It’s funny to hear and see when investors magically forget their near panicked emotional state of just 45 days ago. Now that the markets have just recovered from the “worst start of the year in history”, all is forgiven, all if forgotten. As good contrarians, this makes us nervous. We get squirmy when the mass of investors gets too confident – as they are today.
A Teaching Moment
They say you haven’t mastered something until you can teach it. While no one can ever say they have mastered the world of investing, I am leading an “investment boot camp” for a group of very bright eighth graders who have opted out of standardized state testing. It’s been an interesting exercise to prepare for the class. It took me back to the very foundations of investing in a section I’m calling “Orienting for Success” including various rules regarding risk management, following primary trends, the impact of compounding etc. I am also finding myself choosing to focus on many of the areas of investing that the academic world often omits –like the importance of investor psychology and becoming an icy contrarian. Today, I did my normal market push ups; looking at all the trend indicators, walking through each and every one of our positions through the lens of hold or sell. As I did so, I had those foundational rules buzzing around in my head and it helped me to see things more clearly. The next month will likely provide several teaching moments for investors. We’ll learn if in fact the stock market is carving out a larger bear market-topping pattern. We’ll know if and when the broad indices fail to make a new high and instead we see selling pressure fire up again in the coming weeks. In the next month, we’ll also learn whether or not the Fed’s dovish stance toward monetary policy (they think the US economy is too weak to raise rates) is right or whether they are just afraid to pull the trigger and be blamed for another 10% decline in stocks. We’ll also learn in the next month if the collapse in energy prices is over or if recent strength and stability is just transitory in a much longer and larger move lower.
The very basic rules of risk management suggest that we should be on guard right here and right now. Investors, especially those who tend to be more emotionally reactive (“dumb money”) are now psychologically too bullish and optimistic again. Likewise, our more well informed investors (“Smart money”) are much less so. See below from Sentimentrader.com
Furthermore, practically every sector and equity index is now in overbought territory and prices have moved predictably right up to rather serious resistance levels (old highs and downtrend lines) – graphically shown from Bespoke this AM below.
As I said last week, this is not a time to load up on stocks, perhaps just the opposite. Those same basic rules say to invest in line with the primary trend of the stock market. From my seat, the long-term primary uptrend in stocks dating back to March of 2009, ended in July of 2015 (S&P 500 and the Dow), some would point to November of 2014 (NYSE, Small Caps, internationals and commodities) as the top. Maybe prices will breakout to an all time new high, breaking the current pattern and extinguishing the risk of a real bear market. But thus far, the primary trend for the US stock market is either undetermined or down depending on your chosen benchmark index. Therefore, our investment portfolios should remain defensive or be prepared to get that way on the first signs of trouble from here.
Staying Defensive – for now
In our strategies, we used the recent correction in the markets to upgrade a few of our holdings from overbought “stuff” to oversold “stuff”. Predominantly, this has been a move away from growth and toward more traditional value plays. Some of those moves have driven us toward consumer staples, utilities, low volatility ETFs and dividend payers. Things that were sold were predominantly in overbought technology, healthcare and finance sectors as well a pure growth ETFs. Other action items in the last month or two have been adding back our high yield income securities exposure through emerging market debt, corporate bonds and preferred securities all of which generated clean buy signals in late February. We find these to be an attractive, lower risk way to play the current rebound in the stock market rather than adding more equity or chasing stocks higher. In the last month, I saw a lot of gambling with things like energy stocks on the assumption that oil has bottomed. Back to the basics; I just see a downtrend in energy that might be working to find a base. That’s about all I can say that’s positive about the price action. Now energy is in a deep retreat again and I’m not seeing much conviction behind those bottom fishing buys. Beyond our value buys in February and reengaging our high yield allocations, our Blended Asset strategies haven’t done much in the way of changing our exposure to the equity markets. Our tactical equity models like Worldwide Sectors, High Dividend and New Power have also maintained their defensive positioning through the swift down and up of the markets in the last couple months. As we move into the next earnings cycle and companies bring forward their results, we’ll know if the markets have done a good job of pricing in the expected earnings, shot too high or even too low. That’s what earnings season is all about, confirmation!
Remember, you don’t need to be nervous – because we’re nervous and responding accordingly.
Have a peaceful week –happy spring.