posted on 25 October 2016
by Lance Roberts, Clarity Financial
Is it over yet?
The election I mean.
I am sure I am not the only one who has likely reached the max capacity of election fatigue.
It reminds me of the "This Or That" game where players are given a choice to make with equally bad outcomes in many cases. Such as:
However, in this case, the questions would likely be:
You get the point. The zombie, bear, and death by fire are getting a majority of the votes.
But, it's not just the election that is weighing on me, but the indecision of the markets as well.
Okay, back to work. As I noted last week:
Chart Updated Through Friday Morning
The two dashed red lines show the tightening consolidation pattern more clearly.
Currently, the market has been able to defend crucial support at the level where the markets broke out to new highs earlier this year. However, the market now finds itself "trapped" between that very crucial support and a now declining 50-dma along with the previous bull trend support line.
Importantly, the "sell signal," which is shown in the lower part of the first chart above, suggests that pressure remains to the downside currently.
However, there is a concerted effort currently to keep prices elevated over the last week. Following the bounce off of the critical 2125 level this past week, the market has consistently fought off weak openings and have rallied back into the close. This is shown in the chart below.
The red circles denote when the market had reached extreme overbought levels during the trading day which typically denoted the limit of the upside advance for the day.
The broader point to be made here is that while the market is defending its current support level at 2125, the question is whether the market can muster the momentum to reconstitute the bullish trend into the end of the year.
As shown, the longer the market languishes below the downtrend line, and the previous bullish trend line from the February lows, the sharper the rise needs to be to re-establish the bullish trend. It would currently require a move to 2200 to accomplish that feat next week.
While such a move is certainly quite feasible, there is a substantial level of resistance currently weighing on the markets. The 50-dma moving average has begun to trend lower, the downtrend resistance from the previous market highs remains present and the "sell signal" occurring at high levels suggests the risk of a further correction has not currently been eliminated.
It is important, as an investor, is not to "panic" and make emotionally driven decisions in the short-term. All that has happened currently is a "warning" you should start paying attention to your investments.
With earnings season now in full swing, a pickup in volatility is certainly expected. However, so far, the earnings have been a mixed bag with several companies pointing to the election as a reason for missing earnings. While the election is certainly an easy culprit to point to, the reality is much more likely a strong dollar/weaker economy and consumer story that is actually weighing on their earnings.
Case For A Much Stronger Dollar
Last week, I updated my outlook for a stronger dollar. To wit:
Of course, the real problem of a stronger dollar at this juncture is that it weighs on exports which comprise about 40% of corporate earnings. As I stated last week:
Just this past week Elena Holodny penned an interesting note suggesting the same:
They are correct in the assumption the Fed is unlikely to hike rates at all this year as "economic uncertainty" remains going into the end of the year. Given the current slate of economic data showing deterioration, combined with a stronger dollar weighing on exports, a corresponding weakness in asset prices should not be unexpected.
Yellen Rationalizes Financial Bubble
In a very interesting note from Jesse Felder last week, he lays out a pretty compelling case for a Fed driven asset bubble. To wit:
Of course, what most people don't understand, is that regardless of whether you are a manufacturing or service business the growth requirement needed to sustain a P/S ratio above 2.0 is onerous at 15% compounded annually into infinity.
To put a finer point on this, Scott McNealy, the CEO of Sun Microsystems, once said:
By the way...here are a few stocks in the S&P 500 you are paying a 10x P/S for right now:
As Jesse goes on to note:
Jesse's thought was further fleshed out by Dr. Daniel Thornton via HedgEye:
Obviously, the Fed's ongoing monetary policy is the culprit.
The current level of household net worth and valuations are not sustainable and, at some point either sooner or later, the piper will have to paid. Of course, don't be at all surprised when the response to the bursting of the 3rd bubble since the turn of the century is simply more of the same misguided monetary and fiscal policies as in the past.
Unfortunately, Jesse and Daniel are correct and it will only once again be understood well after the fact.
Stocks & The Election Cycle
As I stated at the beginning of this missive, the election cycle is weighing on me. However, it also is weighing on the markets as well. As noted by Mark DeCambre via MarketWatch on Friday:
Of course, it is the Central Bank moves that will be a bigger influence particularly as the economic and earnings data continues to unfold. The belief that the Federal Reserve will hike rates in December - not at its next meeting in November with the White House in play - is near its highest of the year, with the market pricing in a roughly 75% chance. Very likely those odds will fall once the election is past and the focus returns back to the economy.
With both breadth and momentum deteriorating in the market, as shown in the chart below, it will be critical for the markets not to fail at current levels of support in the "bullish" story is going to continue.
Hang on to your hat, the ride is likely only going to get more bumpy as we head towards the end of the year.
THE MONDAY MORNING CALL
The Monday Morning Call - Analysis For Active Traders
Risks Remaining For The Rest Of The Year
It is interesting that many people believe the stock market has actually been doing well. However, the reality is that for the past two years the market has actually not gone anywhere. This was a point noted by Eric Parnell via Seeking Alpha just recently:
He is correct. On a short-term trading basis, as opposed to the longer-term outlook in the main body of this missive above, we are moving into the "seasonally strong" period of the year for stocks. However, there are many risks, even in the short-term, to consider as Eric notes.
So, while there is a potential the market could hold onto support long enough to muster up a rally into the year end, there are mounting risks that something could indeed go horribly wrong. As an investor, you will be well served to monitor events closely and adjust portfolio risk accordingly depending on how events begin to play out.
No Secular Bull Market
On Monday, I discussed all the reasons why the markets, despite much media commentary to the contrary, have not entered into a new "secular bull market cycle."
However, on Friday, I was having dinner with my friend Jeff Sandene from Marathon Wealth and discussing this issue specifically. He lightened me as follows:
He makes a very compelling argument as shown in the chart below.
Just something I am thinking about and the potential implications therein.
S.A.R.M. Sector Analysis & Weighting
Taking a look at individual sectors of the market the deterioration of momentum and breadth becomes much more evident. The first chart below are the major sectors of the S&P 500 index.
As you will notice 7-out-of-9 sectors have registered short term sell signals with the short-term moving average crossing below the long-term moving average. Furthermore, the majority of the leadership for the current market has come from the technology sector where the momentum of the advance has slowed sharply.
Moving on to other major sectors we find some similar patterns emerging.
Once again we find the majority of major indices registering sell signals and seeing deterioration among the previous leadership.
With the dollar strengthening, interest rates remaining elevated and labor costs on the rise, the risk to corporate profitability is elevated. If earnings season comes in weaker than expected, the recent ability of the market to hold support at bullish levels may fail.
Caution remains a prudent investment stance currently.
Let's take a look at the equal weighted portfolio model.
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 the 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.
Importantly, Financials have now registered, as shown in the last column, a "weekly sell signal" which suggests further weakness in the sector in the near to intermediate term.
There is a broad deterioration across sector performance which suggests overall weakness in the markets will likely continue in the near-term. Some caution is currently advised.
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. However, Utilities, Staples, and Discretionary have begun showing signs of improvement. With the rise in rates largely done, sectors with the most benefit from falling rates look reasonable.
The opposite holds true for those sectors that are adversely affected by a stronger dollar and weaker oil prices. With dollar tailwind still intact, and oil prices grossly extended, profit taking in emerging markets and energy stocks seems logical.
As I stated in this missive last week:
That bounce was nascent at best, and with the markets remaining overbought on a longer-term basis, bond holdings are still favored.
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 has begun to fade as anticipated.
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:
THE REAL 401k PLAN MANAGER
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.
The good news is the market was able to hold 2125 last week keeping support in place. This holding of support keeps allocation models stable this week.
The bad news is a more important correction may have just started, however, it is too early to know for certain. We remain on high alert with our initial "sell signal" in place as shown in the chart above.
We remain cautionary in 401k allocations which has kept volatility low and principal safe. However, we will make changes accordingly depending on what the market decides to do next.
As noted last week:
Again, with 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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