posted on 05 February 2017
by Lance Roberts, Clarity Financial
Trends Matter A Lot
People ask me all the time why I write so much.
Here is the funny part, when I write I am writing for me. The process of writing helps me distill down the daily barrage of financial information into a more focused analysis to help me in the management of portfolios.
From time to time my writings are picked up by other sources, which is both flattering and humbling, which leads to comment threads by readers. These comments are the most enlightening and educational parts of my day.
I have learned two things in particular.
The first is there is a visible dichotomy between those who lived through the "Financial Crisis" and those who made their first investments afterward. The former has a clear understanding of what happens to capital during a major market correction and the effort required to recoup those losses. The latter has a clear belief "this time is different" and the market can only go higher from here.
The second is there is clear misunderstanding of the difference between "understanding and recognizing risks" and investment posturing (aka being "bearish.")
Currently, our portfolios are nearly fully allocated. As I have discussed over the last couple of months we have added "risk off" trades due to the extreme bifurcation in the markets. We have also added Russell 2000 and international exposure along with various sector exposure and broad market coverages.
This is hardly bearish by any means.
As such, if the market continues to rise, that's great for my clients and my portfolios.
But telling you why the market will keep going up is hardly a useful exercise. For that simply turn on any financial television program or read any mainstream financial publication. Bullishness always reigns. Maybe you should ask yourself why? (Optimism sells products, services, and advertisers.)
For me, when I write, I am analyzing the data for where I could be wrong in both my short, as well as my intermediate-term, outlook. That doesn't make me bearish, although it may sound that way. What you are reading is my struggle to battle "confirmation bias."
And...that is where we are today.
The Bullish View
As I noted last week:
It is the last part of that sentence which is most important in the SHORT-term.
As the monthly chart of the S&P 500 shows below, the bullish trend currently remains firmly entrenched. The market continues to trade above the running bullish trendline AND the 24-month moving average. Currently, it would require a break below 2100 to suggest a change of trend is in the works.
This short-term bullish trend mandates that portfolios remain exposed to equity-related risk as long as corrections do not violate either the 24-month or upwardly trending bullish trend.
However, eventually, something will happen to "change the trend" from upwardly sloping to downwardly sloping which will be identifiable by a break of the supportive trendlines. In such a case the second rule applies:
For now, the markets are clearly bullish as optimism and exuberance reign.
The Bearish View
It is the over-optimistic and exuberant outlook currently that gives me caution as to the intermediate and long-term views. As noted last week by Brad Lamensdorf there are multiple indications that suggest a much higher degree of long-term caution. To wit:
These are just a few of the many indications of the extreme deviations which currently exist. This is in addition to the numerous points I have noted previously of extreme positioning in the markets as well.
When all of these measures are combined, the "risk" in the market currently far outweighs the potential for "reward" over the intermediate to long-term time frames. No chart shows that better than the quarterly view of the markets below.
As you will notice, each time there has a been combination of extreme overbought conditions (red vertical dashed lines) combined with high valuations, which coincides with market exuberance, the resulting corrections back to the long-term logarithmic trend line (green dashed line) has not been kind to investors.
Currently, such a correction would entail a decline in the market by more than 40%.
That's not being bearish.
That's just a historical fact.
Market Analysis & Warnings
Since I did a an extensive review of the major markets and domestic sectors last week, not much has changed this week other than the VIX hitting even lower lows. If you didn't catch last week's piece it is worth reviewing.
I did find some very interesting research pieces which I thought were worth sharing with you as they are supportive of much of my own analysis.
The Other Dow Theory Indicator
Dana Lyons pointed out something I missed with respect to the "Other Dow Theory Indicator."
I Don't Care About The Price, Just The Dividend
One of the most common things I hear from individuals is:
This is a mantra that is ONLY stated near major market peaks.
The reality is that when the prices of equities fall two things nearly always happen:
Dividends are a function of your total return. Which means that capital preservation is required as a part of your long-term investment success.
However, here is a more important point from Political Calculations:
Here is the point.
Buying a stock for the dividend alone, and forgetting about the important function of price, is a dangerous way to invest your portfolio. While you may have the best of intentions to hold out for the long-term and collect "the check," it is not a smart way to manage your portfolio as many found out during the last financial crisis.
The Stock-Bond Warning
Michael Kahn had a good piece this week which reiterates a point I have made over the last couple of months about the relationship, longer-term, between bonds and stocks.
There is NO SUBSTITUTION for risk management in a portfolio.
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