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posted on 08 April 2017

Charting The Market's Course

Written by , Clarity Financial

Short-Term

I noted at the beginning of the month that we had lifted some profits out of portfolios and rebalanced risk. I also stated that we were not adding any NEW positions at that time. Such has remained our stance since then.


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However, as noted in the chart below, on a short-term basis the market is approaching a buy signal after finding support at the 50-day moving average. With there still begin a couple of months left in the seasonally strong period of the year, and confidence in the “Trump Trade" still high, if a “buy signal" is issued we will add short-term risk related exposure (tactical holdings) back into portfolios.

Intermediate-Term

However, do not confuse a short-term tactical positioning in the market with an intermediate holding period in portfolios.

Currently, portfolios remain nearly fully allocated to the markets and as noted above we are simply adjusted portfolio weightings for short-term tactical positioning. However, on an intermediate-term basis, the markets remain grossly overbought and very extended. As such, the possibility of a correction has risen markedly.

In fact, my friend, Salil Mehta from Statistical Ideas sent me the following note yesterday.

Long-Term

In the long-term, the picture worsens substantially. From extreme overbought conditions, to similar economic growth rate backdrops, this isn’t a market that currently suggests long-term returns will remain favorable for investors.

Too Bullish?

My friend Dana Lyon’s had a great post on Friday relating to investor confidence in University Of Michigan consumer confidence survey. To wit:

“Specifically, they are asked to guess as to the ‘Probability of Increase in Stock Market in Next Year’. Respondents’ answers are broken down into ranges of probability percentages, e.g., ‘1%-24%’, ‘25%-49%’, etc. One of the answer options is ‘100%’ probability of a stock market increase over the next year. We like to track this statistic as a measure of public sentiment towards stocks. And based on the most recent survey, as of February, the public is relatively quite certain about the prospects of a stock market rally."

“With most sentiment-related statistics, extreme readings are contrary in nature. That is, the market typically moves contrary to the consensus opinion. That dynamic generally holds true here. Here are the 12-month returns in the S&P 500 following the above readings:

  • February 2004 (+5.12%)

  • November 2007 (-39.49%)

  • January 2015 (-2.74%)

  • June 2015 (+1.73%)

While 2 of the 4 precedents saw positive 12-month returns, they still paled in comparison to the median (-10.35%) and average (-8.02%) 12-month returns over the sample period. Plus the 2004 incident saw negative returns out to 8 months, and the June 2015 incident out to 9 months. So, in all 4 cases, the longer-term performance of the stock market was sub-par, at best."

Final Point

As I noted last week:

“Over the last couple of weeks, the market has begun a corrective process. Currently, the market is oversold enough on a daily basis, and holding support at the 50-dma, which suggests a rally attempt is likely next week."

That rally occurred as expected due to end of the quarter “window dressing" and portfolio rebalancing.

However, as noted above, on an intermediate-term basis be cautious.

As noted by RBC on Friday:

Quick note of warning as we transition into the new quarter, with potential for major thematic / sector / factor reversals in stocks. The following observation regarding April seeing a seasonal ‘momentum’ factor market-neutral strategy unwind is ‘equities wonk-ish,’ but with real potential cross-asset impact.

As we know, the Fed watches equities because there are potential implications with regards to broad US ‘financial conditions’ on consumer and economic confidence. Thus, the scale of potential equities volatility does matter across macro, especially in light of general buyside portfolio ‘crowding’ / ‘high beta’ exposure (into ‘growth’ right now especially) which could exacerbate the dynamic."

Translation: “Watch your ASSets."

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