Written by Lance Roberts, Clarity Financial
This past week, the market failed twice in trying to climb back above the 61.8% Fibonacci retracement level which kept the market confined to the same tight trading range we saw in May.
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Because of the breakdown on Monday a week ago, we DID NOT increase equity exposure in portfolios as of yet. With 50% of portfolios currently in cash and fixed income, the damage from last week’s sell-off was mostly mitigated. (This is the advantage of cash and fixed income in a volatile market.)
The good news, if you want to call it that, is the cluster of support at the 50, 75 and 100-dma did hold this week. However, these levels are critically important now and a break below will quickly lead to another test the 200-dma.
On Tuesday last week, I updated the pathway chart above to take into account these potential outcomes.
Pathway #1: Given the recent tendency for bulls to rush in to “buy the dips,” the current oversold condition on a short-term basis provides enough “fuel” to support a rally back to recent highs. (30%)
Pathway #2a: Given both the short-term oversold condition AND the confluence of support at the 100-dma, the market is able to rally back to 2740 remains confined to a tight trading range between the 100-dma and 2740. (30%)
Pathway #2b: follows the path of #2a but fails to hold support at the 100-dma and quickly falls to test support at the 200-dma. The market will be deeply oversold at that point, so a rally back to the 100-dma is probable. If the market fails to move above 100-dma then a break below the 200-dma becomes probable and brings Pathway #3 into focus. (40%)
And just like the first rule of “Fight Club” – we do not talk about “Pathway #3.”
Actually, we will, we just aren’t there yet.
Should a break of the 200-dma occur we will be discussing much more about the onset of a cyclical bear market, risk reduction, and hedging.
“While I remain ‘hopeful’ the market can regain its stability and continue to quickly compensate for Trump’s trade rhetoric, ‘hope’ is not an investment strategy.”
Remember, these “pathways” are how we assess the risk of potential outcomes in a market that is experiencing much higher levels of price volatility than what we have seen previously. As longer-term investors, we “hope” to invest capital that will grow over time, but given the rising risks of a late stage market cycle, reductions in market liquidity, and tighter monetary policy we maintain a focus on capital preservation.
