Market Bounces As Expected, Now Execute Sells

September 1st, 2015
in contributors

X-factor Report 30 August 2015

by Lance Roberts, StreetTalk Live

In last week's missive I specifically stated:

"The time has now come to start moving more heavily to cash. As I will discuss throughout this weekend's missive, including the 401k-Plan Manager, it is now time to "OPPORTUNISTICALLY" REDUCE PORTFOLIO ALLOCATIONS.

Follow up:

As noted in the chart below, the markets are now once again extremely oversold. As I have often stated in the past:

"By the time a market signal is given in the market, the markets are very likely at a point of extreme oversold or bought conditions. Therefore, it is always better to use the subsequent relaxation of those extreme conditions to add or reduce portfolio exposure."

This is why it is never a good idea to "panic" when something initially goes wrong.

With the markets now deeply oversold, it is VERY likely that the markets will bounce next week. The problem, for those with "buy and hold" bullishly biased strategies, is the "bull market" has now least for now.

As shown in the next chart, and confirmed by the above, is that a bounce from these oversold levels will run into a substantial amount of overhead resistance where the rally will very likely fail. THIS WILL BE THE POINT TO LIQUIDATE HOLDINGS."

The chart below is updated through Thursday's close.


As I concluded last week:

"The next chart steps back further to look at the bull market that began in 2009. While you have NOT yet confirmed the end of the long-term bull market, you are exceedingly close. It will take a very strong rally to re-establish the 'bull market' trend at this point, and at such a late stage of the market cycle. The odds are heavily against such an event."


"There is a strong possibility that any advance in the next week or so will be one of the last opportunities to lift excess risk from portfolios before a continuation of the market correction occurs."


If Monday's plunge reminded you of this:

You have too much risk in your portfolio.

I have been instructing for the several months, in both this newsletter and the daily blog, to take actions in your portfolio from a risk management perspective. To wit:

"These practices align with the most basic investment rules/philosophies that have been followed by every great investor/trader in history.

  1. 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.
  2. 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.
  3. Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low

There is no magic formula for long-term investment success. It has always been achieved by following simple processes and disciplines that have managed investment risk thereby reducing emotionally driven decisions during times of increased volatility."

If you have been following these instructions, terrific. Your portfolio is already underweight equities and the slide last week should have had relatively little impact. There is likely only a little clean up left to do this week.

If you are a new subscriber to this report, WELCOME.

Next, review your portfolio with respect to the instructions above and begin to take actions immediately.

The reflex rally last week is very likely our opportunity to clear weak, or high-risk, positions out of portfolios and raise some cash before the next decline.

As stated above, the markets could rally a bit more over the next week or so (S&P 500 2000-2050) but with the markets already moving back to overbought conditions a move substantially higher is likely limited.

IMPORTANTLY: I am NOT saying SELL OUT EVERYTHING. However, I AM saying that you should take actions to reduce risk in portfolios and raise some cash as a hedge against another downturn.

Such actions also give us cash to BUY WITH when the next opportunity presents itself.

What If I'm Wrong

Could I be wrong? Absolutely. With Central Banks globally "at the ready," there is a real possibility that markets could be surprised by what happens next.

At this critical juncture, there are only a couple of things I see that could potentially save the current bull market advance from ending.

  1. There is NO WAY that the Fed will hike rates in September. Of course, I have been a strong proponent since early this year that the Federal Reserve would be unable to do so given the underlying weakness in the economy. (See "Fed Stumbles" for history of my calls) Bill Dudley's comments confirming my suspicions was the primary reason for the markets surge on Wednesday.
  2. The Fed launches another "Quantitative Easing" program. Don't be surprised to see Fed officials drop hints (verbal QE) about further accommodative actions if needed. Currently, they are hoping the markets will hold together. If the market continues to decline, it is a real problem for the Fed.

If the market bounces, and you reduce your portfolio allocation as I suggest, you will have captured previous gains. However, if the market should re-establish its bullish trajectory, it will simply be a function of re-allocating risk back into portfolios.

Yes, you may miss a small portion of the move, but such a "miss" will be far less of a consequence than a potential 20-30% correction if I am right.

Remember, our job as investors is NOT to try and beat some random benchmark index, but to grow our savings in a manner that conserves our principal over time.

Adjusting The Model

Over the last 25-years of "trial and error," and trust me there have been many "trials" and "errors" along the way which is to be expected in portfolio management, I developed a series of 4 signals to drive portfolio models. However, since I do believe in long term investing, the signals are based on weekly data to smooth out portfolio volatility and significantly reduce position turnover.

The signals are as follows:

Alert Signal - Pay attention

Sell Signal 1- Reduce equity allocation by 25%

Sell Signal 2- Reduce equity allocation by 25%

Sell Signal 3- Reduce equity allocation by 25%

If all of the sell signals were in place, it would only reduce the allocation to equities in portfolios by 75% in total. I would most likely never recommend going below that level of exposure. Fully exiting the markets leads to emotional biases that make it extremely difficult to re-enter markets near bottoms. By always maintaining a small piece of exposure to equities in portfolios, it is easier to add to existing positions when the sell signals above begin to reverse back to buy signals.

The chart below shows the history of the market and the relevant "initial sell signals."


(Important Note: The selloff in the market over the last few weeks was enough to trigger both sell signals #1 and #2. This brings portfolio exposure down by 50% as shown below.)

Notice, however, that in the chart above that "panic selling" the initial breakdown was generally not a good idea. Being patient and waiting for the reflexive bounce provided a much better exit point to reduce portfolio risk.

The portfolio allocation model, the same as we use for the 401k plan manager below, shows how the migration works to reduce overall portfolio risk and conserve investment capital.


Reducing The Model By 50%

Let me reiterate. The current "sell" signal does not mean "panic sell" everything you own in your portfolio and run to cash. As shown in the chart above, these sell signals are generated when markets are oversold enough to generate a short-term reflexive bounce.

(Have I repeated that point enough yet???)

As stated and shown in the charts above, it is very likely that the recent selloff has reached a short term bottom. A rally back towards the 13-week moving average is very likely. A failure at those levels is extremely important.

With the two primary sell signals in place, combined with a significant break of long-term bullish support, it is time to PREPARE to take actions in portfolios during a reflexive rally. As shown, I am reducing the model by 50% currently and suggesting using this reflex bounce in the markets to underweight portfolios temporarily.


Portfolio Management Instructions

This expected rally was exactly what was needed to allow a more orderly rebalancing of portfolios according to the following instructions.

  1. Sell "laggards" and "losers" in FULL. These are positions that have performed very poorly relative to the markets. Positions that are out of favor on the run-up, generally tend to fall faster in declines. (Energy, Industrials, Materials, International, Emerging Markets, etc.)
  2. Trim positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits) (Discretionary, Healthcare, Technology, etc.)
  3. Positions that performed with the market should also be reduced back to original portfolio weights.
  4. Move trailing stop losses up to new levels.
  5. Review your portfolio allocation relative to your risk tolerance. If you are aggressively weighted in equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

How you personally manage your investments is up to you. I am only suggesting a few guidelines to rebalance portfolio risk accordingly. Therefore, use this information at your own discretion.

However, if you need assistance do not hesitate to send me an email. Also, follow me on FACEBOOK or TWITTER as I will be updating this analysis intra-week as developments occur.

Have a great weekend

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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