"So often we judge other groups by their worst examples, while judging ourselves by our best intentions. And this has strained our bonds of understanding and common purpose.
But Americans, I think, have a great advantage. To renew our unity, we only need to remember our values. We have never been held together by blood or background. We are bound by things of the spirit - by shared commitments to common ideals.
At our best, we practice empathy, imagining ourselves in the lives and circumstances of others. This is the bridge across our nation's deepest divisions. And it is not merely a matter of tolerance, but of learning from the struggles and stories of our fellow citizens, and finding our better selves in the process.
At our best, we honor the image of God we see in one another. We recognize that we are brothers and sisters, sharing the same brief moment on earth, and owing each other the loyalty of our shared humanity.
At our best, we know we have one country, one future, one destiny. We do not want the unity of grief. Nor do we want the unity of fear.
We want the unity of hope, affection, and high purpose." - George W. Bush
Volatility Returns With A Vengeance
Over the last several weeks, I have been discussing the extremely suppressed levels of volatility in the market and the volatility hedges I was adding to portfolios. To wit:
"The level of "complacency" in the market has simply gotten to an extreme that rarely last's long.
The chart below is the comparison of the S&P 500 to the Volatility Index. As you will note, when the momentum of the VIX has reached current levels, the market has generally stalled out, as we are witnessing now, followed by a more corrective action as volatility increases.
Disclosure: I am currently long the volatility index as of this past Monday.
The bet on a sharp rise in volatility is a hedge against a sharp reversion in asset prices as the high level of"complacency" unwinds."
While it seemed for a while that volatility had been completely eliminated from the market by an ever present Fed, I warned this was a dangerous assumption to make.
On Friday, volatility returned with a vengeance.
Analysts, the media, and Wall Street talking heads rushed to grab every excuse available to explain the sudden sell-off on Friday from the Fed, ECB, and Japan to interest rates and the dollar. However, the reality is I have been warning about a pending correction over the last month as market extensions had reached extremes.
"Despite a 'belief' that 'This Time Is Different (TTID)' due to Central Bank interventions, the reality is that it probably isn't. The only difference is the interventions have elongated the current cycle, and has created a greater deviation, than what would have normally existed. What is 'not different this time' is the eventual reversion of that extreme will likely be just as damaging as every other previous bear market in history.
But, of course, 'TTID' is the old Central Bank driven mantra, today it is 'There Is No Alternative (TINA).' As stated, regardless of what you call it, the results will eventually be the same."
The market, on a short-term basis, remains in extreme overbought territory. This needs to be relaxed somewhat before additional equity exposure is added to portfolios. As shown, a reversion to the current bullish trend line, which coincides with the market's recent breakout levels, is a likely target in the short-term.
However, there is a more than reasonable chance, as I laid out two weeks agofor a deeper correction in the next 60-days. The chart below shows the potential drawdowns from current levels."
"Here is the point. It would take a correction from current levels to break 2000, which is very important support for the markets currently, to even register a 10% correction.
Given the current bullish exuberance for the market, this is probably unlikely between now and the election. Therefore, even a "worst case" correction currently would likely be an 8.5% drawdown back to major support. Of course, for most individuals, even such a small correction would likely feel far more damaging.
Let's take a look at some of the issues that suggest a reversion in prices is likely coming sooner rather than later."
As noted above, we are now approaching a 3% correction from recent highs.
Of course, this is why I have been suggesting over the last several weeks that investors should positions themselves for such a potential "rapid reversion." From last week:
"As I have been repeatedly stating over the last few weeks, as boring as it has been, there has not been enough of a correction of the current overbought condition to justify increasing equity allocations in portfolios yet. This is despite the fact the model has been adjusted higher to represent the target levels of equity exposure we want to migrate toward."
Step 1) Clean Up Your Portfolio
Tighten up stop-loss levels to current support levels for each position.
Hedge portfolios against major market declines.
Take profits in positions that have been big winners
Sell laggards and losers
Raise cash and rebalance portfolios to target weightings.
Step 2) Compare Your Portfolio Allocation To The Model Allocation.
Determine areas requiring new or increased exposure.
Determine how many shares need to be purchased to fill allocation requirements.
Determine cash requirements to make purchases.
Re-examine portfolio to rebalance and raise sufficient cash for requirements.
Determine entry price levels for each new position.
Determine "stop loss" levels for each position.
Determine "sell/profit taking" levels for each position.
(Note: the primary rule of investing that should NEVER be broken is: "Never invest money without knowing where you are going to sell if you are wrong, and if you are right.")
Step 3) Have positions ready to execute accordingly given the proper market set up. In this case, we are looking for a pullback to reduce the extreme overbought condition of the market without violating any major levels of support.
Time To Buy? Or Sell?
So, what do we do now? Is it time to increase equity exposure to target model weights OR is there more to this corrective action left?
The Bull Case (Buy The Dip):
There is little reason to believe at the moment the current bull market has ended. I say this for the following reasons:
Central Banks are still engaged globally which continue to provide liquidity support for the markets.
The Federal Reserve is unlikely to tighten monetary policy in September.
Overall investor sentiment is still in "greed mode."
Short-term oversold conditions have been achieved.
The Bear Case (Deeper Correction)
The problem is despite the bullish supports that currently remain, the list of bearish detractions has grown markedly in recent months.
Economic data continues to deteriorate. (See here)
Fundamentals remain detached from prices. (See here)
Current oversold condition is in conjunction with momentum "sell signal" (see chart above.)
Intermediate-term "buy signals" are close to being reversed from high levels (see first chart below.)
Long-term "sell signals" have been triggered (see second chart below)
If the market fails to hold short-term support, a deeper correction could begin to develop. A violation of the long-term bullish trend from the 2009 lows would be a key indication of a trend change in the market. Currently, that level is around 2050.
I want to give this current market action a few days to play itself out. As shown in the chart below, the oversold condition of the market (green dots on bottom) suggest a very likely bounce next week. However, as I have highlighted (blue boxes) bounces near market tops have generally preceded eventual deeper declines.
Over the last couple of months, I have been laying out the case to increase equity exposure in portfolios. With longer-term "buy signals" still intact, along with the long-term bullish trend, this remains a cyclical bull market currently.
Therefore, I remain on the lookout for an opportunity to "SAFELY" increase equity exposure in portfolios. That opportunity has not yet presented itself as of yet.
There is also, at this late stage of the bull market cycle, a chance it may not.
Monday's action will give us a better clue as to our next steps. Be sure and catch this coming week's "Technically Speaking" post on Tuesday for an update.
You Are Probably Doing It Wrong
The downfall of all investors is ultimately "greed" and "fear."
They don't sell when markets are near peaks, nor do they buy market bottoms. However, this does not just apply to individuals but the majority of advisors as well.
When I read articles from advisors/managers promoting "buy and forget" strategies it is for one of three reasons. They either can't, don't want to, or don't know how to manage portfolio risk. Therefore, the easy message is simply:
"You just have to ride the market out. Long-term it will go up. But hey, let me charge you a fee for holding your stuff in an account."
The reality is that markets do not return 6%, 8% or 10% annually, and spending years making up previous losses is not a way to successfully obtain retirement goals. (Read this)
It is also worth pointing out that those promoting these "couch potato" methodologies are generally out in full force near peaks of bull market cycles, and are rarely heard of near bear market bottoms. This is why, as I discussed in "Why You Still Suck At Investing," investors consistently underperform over long periods of time. To wit:
In 2015, the 20-year annualized S&P return was 8.19% while the 20-year annualized return for the average equity mutual fund investor was only 4.67%, a gap of 3.52%.
Despite commentary which suggests this is the "most hated bull market"ever, the reality is that the majority of investors remain heavily weighted towards equity exposure.
In other words, due to the ongoing Central Bank interventions, investors are now more confused than ever.
While the sentiment data suggests investors are indeed worried about a stock market crash, they are doing nothing about it.
"The financial markets are at present confounded by a plethora of uncertainties that once again prove truth is stranger than fiction. Over one-third of European and Japanese sovereign debt sports a negative yield - an unprecedented occurrence. While not causal, this rate structure likely is tangentially related to both Brexit and the divisive U.S. presidential election. Thus the conundrum of a road ahead that is full of potholes even as many financial risk measures are near their historical lows.
The implicit purpose of quantitative easing (QE) and a zero interest rate policy was to generate asset substitution; that is, to encourage investors to switch from painfully low-yielding but "risk-free" cash or sovereign debt to other assets that would more fully support economic growth. (Of course, this does invite the question as to whether a sovereign bond with a negative yield is "risk-free.")
Notwithstanding a few catcalls, most agree that these policies have so far been quite effective. The concern is that medicines, whether pharmaceutical or financial, should have a prescribed dosage that cannot be exceeded. This should be especially true for home remedies like QE that have only recently been advanced to wider Phase II trials.
Investment managers who a scant nine years ago promised to never again 'keep dancing while the music is playing' are now waltzing with 30-year U.S. Treasury securities at 2.25% and selling both interest rate and equity options (both explicitly and implicitly) at prices that leave little room for error.
Central banks (with good reason) have taken monetary policy to uncharted territory, demographic trends still have seven to nine years before they reverse, and our politicians may take us down an unexpected path, but my mantra is unchanged: "It is never different this time." So while these risk signals may be more policy-driven than fundamental, I can assure you the tides of risk will flow eventually.
Cinderella still has time to find that glass slipper, as the clock has not yet rung its final chime. But let there be no doubt that the bells have begun to toll - are you listening?"
Well, are you?
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