“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 laid out a case for being a bit more “cautious” as the technical action has deteriorated as recession risks have risen.
“More importantly, despite the ongoing defense of support at current levels, the deterioration in momentum and price action has now triggered intermediate and longer-term “sell signals” as shown below.”
“Importantly, notice that both of the previous bullish trend lines (depending on how you measure them) have now been violated. Previously, when both “sell signals” have been triggered, particularly with the market overbought as it is now, the subsequent decline has been rather sharp.”
“Lastly, as stated above, the 50-dma moving average has begun to trend lower, the downtrend resistance from the previous market highs remains present and the “sell signal” occurring at high levels suggests the risk of a further correction has not currently been eliminated.
It is important, as an investor, is not to ‘panic’ and make emotionally driven decisions in the short-term. All that has happened currently is a ‘warning’ you should start paying attention to your investments.
Just be cautious for the moment.”
With earnings season now in full swing, and coming in a bit weaker than expected, volatility at extremely low levels, and the final push to one of the most contentious elections in the history of the country, the question to now ask is “what happens next?”
NOVEMBER STATS & POST-ELECTION HISTORY
As the U.S. Presidential election draws near, it is worth considering how the market has historically performed during the month of November and specifically during election years.
First, if we look at the month of November going back to 1960, we find that there is a bias for the month to end positively 61% of the time. In other words, 3 out of every 5 months finished in positive territory which is why it is included in the seasonally strong period of the entire year. Furthermore, the average and median returns for the month top 1% over the course of that time.
However, when we look at just the November months which coincided with people going to the polls to cast their vote, we find an even split of wins and losses. Even though the number of months are evenly split between gains and losses, the average and median returns were still positive over the given time frame.
Unfortunately, average and median returns aren’t representative of the capital destruction that have taken place historically such as the massive draw drown during the 2008 election. The chart below shows the history of actual market returns by day for every month of November going back to 1960. Importantly, in order for the market to have an average return of 1.01%, it means there has been a variability of returns both above and below that average.
A look at daily price movements during the month, on average, reveal the 5th through the 8th trading days of the month are the weakest followed by mid-month.
However, during election years, we see the same periods remaining weak, but more dramatically so as the volatility of election years skews the average of all years. In other words, regardless of who is elected on the 8th, look for a relief rally on the 9th, followed by a sell-off over the next few days. The traditional post-Thanksgiving rally tends to be stronger performance wise as the “inmates run the asylum” during exceptionally light volume trading days.
Jason Goepfert via Sentimentrader.com did some similar analysis as well recently but took it down to the sector specific level which is helpful in determining what sectors to over/underweight heading into the end of the year.
“We show the same data for each of the 10 major S&P 500 sectors on the next page (REITs aren’t yet included). Again, it’s hard to discern any actionable pattern among the sectors. There was some general weakness in tech ahead of the election, but the group had strong returns in the weeks following, excepting a few large outliers. Financials also did well after the elections, and the returns were more tightly grouped on the upside. Consumer discretionary stocks were the most consistent laggards.”
What If I Am Wrong?
I have repeatedly discussed over the last month the danger of the market correcting to the downside in the near term. With risk/reward dynamics still out of favor, there is little reason to currently be aggressively long equities until the investment environment improves.
I understand the risk of advocating a more conservative posture heading into the “seasonally strong” period of the investment calendar, however, there are many signs suggesting caution. the levels of funds invested “bearishly” is at levels associated with reversals volatility coinciding with market declines.
While the seasonal tendencies suggest an increase in equity exposure, the underlying technical dynamics warn of an increased risk to investment capital. The protection of which is paramount to long-term investment success.
In yesterday’s post 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 longer-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 cannot effectively manage their own money, therefore, indexing is their only choice. I simply disagree.
Yes, managing risk in a portfolio will create underperformance over short-term periods 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 reverse course and begins to rise strongly. The market will have to effectively hit all-time highs at this point to reverse the bearish trends that are currently in place.
However, if the market does re-establish the previous bullish trend, I will certainly recommend strongly increasing allocations to equity-related risk. Any differential in performance which currently exists, will be quickly absorbed.
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 support, the subsequent decline will quickly wipe out what few gains currently exist. The probability of that happening in the months ahead is still very high. The purpose of risk management is to protect investment capital from erosion 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, and deserve, better.
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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