Short-Term Sell Signal Deepens
As noted last week:
“The weakness in the market previously, combined with the threats between the U.S. and North Korea, led to a fairly sharp unwinding in equities on Thursday which in turn triggered a short-term sell signal.
That sell-off has remained confined to the current bullish trend line but has threatened to violate the 50-dma. If the market is unable to regain the 50-dma on Monday, and remain above it for the balance of the coming week, the most likely move in the markets will be lower.“
I have updated the chart above through Friday afternoon. I followed that analysis up on Tuesday stating:
“On Monday, the market surged out of the gate as headlines suggested ‘geopolitical risk’ had subsided. I find this particular explanation hard to digest, given the rising rhetoric of a potential trade war with China, violence in Charlottesville over the weekend, no resolution with North Korea, etc., so forth, and so on. I find little evidence of a global turn in geopolitical stresses currently.
Monday’s ‘buy the dip’ frenzy was no different. The question will be whether the market can both reverse the short-term ‘sell signal’ and climb above the previous resistance of the old highs? Such a reversal would end the current consolidation process and allow for additional capital to be invested.”
That was so last Tuesday…
The reversal, at least to this point, was not to be the case.
Exactly one week after last week’s sell off, the market dumped again. This time it was the news of the complete dismemberment of President Trump’s “economic council” of CEO’s along with the rumor that Gary Cohn would be exiting his position at the White House as well. While the latter turned out to be #FakeNews, the damage had already been done as market participants began to question the ability of the Administration to get its promised legislative action advanced.
Given the run up in the markets since the election, which was based on tax cuts/reform, infrastructure spending, repatriation and repeal of the Affordable Care Act, the lack of progress on that agenda has left the markets pushing higher on “hope” and “promises.” The disbanding of the economic council has led to some disruption of that confidence.
Importantly, with the market currently on a weekly sell signal, it also compounded the bulls problems by breaking the bullish trend line that begins in February of last year.
This is not a “panic and sell everything” signal….yet.
It is, however, a potentially important change to the bullish backdrop of the market in the short-term particularly given the ongoing deterioration in the internal participation in the market. Note that when sell signals have been triggered from similarly high levels (vertical red dashed lines), subsequent corrections have been fairly brutal.
Previously, I questioned whether, or not, to “buy the dip?”
“My best guess currently is – probably. But not yet.”
I also stated the following two reasons for that sentiment:
- Bull markets don’t typically end when the mainstream media is “peeing down both legs” over the 1.5% drop on Thursday.
- The bullish uptrend remains intact and “fear” gauges remain confined to a downtrend.
This remains this week as well. The sell-off, so far, remains contained above the previous bullish breakout to new highs and remains above current price support levels. Furthermore, while volatility did pick up a bit on Thursday, it has not exceeded last week’s volatility spike suggesting traders are less worried about a correction than media headlines makes it appear.
As noted last week, I still believe this to be the case currently:
“The market remains confined within its overall bullish trend while volatility remains confined to downtrend. Given this backdrop, I would suspect that current weakness will result in an internal rotation of sector participation as ‘bulls’ continue to ignore the mounting risk of deteriorating of reported EPS growth, weak revenue growth, slowing economic growth and fading realities of positive legislative agenda coming to fruition.”
Prepping For Action
Last week, I stated that in our core portfolios, we would wait for confirmation the current sell-off has abated before adding additional risk exposure to portfolios.
“In recent years, such market tantrums have been very short-lived and have provided opportunistic entry points for increasing equity-related exposure. However, EVERY TIME is DIFFERENT, so it is always important to NEVER ASSUME the outcome will be the same as the last. That is how you wind up losing a lot of money.”
From a technical basis, there are two potential outcomes as shown below:
The market regains its footing next week and rallies strongly enough to break above the downward trending levels of previous rally attempts. Such action would confirm the bullish trend remains intact and would provide the opportunity to rebalance equity exposure to model weights accordingly.
The market rallies to the upwardly sloping “bullish trend line” that began with the election of President Trump. The rally fails at resistance and turns lower. Such a failure would confirm the current short-term bullish trend has likely concluded leading to a reduction of equity exposure, increases in cash positions and fixed income, and a reduction in overall portfolio equity risk.
What To Do Now
I made a mistake following Monday’s rally by adding mildly to underweight positions in portfolios. Those positions are now under direct threat of being stopped out with the current action. That is part of the investing process, not everything always works out as we plan.
However, we are now actively reviewing all of our portfolios, and positions, in order to be prepared to take action depending on what happens given our two scenarios above.
As I have addressed previously, managing a portfolio is very much like managing a garden. It isn’t about taking drastic action to be “all in,” or “all out,” but rather planting and harvesting according to the season.
- Prepare the soil (accumulate enough cash to build a properly diversified allocation)
- Plant according to the season (build the allocation given the right “season”)
- Water and fertilize (add cash regularly to the portfolio for buying opportunities)
- Weed (sell loser and laggards, weeds will eventually “choke” off the other plants)
- Harvest (take profits regularly otherwise “the bounty rots on the vine”)
- Plant again according to the season (add new investments at the right time)
So, with this analogy in mind, here are the actions to continue taking to prepare portfolios for the next set of actions:
Step 1) Clean Up Your Portfolio
- Tighten up stop-loss levels to current support levels for each position.
- Hedge portfolios against major market declines.
- Take profits in positions that have been big winners
- Sell laggards and losers
- Raise cash and rebalance portfolios to target weightings.
Step 2) Compare Your Portfolio Allocation To The Model Allocation.
- Determine areas requiring new or increased exposure.
- Determine how many shares need to be purchased to fill allocation requirements.
- Determine cash requirements to make purchases.
- Re-examine portfolio to rebalance and raise sufficient cash for requirements.
- Determine entry price levels for each new position.
- Determine “stop loss” levels for each position.
- Determine “sell/profit taking” levels for each position.
(Note: the primary rule of investing that should NEVER be broken is: “Never invest money without knowing your ‘sell points’ when you are both wrong AND right.”)
Step 3) Have positions ready to execute accordingly given the proper market set up. In this case, we are looking for a failure at the bullish uptrend to begin to execute Step (1) above.
IMPORTANT NOTE: Taking these actions has TWO specific benefits depending on what happens in the market next.
- If the market pulls breaks back above resistance and confirms the bullish trend, the actions have cleared out the “weeds” and allowed for “new planting” to benefit from the next advance.
- If the market fails and suggests further declines to come, then the reduction of “risk” protects the portfolio against any substantial decline.
No one knows for sure where markets are headed in the next week, much less the next month, quarter, year, or five years. What we do know is that not managing risk in portfolios to hedge against something going wrong is far more detrimental to the achievement of long-term investment goals due to the inability to recover the “time” lost getting back to even.