Written by Lance Roberts, Clarity Financial
This week is a review of where we have been and a look forward as to what may happen next.
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First, let’s rewind the tape to the beginning of March.
“Most importantly, the market is currently in the process of building a consolidation pattern as shown by the ‘red’ triangle below. Whichever direction the market breaks out from this consolidation will dictate the direction of the next intermediate-term move.”
“Turning points in the market, if this is one, are extremely difficult to navigate. They are also the juncture where the most investing mistakes are made.”
The market did indeed fail to breakout and on March 23rd, as the market first tested the 200-dma for the first time, we laid out the three possible pathways for the market.
I have repeated those options over the last couple of weeks, so click the link above for specific details.
- Option 1: The market regains its bullish underpinnings, the correction concludes and the next leg of the current bull market cycle continues.
- Option 2: The market, given the current oversold condition, provides for a reflexive bounce to the 100-dma and fails.
- Option 3: The market struggles higher to the previous “double top” set in February, retraces back to the 100-dma and then moves higher.
In last weekend’s missive, as the rally approached the 100-dma, we recommended that investors use the rally to take action and rebalance risk in portfolios. We also discussed the benefits of holding extra cash.
“Given the recent rally, and overbought conditions, we are using this rally to follow our basic portfolio management rules. As the market approaches the “neighborhood” of the 100-dma we are:
- Selling laggards and raising cash.
- Rebalancing remaining long-equity exposure to comply with portfolio target weightings
- Rebalancing the total allocation model to comply with target exposure levels. (See 401k plan manager below)”
Chart updated through Friday’s close.
That advice turned out to be warranted (a lucky guess) as the market not only failed at resistance, but has now established a third lower top. That failure also pulls the current downtrend line lower as shown in the chart below. This development should not be lightly dismissed.
This week, we are continuing to carry an overweight position in cash. However, we are monitoring the possible actions heading into next week:
- With the market on a short-term “buy” signal, there remains a potential for another rally attempt next week. If the market can clear the downtrend, then we will be looking for an opportunity to redeploy cash.
- However, the failure at resistance applies more downward pressures to prices in the short-term which keeps risk elevated. Pathway 2 is becoming much more viable if market action doesn’t improve soon.
- Over the next couple of weeks, it is critically important for the market to regain its footing and not break the 200-day moving average which will likely accelerate the correction process.
- Over the next couple of months, with earnings season still in process, volatility will remain a close companion so we will have to continue monitoring changes on a very short-term basis and adjust accordingly.
