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How Far Might A Bounce Go?

Written by admin | Sep, 10, 2013

sp-500-dev-from-50-dma-060611In May the markets went onto a weekly “SELL” signal which prompted us to raise some cash and reduce equity (risk asset) positions in our portfolio. This has served us well so far, but as with anything, we want to scale into and out of defensive postures as confirmation is given that our assumptions were correct. Remember, no one can predict the future accurately so we work on a confirmation program by making portfolio assumptions, taking some small initial steps, if the market confirms our assumptions were correct we then increase our posture. If not, we close it out and move on.

The market has now confirmed that our initial assumptions about a potential summer sell off were correct. However, the recent decline in the market has quite a few people beginning to panic sell holdings in their portfolio. Don’t let emotion rule your investment decisions – that rarely works out well. As you can see in the chart the market is currently three (3) standard deviations oversold (market is touching the red dotted line). In simple terms this means that the market has gone about as far as it can go in one direction without bouncing back some first. To understand this concept think about stretching a rubber band as far as you can in one direction. Before you can stretch it again you have to let it relax some first. The market works the same way because it is based on the supply of stock available to sell and the number of buyers wanting to buy it or vice versa. At a point the number of people wishing to sell – have sold. Therefore, the price will stop dropping and will rise to meet buyer demand. This is where we are now.  

Statistically speaking, the market should bounce to 1300 (the solid red line) and ultimately to the 50 day moving average (50 DMA). These are levels of what is now termed resistance which simply means that most likely sellers who have NOT sold yet, and are hoping for a higher prices, will begin to dump shares at those levels once again driving prices lower.

What Should You Do

It is important that as long as the market remains in a downward trend that you sell into rallies, raise cash and reduce risk to your investment dollars.   As we have stated many times in the past – it is easy to make up a lost opportunity; it is nearly impossible to make up lost capital.

At 1300 on the S&P 500 you should be allocated at our current portfolio model in our weekly newsletter.

15% Cash
35% Fixed Income
15% S&P 500
35% Balanced or Growth & Income

At 1325 you should then reduce exposure to equity even more by moving to:

35% Cash
35% Fixed Income
10% S&P 500
20% Balanced or Growth & Income

The markets most like have quite a bit more work to do on the downside as the economy continues to show more signs of weakness, profit margins begin to weaken and the stimulus injections into the market by the Federal Reserve begin to wane.

Caution is advised, patience is warranted and a focus on conservation of principal is critical.

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