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posted on 26 October 2015

QE Hopes In A Seasonally Strong Period

by Lance Roberts, StreetTalk Live

X-Factor Report 25 October 2015

"Great news... US equity market investors (judging by the S&P 500) have now lost no money this year (and have made no money). All it took to get stocks "back to even" for 2015 was... no Fed hike, more ECB QE and more negative rates, China rate cuts, and negative EPS growth. What more do you need?"

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.

SP500-Stocks-Inflation-Profits-102315

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.

"Digging deeper into Draghi's comments. Concerns over growth prospects in emerging markets, as well as possible repercussions for the economy from developments in financial and commodity markets were well flagged as downside risks for the outlook for growth and inflation for the Euro area. On inflation, Draghi warned that 'most notably, the strength and persistence of the factors that are currently slowing the return of inflation to levels below, but close to, 2% in the medium term require thorough analysis.

With this, Draghi said that 'the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting."

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.

SP500-MarketUpdate-102315

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:

"To recap, we issued our Seasonal MACD Buy Signal after the close on October 5. Current investor sentiment readings do appear to be setting up in support of a year-end rally.There is a healthy amount of skepticism which leaves room for the market to work its way higher.

We are bullish again after spending much of the summer on the defense. However, our current bullish stance is not a strong as it was last year at this time or at the start of previous "Best Six Months."

Economic data this time around is mixed at best and borderline gloomy at worst while typical pre-election-year forces have failed to prop the market up this year. Most economic data tends to be backward looking while the stock market tends to look forward. Earnings are expected to rebound next year, and the Fed is most likely going to remain accommodative in the face of recent labor market and inflation data. We do expect the market to make a run back towards its recent record highs sometime during the "Best Six Months," but we do not see a tremendous amount of upside potential after that."

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).

Seasonally-Strong-Statistics-102015

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:

  1. Weakness in revenue and profit margins

  2. Deteriorating economic data

  3. Deflationary pressures

  4. Increased bearish sentiment

  5. Declining levels of margin debt

  6. Contraction in P/E's (5-year CAPE)

(For visual aids on these points read: 4 Warnings)

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:

"It was nearly a year ago that I looked back at times when stocks became 'extremely overvalued' and then the trend turned down. In every case, it paid very handsomely for investors to implement a system that either shifted to cash (and avoided major drawdowns) or actually got short the major indexes (to profit from major drawdowns)."

Felder-Portfolio-102015

"The point is that an extremely overvalued and over-bullish stock market that shifts from uptrend to downtrend is the sort of rare environment that has led to the largest declines in history. For this reason, it presents investors with the most dangerous of all possible environments."

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.

  1. Trim positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits) (Discretionary, Healthcare, Technology, etc.)

  2. Positions that performed with the market should also be reduced back to original portfolio weights.

  3. Move trailing stop losses up to new levels.

  4. 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.

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. At times, the positions of Mr. Roberts will be contrary to the positions that STA Wealth Management recommends and implements for its clients' accounts. All information provided is strictly for informational and educational purposes and should not be construed to be a solicitation to buy or sell any securities.

It is highly recommended that you read the full website disclaimer and utilize any information provided on this site at your own risk. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level, be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and applicable laws, the content may no longer be reflective of current opinions or positions of Mr. Roberts. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his or her individual situation, he or she is encouraged to consult with the professional advisor of his or her choosing.

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