I was expecting the market to head higher into the new year but now I am not so sure that we will get the widely expected Santa Clause Rally. The S&P 500, NASDAQ and Russell 2000 Indexes are all BELOW their respective 200-day moving averages (dma) except for the Dow. The Dow holds more defensive names and I am seeing big money flows out of the Techs into the presumed big names like Coke, Procter & Gamble and Mc Donald’s which populate the Dow. The Dow is showing a pennant formation that could test the highs going into Thanksgiving. However, most of the former leading stocks remain in busted patterns that may need time to heal. Many mutual funds must stay fully invested and their charts are telling me that they are trying to hide in some of the big Consumer Staple names. I don’t believe this is a healthy sign for the bulls and it might be a good time to jump in the Bear camp (short) until the Indexes can rally firmly above their 200 dma. I do not have any shorts or longs currently, but I am looking for set-ups on either side.
The Junk Bond market continued its steep down-trend! I believe Junk Bonds are a good indicator of investor’s appetite for risk and the market currently seems to have a weak stomach for risk. Junk Bond prices are declining on above average volume (foot-prints) and that tells me that big money is flowing out of Junk! When large institutional money moves in or out of a position, they tend to leave big foot-prints and I try to pay attention to these big moves. In my opinion, Institutions are usually right because they can hire the best analysts that typically see moves before the average investor. Institutions are the cruise ships that create the trends/waves that I (speed boat) like to follow. I can turn on a dime, but it may take institutions weeks or months to make a turn. Remember, the trend is your friend.
Oil prices have declined about 25% since October 3rd! Many oil service company’s profitability is tied to the price of oil. Many oil related companies have issued Junk Bonds that appear to be more at risk of default as oil declines. Another factor putting pressure on oil (traded in dollars) is a rising dollar because a stronger dollar can buy more oil. Junk Bonds are telling me that risk is continuing to elevate, and I am concerned that there may be more downside risk ahead for the Indexes.
Investor’s Business Daily (IBD) declared a Follow Through Day (FTD) on October 7 marking a peak that has yet to be challenged. An FTD is when a major Index is up at least 1.4% and volume is higher than the previous day. We have had three Distribution Days since the FTD and that is not a healthy sign to see so much distribution right after an FTD. This FTD could be considered a “failed” FTD because the market has yet to exceed the price on the FTD as indexes trade below their 200-day moving averages. A Distribution Day is when a major Index is down at least 0.20% on higher volume that the previous day. I took a 25% position in a few stocks breaking out after the FTD, but they turned south so I bailed and went to 100% Cash. I am building my Watch list again and I do have a few stocks that I could buy. However, I am waiting for the market to give me more conviction that we may head higher. I believe that being patient at this juncture is prudent.
Our Fed continues to unwind its QE efforts from years past to the tune of about $40 billion/month. That means that the Fed has plans to remove about $40 billion per month of liquidity in the market. We all seemed to have benefited from the Fed’s balance sheet expansion (QE) efforts as they likely saved us from a financial collapse in 2008. However, the Fed’s Balance Sheet is still above $4.1 trillion! The European Central Bank (ECB) plans to reduce its flow of QE while the Bank of England may have to move in the opposite direction and increase QE due to Brexit issues. It may be necessary for the U.K. to increase QE as the European Union (EU) attempts to prevent Brexit.
Going back 60 years, a divided Congress (gridlock) after midterms has been good for the stock market over the following two years. A unified Congress controlled by the party in opposition to the president has had the worst preference over the succeeding two years. Since 1946, there have been 18 midterm elections. Stocks were higher 12 months after every single midterm, rising an average of 17% in the year after a midterm election despite any political combination over the past 72 years. Since 1990, the major indexes have finished flat to higher after midterms in every year except 1994. Those are interesting facts, but I rely on what the stock market leaders are currently doing to help me discern how much risk is in the market and how I should be positioned.
The markets are concerned about what will happen to trade, health care, immigration, taxes and fiscal policy. I believe that the President’s pro-business and de-regulatory policies will “trump” the counter agenda of the House Democrats who are now in the majority. This does not mean that the market will not struggle through some rough waters which I believe it will. One should always be prepared to abandon ship if we start to take on water. No one needs to go down with a sinking ship if we know how to swim. If you do not know how to swim, now might be a good time to practice. It is always a good idea to learn how to fire a gun before you go into battle. Cash can be a good place until the next “wave” or opportunity starts.
Sometimes you win by not losing. We have all heard “it is not what you make that counts, it is what you keep that counts”. My focus has always been on risk-management. I focus on what I can control and that is how much risk I take. I cannot control the return because that is determined by the market. It takes an 8% gain to get back to break even from an 8% loss! However, a 25% loss requires a 33% gain to break even and a 75% loss requires a 300% gain to get back where you started. A rising tide lifts all boats so don’t wait until the tide goes out to see who is swimming naked. Do your homework and assess your risk every day because no one cares more about your money than you do. A healthy defense is just as important as a good offense and losing the least can sometimes put you ahead of the best. The secret to compounding money is not just about making money when the market is good, it is also about managing your gains when the market isn’t rewarding you for taking risk. Sell rules are designed to limit your losses. I try to lose the least amount of money when I am wrong and make big money when I am right. Losing money is tough but losing confidence in your ability to manage money is something we must all guard against. There are the quick and there are the dead. Stay alive!
Bottom Line: I am cautious because I believe risk has increased! This may be a time to build your Watch List and be patient until the Indexes get back above their 200 dma. I am looking for Leading stocks in Leading industries to break out of sound base patterns on strong volume (big foot prints). This will indicate to me that it may be safe to dip my toe in the water. I hate losing money!
(Portfolio holdings are subject to change at any time and should not be considered investment advice. There is no guarantee that any investment will achieve its objectives, generate positive returns or avoid losses.)
Coffee is high in antioxidants, and studies show that coffee drinkers live longer, and have a reduced risk of type 2 diabetes, Parkinson’s disease, Alzheimer’s and numerous other diseases.
It is during our darkest moments that we must focus to see the light.
Verse of the Day:
May the God of hope fill you with all joy and peace as you trust in him, so that you may overflow with hope by the power of the Holy Spirit. Romans 15:13
The chart below shows the YTD total return of LIONX (Red) verses S&P 500 (Green). I believe that managing risk is the key to long-term success. Notice how less volatile LIONX is for a similar return!