Tag Archives: market top

Technically Speaking: Is It Time To Buy Bonds?

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In this past weekend’s newsletter, I covered the current technical position of oil/energy related investments and the recent bear market rally. The latter is most relevant to today’s discussion on bonds.

“As I have stated before, when the market re-establishes a positive trend, I will recommend putting preserved capital back to work. However, for such an equity increase to be warranted, the market will need to break the current declining price trend and work off some of the currently extreme overbought conditions. This is shown in the updated chart from last week.”

SP500-RallyLevel-030416

“There are quite a few moving pieces here, so let me explain.

  • The shaded areas represent 2 and 3-standard deviations of price movement from the 125-day moving average. I am using a longer-term moving average here to represent more extreme price extensions of the index. The last 4-times prices were 3-standard deviations below the moving average, the subsequent rallies were very sharp as short positions were forced to cover.

  • The top and bottom of the chart show the overbought/sold conditions of the market. The recent rally has responded as expected from recent oversold conditions. With the oversold condition now exhausted, the potential for further upside has been greatly reduced.

  • The easiest path for prices continues to be lower as downward resistance continues to be built. The arching dashed blue line shows the change of overall advancing to now declining price trends. 

The last sentence above is the most important. The signal to increase equity related exposure in portfolios will require a breakout above the currently negative price trend. Until that happens, we remain confined in a ‘bear’market.”

With the markets now struggling to gain ground as the “first of the month” buying frenzy begins to fade, the question is now whether the next decline retests, or breaks, recent lows OR establishes a higher bottom to begin building a more bullish case from. 

However, until the more bullish case can be built and confirmed, it is important to reiterate the most basic rules of portfolio management:

  1. In rising market trends – buy dips.
  2. In declining market trends – sell rallies.

What does this have to do with bonds? Good question.

Bonds remain a true diversifier within a portfolio by providing a return of principal function (if you own individual bonds), an inverse correlation to the financial markets and an income stream derived from the interest payments. This is why over the long-term a bond/stock portfolio will outperform a stock only allocation.

BONDS OVERSOLD?

In June of 2013, when the cries of the “death of the bond bull market” were rampant, I made repeated calls that then was an ideal time to be a “buyer” of bonds.

“However, the recent spike in interest rates has certainly caught everyone’s attention and begs the question is whether the 30-year bond bull market has indeed seen its inevitable end.  I do not think this is the case and, from a portfolio management perspective, I believe this is a prime opportunity to increase fixed income holdings in portfolios.”

As shown in the chart below, this was the correct call and, despite repeated wrong calls by the mainstream analysts, bonds remain in an ongoing bullish trend.

InterestRates-Analysis-030816

Since interest rates are the inverse of bond prices, we can look at a long-term chart of rates to determine when bonds are overbought or oversold. Currently, following the market’s slide from the beginning of the year, interest rates, while having up-ticked slightly over the last couple of weeks, remain oversold.

This suggests that the most likely target for rates in the near term could be as high as 2.0% from the current levels of 1.83%.  While .17% doesn’t sound like a much of a move in rates such an increase back to the long-term downtrend will push rates from their current “oversold” condition back to “overbought.”  This will provide the best opportunity to add to bond exposure back into portfolios.

The same is confirmed by the very long-term chart (50-years) of 10-year interest rates overlaid with a 7-year moving average.

InterestRates-7yr-MA-030816

As you will note, “Bond Bear Markets” exist when rates are rising, due to accelerating economic growth, and remain above their 7-year moving average which is in an uptrend. The opposite occurs during “Bond Bull Markets.” 

The economic comparison is more clearly shown in the chart below which shows the Wage/GDP/Inflation Composite Index as compared to 10-year interest rates.

InterestRates-WageGDPComposite-030816

With the composite index once again on the decline, it is unlikely that the current move higher in rates will last very long. Why? Because interest rates are the “blood” in the veins of the economy. 

Let me explain the importance of rates on everything.

PEOPLE DON’T BUY HOUSES

People don’t buy houses or cars. They buy payments. Payments are a function of interest rates and when interest rates rise sharply mortgage activity falls as payments rise above expectations. In an economy where roughly 70% of American’s have little or no savings, an adjustment higher in payments significantly impacts family budgets. 

Currently, economic activity would be far worse than it is currently if it wasn’t for the surging increase in low/no money down loans, zero-percent interest plans for 60 months and the ability to qualify with sub-prime credit. While these are the same “WMD’s” that led to the last financial crisis, lessons were not learned as the need to generate sales once again exceeds the grasp of logic.

But here are more reasons why the “Great Bond Bull Market” is not dead yet:

1) Rising interest rates raise the debt servicing requirements which reduces future productive investment.

2) As stated above, rising interest rates will immediately slow the housing market taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

3) An increase in interest rates means higher borrowing costs which leads to lower profit margins for corporations. This will negatively impact corporate earnings and the financial markets.

4) One of the main arguments of stock bulls over the last 5-years has been that stocks are cheap based on low interest rates. When rates rise the markets become overvalued very quickly.

5) The massive derivatives and credit markets will be negatively impacted. Much of the recovery to date has been based on suppressing interest rates to spur growth.

6) As rates increase so does the variable rate interest payments on credit cards. With the consumer being impacted by stagnant wages and increased taxes, higher credit payments will lead to a rapid contraction in income and rising defaults.

7) Rising defaults on debt service will negatively impact banks which are still not adequately capitalized and still burdened by large levels of bad debts.

8) Many corporate share buyback plans and dividend issuances have been done through the use of cheap debt, which has led to increases corporate balance sheet leverage. This will end.

9) Corporate capital expenditures are dependent on borrowing costs. Higher borrowing costs leads to lower CapEx.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on, but you get the idea.

BOND BUYING OPPORTUNITY COMING

While bond prices currently remain overbought, such a condition will likely not last very long. As shown below, markets and volatility have an inverse relationship with rates, hence the non-correlation for portfolios. The rising trend of volatility currently corresponds with the decline in markets and the rise in bond prices.

InterestRates-VIX-SP500-030816

This analysis also suggests that the current correction in stocks is likely not over as of yet in the longer term. However, in the very short-term, the current oversold condition in rates suggests that the current “bear market rally” could last through the month of March. Such would not be surprising following a rather brutal first two months of the year.

However, as we approach summer, the seasonal weakness of the markets will likely resurface and bonds will once again become a safe haven for investors against further market declines.

Like every Mom in the world has said at one time or another:

“Before you turn your nose up at those, try them first.  You might just like them.” 

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: March Madness

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


The month of March marks the beginning of Spring. Interestingly, given one of the warmest winters on record, spring flowers have already been in full bloom. However, for investors, it has been a different story as volatile and declining markets have frozen many to inaction.

Important Note: Speaking of weather, last year, the BEA adjusted the “seasonal adjustment” factors to compensate for the cold winter weather over the last couple of years that suppressed first quarter economic growth rates. (The irony here is that they adjusted adjustments for cold weather that generally occurs during winter.)  However, the problem with “tinkering” with the numbers comes when you have an exceptionally warm winter. The new adjustment factors, which boosted Q1 economic growth during the last two years will now create a large over-estimation of activity for the first quarter of this year. This anomaly will boost the “bullish hope” as  the onset of a recession is delayed until those over-estimations are revised away over the course of the next year.  

Currently, many of the bearish trends that existed going into February have persisted, and in many worsened, over the last month. As I wrote at the beginning of last month:

“Those two factors [end of January rebalancing and BOJ negative rate announcement] pushed the markets higher on Friday, and as shown below, broke the markets out of the recent consolidation near critical support. That was the good news.”

(Chart updated through today’s open)

SP500-MarketUpdate-030116-2

The bad news comes from the overbought / oversold indicators again as we head into March. To wit:

“The oversold condition that once existed has been completely exhausted due to the gyrations in the markets over the last couple of weeks. This leaves little ability for a significant rally from this point which makes a push above overhead resistance unlikely. Just as an oversold condition provides the necessary ‘fuel’ for an advance, the opposite is also true.”

The problem is that the market, as of this morning, is struggling at minor resistance. However, if the markets can hold 1940, and work off the overbought condition to some degree through consolidation, then an advance to the current downtrend resistance at 1990 is entirely possible. 

In that same February missive, I noted three potential reflexive rallies based on Fibonacci retracement levels as shown below.

SP500-MarketUpdate-030116-4

As stated above, if the markets can consolidate at the 1940 support level, a push higher to 1970 is entirely possible.

Importantly, the trend of the market is still negative, therefore, all rallies confined within a negative trend should be considered “bear rallies” and used to reduce overall portfolio risk.

The rules here are very simple:

  1. In rising market trends – buy dips.
  2. In declining market trends – sell rallies.

MARCH MADNESS

For basketball fans, the month of March brings a lot of excitement as the NCAA heads into their annual tournament. Individuals that follow teams closely know all of the important statistics from win/loss ratios, player scoring, etc. all to derive the best odds of winning the bets they place.

However, when it comes to the financial markets, most individuals simply “hope” that the month of March will yield positive results. I realize analyzing market data isn’t as fun as basketball teams, but since you are investing your hard earned savings, it is an exercise worth undertaking.

So, let’s dig into the monthly statistics for March to get a better understanding of what we should expect.

Beginning with the “big picture” perspective, the average and median monthly returns for March have not been terrifically exciting and only slightly better than what we would have expected for February.

SP500-Avg-MedReturn-Month-030116

However, what averages and median returns obfuscate are the months when things go exceptionally well and horribly wrong. The next chart displays the best and worst return in March historically.

SP500-Best-WorthMonth-Analysis-030116

While interesting, this still doesn’t tell us much about the month of March. For that, we need to view the entirety of March returns throughout history as shown below.

SP500-MarchReturns-030116

What we now see more clearly is there are many times that March yields negative rates of return for the month. Since 1900, March has delivered 66 positive months and 50 negative months, giving March a winning percentage of 56.9%. Not much better than a coin toss.

SP500-Pos-Neg-Months-030116

“But Lance, since February was a rough month, doesn’t that suggest March will be a winner.” 

Yes, it is often the case that the month following a negative return month will post a positive return as markets bounce from oversold conditions. However, as shown below, this is not always the case.

The chart below shows both February and March returns going back to 1957. During that period, the month of March has posted gains following a February loss 15 times, and losses following a February decline 13 times. Again, at 53.6%, the odds aren’t much better than a coin toss at best.

SP500-MarchGains-FebLosses-030116

One interesting note about the chart above is the sharp increase in monthly market volatility since the turn of the century as computers, online-trading, and algorithms took over the markets. Also, QE programs accelerated returns during the post-financial crisis period which has positively skewed the statistical analysis.

IDES OF MARCH

At the time of this writing, the S&P 500 is currently up 25 points to 1957.  This is not surprising given that this is the first day of a new trading month where institutions typically put money to work. However, as noted above, and shown below, the bounce in the markets is still confined to a very negative trend.

SP500-MarketUpdate-030116-5

All the signs of previous major corrective market tops are currently flashing which suggests that overall market action will remain under pressure. Such price action suggests that overall portfolio risk should be reduced to more defensive levels.

This negative trend will eventually reverse, and when it does, it will be important to put cash holdings back to work. At such a time, the risk/reward scenario will be in a much better position to ensure longer-term gains. However, that time is not now.

While many have suggested that investors should “buy and hold” investments and just ride them out over the long-term, that is just half the story. J. Paul Getty provided the full definition of “buy and hold” investing:

It is unfortunate that some many have forgotten what “investing” actually means. With the markets still in a negative trend, and back to overbought levels, investors may well be suited to “Beware the Ides Of March.” 

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: Bulls Back In Town Or Passing Through

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


The market started the week off with the bulls in charge pushing the markets up to key short-term resistance levels as shown in the chart below. (Note: as of this writing the markets are failing at resistance. If the market ends this week below resistance, the downtrend will be confirmed.)

SP500-MarketUpdate-022316-3

With markets back to very overbought levels short term, the question is now whether the “bulls are back in town” or were they “just passing through.”  The following chart attempts to prescribe the most likely path for prices in the short-term.

SP500-MarketUpdate-022316-2

There are quite a few moving pieces here, so let me explain.

The shaded areas represent 2 and 3-standard deviations of price movement from the 125-day moving average. I am using a longer-term moving average here to represent more extreme price extensions in the index. The last 4-times prices were 3-standard deviations below the moving average, the subsequent rallies were very sharp as short-positions were forced to cover. The vertical blue bars show the previous two periods where bulls regained footing and pushed markets from lows towards new highs. The current setup is indeed similar to those previous two attempts. All we are lacking is some serious “jawboning” from a Fed official about accommodative support to push markets higher.  

The bottom of the chart shows the overbought/sold conditions of the market. The vertical dashed lines show that oversold conditions lead to fairly sharp rallies. The recent rally, while the “best rally of the year,” has responded as expected from recent oversold conditions. With more than half of the oversold condition now exhausted, the potential for further upside has been reduced.

With the 125-day moving average trading below the 150-dma, and with both averages declining rather than advancing, the easiest path for prices continues to be lower as downward resistance continues to be built. The arching dashed red line shows the change of overall advancing to now declining price trends. 

Given the current oversold condition, there is a strong possibility that prices could advance back towards the cluster of resistance now forming at 1990 on the S&P 500. As I have indicated, such an advance would correspond with a rally in the ongoing downtrend and a return of the markets back to extreme overbought conditions. Such would set the markets back up for the next retest of recent lows.

Bear Market Rallies Can Be Sharp

While “bull markets” are much more enjoyable than “bear markets,” being too quick to jump back on the bullish bandwagon can be hazardous to your financial health.

During bear market declines it is not uncommon to see sizable retracements in prices as “short-covering” rallies create fast burning advances that look like a return to a bull market. They usually aren’t and lead to further pain as markets once again fail and head back to previous lows.

As Richard Mojena recently penned:

Impressive rallies during bear markets are far more common than we might believe, even dramatic.  The twin-bears over 2000-2002 (-48%) had 6 weekly gains greater than +4%, the biggest at +7%; the shorter twin bears spanning 2007-2009 (-56%) marked 5 rallies over +4% in one week,the best clocking in at over +10%.

That’s not to say we’re currently in a bear market.  We will only know that after the fact.  What is a fact that was confirmed on January 15 and reconfirmed on February 11 is that we’re in a primary downtrend since 6 November 2015, until proven otherwise by a weekly close greater than 2014 (8% above the February 12 week-closing low of 1865) on or after April 8 (at least 8 weeks from the February low).

This is absolutely correct. Most of the biggest daily and weekly gains have occurred during bear market declines. It is unlikely that the recent advance in the market, while it remains within a defined downtrend, is any different.

Numerous Outcomes – Mostly Adverse

Doug Kass recently penned an excellent piece on the current state of the market as well. To wit:

“In the four decades I’ve been investing, I can’t recall a time when there were so many possible market and economic outcomes, many of them adverse. Our markets and economies have never been so monetary-policy dependent, as our fiscal authorities have never been so partisan and inert.

Quantitative Easing and the Zero Interest Rate Policy were successful in trickling up to the S&P 500, although that didn’t trickle down to the average Joe. Our markets responded exuberantly over the past six years, but I’m fearful that a further drop in U.S. stocks could now run that “movie” in reverse — triggering a ‘negative wealth effect’ and bringing on a recession.

The risks and unintended consequences of ever-lower interest rates are rising. For example:

*     Many companies have abandoned capital spending in favor of financial engineering.

*     The risk of ‘saving ourselves into a recession’ (i.e. the ‘paradox of thrift’) is expanding.

*     Low interest rates could cause cash hoarding, lowering personal-consumption expenditures.

*     The ‘Ah-Ha Moment,’ in which investors lose faith in central banks, might be at hand.

*     Bank net-interest margins and profitability could become challenged, and lending might be curtailed.

Most importantly, I’m fearful that years of artificially low interest rates have pulled forward economic activity and corporate sales/profits. I continue to see a 35% chance of a ‘garden-variety’ recession and a 15% chance of a deeper recession.”

Importantly, if Kass is correct, a normal “garden variety” recession sees stocks declining by an average of 30%. A deeper recession gets substantially worse.

Fundamentals Continue To Worsen

While the technical backdrop continues to deteriorate on many levels (such as momentum, relative strength and price trends,) the bond market continues to recognize the deteriorating fundamental underpinnings of equities.

Despite the recent surge in equities, interest rates continue to trade near the lowest levels we have seen in the last 40 years. Commodity prices continue to remain weak which suggests the global economy is struggling.

We’re seeing it in the negative real and absolute interest rates around the world and in the widening spreads between investment-grade and high-yield debt. And we’re seeing it in the absence of corporate pricing power and the wobbly global economic growth.”

SP500-Earnings-Growth-022316

With profit forecast continually moving lower it is going to be much more difficult for the “bulls” to sustain a broader advance in the markets currently. Furthermore, with the ongoing strength in the dollar, which continues to erode exports, and consumer spending being diverted by surging healthcare costs which is dragging on imports and pricing power, profit margins continue to mean revert.

SP500-ProfitMargins-Price-022316

As Kass concludes:

“The 2009-2015 bull market reflected a recovery from the 2008 crash, as well as stocks’ upward revaluations based on investors’ realization that interest rates would probably remain ‘low for long’ by historic standards. But the market’s recent ‘re-rating’ of stocks downward seems to reflect a recognition that corporate profits will be ‘lower for longer,’ too.

Our recent market weakness might also reflect investors’ loss of confidence in central banks, as well as concerns that U.S. monetary policy has lost its effectiveness and/or simply pulled economic activity and corporate sales and profits forward. Again, I call this the ‘Ah-Ha Moment.’

Lastly, while the odds of a recession appear to be mounting, it’s important to note that a recession isn’t necessarily a precondition for a bear market.

Bear markets can occur even if America fails to fall into a recession, as happened in 1962, 1966, 1987 and 1998.

As legendary technical analyst Wally Deemer (a colleague of mine at Putnam in the 1970s) once put it: ‘You don’t buy GDP futures. You buy S&P 500 futures.'”

The important point is that the recent bullish advance, while heralded as the “second coming” by much of the mainstream media, remains a reflexive bounce within a bear market trend. That will remain the case until the trend is reversed and the fundamental underpinnings begin to improve.

Until then, for investors who continue to ignore the warning signs, the “beatings will continue until morale improves.”

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: Gimme A Rally

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In this past weekend’s newsletter, I discussed the timing and process of reducing equity risk in portfolios to minimize the ongoing deterioration in the markets.

“On a very short-term basis the market is oversold and the bounce on Friday was JUST enough to close above the October lows support at 1860. Any continued rally next week should be used to further reduce equity risk and rebalance portfolios.”

SP500-MarketUpdate-021616

I have added the dashed blue line showing the formation of the asymmetrical bubble pattern that has been the hallmark of major market peaks in the past. While this pattern is not a definitive indicator of the entrance into a cyclical bear market, it does indicate that the easiest path for market prices is currently lower.

However, market bulls will argue, and correctly so, that the continued retests of the 1860 level by the markets is building bullish support for the market. However, this action is not uncommon at major market peaks as it takes time to erode bullish “hopes” to the point those supports finally give way.

With the markets once again oversold after last week’s fairly brutal sell-off, a rally is expected over the next couple of days to allow portfolio risk to be rebalanced. That rally could take the markets back to the previous resistance of 1940 (about a 4% push) from current levels. Such a rally would be enough to suck many of the “bulls” back into the markets pushing markets back into overbought territory and setting up the next decline.

Most likely the next retest of the 1860 lows will fail and, as we move into the summer months, the markets will begin to push to lower levels of support.

EXPECTATIONS VS REALITY

The analysis above, while considered “bearish,” is just an honest assessment of price trends currently. You can dismiss it, ignore it, and doubt it but that won’t change the potential negative impact to your personal wealth.

As Bob Farrell once quipped:

“Bull markets are more fun than bear markets”

That doesn’t mean that you should not acknowledge the risk of one. As I have discussed before, Wall Street has an incentive to keep you invested in the market at all times. There is nothing wrong with that as long as you understand the conflict of interest – their bottom line versus yours.

Let me show you what I mean. A recent survey of Wall Street firms 2016 year-end price targets revealed only slight reductions from where they were at the beginning of the year. At the beginning of this year in the 2016 Outlook & Forecast, I published a table of Wall Street targets:

Wall-Street-Targets-2016-1

Here is the updated version just 45 days later.

Wall-Street-Targets-2016-2

None of them expected a market decline just 45 days ago, and even after the recent rout, only two expect a moderately negative return by year-end. If you are betting your retirement on people making predictions 12-months out, you are likely going to be very disappointed. (Furthermore, with the markets already down -8.5% for the year, you are now almost 3-years behind on your financial plan if you are using those 8% annualized rates of return Wall Street keeps touting.)

The problem with the “always bullish mantra” is the lulling of individuals into a false sense of security which leads to a host of investor mistakes.

Just recently, Ben Carlson, via A Wealth Of Common Sense, wrote a really good piece on why “bear markets” are so painful. Simply put, and as shown below, “bull markets” generally advance over longer periods causing individuals to forget about the very short-term, vicious “mauling” of the previous “bear.”

SP500-MarketUpdate-021616-2

While the entire article is worth reading, I do disagree with one point Ben makes. In his missive he states:

“…the majority of investor mistakes occur during bear markets.”

In actuality, the majority of mistakes that investors make are during bull markets as they:

  • Chase performance
  • Chase yield
  • Overpay for investments
  • Ignore accrued build up of portfolio risk
  • Opt out of fixed income to chase performance
  • Skew diversification by incorrectly rebalancing
  • Misalign portfolio duration to financial goals.

I could go on, the list is long. During rising bull markets investors are continually forgiven for a whole bevy of investment mistakes. It is only during bear markets that these mistakes are realized and the true meaning of “risk” is revealed.

Ben is correct that investors make the mistake of making “emotionally driven” decisions during sharply declining markets. However, if investors had been counseled about portfolio and risk management during the first half of the “full market” cycle, they would not be making “panic” based decisions during the second half.

SPEAKING OF COMPLACENT

While the market has been under substantial attack since the beginning of the year, one of the reasons I remain more “risk averse” currently is simply due to the fact that investor complacency is still very high. The chart below is the volatility index (VIX) smoothed with a 6-month average to reduce the noise of short-term market dynamics.

SP500-VIXRatio-021616

As you will notice, volatility has indeed risen over the last couple of months which would be expected during a market decline.

However, and most importantly, the rise in the 6-month smoothed index is more consistent with the onset of more severe market corrections. Furthermore, despite the recent turmoil, volatility remains at levels more normally associated with investors complacency rather than capitulatory levels normally associated with the end of a bear cycle.

CENTRAL BANKERS UNITE

Of course, the one thing that could quickly change the entirety of this analysis would be a reversal of policy by the Federal Reserve in March.

If Yellen & Co. would decide to join the rest of the major Central Bank’s push into negative interest rate territory, and/or launch an additional round of Quantitative Easing (QE), the markets would reverse sharply.

In such an event, recommendations would change to begin increase equity exposure accordingly. That is…what it is.

In the meantime, there is no indication of such a policy shift near term, as Ms. Yellen seems determined to promote the underlying economic recovery story. Although, if the market decline begins to significantly erode consumer confidence, action by the Fed would not be surprising.

However, until then, I continue to suggest taking actions to reduce risk in portfolios by using the current rally to:

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

As you will note these are not drastic changes. Simply rules of portfolio management that have survived the test of time and are the basis of every great investor’s philosophy throughout history.

As Gerald Loeb once stated:

“The art of investing is being able to adjust to change.” 

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: February Stats & Taking Action

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In this past weekend’s newsletter, I discussed the two factors that saved the markets from breaking critical support and likely pushing the markets into a critical correction. To wit:

The first is month-end window dressing by fund managers after a brutal start to the new year. After much liquidation, fund managers will need to rebalance holdings.

The second is the potential for Central Banks to intervene which could embolden the bulls as further support could temporarily delay the onset of a bear market and recession.

Not to be disappointed, the BOJ announced a move into NEGATIVE interest rate territory to try and boost economic growth in Japan.

Those two factors pushed the markets higher on Friday, and as shown below, broke the markets out of the recent consolidation near critical support. That was the good news.

SP500-MarketUpdate-020216

The bad news comes from the overbought / oversold indicators at the top and bottom of the chart. As I stated on Friday:

“The oversold condition that once existed has been completely exhausted due to the gyrations in the markets over the last couple of weeks. This leaves little ability for a significant rally from this point which makes a push above overhead resistance unlikely. Just as an oversold condition provides the necessary ‘fuel’ for an advance, the opposite is also true.”

The problem is that the market, as of this morning, appears to be failing at minor resistance. It is now critical that the markets hold previous lows or a more severe correction will likely take hold.

MORE BAD NEWS

In last week’s technical update I noted three potential reflexive rallies that should be used to rebalance equity risk into as follows:

“The chart below identifies the potential retracement levels of such a reflexive rally.

1970ish – Sell laggards and losers in portfolios.

2000ish – Trim back winners to target levels

2030ish – Be at final risk-adjusted allocations.”

SP500-MarketUpdate-012916-4

NOTE: For conservative investors it is currently unlikely the market will rise much more than between 1970-1990 during this rally. I would do the majority of your portfolio rebalancing and risk reduction in this range.

Unfortunately, the 1970 level is likely no longer a viable option unless the market can reverse the decline and end the week higher than where it began. A failure to do so, by close of the market on Friday, will suggest more risk reduction actions must be taken in portfolios to preserve capital.

(Important Note: Portfolio allocation models have been at 50% exposure to equity since May of 2015. Further reductions would reduce the allocation model to 25% as shown below. For more information on the allocation model click here and scroll down to the 401k Plan Manager section.)

401k-AllocationModel-011516

ANOTHER WARNING SIGN

Furthermore, as shown in the chart below, another bit of technical data was brought to my attention just recently by a reader (HatTip RZ):

“Most identify the death cross as when the 50-day moving average breaks below the 200-day moving average on the S&P 500. However, the real death cross  takes place when the 200-day moving average crosses below the 400. In 13 of the last 18 major correction episodes going back 1920- 72%  this crossover marked the onset of a major Bear market.

In the five exceptions, which were 1953, 1990, 1984, 1987, and 1996, the same crossover actually ended the correction at that time. Importantly, these five episodes were during strongly trending SECULAR bull market cycles. Given we are not currently in one of those periods, it is likely a cross-over now would be more related to each of the market failures since the turn of the century.”

SP500-MarketUpdate-020216-2

This cross-over WILL occur in next few weeks UNLESS the market can turn up sharply, break out to new highs and resume the bull market trend. Given the deterioration in the economic, fundamental and earnings backdrop, this seems highly unlikely currently.

FEBRUARY STATS AS AN ACTION GUIDE

Last week, I took a look at the statistics of February months following poor performances in January. Statistically speaking, the odds are currently 70% that February will also end lower than where it began.

However, this week I want to dig into the month of February more deeply to see where the best opportunity to lighten exposure will most likely occur.

First, if we look at the month of February going back to 1960 we find that there is a slight bias to February ending positively 57% of the time.

SP500-Feb-MonthlyPerformance-020216

Unfortunately, the declines in losing months have wiped out the gains in the positive months leaving the average return for February almost a draw (+.01%)

SP500-FebruaryStat-DollarGrowth-020216

However, a look at daily price movements during the month, on average, reveal the 4th trading day of February through the 12th day are the best opportunity we will likely have to rebalance portfolio allocations and reduce overall portfolio risk.

SP500-Feb-DailyPriceChg-020216

SO, WHAT IF I’M WRONG?

Last week, I penned a piece on the problem with “Buy and Hold” investing. The crux of the article is that spending a bulk of your time making up lost gains is hardly a way to build wealth long-term. More importantly, is the consideration of “time” in that equation. Unless you discovered the secret of immortality, “long-term” is simply the amount of time between today and the day you will need your funds for retirement.

Of course, such articles always derive a good bit of push back suggesting that individuals can not effectively manage their own money, therefore, indexing is their only choice. I simply disagree.

Beginning last May, I suggested individuals reduce their portfolio risk to equities by 50%. According to the model I publish each week, that reduced equity to 30% in portfolios and raised cash to 35% and bonds remained at 35%. For simplicity sake, we are going to assume that cash yields nothing, bonds yield 2% and stocks equate to the S&P 500 on a capital appreciation basis only.

Since May, the S&P 500 has declined by 9.04%.

However, a portfolio allocated as described above declined by just 2.1%.

[35% Cash @ 0% + 35% Bonds @ 0.7% (2% X 35%) + Stocks @  -2.82% (-9.40% X 30%) = -2.1%]

Yes, managing risk still effectively lost money in the short-term, BUT much less than being overly exposed to equities during a period of decline.

Let’s assume that I am wrong in my current downside risk assessment and the markets reverses course and begins to rise strongly. The market will have to effectively hit all-time highs at this point just to break even with the current allocation model.

However, if the market does turn and re-establish the previous bullish trend, the allocation would likewise be adjusted to increase exposure to equities. The differential in performance currently gives a fairly substantial cushion in which to make non-emotional, logically based, investment decisions. Did you miss some of the gains? Sure. Does it matter? No.

But what if I am right?

If I am right, the preservation of capital will be far more beneficial. As I have stated previously, participating in the bull market over the last seven years is only one-half of the job. The other half is keeping those gains during the second half of the full market cycle.

If the market breaks critical support, the subsequent decline into a more corrective bear market will only widen the performance gap further. The purpose of risk management is to protect investment capital from destruction which has two very negative consequences.

First, when investment capital is destroyed, there is less capital to reinvest for future gains. The second, is the destruction of compounded returns. Small losses in principal can quickly erode years of gains in wealth.

Raising cash and protecting the gains you have accrued in recent years really should not be a tough decision. Not doing so should make you question your own discipline and whether “greed” is overriding your investment logic.

While the financial press is full of hope, optimism and advice that staying fully invested is the only way to win the long-term investing game; the reality is that most won’t live long enough to see that play out.

You can do better.

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: January Losses Lead To February Declines

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In this past weekend’s newsletter, I discussed that the markets finally got a bounce as Mario Draghi announced the potential for more QE. To wit:

“Furthermore, with the markets VERY oversold currently, the expected bounce is likely starting now.”

SP500-Chart2-012216

It is that very oversold condition that has continually suggested that something would happen to elicit a short-term retracement in the market. Not to be disappointed it was the promise of more liquidity by the ECB and Mario Draghi that elicited a massive short-covering rally on Friday.

With the Federal Reserve now heading into a two-day FOMC meeting, there are many hoping the Fed may come to the markets rescue. This could come in two forms:

  1. Discussion on pushing additional rate hikes out further into the year to evaluate the impact from China and the strong dollar on the economy.
  2. Potential for further accommodative action if necessary (QE-4)

Either insinuation will excite the bulls and create a rather significant short-covering rally in the short-term. However, such a rally would not change the ongoing deterioration in the underlying fundamental and technical backdrop. With price trends still primarily negative, it is still a “sell the rally” market currently.

The problem for the Federal Reserve is that they painted themselves into a corner in December when they hiked rates by saying:

“The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”

What they do on Wednesday will likely be a “make or break” moment for the markets. I would not be overly complacent about existing portfolio risk. However, with the markets deeply oversold, I do expect the short-term rally to continue for the moment.  

The chart below identifies the potential retracement levels of such a reflexive rally. IMPORTANTLY, there is no guarantee that these mathematical retracement levels will be precise. These levels are a general AREA to begin rebalancing portfolio risk accordingly.

1970ish – Sell laggards and losers in portfolios.

(You know the one’s, the one’s you secretly keep hoping will come back.)

2000ish – Trim back winners to target levels

2030ish – Be at final risk-adjusted allocations.

SP500-Chart3-012216

NOTE: For conservative investors it is currently unlikely the market will rise much more than between 1970-1990 during this rally. I would do the majority of your portfolio rebalancing and risk reduction in this range. 

IMPORTANT: Notice the market has now traced out a fairly definitive “head and shoulder’s” technical pattern similar to that seen in 2008. If this rally fails, and breaks neckline support, the market will be in a confirmed bear market.

January Losses Lead To February Rallies?

It would seem logical that a weak performance in January would lead to some recovery in February. Markets are oversold, sentiment is bearish and February is still within the seasonally strong 6-months of the year. Makes sense.

Unfortunately, the historical data suggests that this will likely not be the case. The chart below is the historical point gain/loss for January and February back to 1957. Since 1957, there have been 20 January months that have posted negative returns or 33% of the time.

SP500-Jan-Fed-Loss-Gain-012616

February has followed those 20 losing January months by posting gains 5-times and declining 14-times. In other words, with January likely to close out the month in negative territory, there is a 70% chance that February will decline also.

The high degree of risk of further declines in February would likely result in a confirmation of the bear market. This is not a market to be trifled with. Caution is advised. 

S&P 500 Has A Strong Recession Prediction Record

The mainstream press has been publishing a good bit of commentary to support the “bullish” market calls of late by suggesting the S&P 500 has a poor track record of predicting recessions. To wit:

“The stock market sends a lot of false signals — there are 11 signals for the last six recessions.”

The problem is that the statement is not actually correct. The problem is in looking at historical data to come to that conclusion.

Looking backward, we now know the exact starting and ending periods of recessions. However, currently, we will not know the exact starting point of the next recession until at least 6-months after it has begun. This is because of the backward revisions to the economic data which is used by the National Bureau of Economic Research date the start of the recession. The lag between market declines, recessions and the NBER recession calls is shown below.

SP500-NBER-RecessionDating-012616

As you will notice in the chart above the S&P 500, with the exception of 1987, has declined in advance of the recession call in every case since 1980. (The NBER did not make formal recession announcements prior to 1979.)

However, if we look at the annual rate of change in the S&P 500 we also find a fairly strong predictive pattern of market prices and the onset of previous recessions. Going back to 1900 there have only been 10 cases where the YoY decline didn’t occur prior to, or in concert, with a recession.

SP500-YoY-PctChg-012616

This only makes sense as market participants are operating on future expectations. The problem with suggesting the market is a horrible predictor of recessions is by waiting until the economic data is revised to expose the start of the recession, it will be far too late for investors to do anything about it.

With the year-over-year rate of change for the S&P 500 now negative, the question is whether this is one of the few times that it will be wrong? The market has a really good track record for sniffing out recessions. Unfortunately, until we get the revisions to the economic data later this year and next, we won’t know for sure. Are you really going to wait to find out? 

Lance Robertslance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: The Bear Awakens

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


Over the course of the last three week’s newsletters (subscribe for free e-delivery) I have discussed the ongoing topping process and the issuance of all three major “sell signals.” The importance of these signals is they have only simultaneously occurred at major market peaks.

“As shown in the chart below, not only have both lower sell signals been triggered by deterioration in price momentum, the short and long-term moving averages have now crossed.”

SP500-MarketUpdate-010716-2

“Since the turn of the century, the two primary moving averages have only crossed three other times – at the peak of the markets in 2001 and early 2008, and in 2011. The difference in 2011 is that while the sharp decline in the prices due to the debt ceiling debate caused the moving averages to cross, the two lower sell signals were not triggered. This kept portfolios allocated more towards equities at that time.

The current topping process, as discussed on last week, is more akin to that seen in 2000 and early 2008. With primary moving averages now crossed, sell signals in place and markets trading below supports, rallies in equities should be used to rebalance portfolios and reduce risk. 

While the markets are not ‘technically’ in a ‘bear market’ currently, it is important to remember that they weren’t in 2001 and early 2008 either. Waiting to make adjustments until after full recognition of the event doesn’t leave you many options.”

The problem for most investors during market sell-offs is the emotional desire to “panic sell” declines. Emotionally driven investment decisions never work out well.


No Bull, No Bear

Let me clarify something before I go further.

In the media, and on Wall Street, there is an overwhelming push to classify views as either bullish or bearish. This is a VERY dangerous thing for investors.

The reason I say this is since, in the words of Bob Farrell, “bull markets are more fun than bear markets,” investors tend to seek out “bullish” commentary to support their “hopes” of a continually rising bull market. The danger, as I have addressed in the past, is that individuals become “willfully blinded” to data that does not conform to their personal biases. This bias of seeking out only “confirming data,” known as “confirmation bias”, leads to decision making that is ultimately prone to error.

While I am personally tagged as a “bear” because I point out the inherent risks in investing, I assure you I am NOT a bear. I am also NOT a bull. I simply look at the relevant data and make determinations of risk based on historical precedents and statistical data.

As a portfolio manager of OTHER PEOPLE’S money, my biggest concern is not how much money I can make during market advances, but rather how much I keep from losing during market declines. While this seems counter-intuitive, it reality it is where long-term gains are actually generated. As William Lippman once quipped:

“Better to preserve capital on the downside rather than outperform on the upside”

Furthermore, it is a function of math.

Let’s assume an investor wants to compound their investments by 10% a year over a 5-year period.

Math-Of-Loss-10pct-Compound-011916

The “power of compounding” ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required. In reality, chasing returns is much less important to your long-term investment success than most believe. 

In the end, it does not matter IF you are “bullish” or “bearish.”  The reality is that both “bulls” and “bears” will be owned by the full-market cycle. However, what is grossly important in achieving long-term investment success is not necessarily being “right” during the first half of the cycle, but by not being “wrong” during the second half.


The Bear Awakens

Okay, with that said, let me be the “bear.”

As I noted in the last paragraph above, there are two halves to a full-market cycle as shown below. Notice that peaks in valuations denotes the end of the first half of the full-market cycle.

SP500-Full-Market-Cycles-010516

The concept of the full-market cycle is critically important to understand considering the markets have very likely broken the bullish trend that began in 2009. Take a look at the first chart below.

SP500-MarketUpdate-011516-3

This “weekly” chart of the S&P 500 shows the bullish trends which were clearly defined during their advances in the late 1990’s, 2003-2007 and 2009-present. Each of these bullish advances, despite ongoing bullish calls to the contrary, ended rather badly with extremely similar circumstances: technical breakdowns, weakening economics, and deteriorating earnings.

As I have shown in the chart above, when the markets broke the bullish trends (blue dashed lines), the subsequent bear market occurred rather rapidly. The conversion from the bull market to the bear market was marked by a breakdown in prices and the issuance of a very long-term “sell signal” as noted in the bottom of the chart.

We can look at this same analysis a little differently and see much of the same evidence.

SP500-MarketUpdate-011516

The chart above shows something I discussed last week:

“Markets crash when they’re oversold.”

When markets break their long-term bullish trend supports, combined with important long-term sell signals and a sharp decline in momentum, it has historically denoted the start of a “bearish market trend.” The red highlight denotes the start of the bear market and the yellow highlight shows the ensuing bear market completion. They are swift and brutal.

The next chart, which is the same as above, completes the analysis by pointing out the important signals showing the change in trend.

SP500-MarketUpdate-011516-2


Looking For A Sellable Bounce

It is important to note that I am not suggesting “selling everything and buying guns and ammo.” Furthermore, for clarity, I HAVE NEVER suggested being in “all cash.” From a portfolio management standpoint, going from “all equity” to “all cash” and back again have never been a good idea. Trying to “time the market” is impossible to successfully replicate over multiple market cycles.

However, as I regularly write, it is our job to reduce portfolio risk to manageable levels to preserve capital over time. We can do that by increasing and reducing our exposure to equity-related risk by paying attention to the price trends of the market.

Currently, all of the longer-term technical trends are suggesting that the time has likely come to reduce equity risk to more manageable levels. However, that time is not today.

By the time markets register important “sell signals” which denote a change from the bullish to bearish trend, the markets are generally oversold from the selling that is creating the change of trend. This is, as shown in the chart below, always the case.

SP500-MarketUpdate-011516-4

The top section of the chart is a basic “overbought / oversold” indicator with extreme levels of “oversold” conditions circled. The shaded area on the main part of the chart represents 2-standard deviations of price movement above and below the short-term moving average.

There a couple of very important things to take away from this chart.

  1. When markets begin a “bear market” cycle [which is identified by a moving average crossover (red circles) combined with a MACD sell-signal (lower part of chart)], the market remains in an oversold condition for extended periods (yellow highlighted areas.)
  2. More importantly, during these corrective cycles, market rallies fail to reach higher levels than the previous rally as the negative trend is reinforced.

Both of these conditions currently exist.

Does this mean that the markets will go straight down 20% without a bounce? Anything is possible. However, history suggests that even during bear market cycles investors should be patient and allow rallies to occur before making adjustments to portfolio risk. More often than not, it will keep you from panic selling a short-term market bottom.

Take a look at the daily price chart below.

SP500-MarketUpdate-011916

In particular note the top and bottom portions of the chart. These two indicators measure the “over bought” and “over sold” conditions of the market. You will notice that when these indicators get stretched to the downside, there is an effective “snap back” in fairly short order.

As I stated last week, chart updated from then:

“With the markets having issued multiple sell signals, broken very important support and both technical and fundamental deterioration in progress, it is suggested that investors use these “snap back” rallies to reduce equity risk in portfolios.”

While it is possible the markets could rally back to previous support at 1990, what we are looking for primarily is for current oversold conditions to be alleviated. Regardless of where the markets are trading, the time to begin reducing risk is when the short-term overbought conditions return.

Again, let me reiterate that I am not suggesting selling everything, but rather taking a prudent approach to managing risk in your portfolio by:

1) Trimming positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits)

2) Sell those positions that you are “hoping” will get back to even someday. They are losers now and will be bigger losers during the bear market.

3) Move trailing stop losses up to new levels.

4) Review your portfolio allocation relative to your risk tolerance. If you are aggressively weighted in equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

The Risk Of Being Wrong

Could I be wrong? Absolutely.

This entire outlook could literally change overnight if the Federal Reserve leaps into action with a rate cut, another liquidity program or direct market intervention.

If it does, then I will recommend a healthy dose of equity buying to increase risk in portfolios. Sure, I might miss a little of initial upside, but my portfolios will be quickly realigned to participate with a much higher reward to risk ratio than what currently exists.

If I am right, however, the preservation of capital during an ensuing market decline will provide a permanent portfolio advantage going forward. The true power of compounding is not found in the winning, but in the not losing.  

lance_sig

Lance Roberts

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: Managing A Trend Change

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In last weekend’s newsletter (subscribe for free e-delivery) I discussed the ongoing topping process and the issuance of all three “sell signals,” which only occur at major market peaks. To wit:

“Over the last couple of months, I have repeatedly discussed the deterioration of market breadth, momentum and the fundamental backdrop of the markets.

>> Signs Of A Fundamental Top

As shown in the chart below, not only have both lower sell signals been triggered by deterioration in price momentum, the short and long-term moving averages have now crossed.”

SP500-MarketUpdate-010716-2

“Since the turn of the century, the two primary moving averages have only crossed three other times – at the peak of the markets in 2001 and early 2008, and in 2011.The difference in 2011 is that while the sharp decline in the prices due to the debt ceiling debate caused the moving averages to cross, the two lower sell signals were not triggered. This kept portfolios allocated more towards equities at that time.

The current topping process, as discussed on Tuesday, is more akin to that seen in 2000 and early 2008. With primary moving averages now crossed, sell signals in place and markets trading below supports, rallies in equities should be used to rebalance portfolios and reduce risk. 

While the markets are not ‘technically’ in a ‘bear market’ currently, it is important to remember that they weren’t in 2001 and early 2008 either. Waiting to make adjustments until after full recognition of the event doesn’t leave you many options.”

The problem for most investors during market sell-offs is the emotional desire to “panic sell” declines. Emotionally driven investment decisions never work out well.

Navigating A Trend Change

However, understanding market dynamics, and applying a disciplined approach to your portfolio management practices, will provide for better control over portfolio risk in the long run.

The chart below is a VERY long-term look at the S&P 500 going back to 1965. It is a monthly analysis of changes in price momentum and long-term moving average support.

SP500-MarketUpdate-010816

The vertical orange lines are when SELL signals were issued as both momentum turned negative and prices violated the long-term moving average. Conversely, the vertical blue lines are BUY signals when market dynamics reversed to the positive.

Currently, the markets are registering the first confirmed set of monthly SELL signals since the peak of the market in late 2007.

“Oh my gosh, the markets are going to crash I need to sell everything now.”

Stop! That is emotion at work.

With all of the alarm bells currently triggering, the initial “emotionally” driven response is most likely an urge to go look at your portfolio statement and start pushing the “sell” button. Don’t Do It!

On a short-term basis, prices oscillate back and forth like a rubber band be pulled and let loose. Physics state that a rubber band stretched in one direction, will initially travel an equal distance in the opposite direction when released.

Take a look at the chart below.

SP500-MarketUpdate-011216

In particular note the top and bottom portions of the chart. These two indicators measure the “over-bought” and “over-sold” conditions of the market. As with the rubber band example above, you will notice that when these indicators get stretched to the downside, there is an effective “snap back” in fairly short order.

With the markets having issued multiple sell signals, broken very important support and both technical and fundamental deterioration in progress, it is suggested that investors use these “snap back” rallies to reduce equity risk in portfolios. 

Whatever relief rally comes, starting today, will likely be brief in nature. It is suggested that some actions are taken within portfolios to reduce excess exposure to risk.

A Note On Risk Management

There are no great investors of our time that “buy and hold” investments. Even the great Warren Buffett occasionally sells investments. Successful investors look to buy when they see value and sell when value no longer exists.

Investing for the long-term requires attention, patience and discipline. Things that work today, will not work tomorrow. Companies that are great investments today, will not be in the future. That financial markets are a living, breathing, reflection of the psychology of the herd of individuals making buy/sell decisions on a daily basis.

Just like a school of fish, the direction of the markets can take a swift and unexpected turn at moments notice leaving you exposed to the risk that prevails.

While there are many sophisticated methods of handling risk within a portfolio, the use of a simplistic method of price analysis can be a valuable tool over long-term holding periods. Will such a method ALWAYS be right? Absolutely not. However, will such a method keep you from losing large amounts of capital? Absolutely.

The chart below shows a simple moving average crossover study. The actual moving averages used are not important, but what is clear is that using a basic form of price movement analysis can provide a useful identification of periods when portfolio risk should be REDUCED. Importantly, I did not say risk should be eliminated; just reduced.

SP500-MovingAverage-Xver-Study-011216

Again, I am not implying, suggesting or stating that such signals mean going 100% to cash. What I am suggesting is that when “sell signals” are given that is the time when individuals should perform some basic portfolio risk management such as:

  • Trim back winning positions to original portfolio weights: Investment Rule: Let Winners Run
  • Sell positions that simply are not working (if the position was not working in a rising market, it likely won’t in a declining market.) Investment Rule: Cut Losers Short
  • Hold the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

Missing The 10 Worst Days

The reason that portfolio risk management is so crucial is that it is not “missing the 10-best days” that is important, it is “missing the 10-worst days.” The chart below shows the comparison of $100,000 invested in the S&P 500 Index (log scale base 2) and the return when adjusted for missing the 10 best and worst days.

Math-Of-Loss-122115

Clearly, avoiding major draw-downs in the market is key to long-term investment success. If I am not spending the bulk of my time making up previous losses in my portfolio, I spend more time compounding my invested dollars towards my long term goals.

You Can’t Handle The Volatility

Despite the mainstream attempt at convincing you that it is “time in the market” that matters, the reality is that there have been many periods in history where you simply “ran out of time.” As shown, when adjusted for inflation, there are several 20-year periods in history where market returns have resulted in either low or negative outcomes.

SP500-Rolling-20yr-Returns-122115

Of course, such dismal forward returns have only occurred when the starting 10-year cyclically adjusted P/E ratio was above 23x earnings. At nearly 26x earnings, this would suggest that “time in the market” may not be as beneficial over the next 20-years.

More importantly, it is the “human factor” that leads to the poorest of outcomes over time. When markets are strongly trending positively, the emotion of “greed” leads to a diminished understanding of risk contained within portfolios. Even the worst possible investment mistakes are masked by a strongly rising prices.

(It is near the peak of these periods when articles espousing “this time is different” and chastising those that “missed the rally…”)

However, it is only after a significant decline in prices, and a large amount of capital destruction, that individuals “panic sell” to stop the “pain of loss” as the risk in portfolios is realized. This is where investors do the most damage to their long-term portfolio goals. I have published the following “investor psychology” chart many times in the past – the message is all too clear.

Investor-Psychology-011216

Let me reiterate this point. A strict discipline of portfolio risk management will NOT eliminate all losses in portfolios. However, it will minimize the capital destruction to a level that can be dealt with logically rather than emotionally.

There is no reason to “benchmark” your portfolio to some random index. Investing is not a competition and, as history shows, there are horrid consequences for treating it as such. This is why incorporating some method of managing the inherent risk of investing over full-market cycle.

In the long run, you probably will NOT beat the index, but you are likely to achieve your financial goals which is why you invested in the first place.

lance_sig

Lance Roberts

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In

Technically Speaking: Rough Start To New Year

“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.


In the last “Technical Update” I discussed the outlook for 2016 (you can also get the full version here) and the risks that lay ahead as we approach the end of the first half of the full market cycle.

The New Year, unfortunately, started off with the wrong kind of bang. However, the sell-off was not unanticipated. As I stated previously, a lot of the selling in December was a result of capital losses being taken by institutional players for tax purposes for the 2015 tax year. Monday’s decent was the opposite.  Most of the action appeared to be capital gains harvesting for the 2016 tax year where taxes will not have to be paid for 15 months.

I say this because the focus of the bloodbath on Monday was last years big winners – the FANG trade: Facebook (-2.33%), Amazon (-5.76%), NetFlix (-3.86%), and Google (-2.25%). Financials, Healthcare, Mid/Small-Cap and Emerging Markets also took a pretty healthy beating.

However, regardless of the reasoning behind the sell-off, the technical downtrend that begin in December remains firmly entrenched. As I wrote last week:

After a second attempt at the downtrend resistance, the market has built an accelerated downtrend. If the market is unable to reverse this decline in short-order, the odds of a more substantial correction increase.”

SP500-MarketUpdate-010516

(Chart updated through Monday’s close)

Importantly, the ongoing topping process continues in earnest. As shown in the two charts below, the current topping process is very akin to the processes witnessed at the previous two major market peaks in 2000 and 2007.

You can clearly see the topping process being made over the last 18 months in the market. Until, or unless, the market can break out of the current downward trend, the risk of lower asset prices remains elevated.

SP500-MarketUpdate-010516-3

As I stated above, the chart below shows the current topping process at the peaks of the last two major bull markets. The current topping process has been extended due to ongoing global bank interventions (and a lot of exuberance) but even those interventions now appear at risk of no longer working.

SP500-MarketUpdate-010516-2


A Fundamental Topping Process? 

While price action certainly appears to be taking the shape of a topping process, we can also see similar issues emerging in more traditional fundamental measures of the market as well.

For example, take a look at corporate profits as a percentage of GDP. While it is widely hoped by analysts that the current slump in corporate profitability is only a transient issue due to slumping oil prices, a more historical perspective suggests the current profit cycle has come to an end. Previous peaks in corporate profits have led more severe declines in the financial markets as well as the onset of recessionary environments.

Profit-Margins-GDP-SP500-010516

Valuations also suggest the current bull market may be close to completing the first half of the full market cycle. While many look at the smoothed 10-year valuation measure (CAPE), a shortened 5-year analysis has provided a better leading indicator of market cycles.

Note that peaks in the 5-year cyclically adjusted P/E ratio have typically led major peaks in the inflation-adjusted S&P 500 index.

PE-CAPE5-010516

We can also see evidence of a more fundamental weakness in the markets by looking at market capitalization as a ratio to economic growth (GDP). The first chart below is the inflation adjust S&P 500 index market capitalization as compared to real GDP. There are two things of importance to note:

  1. The current peak in the market cap/GDP ratio is the second highest in history.
  2. While early in the process, the current peak has many of the same structures which led to previous major market downturns.

SP500-MarketCap-GDP-010516

The same can be seen in Warren Buffet’s favorite valuation indicator. The Wilshire 5000, which is a very broad market index, provides a better measure of total market activity. Currently, as with the S&P 500, the Wilshire 5000 market cap is at levels only witnessed previously during the “dot.com” mania. While this particular indicator has not begun to peak as of yet, it remains an important reminder of the extreme valuations that current exist in the financial markets.

Buffett-Indicator-010516

From both from a technical and fundamental view, the markets appear to be in the process of forming a cyclical top. While such a view is considered “bearish” and quickly dismissed in the “hopes” of further market gains, it should be remembered that such is part of the normal full market cycles that have existed throughout the entirety of the financial markets. As shown in the chart below, the combination high prices and valuations have been the hallmark of the conclusion of the first half of the cycle.

SP500-Full-Market-Cycles-010516

Lastly, as I wrote previously in “All Bubbles Are Different:”

“Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions.

The chart below is an example of asymmetric bubbles.

Asymmetric-bubbles

The pattern of bubbles is interesting because it changes the argument from a fundamental view to a technical view. Prices reflect the psychology of the market which can create a feedback loop between the markets and fundamentals.

This pattern of bubbles can be clearly seen at every bull market peak in history.The chart below utilizes Dr. Robert Shiller’s stock market data going back to 1900 on an inflation adjusted basis with an overlay of the asymmetrical bubble shape.”

Asymmetrical-Bubbles-010516

There is currently a strong belief that the financial markets are not in a bubble. The arguments supporting those beliefs are all based on comparisons to past market bubbles.

The inherent problem with much of the mainstream analysis is it assumes everything remains status quo. However, the question remains of what can go wrong in the markets? In a word, “much.”

Economic growth remains very elusive, corporate profits appear to have peaked, and there is an overwhelming complacency with regards to risk. Those ingredients, combined with a tightening of monetary policy by the Federal Reserve, leaves the markets more vulnerable to an exogenous event than currently believed.

It is likely that in a world where there is “little fear” of a market correction, an overwhelming sense of “urgency” to be invested and a continual drone of “bullish chatter;” markets are poised for the unexpected, unanticipated and inevitable completion of the full market cycle.

Take a step back from the media, and Wall Street commentary, for a moment and make an honest assessment of the financial markets today. If our job is to “bet” when the “odds” of winning are in our favor, then exactly how “strong” is the fundamental hand you are currently betting on?

This “time IS different” only from the standpoint that the variables are not exactly the same as they have been previously. Of course, they never are, and the result will be “…the same as it ever was.”

lance_sig

Lance Roberts

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” 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, and Linked-In