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posted on 09 May 2016

Monday Morning Call 09 May 2016

Written by , Clarity Financial

On a short-term basis, the ongoing correction last week took the market back to its rising 50-day moving average and has worked off the overbought condition that previously existed.

Importantly, on Friday, the market defended the 50-dma and turned back into positive territory for the day.

SP500-Chart5-050616

As I have noted in the chart above, the yellow highlights point out the short-term oversold conditions which have been previously consistent with a market bounce. With the market defending the 50-dma on Friday, combined with the short-term oversold condition, a bounce early next week is likely.

However, this does not mean the markets are ready to go soaring back to new highs. As shown these bounces can, and have been, very short-lived in many cases.

The bounce on Friday was also important as the market defended the 400-day moving average as well. Just as I showed above, the combined defense of support at the 400-dma with an oversold condition suggests that markets are set up for at least a short-term bullish advance.

SP500-Chart4-050616

Intermediate-Term Setup Still Cautionary

As stated above, while the very short-term indicators suggest a more bullish backdrop going into next week, I do want to continue to issue a word of a caution:

  1. We still remain in a major trading range that has yet to be resolved.

  2. Economic data remains weak both domestically and globally.

  3. Earnings continue to remain poor.

  4. We are moving into summer which historically tends to be weak.

  5. This is a Presidential election year which has historically also been weak.

Furthermore, as shown below, the current advance and topping process, remains in the confines currently of a "lower high and lower low" scenario. While it may not "feel" that way, we are still within the broader confines of a downward trending market. As I stated last week:

"The last time the same combination of signals existed was in November of last year. The resulting outcomes were not pleasant for most investors. There has not been a fundamental or economic development to suggest 'this time is different.' In fact, in many ways, it is worse."

SP500-Chart6-050616

As I have repeatedly stated over the last couple of weeks the current market setup feels like a "trap." I remain cautious and already have an "inverse market" position loaded in our trading system to move portfolios quickly back to market neutral if markets break support.

In the short-term, bullish dynamics are in place giving short-term investors and traders an opportunity to put capital to work.

However, for longer-term investors, and particularly those with a short time-frame to retirement, let me leave you with the recent conclusion from Stan Druckenmiller of Duquesne Capital:

"If we have borrowed more from our future than any time in history and markets value the future, we should be selling at a discount, not a premium to historic valuations. It is hard to avoid the comparison with 1982 when the market sold for 7x depressed earnings with dozens of rate cuts and productivity rising going forward vs. 18x inflated earnings, productivity declining and no further ammo on interest rates.

The lack of progress and volatility in global equity markets the past year, which often precedes a major trend change, suggests that their risk/reward is negative without substantially lower prices and/or structural reform. Don't hold your breath for the latter. While policymakers have no end game, markets do."


S.A.R.M. Model Allocation

The Sector Allocation Rotation Model (SARM) is an example of a basic well-diversified portfolio. The purpose of the model is to look "under the hood" of a portfolio to see what parts of the engine are driving returns versus detracting from it. From this analysis, we can then determine where to overweight sectors which are leading performance, reduce in areas lagging, and eliminate those areas that are dragging.

GOLD BUG NOTE: I have had a tremendous number of requests to include "that special shiny metal" into the weekly SARM analysis. Beginning this week, that request has been fulfilled.

Over the last five weeks, RISK based sectors have continued their streak of improvements as money has flowed out of perceived areas of SAFETY.

SARM-Chart-050716

The rotation from defensive to "risk on" sectors is now complete:

LEADING: Energy, Materials, Industrials, Mid-cap, Small-cap, Discretionary. (REIT's are leading as investors chase risk and yield. Financials are rapidly improving playing catch-up)

LAGGING: Utilities, Gold, Bonds, Staples, Technology, Healthcare

The sector comparison chart below shows the 9-major sectors of the S&P 500.

Sector-Signals-050716

The best sectors for short-term traders to over-weight next week remains:

Discretionary, Industrials, Materials, Staples, Energy, Utilities and Financials.

This is also shown in the sector analysis tables below.


S.A.R.M. Sector Analysis & Weighting

As stated above, the SARM Model is an "equally weighted model" adjusted for risk. The current risk weighting remains at 50% this week. It will require a move to new all-time highs in order to safely increase model allocations further at this juncture.

SARM-Allocation-Model-050716

Relative performance of each sector of the model as compared to the S&P 500 is shown below. The table compares each position in the model relative to the benchmark over a 1, 4, 12, 24 and 52-week basis.

Historically speaking, sectors that are leading the markets higher continue to do so in the short-term and vice-versa. The relative improvement or weakness of each sector relative to index over time can show where money is flowing into and out of. Normally, these performance changes signal a change that last several weeks.

SARM-Performance-050716

The last column is a sector specific "buy/sell" signal which is simply when the short-term weekly moving average has crossed above or below the long-term weekly average. The number of sectors on "buy signals" has improved from just two a few weeks ago to 10 this past week. Sectors that are on buy signals tend to outperform in the near term.

The risk-adjusted equally weighted model remains from last week. No changes this week.

SARM-Allocation-Model-050716-2

The portfolio model remains at 35% Cash, 35% Bonds, and 30% in Equities.

As always, this is just a guide, not a recommendation. It is completely OKAY if your current allocation to cash is different based on your personal risk tolerance, time frames, and goals.

For longer-term investors, we need to see an improvement in the fundamental and economic backdrop to support a resumption of the bullish trend. Currently, there is no evidence of that occurring.

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