July 29th, 2015
by Lance Roberts, StreetTalk Live
Maybe I should leave town more often. Last week, while on our annual family vacation, Greece caves to the ECB and China stopped their market meltdown sending shares surging higher.
Unfortunately, as I left white, sandy beaches and clear ocean waters behind me to return to the sweltering heat and reality of Houston the markets also returned to reality. As discussed in this past Tuesday's market update:
"While the prices did manage to break out of the downtrend that has contained the market since mid-May, so far that rally has failed to attain new highs. Furthermore, the previous oversold condition that acted as the "fuel" for the recent rally has been exhausted with the markets are now back to an extreme overbought condition. This suggests that there is likely very little upside currently and that investors should consider using this opportunity to engage in prudent portfolio management practices such as taking profits, reducing laggards, and rebalancing allocations."
The chart below is updated through Friday morning's open.
That advice has played out well as the markets have continued to deteriorate, along with a vast majority of internal measures.
The decline this week keeps the market contained within the broader declining consolidation which suggests a lack of strength by bulls currently. However, the long-term bullish support (red-dashed moving average) currently resides at 2085 which should afford some near-term support. However, a failure of that level will likely push the markets back towards 2040 once again.
If we step back and slow volatility down by using a WEEKLY price chart, a clear picture emerges.
You can clearly see that the rising bullish consolidation (dashed blue lines) has been resolved negatively which will keep pressure on stocks in the shorter-term.
Importantly, the market failed to break out to sustained new highs for a third time and the decline back into the current downtrend suggests stocks are likely to work their way lower for now. A break below the weekly long-term bullish trend moving average will set the markets up for a decline back to 2000.
With the markets on their first weekly sell signal since 2007, the bottom part of the chart, the easiest path for prices currently is lower. However, given that the markets have not violated their long-term bullish trends, it does not require a substantial adjustment to portfolio allocations.
However, as I have repeatedly discussed over the last several weeks, prudent portfolio management processes and disciplines are required to reduce inherent portfolio risk. Just to repeat for new readers:
- Sell positions that simply are not working. If they are not working in a strongly rising market, they will hurt you more when the market falls. Investment Rule: Cut losers short.
- Trim winning positions back to original portfolio weightings. This allows you to harvest profits but remain invested in positions that are working. Investment Rule: Let winners run.
- Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low
No Time For Complacency
While the market remains trapped in an evenly matched bout between bulls and bears, this is not a time for complacency.
After an extended run from the end of 2012 through the end of 2014, which was driven by massive liquidity injections by the Federal Reserve, the market has now stalled. If we look back at history, we can see that such periods have typically led to either short-term corrections or more severe market reversions.
With the market still very overbought, the flatlining of markets has historically not ended well for investors. However, until the long-term bullish moving average is violated to the downside, investors should not become overly cautious.
As shown, back in 2007, investors had several opportunities to exit the markets after the top was confirmed but well before the actual "crash" occurred in September of 2008. The current topping process is very similar.
Topping processes are very slow, and frustrating, to mature. However, as investors our job is not to "guess" at what the market might do, but react to changes as they occur. In other words, by allowing the market to "tell" us what actions should be taken in a portfolio, many of the emotional biases can be removed from the portfolio management decision processes.
Currently, there is NO defining evidence that the markets are indeed correcting. Currently, this is an ongoing consolidation process that has yet to resolve itself. If you are GUESSING at the eventual conclusion of this process (bullish or bearish), then you are allowing the emotions of "greed" or "fear" to influence your decision-making process. No matter what decision you make you have a 50% chance of being wrong.
However, by allowing the markets to dictate your actions (which is a confirmation by the majority of investors or "the herd") then the odds of making a successful decision increase dramatically in your favor.
Are there still going to be times that a decision turns out to be wrong? ABSOLUTELY. If that bothers you, or if you have a difficult time taking a quick loss, then you really should not be investing your own money. No one has ever figured out how to "only buy things that go up."
Interest Rates - Told You So
At the beginning of May, I discussed in detail the "surge in interest rates" and why you SHOULD own bonds in your portfolio. (FYI: It is a good primer if you know very little about bonds and how they work.)
I stated then:
"It is likely time to BUY bonds in portfolios or add to underweight bond fund/ETF exposure. With the recent rally in interest rates, as I have been suggesting would happen over the last several weeks, bond prices have become depressed enough to add to existing holdings and increase bond weightings back to target portfolio weights."
Well, since then, two things have come to light.
FIRST: We now know why interest rates surged from the January lows to recent highs of 2.5%.
"Looking at China more specifically, it appears that, after adjusting for currency changes, Chinese FX reserves were depleted for a fourth straight quarter by around $50bn in Q2. The cumulative reserve depletion between Q3 2014 and Q2 2015 is $160bn after adjusting for currency changes. At the same time, a current account surplus in Q2 combined with a drawdown in reserves suggests that capital outflows from China continued for the fifth straight quarter. Assuming a current account surplus in Q2 of around $92bn, i.e. $16bn higher than in Q1 due to higher merchandise trade surplus, we estimate that around $142bn of capital left China in Q2, similar to the previous quarter.
This brings the cumulative capital outflow over the past five quarters to $520bn. Again, we approximate capital flow from the change in FX reserves minus the current account balance for each previous quarter to arrive at this estimate (Figure 2)."
When more bonds are sold than bought, interest rates move higher as bond prices move lower.
SECONDLY: Increased stock market volatility and plunging global growth, particularly as shown by commodities, drives money into "safe" assets. With more deflationary pressures mounting, rates have reversed off of recent highs as expected and are once again moving back towards my target of 2% to 2.2%.
Interest rates are still very OVERBOUGHT currently which suggest that bond remain oversold allowing investors a good opportunity to increase fixed income allocations in portfolios accordingly.
Stay tuned...things are getting more interesting.
Have a great week.
Disclaimer: All content in this newsletter, and on StreetTalkLive.com, 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 StreetTalkLive.com in developing investment objectives or portfolios for its clients. Please read the full disclaimer.