posted on 02 November 2015
by Lance Roberts, StreetTalk Live
This past week, the Federal Reserve, as expected, failed to raise interest rates once again due to ongoing economic weakness and weak labor market results.
However, while that meant "accommodative policies" are here to stay for a while longer, it was their forecast that got the "bulls" excited. As Mohamed El-Erian penned for Bloomberg:
The last sentence is the most important. While the "bulls" came piling back into the market (creating a short-covering squeeze late Wednesday afternoon) the consequences of higher rates as noted really isn't that bullish for stocks.
First, let's take a look at the beloved yield-spread which is currently signaling "no recession" in the economy. As the chart below shows, the spread currently between the 10-year and the 2-year Treasury bonds is positive. However, as shown by the dashed red-line, when the Fed starts hiking the short-end of the curve, without economic growth picking up the long end, recessionary inversions can happen very quickly.
Secondly, as we have already witnessed over the past year, a strong dollar in a world where every country is battling deflationary pressures due to accelerating debt levels, has not been bullish. This has particularly been the case for the more economically sensitive sectors of the economy.
Think about that statement for a moment. The Fed will raise short-term borrowing costs, which makes credit more expensive, which will increase the value of the dollar, which makes exports more expensive, and this is GOOD for the stock market.
Historically, this has not been the case even when the economy was growing much more strongly than it is currently.
However, for now, the bulls "liked what they heard" and have sent investors stampeding back into the markets.
Bulls Regain Leadership
October has pulled in one of the largest monthly point gains in history surging over 8.5% for the month. Driven by a combination of short-term extreme bearishness and record short interest, the market pushed rapidly through previous resistance levels putting "Bulls" back in charge of the market for now.
The rally, not so unlike what was seen in 2014, took the markets from extreme oversold to extreme overbought in a very short period. That advance, like then, was once again driven by hopes of improving economic growth and promises of more monetary support (ECB, PBOC, and BOJ).
As I discussed over the last couple of weeks, this action, much like last winter, coincides with the entrance of the market into the seasonally strong period of the year. To wit from last week:
With the markets EXTREMELY overbought short-term, the setup for putting money into the market currently is not ideal.
However, as shown in the chart below, the markets have registered a short-term BUY signal which suggests that we remain alert for a pullback that generates a short-term oversold condition without violating any important supports. That important support level is currently 1900 on the S&P 500 index.
While the "Sell Signal" earlier this year reduced portfolio exposure to the market, all that was missed was a lot of volatility with no real gains.
As restated below, I have continued to print instructions during this "sideways" period to reduce risk and rebalance portfolios. While portfolios are currently overweighted in cash, that overweight position has led to much less volatile portfolios during the summer decline. This has reduced the potential for "emotional" mistakes to be made.
Now, with the "seasonally strong period" upon us, some of that cash can be redeployed during any corrective action that provides a better "risk/reward" entry point. That point is not today.
Short-Term Opportunity, Long-Term Risk
As shown in the chart below, while I am talking about increasing equity risk exposure "opportunistically" over the next couple of weeks for the short-term seasonally strong period, the long-term outlook still remains heavily biased toward risk.
The combined "sell signals," as measured by both momentum and MACD, have only coincided near major bull-market peaks.
However, as you will notice, these coinciding signals can occur several months before the "bullish momentum" of the market is ground to a halt. This is why the relevance of these signals should not be ignored. However, it also doesn't mean that you should immediately run to cash and hide.
I will continue to monitor and update the markets each week for you and adjust allocations accordingly.
For now, however, enjoy "Halloween" with your family and I will be back next week with either a "Trick or Treat."
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.
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.
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