if they want to and get serious about capital preservation. Based on the speed and acute pain of the near free fall in stock prices over the last couple weeks, I think it’s safe to say that many portfolios and investors still feel over exposed and might just take that opportunity to take profits. On the other hand, buyers might be more enthusiastic than sellers between the two red lines taking us all the way back up to the old highs without ever revisiting the lows again. What happens in this inflection Zone will determine the future of the markets for the rest of the year.
Oddly enough, the perfect pattern would call for a healthy multi-week congestion of prices below the top red line (2044). This gives everyone a chance to get positioned for whatever they think is coming next. Sellers would be given a chance to cut exposure and buyers would be given several opportunities to buy at discounted prices. What we should hope for is another mild round of selling in the weeks ahead and another series of very strong up days that potentially takes prices out to all time new highs giving the bull market another breath of life. If prices fail to make an all time new high in the next month and instead we see the steep down trend continue, then a more destructive bear market price pattern become more likely.
Looking at a longer term (weekly) chart of the same index, you get the idea that the long-term uptrend for stocks is now seriously in question. The topping process that began last December has now resolved to the downside. Is this just a stiff and quick correction or the beginning of something more sinister? We simply don’t know yet – and NO ONE DOES!
As indicated in the note on the chart above, many of our positions hit sell stops when they broke down into the “red zone” . This was the price and time zone when we raised cash to our current 40-50% level (from 16-25%). We call that prudent risk management without guessing at the future. Again, in these types of markets that take no prisoners, it’s all about exposure. If, this turns out to be just a quick hit to the market, we can simply add back exposure in the same zone where we sold (or lower) with no harm done to our prospects for returns. If this is the beginning of new bear market, we’ll be glad we cut exposure when we did.
That’s it for this week. We may be sending out more special updates during the week considering the importance of this situation. As always, feel free to call to discuss you personal situation if you feel the need. Have a great week and know that we are on it daily with regards to your money and the market.
Cheers
Sam Jones
