Market Finally Breaks Out

May 18th, 2015
in contributors

X-factor Report 17 May 2015

by Lance Roberts, StreetTalk Live

I have been discussing over the last couple of months the potential resolution of the consolidation pattern that has confined the markets to a fairly narrow trading range,

Follow up:

to wit:

"Despite the recent weakness seen since the beginning of this year, the market has remained solidly in its uptrend that began in December of 2013. Since that time, the markets have proceeded in one of the longest stretches in history without a 10% correction or more. This is abnormal by any measure and has been a function of investor exuberance and continued hopes of ongoing Central Bank interventions globally.

The daily chart of the S&P 500 below clearly shows that the 150-day moving average has formulated the underlying support of the current bull trend. The break of that support this past October should have culminated in a much bigger decline. However, that V-shaped recovery back into the bull trend, spurred by Federal Reserve member Bullard's comments and Japan's expansion of its QE program, kept the overall momentum alive."


"I have noted in gray the previous consolidation that occurred from December through January of this year. That consolidation was eventually resolved to the upside, and the markets were able to obtain a marginal new high.

As noted in red, the current consolidation is still at work and has not yet resolved itself. A breakout to the upside should allow for marginal new highs to once again be established. This outcome is quite likely given the current momentum of the market.

This is why, in the short-term, the model allocation remains fully invested. As long as the bullish trend remains intact, there is no reason to become more defensive currently."

This past week, as I suggested above, the market did indeed break out to new highs.


This suggests that portfolios should remain FULLY ALLOCATED to equities for the time being as the tendency for the markets remains upwardly biased.

WARNING: This does NOT mean that this will be the case for the next three (3) months or the next year. It just means that the markets are still moving higher at the current time. However, investors should continue to monitor portfolios and manage risk going forward as things will change. As I stated previously:

"...this does NOT mean that all market risk is now resolved, or that investors should return to their complacent slumber."

Time To Buy Bonds

As I discussed in detail during last week's newsletter, and reiterated in a recent blog post, it is now time to add bonds into portfolios. The chart below details my bond "buy/sell" calls going back to 2013.


Importantly, the steady deterioration in economic data suggests that interest rates will remain range-bound for quite some time. As I discussed last week:

"The problem with most of the forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds.

However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy. Interest rates, however, are an entirely different matter.

While there is not much downside left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases. Since interest rates affects 'payments,' increases in rates quickly have negative impacts on consumption, housing, and investment.

This idea suggests is that there is one other possibility that the majority of analysts and economists ignore which I call the 'Japan Syndrome.'"


"Japan is has been fighting many of the same issues for the past two decades. The 'Japan Syndrome' suggests that while interest rates are near lows it is more likely a reflection of the real levels of economic growth, inflation, and wages. If that is true, then rates are most likely 'fairly valued' which implies that the U.S. could remain trapped within the current trading range for years as the economy continues to 'muddle' along.

So, can we just put the recent bump in interest rates into some perspective? Will the 'bond bull' market eventually come to an end? Yes, eventually. However, the catalysts needed to create the type of economic growth required to drive interest rates substantially higher, as we saw previous to the 1960-70's, are simply not available today. This will likely be the case for many years to come as the Fed, and the administration, comes to the inevitable conclusion that we are now caught within a 'liquidity trap' along with the bulk of developed countries."

As discussed in last weeks' missive, bond funds/ETF's are not a "buy and hold" investment but must be traded relative to the rise and fall of interest rates.

The recent rise in rates due to fear of Federal Reserve rate hikes is likely over for now and the continued spate of weak economic data will continue to stretch out Wall Street's expectations of Fed action.

(Note: as I have stated many times previously, the Fed will likely not be able to raise rates this year due to continued weak economic data.)

Time To Take Some Actions

The breakout of the consolidation to the upside suggests that investors who portfolios are not in alignment with the basic model (see 401k plan manager), should take some action.

  • Increase equity and fixed income exposure to target weights
  • Reduce overweight cash holdings back to targets
  • Increase bond weightings back to target after recent profit taking recommendations

However, as regularly stated in this missive, such actions should be consistent with your own "risk tolerance" and "goals." The breakout could be rather short lived and could disappoint investors during the seasonally weak period this summer.

Importantly, as I wrote in "Some Thoughts On Long Term Investing:"

  • Investing is not a competition. There are no prizes for winning, but there are severe penalties for losing.
  • Emotions have no place in investing. You are generally better off doing the opposite of what you "feel" you should be doing.
  • The ONLY investments that you can "buy and hold" are those that provide an income stream with a return of principal function.
  • Market valuations (except at extremes) are very poor market timing devices.
  • Fundamentals and Economics drive long-term investment decisions - "Greed and Fear" drive short term trading. Knowing what type of investor you are will determine the basis of your strategy.
  • "Market timing" is impossible - managing exposure to risk is both logical and possible.
  • Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.
  • There is no value in daily media commentary - turn off the television and save yourself the mental capital.
  • Investing is no different than gambling - both are "guesses" about future outcomes based on probabilities. The winner is the one who knows when to "fold" and when to go "all in".
  • No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

As an investment manager, I am neither bullish nor bearish. I simply view the world through the lens of statistics and probabilities. My job is to manage the inherent risk to investment capital. If I protect the investment capital in the short term - the long-term capital appreciation will take of itself.

Therefore, if you want to hold more cash or fixed income than the model shows, that is completely acceptable. If you want to be more aggressive, that is okay also as long as you are aware that the additional risk will provide little actual increase in long-term returns but will substantially increase losses during a decline.

For new readers let me quickly repeat the portfolio management rules from the last couple of weeks.

" is worth remembering that portfolios, like a garden, must be carefully tended to otherwise the bounty will be reclaimed by nature itself. If fruits are not harvested (profit taking,) they 'rot on the vine.' If weeds are not pulled (sell losers,) they will choke out the garden. If the soil is not fertilized (savings,) then the garden will fail to produce as successfully as it could.

So, as a reminder, and considering where the markets are currently, here are the rules for managing your garden:

1) HARVEST: Reduce "winners" back to original portfolio weights. This does NOT mean sell the whole position. You pluck the tomatoes off the vine, not yank the whole plant from the ground.

2) WEED: Sell losers and laggards and remove them garden. If you do not sell losers and laggards, they reduce the performance of the portfolio over time by absorbing 'nutrients' that could be used for more productive plants. The first rule of thumb in investing: 'Sell losers short.'

3) FERTILIZE AND WATER: Add savings on a regular basis. A garden cannot grow if the soil is depleted of nutrients or lost to erosion. Likewise, a portfolio cannot grow if capital is not contributed regularly to replace capital lost due to erosion and loss. If you think you will NEVER LOSE money investing in the markets...then STOP investing immediately!

4) WATCH THE WEATHER: Pay attention to markets. A garden can quickly be destroyed by a winter freeze or a drought. Not paying attention to the major market trends can have devastating effects on your portfolio if you fail to see the turn for the worse. As with a garden, it has never been harmful to put protections in place for expected bad weather that didn't occur. Likewise, a portfolio protected against 'risk' in the short-term, never harmed investors in the long-term."

That's enough for this week. Have a great week and email me if you need any assistance.

Disclaimer: All content in this newsletter, and on, is solely the view and opinion of Lance Roberts. Mr. Roberts is a member of STA Wealth Management; however, STA Wealth Management does not directly subscribe to, endorse or utilize the analysis provided in this newsletter or on in developing investment objectives or portfolios for its clients. Please read the full disclaimer.

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