Written by Lance Roberts, Clarity Financial
Stuck in the Middle With You
This my weekly summary report for the week ending 26 May 2018.
Stuck In The Middle
“Trying to make some sense of it all,
But I can see that it makes no sense at all,
Is it cool to go to sleep on the floor,
‘Cause I don’t think that I can take any more
Clowns to the left of me, jokers to the right,
Here I am, stuck in the middle with you” – Stealers Wheel
On Tuesday, I updated our weekly analysis. To wit:
“With Monday’s move higher on reports, the ‘trade war’ with China has been put on hold to negotiate a reduction in the ‘trade deficit.’
When the market broke above the 100-dma, we used some of the cash we had raised on previous rallies to increase the allocation to equities in our portfolios. However, we still maintain an overweight position on cash currently as a hedge against potential market risk.
While the markets moved higher yesterday, it remains contained in a short-term trading range. We are looking to add further exposure to equities if the market can close above last week’s closing high.”
Chart updated through Friday
Unfortunately, the market was unable to gather enough steam to make the break and remained below the current downtrend resistance line. This keeps our portfolio allocations on hold currently.
Importantly, our current equity exposure remains under strict guidelines:
- Overweight cash in portfolios as the “risk” of a failure has not been absolved as of yet,
- Positions are carrying a “tighter than normal” stop-loss level, and;
- We will quickly add negative hedges as necessary on any failure of support.
I also noted that I would need to update our three potential “pathways” this week as well.
As shown by the reddish triangle, the ongoing consolidation process continues. Eventually, this will end with either a bullish or bearish conclusion. There is no “middle ground” to be had here.
- Pathway #1 – a breakout to the upside on heavy volume that pushes the market through resistance at 2780 and back to old highs. (Probability 20%)
- Pathway #2a and #2b – a breakout to the upside which fails resistance at 2780. The market then either a) retests the 100-dma and then is able to push to old highs, or, b) fails at 2780 a second time and continues the consolidation process through the summer. (Probability 50%)
- Pathway #3 – the market breaks down next week on continued geopolitical worries, economic data or some unexpected catalyst and retests the 200-dma. (Probability 30%)
I have increased the more “bearish” probability from 20% last week to 30% this week given the potential triggering of a short-term “sell-signal.” (Lower panel) If the market struggles next week, a triggering of that signal will increase the downward pressure on equity prices.
We will continue to hold our cash position until the market makes some determination as to its direction.
As my friend Doug Kass noted on Friday:
“More dovish (than expected) Fed comments contributed to a midday reversal in the averages in Wednesday’s trading session. Tactically, I believe that the rally will be short-lived and that, the current high end of the recent trading range (since early February), will prove to be difficult to overcome over the near term.
My concerns are multiple. Most importantly, we are in an advanced economic and market cycle.
The cracks in the foundation of global growth have already surfaced – seen quite visibly in the submergence of the emerging markets over the last five weeks and the growing signs of ambiguity with regard to world-wide economic growth (see this week’s European PMIs, the two year low in Citigroup’s European Economic Surprise Index and the downturn in the global economic Surprise Index).
Bears have been frustrated by the lack of follow through. But the structural supply of listed companies (down from about 7800 in 1999 to 3900 today) and the reduction of the shares outstanding (by 17%) of the remaining public companies when coupled with still steady buying from non-economic players (e.g.,central banks and sovereign wealth funds) buying of stocks and massive money committed to passive products and strategies have limited downside vulnerability and, frankly, has destroyed price discovery.
Bulls have been frustrated by the inability of sales and profit beats to catalyze the markets.
With interest rates and inflation rising and the Federal Reserve retreating from QE – the liquidity that provided a catalyst to the near decade Bull Market are being removed.
Meanwhile, a steady rise in interest rates (particularly in maturities of five years and less) have tapped T.I.N.A. (“there is no alternative”) on the shoulder and is being tempted to ask C.I.T.A. (“cash is the alternative”) to the dance.”
I agree with his points, and “cash” as an alternative has served us well over the last couple of months. This is particularly the case given the market offers much more risk than reward currently and the risk of a bigger correction later this year is an increasing possibility.
