Market Risk Elevated Heading Into Distribution Season

By Lance Roberts | November 27, 2020

In this issue of “Market Risk Elevated Heading Into Distribution Season.”

  • Stuck Near All-Time Highs
  • More Signs Of Market Risk
  • Portfolio Positioning Update
  • MacroView: A Vaccine & The New “New Normal”
  • Sector & Market Analysis
  • 401k Plan Manager

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Catch Up On What You Missed Last Week

Happy Thanksgiving

I wanted to take a moment to say “Thank You” for your loyal readership of our newsletter. I have produced a form of this newsletter for almost 20-years. It’s incredible to see some of the same readers from the beginning.

If you are new to the letter, welcome, and I sincerely hope you will stay with us for the long-haul as we continue to work to navigate markets safely and profitability.

In 2021, we have a slate of new upgrades in the works. We will be redesigning our website from the ground up, launching an automated trading platform for DIY investors, and expanding our research and financial planning tools.

It will be an exciting year, and we are looking forward to sharing it with you.

Thank you.

Market Stuck Near All-Time Highs

Just a short note this week so that I can catch up on my “Turkey Induced Coma.”

Despite three consecutive Monday announcements of “potential vaccines,” an agreement by President Trump to allow the “Biden Transition” to begin, and a holiday-shortened trading week that left the “inmates in charge of the asylum,” the market hasn’t done much with it. As of Friday, the market is only about 1.62% higher than it was three months ago.

Unfortunately, as we will discuss in more detail momentarily, the surge in November, one of the largest monthly advances in history, consumed the entirety of the market’s oversold condition that existed before the election.

Furthermore, you have to wonder precisely how much “gas is left in the tank” when even “perma-bears” are now bullish.

Consequently, you will notice the previous peaks in perma-bull exuberance have coincided with short-term corrections.

Therefore, the question we should ask is “if everyone is in, who is left to buy?”

A Lack Of Buyers

As I have noted previously, one of the primary drivers, unsurprisingly, is the extremely easy “financial conditions” caused by low-interest rates, fiscal and monetary policies. Consequently, easy financial conditions have historically also come with a “price tag” attached. (Chart courtesy of Tavi Costa of Crescat Capital)

Furthermore, investors’ extreme bullishness, particularly post-election, has dragged buyers into the market. As David Larew of ThinkTankCharts notes, the National Associate Of Investment Managers is carrying above 100% exposure to stocks (leverage). Such levels of ownership have previously coincided with short- to intermediate-term corrections in the market.

Correspondingly, the surge in buying has also pushed investors to give up hedging portfolios by buying “put options.With the Put/Call ratio back to more extreme conditions, market corrections have generally been close by.

Deviations Are Extreme

Lastly, the market’s monthly deviations from the 3-year moving average are pushing well into 3-standard deviation territory and trading more the 30% above its mean. Such deviations, as shown, have historically not worked out well for buyers.

The critical ingredient of a bullish advance is “confidence.”

Nothing Can Stop It?

The current consensus is with a vaccine coming and more stimulus, a surge in economic recovery will occur.

“When all experts agree, something else tends to happen.” – Bob Farrell

Previously, I discussed why it doesn’t take much of a catalyst to start a bout of “panic selling.” We quoted Doug Kass on a list of potential risks which few seem to be considering:

  • The virus mutates, rendering “vaccines” ineffective. 
  • There are unexpected manufacturing, distribution, and storage problems with delivering a Covid-19 virus.
  • With a delay and without a timely vaccine, the spread of Covid-19 intensifies.
  • As Covid spreads over the next month, there is an increase of state lockdowns, business, school closings, “stay at home orders,” and curfews enacted around the country.
  • The debated election results linger into 2021 as lawsuits multiply.
  • Global economic growth fails to reaccelerate in the second quarter of 2021.
  • Housing falls under the weight of higher home prices – affordability suffers. Housing’s economic multiplier effect moves into reverse.
  • Consumer and business confidence takes a downturn.
  • Bond spreads widen.
  • A divided and partisan House fails to deliver a sizeable and credible stimulus bill.
  • Investors realize that monetary policy can no longer foster or catalyze economic growth.
  • Deflationary conditions accelerate based on unexpected economic weakness.
  • A sizeable corporate fraud gets discovered – further deflating investor confidence.

In a market where investors are throwing money into “SPAC’s,” or shell companies that will try and find something to invest in, the potential for a massive corporate fraud to develop is not that far “out of the box.” 

Furthermore, when everyone is long equities and leveraged, it is an unexpected, exogenous event, which begins the rush for the exit.

Such is why you don’t wait for it to start raining to “build the ark.”

Portfolio Positioning Update

The idea of “building the ark” has continued to be our motto over the past week in our portfolios. Specifically, our primary focus is to adjust our allocations, capture profits, and protect capital when the “risk/reward” profile becomes unbalanced.

Therefore, given the ongoing extremes of the market, as discussed above, the imbalances suggest a more cautious approach to portfolios currently. As such, we continued reducing our equity exposure, adjusting our bond holdings, and raising our cash levels.

Earlier, I discussed in our “3-Minutes” video, the risk of selling pressure after the holiday as pension fund and institutional managers rebalance and mutual funds distribute capital gains.

As shown below, with fund managers carrying some of the lowest cash balances on record, we could see selling pressure to make distributions. 

With the markets exceedingly exuberant on many fronts, caution is certainly warranted. With margin debt near peaks, stock prices at all-time highs, and “junk bond yields” near record lows, the bullish media continues to suggest there is no reason for concern.

Of course, such should not be a surprise. 

At market peaks – “everyone’s in the pool.”

“The investor’s chief problem – and even his worst enemy – is likely to be himself.” – Benjamin Graham

7-Impossible Trading Rules To Follow

In the “heat of the moment,” it is easy to get swept up into narratives as the “Fear Of Missing Out” overtakes our logical thought processes. As such, here are the 7-impossible trading rules to follow:

1) Sell Losers ShortLet Winners Run:

It seems like a simple thing to do, but the average investor sells their winners and keeps their losers, hoping they will eventually return to even.

2) Buy Cheap And Sell Expensive: 

If an investment isn’t “cheap, – it isn’t. Don’t make excuses to justify overpaying for an investment. In the long run, overpaying always reduces returns.

3) This Time Is Never Different:

As much as our emotions and psychology always want to hope for the best – this time is never different. History may not repeat exactly, but it generally rhymes.

4) Be Patient:

There is never a rush to invest. There is also NOTHING WRONG with sitting on cash until a real opportunity comes along. Being patient is an excellent way to keep yourself out of trouble.

5) Turn Off The Television: 

The only thing you achieve by watching the television from one minute to the next is increasing your blood pressure.

6) Risk Is Not Equal To Your Return: 

Risk only relates to the loss of capital incurred when an investment goes wrong. Invest conservatively and grow your money over time with the least amount of risk possible.

7) Go Against The Herd: 

When everyone agrees on the market’s direction due to any given set of reasons – generally, something else happens. Such also cedes to points 2) and 4). To buy something cheap or to sell expensive, you are buying when everyone is selling and selling when everyone is buying.

Happy Thanksgiving.

The MacroView

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO

Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members

S&P 500 Tear Sheet

Performance Analysis

Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. 

Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

Sector Model Analysis & Risk Ranges

How To Read.

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • The “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • The table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are 3-different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Aggressive Growth Strategy

Portfolio / Client Update

The past week was crazy. On Monday, Moderna announced they might have a vaccine that could be 94.5% effective, trumping Pfizer’s 90% effectiveness. That market rallied on Monday but gave it all back on Tuesday and Wednesday.

As noted last week, we finally got some “love” in our “value” stocks like CLX, CVS, CVX, and RTX. And this past week, due to more extreme extensions in these stocks, we took profits and raised cash levels by 5%. (See below)

With next week being a holiday-shortened week, the “inmates tend to run the asylum.” If we continue to see a relative increase in these value names, we will add some more incrementally. Having extra cash will give us a bit of protection against volatility. As noted in the newsletter’s main body, we are about to enter the mutual fund distribution season, which could apply more pressure to stocks. We may raise more cash and hedge if our indicators turn lower.

Portfolio Changes

This past week we made the following changes to portfolios, as we noted in real-time on RIAPRO.NET.

“As noted in this past weekend’s Real Investment Report the market has gotten back to more extreme overbought, extended, and bullish levels. Historically, such a setup has led to short-term corrections, or worse.

While the vaccine news on this morning is certainly welcome, the markets have already priced much of that into stocks currently. Considering a vaccine won’t be widely available to mid- to late-next year, the economic weakness will continue to weigh on profitability for now.

As such, we are taking profits in some of our more egregiously extended positions and will use a post-Thanksgiving correction to add back to holdings at a cheaper level.”

Equity Portfolio – Taking Profits 

  • CVX from 2.5% to 1.5%
  • CMCSA from 3% to 2.5%
  • GOOG from 2.5% to 2%
  • AAPL from 3% to 2.5%
  • VZ from 3% to 2.5%
  • UNH from 2.5% to 2%
  • CVS from 2% to 1.5%
  • TLT from 15% to 12.5%

ETF Portfolio – Taking Profits

  • CVX from 2.5% to 1.5%
  • XLV from 9% to 8%
  • XLP from 6.5% to 5.5%
  • XLB from 3% to 2%
  • TLT from 15% to 12.5%

As always, our short-term concern remains the protection of your portfolio. We have now shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts



A Conservative Strategy For Long-Term Investors

If you need help after reading the alert, do not hesitate to contact me.

Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only, and one should not rely on it for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.  

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Lance Roberts is a Chief Portfolio Strategist/Economist for RIA Advisors. He is also the host of “The Lance Roberts Podcast” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, Linked-In and YouTube
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