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posted on 10 October 2016

Monday Morning Call 10 October

Written by , Clarity Financial

Double Inside Weeks

Sentiment Trader recently had a very interesting note:

“For the second week in a row, the S&P 500 formed an inside week. This is when this week’s high is lower than the previous week’s high, and this week’s low is higher than the previous week’s low.

In other words, this week’s bar on a chart completely fits within the prior week’s bar. It’s rare to see a single inside week, much less two in a row. The last occurrences were prior to the last two bear markets, which is interesting.

Obviously, anything with the only two precedents being those dates is worth looking at further, so the table below shows every date back to 1928 when this occurred. The S&P’s immediate bias was to the downside, showing a poor risk/reward ratio over the next 1 and 2 weeks. It wasn’t exactly great on any time frame, but with a relatively short-term price pattern, we wouldn’t read too much into beyond the medium-term."


This analysis corresponds with much of what we have been discussing over the last several weeks.

As I noted last week:

“Outside of a volatile price week, not much has changed in terms of the broader market keeping allocations reduced from targeted levels currently."


“As stated at the beginning of this missive, the bullish trend remains intact currently and the “buy signal" from the February lows is still rising. However, that ‘buy signal,’ as shown at the bottom of the chart, has reversed. With the S&P 500 currently in a very tight consolidation pattern, a break to the downside would likely quickly test support where the previous breakout level intersects with the bullish trend from the February lows. A violation of that level would likely lead to a rather sharp market correction of 8-10%."

However, I want to juxtapose the analysis from Sentiment Trader above with one other thought. The one differential between the periods where the double-inside week led to just a mild-correction or sloppy performance, versus the onset of a more major correction, was when the market was NOT on a more major sell signal combined with extreme overbought conditions as shown in the chart below.


In other words, don’t get too complacent.

Model Update

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

Another week of rather volatile price action this past week which substantially changes nothing. For the week, the market declined by 0.57% but maintained its bullish trend line for now. This keeps portfolio equity risk weightings remain below our target of 75% but did we also did not get stopped out of our trading position we added last week. The consolidation pattern of the market keeps us somewhat on hold.

As I stated last week:

I am not highly confident in the addition of the position at the current time, but the market has continued to consistently hold the bullish trend line. Again, this is a trading position and NOT a long-term hold at this point."


Last week, I also stated that I would consider re-adding another trading position in the volatility index (VXX). As shown in the chart below, while volatility has declined it is not yet at the extreme oversold condition that provides the best risk/reward for a VXX hedge at this time.

I am still considering adding the hedge if volatility once again gets smashed to extremely low levels. I will update this analysis in Tuesday’s Technically Speaking post (click here for free e-delivery)


Let’s take a look at the equal weighted portfolio model.

(Note: This is an equally weighted model example and may differ from discussions of overweighting/underweighting specific sectors or holdings.)


The overall model still remains underweight target allocations. This is due to the inability of the markets to generate a reasonable risk/reward setup to take on more aggressive equity exposure at this time.

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.


Notice in the next to last column to the right, the majority of sectors which have previously been pushing extreme levels of deviation from their long-term moving average, have corrected much of those extremes.

Financials, Basic Materials, Staples, Utilities, REIT’s and Bonds are currently at the biggest deviations below their short-term moving average. Historically speaking, and as noted above, such deviations would suggest these sectors deserve some attention in portfolios as this is where buying opportunities TEND to exist. It also supports the idea of further consolidation, or correction, in the markets is likely as these more defensive sectors tend to benefit from the rotation from “risk" to “safety."

The chart below is the “spaghetti" chart, via StockCharts, showing the relative strength/performance rotation of sectors relative to the S&P 500. If we are trying to “beat the index" over time, we want to overweight sectors/asset classes that are either improving in performance or outperforming the index, and underweight or exclude everything else.



Utilities, REIT’s, Staples, Discretionary, Materials, Bonds, Gold, and Healthcare have remained under pressure this past week. This has largely been due to the rise in interest rates. However, that rise in rates looks largely done and suggests a decline in rates from here is much more likely as hopes of a Fed rate hike in December fades along with upcoming economic data.


With rates now back to overbought conditions, bonds and interest rate sensitive sectors are now extremely oversold.

We have been pretty aggressive buyers of bonds over the last week in anticipation of a rotation back into safety. Such a rotation will likely coincide with weaker than expected economic data and/or a break of the bullish trend line in the markets.

Conversely, the rush into International, Emerging Markets, Small Cap, and Financial sectors has likely run a bulk of its course. These are excellent areas to lift profits in particularly given the recent strength in the US dollar.

Most importantly, given that a bulk of the sectors remain either in weakening or lagging sectors, this suggests the current advance in the market remains on relatively weak footing.

Profit taking should also be focused on Technology stocks as the current outperformance of this sector is very long in the tooth.

The risk-adjusted equally weighted model has been increased to 75%. However, the markets need to break above the previous consolidation range to remove resistance to a further advance.


Such an increase will change model allocations to:

  • 20% Cash

  • 35% Bonds

  • 45% 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 still need to see improvement in the fundamental and economic backdrop to support the resumption of a long-term bullish trend. Currently, there is no evidence of that occurring.


The Real 401k Plan Manager - A Conservative Strategy For Long-Term Investors


NOTE: I have redesigned the 401k plan manager to accurately reflect the changes in the allocation model over time. I have overlaid the actual model changes on top of the indicators to reflect the timing of the changes relative to the signals.

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. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.


We’re Stuck

Once again, we remain stuck. The market remains confined within in a very narrow trading range that limits our ability to assess the current risk/reward for increasing or decreasing equity related exposure.

This past week the markets bounced sharply off of the bullish trend support line but was unable to make any headway through overhead resistance. So, as stated, we’re stuck.

Early warning signals are suggesting the correction has more room to go, so let’s be patient once again this coming week.

With the election right around the corner, increased volatility is expected. Therefore, having a little extra cash in portfolios will likely be a good hedge for now. Sit tight for now and I will update you on Tuesday.

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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