Over the last several weeks, I have discussed the entrance of the markets into the seasonally strong period of the year and the potential to increase equity exposure in portfolios on a "short-term" basis.
"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 that suggests that we remain alert for a pullback that generates a short-term oversold condition without violating any important supports."
The recent surge in the markets has driven asset prices back to resistance near old highs. Simultaneously, the markets are pushing into very overbought conditions with a rather extreme deviation from the longer-term moving average. Such deviations tend not to last for an extended period.
More importantly, the ongoing "topping process" remains a more major concern as the underlying internals of the market, as discussed below, remain exceptionally weak.
"In plain English it essentially means the markets have likely completed its current advance and need a short-term correction to provide a better 'risk/reward' entry for investors to increase equity exposure."
I said two weeks ago that:
"The expected correction began in earnest this past week. While there is no guarantee, with the market still overbought on a short basis, it seems most reasonable that a correction back to previous support levels (2040-2060) will likely find "buyers" betting on the traditional year-end rally. This also aligns with the more traditional pre- or post-Thanksgiving correction."
That target range was broken on Friday as stocks closed sharply lower on very weak retail sales reports. With the markets NOW oversold, it will be critically important that support at 2020 is not broken. The next critical level of support is the short-term moving average (dashed blue line) at 2010, then 1990 at previous support levels from early this year. It will be important for the market to hold these current levels of support without violating it over the next few trading days in order to set up a more tradeable short-term rally.
Be sure and read Tuesday's "Technically Speaking" blog post for updates to this analysis and the potential for entering a trading opportunity.
Internals Remain Weak
After more than 6-years of a "bull rally," the Federal Reserve threatening to tighten monetary policy and global deflationary pressures on the rise, it is not surprising the markets are beginning to show signs of age. While the media and Wall Street analysts remain optimistically biased for further gains in the years to come, the reality is that we are likely closer to the next recessionary correction than not.
"Stocks also belie this belief that the Fed finally has it right, that growth is finally accelerating and the real recovery is finally underway. Yes, stocks have rallied nicely the last few weeks and have nearly recovered from their August swoon. But all that has done so far is to bring stocks back to where they were in mid-August just before the sell-off. While it is certainly possible that we will yet make new highs, I think it is important that momentum is not confirming the move higher except, again, in the very short term. Long term momentum indicators still show a market in the process of topping."
He is correct about the long-term momentum measures still suggesting a topping process. The chart below shows several measures of internal "strength," that clearly are not "strong" currently.
There is little evidence currently that the rally over the last couple of months has done much to reverse the more "bearish" market signals that currently exist. Furthermore, as noted above, the current market action may be more indicative of market topping process.
More Than Meets The Eye
It is not just momentum measures that remain weak, but also the internal "breadth" of the market. Historically speaking, at the latter stages of a bullish advance, the number of stocks participating in the advance begins to weaken. That is much of what we are seeing currently.
Furthermore, "narrow" rallies are historically very symptomatic of market tops. As noted recently by Goldman Sachs, if it were not for just EIGHT (8) stocks, the S&P 500 would be negative for the year.
But it isn't just me, BofA also noted the same stating:
"A month-long bearish divergence for the US 15 most active advance-decline line has the potential to limit S&P 500 upside. The weekly global A-D line of 73 country indices in US Dollars peaked on September 5, 2014, vs. a May 15 peak for the weekly closing price of the MSCI ACWI Index, which is also based in US Dollars. The rise in the US Dollar has had a bearish impact on global equity market breadth (many equity markets have done much better in local currencies) and this A-D line has not confirmed the global equity market rally. This is a major bearish breadth divergence and a classic sign of diminishing breadth for global equity market indices."
"Big breakdowns in the most active A-D line preceded or coincided with big breakdowns for the S&P 500 in 2000 and 2007. The key for the US equity market in late 2015 and into early 2016 is for the most active A-D line to hold its support at the August, July, and December 2014 lows. A failure to do so would put in a top for this advance-decline line and increase the risk for a deeper US equity market pullback."
Looking For Santa Claus
As I suggested above the "seasonally strong" period of the year may present an opportunity for more seasoned and tactical traders willing to take on additional risk. However, for longer-term investors the risk/reward ratio is not favorably tilted currently.
As we progress through the last two months of the year, historical tendencies suggest a bias to the upside.This is particularly the case given the weakness this past summer which has left many mutual and hedge funds trailing their benchmarks. The need to play "catch-up" will likely create a push into larger capitalization stocks as portfolios are "window dressed" for year end reporting.
This traditional "Santa Claus" rally, however, does not guarantee the resumption of the ongoing "bull market" into 2016.
For that corporate earnings will need to recover, and soon. However, as Joe notes in his missive, this is unlikely to occur:
"That shouldn't really be that surprising considering what is going on with earnings. With so much hoopla surrounding the Fed it has almost been lost in the shuffle but earnings this quarter have not been very good overall. If you look at "operating earnings" - earnings before all the bad stuff that is allegedly one time but rarely is - over 70% of companies are beating estimates although the beat rate for revenue is quite a bit lower. However, reported earnings paint a different picture with less than half the companies beating estimates. This kind of divergence happens every cycle as we get near the end of the expansion. It speaks to the quality of the earnings and the creativity of CFOs at the end of an expansion.
Companies this cycle have loaded up on debt to buy back stock and keep earnings per share rising. That and other means of cost cutting were necessary because revenue growth has been hard to come by. Particularly hard hit recently have been the US multinational companies, hit by the double whammy of a rapidly rising dollar."
There is a vast difference between having a strong dollar in a strongly growing economy, and a strong dollar in a weak one. The later weighs on further growth as the deterioration of exports is not offset by the rising consumption of imports. As I discussed last week, a combination of plunging imports and exports is something that should not be ignored.
"The sharp rise in the dollar, which has been cited by many companies as the reason for weak earnings results due to the negative impact to exports, should be a boon for consumers as the stronger dollar makes imports cheaper. However, that has clearly not been the case and suggests the domestic consumer is substantially weaker than other headline data suggests.
The import/export data is suggesting that the global weakness arising from China and the Eurozone have now impacted the domestic economy. While the Fed continues to suggest that economic strength is improving, the underlying data continues to suggest it isn't."
As I have continued to suggest, there is a probability that the markets could rally through the end of the year. However, without a strengthening of the earnings and economic backdrop, such a rally will likely be a continuation of the current market topping process over the intermediate term.
While none of this means that a major market reversion is imminent, it does suggest taking on an accelerated risk profile in the current environment will likely not be greatly rewarding.
I will continue to monitor and update the markets each week for you and adjust allocations accordingly.
Portfolio Management Instructions
Repeating instructions from last week, it is time to take some action if you have not done so already.
Trim positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits) (Discretionary, Healthcare, Technology, etc.)
Positions that performed with the market should also be reduced back to original portfolio weights.
Move trailing stop losses up to new levels.
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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