We have been reporting quite a bit recently about the high level of risk that is currently prevalent in the market and have been advising higher levels of cash and fixed income relative to equity exposure since late April. This has paid off well to date as the economy is now, finally, coming to grips with the reality that the economy is much weaker than previously thought.
As we stated on July 28th in “STA Risk Indicator Still On A Sell Signal” – “Our proprietary risk ratio indicator is still flashing a warning signal at the moment BUT is beginning to get to levels that are more normally associated with intermediate term bottoms. While this indicator is very slow to move because it is built on weekly data – it has been a good overall risk management tool for the increasing and decreasing of portfolio risk associated with market movements.
Back in April when we first published this indicator to the public we addressed that it was time to remove money from risk assets and overweight cash and fixed income. This has provided a good hedge for the summer volatility up to this point. Now, the markets are beginning to show enough weakness to begin hitting our radar for a potential buying opportunity within the next couple of months provided some crisis doesn’t assert itself and push the markets into panic mode.
…Caution is still advised as all of our signals are still on a SELL signal at the current time. We still recommend an overweight position in cash and fixed income at the current time and underweight equities with a bias to lower volatility, defensive positions.”
Head And Shoulders – Not The Shampoo
The market is also very close to violating an important level of support that would complete the formation of a “head and shoulders” technical pattern. Generally, a completion of this pattern indicates a market top and further downside risk is possible.
The market has also broken the 50 and 200 day moving average with the 50 day moving average now approaching a potential bearish cross of the 200 day moving average. While all of this is very technical in nature the bottom line is that risk, currently, is heavily outweighs the potential reward opportunity.
Bounce Is Likely
The market is oversold on a daily basis and a bounce is likely in the next couple of days. Where we finish this week will be very telling as to the direction the markets will go next but with today’s violation of important support the path of least resistance is to the downside. However, a bounce would potentially take the market to the 200 day moving average which will, most likely, provide a high level of resistance to further upward movement.
It is highly advised that on this rally you rebalance your portfolio to the model in the weekly newsletter. If you are not a member yet, it is free, and the model is updated each week in the newsletter.
Reason To Be Bearish
I have been bashed quite a bit lately about our bearish stance on the market since most of the mainstream media and analysts have been calling for strong markets in light of the poor economic data. We are not bullish or bearish by nature – just reading the risks that are prevalent in the market and trying to apply that risk assessment to a portfolio strategy to protect and preserve the capital of our clients.
The economic and fundamental data is showing signs of pervasive weakness and requires us to be on a more cautious stance regarding equity exposure. The mainstream media and market analysts are about to roll out the carpet on trying to reason why their calls for higher markets have all been so horribly wrong, however, we recommend that you disregard the clarion calls of optimism and pay attention to the reality of the data.
Reason To Be Bullish
There is a reason for us to be bullish – in the short term. I sent a list of 4 reasons why we will get QE 3 recently to a friend of mine they were:
- 2nd quarter GDP gets revised to 1% or less. – very likely in the coming month.
- Unemployment Rate goes to 9.3 on Friday.
- Jobless Claims climb back above 400,000 on Thursday
- Stock market declines meaningfully – a 10% correction by the end of August possibly.
With today’s decline – I am sure that Uncle Ben will be up burning the late night oil trying to figure our how to keep the markets from going into an all out rout. We still expect an announcement or a strong “hint” by the time Bernanke gets to Jackson Hole at the end of the month. As we were quoted as saying in the Wall Street Journal today:
“And that, in turn, is getting the QE3 boosters fired up again. ‘This economy has been weakening, and it’s more than just the Japan earthquake effect,’ says Lance Roberts, chief executive of Streettalk Advisors, which manages $400 million in client assets. Mr. Roberts acknowledges that quantitative easing has had, at best, a mixed effect on the economy, and that the political headwinds are strong.
But Mr. Roberts is convinced QE3 is on the way, noting that the Fed’s stimulus measures have at least been successful in keeping markets afloat. And with a big re-election campaign on the way, the imperative to keep the economy juiced is paramount — even if The Bernank’s voter-registration card doesn’t match that of the President.
‘Particularly if these economic numbers continue to weaken, and it’s clear it’s not just a temporary slowdown, I would not be surprised to see the Fed come in with some program by September,’ says Mr. Roberts. ‘It probably won’t be titled ‘quantitative easing,’ because that’s a political no-go, but some sort of stimulus-related program wouldn’t surprise me here.’”
Of course, another round of injections could hoist the markets temporarily higher as the mainstreet of America is further decimated by higher costs and lower wages. Nonetheless, if QE 3 is announced we will want to take a more bullish stance on investment portfolios and follow our discipline and technical indicators accordingly. We’ll see if I am right soon.