posted on 13 June 2016
Market Fails To Breakout
Okay, so let's get to what you really want to know. On Friday, the market failed to hold its breakout of 2100, as stated our earlier post, which keeps the market confined to its longer-term bearish trend.
As I stated last week:
That overbought condition, and downtrend resistance, remains this week and is confirmed by the daily price chart as well
As shown in the top part of the chart above, when the markets are as overbought as they are now, it has generally been at, or near, a short-term peak in the market.
The short-term outlook suggests more vulnerability to selling. Importantly, the markets must hold support at 2080, the short-term moving average, or 2040 which is the recent bottoms of what currently appears to be a potential topping process.
The failure of the markets this week to break, and hold, above 2100 keeps portfolio allocations at current levels. As shown below, the downtrend resistance, on a weekly basis, also coincides with 2040 reinforcing the importance of that support level. Stop loss levels are current set at 2020, and portfolio hedges will be added with a subsequent break of 2000.
Portfolio Management Rules
It is important to understand that as a portfolio manager, I am truly neither bullish or bearish. I follow a very simple set of rules which are the core of my portfolio management philosophy which focus on capital preservation and long-term returns.
The fundamental, economic and price analysis forms the backdrop of overall risk exposure and asset allocation. However, the following rules are the "control boundaries" for all specific actions.
As stated above, the long-term price trends determine a bulk of portfolio actions. Currently, the bullish trend from 2009 remains intact. However, a violation of 2000 will negate that bullish trend and require portfolios to be either "neutral or short." Importantly, until that violation occurs, portfolios can, and should be, either long or neutral.
This is why currently, portfolio allocations remain long 50% equity, which is where they have primarily been since May, 2015 when I reduced allocations from a 100% allocation to risk. Since that time, reduced allocations have not impeded portfolio returns but has significantly reduced overall portfolio volatility.
Furthermore, as stated above, by focusing on "risk controls" in the short-term, and avoiding subsequent major drawdowns, long-term returns tend to take care of themselves.
It is through following these basic rules that, with the markets overbought, underlying fundamentals and economics deteriorating, and profits still weak, some portfolio actions should be taken to reduce, not eliminate, overall risk.
Of course, everyone approaches money management differently. I am simply sharing my process and I hope you find something useful in it.
S.A.R.M. Model Allocation
Over the last several weeks I have been discussing the move of RISK based sectors which have outpaced performance relative to SAFETY. Starting three weeks ago, that level of outperformance began to fade rather significantly suggesting the risk-based rally was coming to its inevitable conclusion.
This past week saw a continuation of that relative rotation from RISK to SAFETY as performance improved in bonds and areas that benefit from lower rates.
Health Care and Financials continued their relative improvement last week, but Discretionary lost footing and has slipped very quickly from its previously leading position. While Energy, Basic Materials, Mid-Cap, Small-Cap and International continue to provide leadership, relative outperformance has weakened markedly.
The sector comparison chart below shows the 9-major sectors of the S&P 500.
The sell-off on Friday was most clearly seen in Discretionary, Health Care, Energy and Financial sectors. However, the one-day reversal was not enough to severely change the short-term dynamics of the market, but the failure to close above 2100 is enough to raise warning flags.
Staples, Healthcare, Industrials, and Utilities are pushing extreme overbought which suggests some profit taking would be wise. As I stated last week:
The same can be seen in Small-Cap and Mid-Cap stocks where the advance has gone too far too fast in a catch-up rotation move. Bonds also paced a tremendous move last week, as money rotated from equity risk to safety.
Gold is the clear loser for now as the "reflation trade" is still currently alive and well.
S.A.R.M. Sector Analysis & Weighting
The current risk weighting remains at 50% this week. The failure to maintain the breakout above 2100 holds allocation changes for now. With technical underpinnings still "bullishly biased," we want to give the markets the benefit of the doubt for now.
It will require a move to new all-time highs in order to safely increase model allocations further at this juncture.
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.
As stated above, Bonds, Staples & Utilities had the biggest performance improvements last week.
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 2 a few weeks ago to 19 this past week.
It is worth noting that ALL 19-sectors are now on bullish buy signals. As stated above, the technical underpinnings are bullish and should not be lightly dismissed. It is just highly unusual for such to be the case at a time where economic and fundamental weakness is so prevalent. In other words, this is a clear sign of market exuberance in the making.
The risk-adjusted equally weighted model remains from last week. No changes this week.
The portfolio model remains at 35% Cash, 35% Bonds, and 30% in Equities.
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