posted on 26 October 2015
by Lance Roberts, StreetTalk Live
Think about that statement for a moment.
Stocks, and ultimately the stock market, are a reflection of economic, revenue and inflation growth.
When the economy is doing well, companies hire individuals and pay them wages with which they consume boosting corporate revenues and leading to higher pricing power. Take a look at the chart below.
Here is the point. Stocks are rallying not on the idea that things are improving economically, but rather because the deterioration means more Central Bank liquidity to keep things "propped" up.
Think about it this way. Despite what the media and Central Bankers say, IF the economy WERE INDEED improving then there would be NO NEED for additional liquidity programs to provide financial support.
The reality is that the economic backdrop globally continues to weaken, and that is a problem longer term that stock markets will not indefintetely be able to dismiss. However, as it appears, stocks can remain buoyant far longer than logic and fundamentals would otherwise dictate. This is why it is so important to pay attention to overall trends rather than allowing emotions to control the decision making process.
Importantly, despite the markets rampant surge Thursday and Friday on the expectations of additional bond buying by the ECB - the reality is that the ECB only SUGGESTED such might be the case.
However, the promise of more liquidity was enough to once again send the remain short-interest players running for cover pushing stock prices above resistance.
With the markets currently in EXTREME OVERBOUGHT conditions, it is suggested that investors continue to make the necessary adjustments to portfolios to rebalance risk in the short-term (see instructions below.)
However, the break above the correction downtrend that began earlier this year now sets the markets up for an advance through the end of the year. As I wrote earlier this week:
Seasonally Strong Period
The technical deterioration of the markets, combined with weakening economic and earnings data, suggest the markets are likely to struggle in the months ahead. However, there is a reasonable expectation that following a weak summer performance, that there could be better performance as we enter the historically stronger period of the investment year.
As Stocktraders Almanac recently penned:
The table below shows the statistics of the seasonally strong/weak periods of the S&P 500 from 1957 to present using the data from the Federal Reserve (FRED).
As noted above, there is a statistical probability that the markets will potentially try and trade higher over the next couple of months particularly as portfolio managers try and make up lost ground from the summer.
However, it is important to note that not ALL seasonally strong periods have been positive. Therefore, while it is more probable that markets could trade higher in the few months ahead, there is also a not-so-insignificant possibility of a continued correction phase.
Furthermore, the probability of a continued correction is increased by factors not normally found in more "bullishly biased" markets:
How To Play It
With the markets currently in extreme short-term overbought territory and encountering a significant amount of overhead resistance, it is likely that the current reflexive rally that began three weeks ago is near its conclusion.
For individuals with a short-term investment focus, pullbacks in the market can be used to selectively add exposure for trading opportunities. However, such opportunities should be done with a very strict buy/sell discipline just in case things go wrong.
However, for longer-term investors, and particularly those with a relatively short window to retirement, the downside risk far outweighs the potential upside in the market currently. Therefore, using the seasonally strong period to reduce portfolio risk and adjust underlying allocations makes more sense currently. When a more constructive backdrop emerges, portfolio risk can be increased to garner actual returns rather than using the ensuing rally to make up previous losses.
I know, the "buy and hold" crowd just had a cardiac arrest. However, it is important to note that you can indeed "opt" to reduce risk in portfolios during times of uncertainty. As my colleague Jesse Felder pointed out recently:
For More Read: "You Can't Time The Market?"
This is not a market that should be trifled with or ignored. With the current market and economic cycles already very long by historical norms, the deteriorating backdrop is no longer as supportive as it has been.
"Benchmarking" your portfolio remains a bad choice for most investors with a visible time frame to retirement. While it is true that over VERY long periods of time, "benchmarking" your portfolio will indeed lead to gains. The problem is that most individuals do not have 115 years to garner 8% annualized rates of return.
The index is a mythical creature, like the Unicorn, and chasing it takes your focus off of what is most important - your money and your specific goals. Investing is not a competition and, as history shows, there are horrid consequences for treating it as such.
Incorporating some method of managing the inherent risk of investing over a full-market cycle is crucially important to conserving principal and creating longer-term risk-adjusted returns. While you will probably not beat the index from one year to the next, you are likely to arrive at your financial destination on time and intact. But isn't that really why you invested in the first place?
Portfolio Management Instructions
Repeating instructions from last week, it is time to take some action if you have not done so already.
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.
Have a great week.
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