Written by Lance Roberts, Clarity Financial
It is this longer-term backdrop which keeps us cautious for now, and while we are “trading” the short-term breakout in our portfolios, we are well aware of the more deteriorating conditions on a long-term basis.
As my friend Doug Kass so aptly penned last week.
“I like to write that buyers live higher and sellers live lower because of the structural change in our markets in which passive strategies (quant strategies like volatility trending, risk parity and ETFs, etc.) now dominate over active strategies (hedge funds and mutual funds).
But so do non-passive strategies and far too many retail investors – many of whom worship at the altar of price momentum – buy higher and sell lower. And so do strategists and “talking heads” too often bend with the market winds.
Personally, I don’t think a lot on my bearish checklist has changed since the Spyders (SPY) made another successful test at about $259 only a week or so ago and now are trading at $272. Prices have risen and reward versus risk has eroded.
I continue to look for a down second half of the year.
The political, geopolitical, economic and corporate profit concerns which I have highlighted over the last several months remain very much intact. So does the outlook for interest rate risks, inflation and other fundamental issues present headwinds to a new Bull Market leg.
My view is that the market and economic cycle are maturing.
Rather, I prefer to be opportunistic in the new regime of volatility – buying when others are fearful and stocks are at the lower end of my trading range and selling (now) when others are greedy and stocks are at the upper end of my trading range.
With S&P cash now at around 2720, against an estimated near-term trading range of 2550-2725, a broader projected range over the balance of 2018 at 2200-2850 with a “fair market value” projected at about 2400 – the upside reward versus the downside risk has once again turned negative in all three of these calculations:
- Within the context of the short-term trading range (2550-2725) there is limited upside and about 165 S&P points of downside.
- Looking at “fair market value” (2400) versus the top end of the 2018 trading range (2850) there is upside of about 130 S&P points compared to 320 S&P points of risk – for a negative ratio of 2.4x.
- Finally, when viewed against the low end of the full year range (2200) and the top end (2850) there is upside of only 130 S&P points and downside risk of 520 points – for a negative ratio of 4x.
- Let some rationalize the advance and grow more bullish, just as they rationalized the decline (and grew bearish). Though I have enjoyed the ride recently and while I am still net long in net exposure, my foot is now off the accelerator (as discussed in this morning’s opener) as I approach a tactical market exit (likely through defined risk puts).
As always I approach my market view without the sort of hubris and self-confidence that many conduct themselves – recognizing that the only certainty is the lack of certainty and that I do not have a concession on the truth.
I recognize my infallibility especially as it relates to Mr. Market – who often punishes the most and brightest investors at its whim.
I deal with probabilities, not relative strength.
Here are my core observations and current views:
- Investor sentiment is growing more bullish with higher prices and investor complacency is now swelling
- In a market dominated by passive and momentum based strategies – buyers live higher and sellers live lower
- Mr. Market may be approaching the top end of an intact trading range – and reward vs risk has, again, deteriorated
- We are in a new regime of volatility that will likely reign over the balance of the year
- We remain in a trading sardine market and not an eating sardine market
- With machine/algo domination I am giving Mr. Market a wider berth in my trading strategy – that is to say that I am not trying to capture every zig and zag
- I may be wrong!
Moreover, and importantly, the most recent leg higher has been led by energy stocks – historically a signpost of caution and another possible arrow for the Bearish cabal.”
While we are more “reactive” than “predictive,” I couldn’t agree with Doug’s sentiment more. We are long-term investors and seek to buy “value” when such is present.
Currently, value is a scarce commodity so we remain both patient and highly sensitive to the risk of a bigger correction action coming in the months ahead.
Just to be clear, we have modestly increased equity exposure, but we do so from a “trading” perspective with very tight “stop-loss” levels while we still continue to hold a higher level of cash. If the market repairs itself and begins to resume its “bullish trend,” these “trades” will become “investments” over a longer-term time horizon and we will use our stored cash to continue to build into things that are working.
We follow one of the simplest rules for successful investing:
“Don’t more of what works and less of what doesn’t.”
See you next week.
