posted on 26 June 2016
by Lance Roberts, Clarity Financial
This week's report is going to deviate a little from the norm as I am just going to focus on the technical impact from the Brexit vote on Thursday, and the subsequent fallout on Friday.
First, let's pick up with where I left off on Tuesday:
The market has repeatedly made attempts to break out above 2100. But that level has rejected investors more often than Josh Richardson at the net. (Miami Heat)
The good news, if you want to call it that, is that 2040 still contains the downside to the market currently. However, the neckline forming at 2040, on a weekly basis, will become critically more important if the development of a "head and shoulder" formation comes to fruition.
As has been the case since the beginning of the year, the markets have migrated investment strategies to follow "Fed Speak" and headline events rather than fundamentals. The annotated chart below is rapidly running out of room to notate these events while earnings continue to deteriorate.
As I have stated repeatedly over the last several weeks, with risk outweighing reward, a more cautious stance to portfolio management should be considered. It is always why I continue to hold excess levels of cash:
The chart below shows the now 13-month long sideways trading range of the market. However, most importantly, the downward trending price pattern remains in place. The recent failure at the downtrend resistance line remains a concern as well as the violation of the short-term moving average which has been acting as support.
The vertical blue-dashed lines denote market sell signals where subsequent price action has been poor, to say the least. While a "sell signal" is NOT CURRENTLY in place, it will not require much further deterioration in price to trigger one.
Again, as noted above, the compression that was building between the short-term moving average (blue dashed line) and the current "downtrend resistance" was due to resolve itself. The break to the downside puts 2040 support, as noted above, into focus.
The problem for investors remains the focus on short-term "hopes" rather than longer-term fundamental dynamics. The issue of such "short-termism" is such a focus has had generally poor longer-term outcomes. As discussed in the "Theory Of Bubbles":
Last Tuesday, while the markets were ramping higher on expectations Britain would "remain" in the Eurozone, I wrote:
Well, things certainly went wrong.
However, the problem is we remain trapped in limbo. With the markets holding above supports, but still within an overall corrective topping process, there is no reason to become extremely negative on the markets at the moment OR be extremely bullish.
In other words, the only option is to continue to "do nothing" until the market resolves its current state in one direction or another.
The bad news is the longer the market remains in this current state, the risk are rising of a more substantial downside break.
The chart below is a monthly chart of the S&P 500 with GAAP earnings and Peak Earnings shown. The current topping process, stuck below "all-time" highs, is not too dissimilar to what has been seen at previous major bull market peaks. As was the case then, "doing nothing" may be the best solution.
BACK TO FUNDAMENTALS
While the initial shake out of the markets was severe, the "shock" of the exit will be quickly absorbed by the financial markets. In the longer-term, the markets will have to come back to focus on the fundamentals, which are, to say the least, wanting.
As Andrew Lapthorne noted from SocGen earlier this week (via ZeroHedge):
He is absolutely correct. However, this note from Nomura on Friday reiterated the point:
As I have written recently, the markets have been drifting from one Central Bank speech or action to the next. The disregard for underlying fundamentals is something that has only been witnessed at major market peaks historically.
Furthermore, it is virtually assured the Federal Reserve will not hike rates now. In fact, the Fed will likely not hike rates at any point in 2016.
Here are the big risks going forward as money shifts from the instability of Europe to the "safety" of the U.S.
This is just some initial outlooks. I will continue to monitor and report on these specific areas each week from a price trend basis and make adjustments/recommendations accordingly.
Of course, the reality is that we will likely see a globally coordinated Central Bank response to the financial markets over the next few days if the selling pressure picks up steam. This will come in the form:
The problem that potentially exists, and should be paid attention to by investors, is the lack of credibility of the Central Banks themselves. If the Central Banks do intervene, as expected, there is a possibility of a "negative" response by financial markets as the veil of "an improving economic backdrop" is ripped away.
While I stated above that you should "do nothing" over the next day or two until the initial "panic" subsides, it is prudent that over the next few days you continue to take prudent portfolio and risk mitigation actions.
Continue with the steps laid out in the "Monday Morning Call" Section a couple of weeks ago:
Next, as shown in the chart below, tighten up "stop loss" levels and have a strategy to hedge equity risk in portfolios in the event the market breaks down.
While the 2040 level was "technically" broken on Friday, I recommend waiting until next week before liquidating positions. With the markets now very oversold on a short-term basis, a bounce early next week would not be surprising. Use any bounce to rebalance portfolios.
Importantly, I am moving the level where a "negative market (short) hedge" is added to portfolio up to 2020 from 2000. This is due to the recent rally which has pulled the longer-term moving average up to that level as shown above.
This week's actions is the reason I have continued maintaining a large exposure to "cash" in portfolios despite much criticism. As Mohamed El-Erian discussed last week:
While we can debate over methodologies, allocations, etc., the point here is that "time frames" are crucial in the discussion of cash as an asset class. If an individual is "literally" burying cash in their backyard, then the discussion of the loss of purchasing power is appropriate. However, if the holding of cash is a "tactical" holding to avoid short-term destruction of capital, then the protection afforded outweighs the loss of purchasing power in the distant future.
Of course, since Wall Street does not make fees on investors holding cash, maybe there is another reason they are so adamant that you remain invested all the time.
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