Next Chess Moves Ready To Go

September 30, 2014

The rules allow us to make intraday changes when the market’s profile is this vulnerable. We have levels picked out and the next set of defensive orders ready to go. Price and the markets will guide us over the next few days. The bulls have very little margin of error, but the S&P is still holding near its 50-day (for now).

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Guideposts For An Indecisive Stock Market

September 30, 2014

Three Economic Strikes

Tuesday’s economic news carried a theme of “below expectations”. From The Wall Street Journal:

The Chicago Business Barometer, referred to as the Chicago PMI, fell to 60.5 in September from 64.3 in August. Economists surveyed by The Wall Street Journal had expected a reading of 62. The Conference Board’s index of consumer conference fell to 86 in September from 93.4 in August, missing expectations for a reading of 92.8. And the S&P/Case-Shiller Home Price Index showed U.S. home prices rose 5.6% in the 12 months ended in July, down from 6.3% in June. Economists surveyed by The Wall Street Journal had expected a 5.8% rise in the national index. The 20-city price index rose 6.7%, less than the 7.3% expected.

Short-Term Guideposts

As noted in this week’s video, the broader equity market is showing some “pay attention” signals, along with deteriorating market breadth. On the bullish side of the ledger, the longer-term charts still look good and we know an open mind is required when the S&P 500 is hovering near a flat 50-day moving average (as it is now). Therefore, drawing lines in the sand can help us balance the need to be patient with the need to protect capital in the event of ongoing weakness. In the short-term, if Monday’s lows are taken out, it increases the odds of additional weakness in stocks (see point A below). The odds of good things happening short-term will increase if the NYSE Composite can close above its 50-day (near point B).

The current state of weekly stock market momentum (very weak and vulnerable) tells us risk levels need to be watched closely. We are accounting for downside risks with a higher than normal stake in cash and IF, THEN contingency planning. Wednesday brings a report on manufacturing and Friday features the monthly labor report.

Sign image from The Tire Zoo (slightly altered)

Key Week For Bull/Bear Battle

September 29, 2014

Good News, Bad News

An encouraging economic report was released Monday, which increased concerns about a sooner rather than later Fed rate hike. From Reuters:

Consumer spending rose 0.5 percent last month after being unchanged in July, the Commerce Department said. The growth in August was just above the median forecast in a Reuters poll of economists…Even after adjusting for inflation, spending was 0.5 percent higher, the biggest gain since March. Growth in personal income ticked up 0.3 percent, in line with forecasts.

Big Picture Deteriorating

This week’s stock market video shows while the bulls are still in control, their margin of error is getting quite thin as interest rate concerns increase.

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1994 Fears Linger

With the Fed signaling “considerable time” may be removed from their policy statement in the coming months, market participants are concerned about a 1994-like event taking place in late 2014 or early 2015. From Businessweek:

The last time consumer-price increases were slowing before the Fed started increasing borrowing costs was in 1994…“The critical example for the markets is 1994, and that’s the thing that we all fear,” Gary Pollack, the New York-based head of fixed-income trading at Deutsche Bank AG’s private wealth management unit.

Investment Implications – The Weight Of The Evidence

Our market model called for a reduction in our equity exposure last week based on evidence of waning economic and market confidence. As shown in the two weekly snapshots of the S&P 500 below, the market’s indecisiveness is starting to impact the intermediate-term trend in a negative manner.

Since the look of a weekly chart is much more important at the end of the week, the bulls do have some time to repair the damage. Therefore, we will continue to hold a mix of stocks (SPY), leading sectors (XLV), bonds (TLT), and an offsetting position in cash until the evidence improves.

Two Big Reports Coming

If there was ever an economic report that could flip the bull/bear field, it would have to be the monthly employment report, which is coming this Friday. Wednesday brings the latest read on U.S. manufacturing activity.

Bull/Bear Tipping Point?

September 26, 2014

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Indecisiveness Means Higher Risk For Stocks

September 26, 2014

GDP Will Keep Fed Fears In Play

As we will demonstrate via charts below, the financial markets have been becoming increasingly concerned about the coming shift in Fed policy. Friday’s economic data reinforces the idea that the Fed has to begin raising rates soon given recent economic improvements:

From The Wall Street Journal:

The U.S. economy grew in the spring at the fastest pace since late 2011, another sign the recovery is accelerating after five years of sluggishness. The economy last grew at a 4.6% pace in the fourth quarter of 2011 and hasn’t exceeded that rate since the first three months of 2006.

Investment Buckets

The million dollar question in 2014:

Is the economy strong enough for stocks to withstand higher interest rates?

The concept of investment buckets can help us monitor the risk related to a Fed-induced correction in stocks. In the 1990s, tech stocks were the place to be. After the dot-com bust, those who placed their money in bonds or shorted stocks did very well until October 2002. The winning asset class between late 2002 and October 2007 was stocks. History tells us picking the right asset class bucket is extremely important in the quest for satisfying investment returns.

Limited Capital To Allocate To Buckets

With central banks around the globe skewing the prices of stocks and bonds via artificially low interest rates, it has become more difficult to monitor risk and make allocation decisions.

Paying Attention Works

To gain a better understanding of how monitoring the markets can assist with investment risk management, consider the statement made above:

After the dot-com bust, those who placed their money in bonds or shorted stocks did very well until October 2002.

With the benefit of hindsight, the statement above seems obvious to anyone who lived through the 2000-2002 bear market in stocks. Was there a logical way to sidestep the painful losses experienced by stockholders (March 2000 - October 2002)?

Evidence Showed An Observable Shift

From a probability perspective, the answer is yes by simply paying attention to what was happening, rather than focusing on what might happen next. The charts below clearly identified a shift from “risk-on” to “risk-off” that occurred as the dot-com bubble was bursting.

In the second half of 2000, with the S&P 500 ETF (SPY) trading near $112, a clear and observable shift favoring bonds over stocks had taken place (see Section A below). After the charts said “bonds are a better place to be than stocks”, SPY dropped an additional 44% before hitting bottom at $63.14 in October 2002. Section A in the image below shows the performance of bonds (VBMFX) relative to the S&P 500. Section B is the S&P 500 in isolation. Section C is bonds in isolation.

What Are The Markets Telling Us Now?

As we noted September 16, bullish momentum has slowed noticeably in recent weeks, which tells us to keep an open mind about further weakness in stocks. The chart below shows the weekly trends continue to favor stocks over bonds (AGG). However, the market is not as confident today as it was earlier this year (compare slopes of green and orange lines). The slope of the orange line indicates confusion about Fed policy, the economy, and the stock market’s ability to avoid a corrective episode.

Investment Implications - The Weight of The Evidence

Is the market’s indecisiveness related to the Fed particularly new? No, we outlined our concerns in more detail in this September 12 video clip, which made it easier to cut risk this week. During Thursday’s selloff in stocks, numerous forms of support were violated (see chart below).

Our market model allocates heavily to equities when the odds of success are favorable. With the break of support in the chart above, and given the market’s current bigger picture profile, the odds of success have shifted this week to mixed-to-unfavorable. Therefore, a lower allocation to stocks is prudent until things improve. We reduced our exposure to stocks three times between Tuesday and the end of Thursday’s session. We will enter Friday’s session with a flexible and open mind, but the market must prove it to us now.

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September 25, 2014

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Managing Stock Market Risk In A Schizophrenic Environment

September 24, 2014

Stocks Reverse Two-Day Slide

Stocks tried to regain their short-term mojo Wednesday following some better than expected economic data and a development on the regulatory front. From Bloomberg:

Data today showed new-home sales in the U.S. surged in August to the highest level in more than six years, a sign that the housing recovery is making progress…Eight of the 10 main S&P 500 groups gained as health-care companies jumped 1.6 percent, after a two-day slide, amid signs the Obama administration’s efforts to curtail tax-friendly overseas deals might fall short.

How Much Damage To Equities?

While the top callers continue to get attention, the reality is stocks dropped for two days following last week’s new highs. The market continues to be concerned about a future shift from the Fed, which aligns well with the historical interest rate cycle script. A Fed-induced correction could occur in the coming months. Is there a way to monitor risk in the equity markets?

Trends Speak To Economic Conviction

Trends can help with risk management. When the net aggregate opinion of all market participants is favorable, markets tend to push higher. Conversely, when the net aggregate opinion becomes pessimistic, markets tend to drop. Moving averages help us monitor the market’s pulse. During a correction, the S&P 500 (shown in black below) tends to drop below the colored moving averages. Also note the slopes of the colored moving averages (MAs) tend to roll over during sharper pullbacks in equity prices. Relative to the bearish period on the left, the bullish period on the right side of the chart looks quite a bit different (price above MAs, slopes of MAs are positive).

How Does The Market Look Today?

The chart below is as of 3:08 p.m. ET Wednesday. While there are reasons to be concerned and to pay closer attention, the market has not rolled over in a significant manner. The chart below tells us to exercise some patience with the core portion of our equity-based holdings.

Investment Implications - The Weight of The Evidence

It is not all fun and games from a risk-reward perspective. Wednesday morning the S&P 500 hit a low of 1,978 and was testing the important cluster of support shown below. The market held, but the issues related to a flat 50-day moving average, outlined on September 16, still apply.

Fed: Mixed Message On Rates

On Tuesday, Federal Reserve Bank of St. Louis President James Bullard said he sees the Fed raising interest rates some time early next year. On Wednesday, Chicago Federal Reserve Bank President Charles Evans took the other side of the argument saying the Fed should be “exceptionally patient” in removing monetary policy accommodation.

Guideposts Can Help

How can we logically balance risk and reward in this schizophrenic environment? One way is to use market levels as a guide. The tweet during Tuesday’s selloff in stocks illustrates the concepts.

The S&P 500 closed below 1984 Tuesday, but above the more important 1976 (50-day moving average). Therefore, we reduced risk in a relatively small manner before Tuesday’s close. When stocks rallied Wednesday, we still had significant equity exposure. Why do we use a level-based and incremental approach?

As long as the S&P 500 holds above the key support cluster in the 1976 area, our bias will be to leave our stocks (VOO) and leading sectors (XLK) alone. Below 1976, we will be more apt to make some additional chess moves. The market will guide us if we are willing to listen.

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September 23, 2014

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A Rational Look At Stock Market Risk

September 22, 2014

No Fear Mongering, Just Facts

Group of 20 finance chiefs and central bankers said current risks include uneven growth and the possibility of excessive risk-taking in a low interest rate environment. They also pointed out that when push comes to shove, they will continue to stimulate. From Bloomberg:

“It is critical that we take concrete steps to boost growth and create jobs,” Australian Treasurer Joe Hockey, who hosted the meeting, told reporters after the communique was released. “We will use all levers available, including additional fiscal and monetary policy leverage where appropriate.”

This Is What Risk-Off Looks Like

If an increasing threat of a global recession is the primary concern, we would expect more conservative assets to be gaining traction. Investor preferences allow us to better understand the stock market’s risk-reward profile. For example, when economic fear was high in 2008, the performance of growth-oriented stocks (SPY) was weak relative to defensive-oriented bonds (AGG) (see chart below).

This is What Risk-On Looks Like

When fear started to subside in March 2009, equities started to outperform bonds, telling us the risk-reward profile of the general stock market was improving.

This Is What Today Looks Like

How does the same ratio look now? September 22, 2014 still looks similar to the “risk-on” period in 2009 rather than the “risk-off” period in 2008, which tells us the bias is still bullish looking out weeks and months. The chart below includes the weak open in stocks on September 22.

But, Bonds Are Impacted By The Fed

A fair criticism of the analysis above is “you can’t rely on those charts in a rising rate environment”. If the stock vs. bond charts are skewed, we can offset that by looking at stocks in isolation. This week’s stock market video compares the S&P 500 in 1987, 2002, 2003, 2007, and 2009 to the present day.

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Investment Implications - The Weight of The Evidence

Even with the S&P 500 down 14 points during Monday’s session, the intermediate-term trend in stocks remains up (see slope of blue 50-day below). Buyers could step in near various forms of possible support between 1975 and 1997.

How long will the bullish trends hold? We don’t know and we do not need to know if we are willing to pay attention meticulously and make portfolio adjustments when the observable evidence changes in a meaningful way. The process could start soon, but for now Monday’s weakness still falls into the “normal and expected volatility within the context of a favorable trend” category. Therefore, we continue to hold stocks (SPY), leading sectors (XLK), and some offsetting exposure to bonds (TLT).

Bear Market Odds: A Rational Assessment

September 19, 2014

Don’t have a plan? Some ideas can be found in this article.

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Still Relevant Big Picture Risk Management Articles - Weekend Reading.
More links and charts on Twitter.