Last night on the radio show I said that the market would likely get a very strong bounce today due to the hints that QE 3 was on the way as Jon Hilsenrath of the WSJ hit the wires with last night stating “Disappointing U.S. economic data, new strains in financial markets and deepening worries about Europe’s fiscal crisis have prompted a shift at the Federal Reserve, putting back on the table the possibility of action to spur the recovery.” I said that the first target would be a bounce to 1313 and then our targets set out in last weekend’s missive of 1337.
In just one day the markets not only reached the first target of 1313 but also retraced 50% of the oversold condition that existed as of yesterday. Let me be clear. This is not the beginning of a new bull rally. This is the extreme oversold bounce that we stated would happen as stocks and commodities had reached 2 and 3-standard deviations below their moving averages. We also stated the interest rates would reverse as money moved out of bonds and back into risk assets. This is exactly what occurred today.
The question is now what does happen next?
In each of the past two summers the market has experienced an initial very sharp decline which took the markets from extremely over bought to extremely over sold. This temporary washout allowed for a bounce back to previous resistance levels where investors, previously trapped into the decline, begin liquidating out of the market.
It was at this point that the markets retraced and set new lows as concerns over a weakening economy, the lack of liquidity and Eurozone crisis that continued to plague the markets. As stimulative programs were introduced in late summer and early fall the markets rallied and broke out of their respective downtrends.
I highly suspect that the current rebound will last only a few days more at the most. I mentioned last night that positions should be sold at levels of 1313 to 1330 and this is still the most recommended course of action at the current time.
Do not dismiss the many headwinds that currently face the market:
- The economy is very weak and susceptible to external shocks
- The Eurozone will slow economic growth in the U.S. – the only real question is how much?
- The “fiscal cliff” will have to be dealt with – but when and will it be too late?
- The debt ceiling debate is approaching, again.
- Emerging markets are slowing as well putting more pressure on the U.S. economy.
- Economic indicators are all beginning to signs of increased weakness
- The Eurozone crisis continues with no real solution in site.
- Corporate profits continue to weaken
- Market valuations and price targets are still very optimistic
All of these issues, and many more, currently put equity investors at risk. This is why we have recommended holding higher cash levels than normal and waiting for a better risk/reward entry point ahead. With our “sell” signals currently in play it has paid to remain cautious since our initial recommendations back in April.
The bottom of the next decline will likely be between August and September with a potential of 1200-1250 on the S&P 500. If this occurs, and I suspect that this will coincide with the initiation of a new round of bond buying (QE3), which will provide investors with the best opportunity to increase equity exposure in portfolios for the end of the year.
Recommended Actions and Allocation
On this rally it is important to take action to raise cash and reduce portfolio risk. We related these actions to the concept of managing a garden. If you don’t weed, prune and harvest the garden it will die and the bounty will wither and rot on the vine. These recommended actions in our recent interviews still remain salient today:
- Sell laggards and losers and remove them from portfolios entirely. (weed the garden)
- Harvest profits in winners by reducing weights back to original purchase sizes. (harvest the bounty)
- Reweight portfolio allocations to align with recommended target levels – 35% Cash, 35% Fixed Income and 30% Equities. (prune the garden)
The next buying opportunity will come when we start getting more information about the next quantitative easing program from the Fed. It is only a function of time as there are simply no other tools available to support the markets and the banks. Do not be fooled – QE is only about supporting the banking institutions and Wall Street and has no real effect on the economy. In fact, I would argue, that QE is actually very bad for the economy longer term as it creates inflationary pressures that immediately attack the average household in the forms of higher food, energy and utility costs.
The only problem that currently exists is that we do not know WHEN it will arrive, or in what form, which will have various effects on the market and asset classes. DISCLAIMER: All of the analysis in this report is based on the assumption that the next QE from the Federal Reserve will arrive between August and September of 2012. If it arrives earlier than that then the recommendations will immediately change.
When it comes to technical analysis – we are making an evaluation of what is most likely going to happen in the future based upon the weight of evidence of what has occurred in the past. It is NOT an exact science and must be constantly measured, evaluated and tweaked.
- You must be prepared to sell investments at a loss.
- You must be prepared to be wrong.
- You must be willing to take action today that may have a negative result in the future.
These are all part of the risks of investing in the financial markets. If you cannot comply with these basic rules you have no business investing in the market. However, by limiting losses, taking profits and following some sort of investment discipline that keeps you on the right side of the trade 60-70% of the time – you will be a successful investor over the long term.
Remember – the biggest detriment to your success as an investor are your own emotions. It is always generally better to do exactly the opposite of what you feel. “Buy” when you are scared and “Sell” when you are greedy.
More often than not – you will be right.