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posted on 22 February 2016

Monday Morning Call For 22 February 2016

by Lance Roberts, Clarity Financial

"Stocks finish the best week of the year!"

That was the headline from Myles Udland at Business Insider on Friday. Talk about pandering to the bullish hype, really?

Given that we are now almost two full months in the year the markets strung together its FIRST three-day win streak which totaled a whopping 2.5% gain. That is a pretty dismal showing on just about every front considering we are in the "seasonally strong" period of the year.


Setting aside the "bullish arm-waving" by journalist portraying themselves as astute practitioners of money management for the moment, a look at the next chart shows something much ominous.


Markets do not rise and fall in a straight line. The vacillate from overbought to oversold and back again. Sharp reflexive bounces are predominately found during corrective markets as selling pushes prices to extreme oversold conditions which leads to short-covering rallies. Like striking a match, short-covering rallies burn fast and furious, but are quickly exhausted and then fade.

The recent market rally, in typical short-covering fashion, ran from the bottom of the current downtrend to the top. At the same time, the market moved from extremely oversold to overbought once again. With the 50-dma and resistance from the previous high sitting directly overhead, the markets will face a fairly tough challenge next week. A failure to push through that resistance will lead back to a retest of recent lows.

Another fairly substantial concern at this juncture that keeps portfolios positioned more cautiously is recent volume.


During the markets bullish advance from 2009 through 2013, volume on the market declined. As the Fed began to wind down the final round of QE, and began to tighten interest rates, market volatility picked up significantly. Following the turmoil that began last August, volume has picked up markedly confirming that we have likely entered into a more protracted cyclical bear market.


Last week I recommended using any rally this week to move to the lowest level of equity exposure for this part of the cycle. (When the bear market is confirmed we will take portfolios to market neutral by hedging off any remaining equity risk, but we are not there as of yet.)

I suggested doing this by:

  • Trimming back winning positions to original portfolio weights: Investment Rule: Let Winners Run

  • Selling positions that simply are not working (if the position was not working in a rising market, it likely won't in a declining market.) Investment Rule: Cut Losers Short

  • Holding the cash raised from these activities until the next buying opportunity occurs. Investment Rule: Buy Low

As such there is now little for us to do except to wait, and watch patiently, for the market to either confirm a "bear market," OR stabilize and begin to rebuild the bullish supports necessary to allow equity risk to once again be increased.

Neither situation will make itself apparent in short order, so relax and we let the market dictate what actions we take next. "Guessing" at the markets has not typically been a successful and repeatable strategy.

But how we will know when its time to start buying back in?

Good question. Let's take a look at the last two times the market had all of the confirming "sell signals" in place and what it looked like when it was time to "get back in."

First, let me show you the entire picture for perspective.


As shown, markets can only remain extremely deviated from their long-term trends for so long. Like stretching a rubber band to the extreme in one direction, the band must revert an equal distance in the opposite direction before it can be stretched again. It's physics in action.

The red-dashed line is the 104-week moving average (2-years). As you will notice, the length of the moving average has corresponded with the primary bullish trend lines of the past three cyclical bull markets. The only violation of that moving average, outside of the onset of a bear market, was briefly in 2011 which was offset by the implementation of "Operation Twist" by then Fed Chairman Ben Bernanke.

So, with this perspective, we can look more closely at the signals we will need to see to provide the confidence necessary that the current "bear market" dynamics have ended.

Ending The 2000-Bear Market


The confirmation that the "bear market" in 2001-2002 had ended was when relative strength stopped declining and turned back to positive. Furthermore, while "buying the exact bottom" was missed, when the longer-term confirming "buy signals" were issued, confirming a break above the long-term moving average, it was still VERY early in the bullish advance that would follow over the next several years.

Ending The 2008-Financial Crisis


Again, notice the same exact bottoming behavior and confirmation of the start of a new bull-market cycle.

Currently, as shown below, all "sell signals" are currently in place with RSI still on the decline, momentum measures broadly negative and the market trading BELOW its long-term moving average. Does this even look remotely like a market ready to turn around and push higher?


For now, we wait. When these indicators improve and turn back into the positive, which could be next week, month, or year, then it will be time to aggressively begin to increase exposure to equity risk as the bullish trend is re-established.

As investors, we should not be basing our investment decisions on "hope," but rather an analysis of the evidence that would put the highest probability of "winning" in our favor. While you can certainly continue betting on "weak hands," any good poker player will tell you that is a sure way to eventually go broke.

S.A.R.M. Model Allocation

If you are new reader to this missive, click here and review previous explanations of the S.A.R.M. Model.

I have adjusted the model allocation to account for the rebalancing of bonds, REITS, and Utilities in portfolios.

This past week's bounce in the market was used to adjust weightings as follows:


Last week's rally increased CASH to 50% of the portfolio from 45%, with 35% in bonds, and 15% in equities.

It is completely OKAY if your current allocation to cash is different based on your personal risk tolerance. This is just a guide.

As you can see, there are not DRASTIC movements being made. Just incremental changes to reducing overall portfolio volatility risks. However, if the expected bounce fails at resistance, then further reductions will be required in accordance with the risk reduction modeling.

Remember, as investors, our job is not to try and capture every single relative point gain of the market as it rises. While we certainly want to participate in the rise, our JOB is to protect our capital against substantial losses in the future. A methodology that regularly harvests gains, reduces risk and keeps the portfolio focused on longer-term goals will lead to a more successful outcome.



As you will notice, I never advocate being 100% out of the market. However, I will recommend a market neutral strategy once a confirmed bear market trend is established. As I have discussed many times in the past, it is far too difficult to reverse course when the market changes from a negative back to a positive trend. Emotions keep us from taking the correct action. There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks.



As I have repeatedly discussed over the last couple of weeks, the market has NOW BROKEN the long-term trend. Such a change in TREND is critical and suggests that the bull market advance that began in 2009 is over. As discussed throughout the entirety of this week's missive, the technical damage to the market is significant.

Last week's rally was enough to warrant reducing portfolio allocations to TARGET levels. As discussed in detail above, we are now in a position to just WAIT and allow the market to TELL us what it wants to do next.

While many will speculate on a resumption of a "bull market" in the short-term, the RISK of being WRONG far outweighs the possibility that such prognostications are correct. However, in the event the market does reverse course, and re-establish a bull trend, we will simply increase equity allocations back up accordingly.

Yes, it really is just that simple. As I wrote last week:

"Remember, it is far easier to add capital back into the markets as opportunities become more visible, rather than trying to figure out how to make up previous losses. "

If you need help after reading the alert; don't hesitate to contact me.

Current 401-k Allocation Model

The 401k plan allocation plan below follows the K.I.S.S. principal. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)


401k Choice Matching List

The list below shows sample 401k plan funds for each major category. In reality, the majority of funds all track their indices fairly closely. Therefore, if you don't see your exact fund listed, look for a fund that is similar in nature.


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