Markets Reverse, Bull Trend Remains

X-factor Report 04 November 2014

by Lance Roberts, Streetalk Live

In last week’s analysis, I laid out four levels of resistance that the markets would have to penetrate in order to keep the current bullish trend intact. Over the past week, the markets have managed one of the largest weekly rallies in recent history to clear 3 of those hurdles as of the time of this writing.

a 1900 –is the previous psychological support which is now resistance. This is a good level to reduce major laggards or losers in the portfolio. A little “house cleaning” will free up cash for reinvestment at a later date. (

a 1925 –This is the long-term moving average that has held the bullish uptrend since 2012. This moving average is now major resistance for the market and a failure at this level will signal that the correction is not yet complete. Reduce more towards target levels if this level is reached.

a 1960 –This is the short-term moving average which is also now resistance. If the short-term moving average crosses below the long-term, we have a real problem

r 2019 –However, should the markets somehow find the strength to surge to all-time highs from here, which is a possibility, and then the cash raised from the rebalance and portfolio cleanup

Specifically, I issued instructions to pare back on equity exposure in portfolios stating:

“There is little risk in practicing some form of portfolio ‘risk management.’ The real risk is doing nothing and then spending the next advance in the market making up previous losses. That has been a successful investment strategy ‘nowhere, never.’

I have reduced the model allocation by 25% and had suggested using the reflex bounce in the markets, which occurred as expected, to underweight portfolios temporarily.”

“With the second “sell” signal not yet confirmed, there is no need currently to reduce portfolio allocations any further.

IMPORTANT: Reducing allocations does not mean “selling everything and going to cash.” It is a rebalancing of holdings to correspond with the overall portfolio allocation model. For example, and this is for illustrative purposes only and not a recommendation to buy or sell any security, the following table shows a sample portfolio and the rebalancing process.”

“As you can see, it is not a wholesale liquidation of assets across the board but simply a reduction and rebalancing of the portfolio relative to economic and financial metrics.”

While the rally has been exceedingly strong over the last two weeks, it does not change the strategy at this point.

Sell Signal Still Intact

With some extra cash in the “kitty” it provides portfolios a little flexibility to respond to rather volatile market dynamics. The chart below shows the series of events that has propelled the markets higher in recent days as a massive short covering rally, on declining volume, has taken place.

The chart below is an hourly chart of the market over the last month. It shows the flip-flop of Fed President Bullard, the end of QE, the impact of 12 day old news that Japan’s GPIF was upping their allocation to equities which was followed by a surprise announcement that Japan would double down on their failing QE program. That is how you concoct an equity rally that forces short positions to liquidate “en masse”.

However, the recent rally, as massive as it has been, has failed to reverse the current sell signal as shown in the chart below.

With the markets back to extensively overbought areas, this suggests that a “cooling off period” is likely in the days and weeks ahead. As long as any consolidation or pullback does not violate any important support levels AND allows the current sell signal to be reversed, such action will provide a safer entry point to reallocate stored cash back into equities.

However, that time is not today.

Year End Rally And Into 2015

It is important to remember that the markets are entering their seasonally strong time of year. While historical statistics suggests that markets will rally post the mid-term elections and into 2015, there is no guarantee that will be the case. However, it does not pay to bet against statistical tendencies.

In January of this year, I laid out the case for the continuation of the current bull market into 2015 and that the next recession will likely begin in 2016. To wit:

“There is a very high probability (83%) that the 5th year of the decade will be positive with an average historical return of 21.47%.

The return of the positive years is also quite amazing with 10 out of the 15 positive 5th years (66%) rising 20% or more. However, 2015 will also likely mark the peak of the cyclical bull market as economic tailwinds fade, and the reality of an excessively stretched valuation and price metrics become a major issue.

As you will notice, returns in the 6th and 7th years (2016-17) become substantially worse with a potential of negative return years rising. The chart below shows the win/loss ratio of each year of the decennial cycle.”

“It was in 1996 that Alan Greenspan first uttered the words ‘irrational exuberance’ but it was four more years before the ‘bull mania’ was completed. The’ mania’ of crowds can last far longer than logic would dictate and especially when that mania is supported by artificial supports.

The statistical data suggests that the next economic recession will likely begin in 2016 with a negative market shock occurring late that year, or in 2017. This would also correspond with the historical precedent of when recessions tend to begin during the decennial cycle. As shown in the chart below the 3rd, 7th and 10th years of the cycle have the highest occurrence of recession starts.

With the Fed’s artificial interventions suppressing interest rates and inflation, it is likelythat the bullish mania will continue into 2015 as the ‘herd mentality’ is sucked into the bullish vortex.

While the historical evidence suggests that 2014 will see a buying opportunity going into 2015, it is important to remember one simple phrase that is too often forgotten by the ‘bullish crowd:’

“Past Performance Is No Guarantee Of Future Results.”

In the next week or two, IF the markets can maintain their current forward momentum, a buying opportunity should be presented to add selected equity exposure back into portfolios. The market is becoming much narrower in terms of leadership that is expected at this late stage of the game as most of the “low hanging” fruit has already been harvested.

While it is currently believed that the market, and economy, is now bulletproof – the reality is that is not the case. It has just been a combination or artificial supports that have obfuscated risk in the markets so far.

Here are some predictions that no one is currently paying attention to:

• An extremely cold winter that comes early and last longer than normal that impacts economic growth.
• Japan’s latest round of QE, which is simply doubling down on an already failed experiment, fails again in fairly short order.
• The economy slows despite lower oil prices as global deflationary pressures increases.
• The markets begin to realize that corporate buybacks are slowing, and real earnings growth is slowing more quickly than realized.

The next couple of months is likely to prove rather interesting. Keep some powder dry and let’s look for a good opportunity to put some capital back to work.

Have a good week.

Disclaimer: All content in this newsletter, and on Streettalklive.com, is solely the view and opinion of Lance Roberts. Mr. Roberts is a member of STA Wealth Management; however, STA Wealth Management does not directly subscribe to, endorse or utilize the analysis provided in this newsletter or on the Streettalklive.com in developing investment objectives or portfolios for its clients. At times, the positions of Mr. Roberts will be contrary to the positions that STA Wealth Management recommends and implements for its clients’ accounts. All information provided is strictly for informational and educational purposes and should not be construed to be a solicitation to buy or sell any securities.

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