Written by Lance Roberts, Clarity Financial
Over the last several weeks, we have been discussing the potential for a market correction simply due to divergences in the technical indicators which suggested near-term market risk outweighed the reward. As is generally the case, bonds have been warning the bullish bias of equity investors was likely misplaced. I have updated last week’s chart for reference.
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The increase in risks has had us rotating exposure in our portfolios to a more defensive tilt. We previously trimmed back our overweight exposure to Technology, Then, two weeks ago, we noted we further tweaked client portfolios by reducing exposure to “trade sensitive” areas by selling half of our holdings in Industrials, Materials, and Discretionary areas.
Last week, we continued to process of the defensive rotation, reducing risk, and rebalancing allocations.
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“As noted in our newsletter over the last couple of weeks, we are seeing the early signs of a defensive rotation in equities due to the resurgence of the trade war. Therefore, we are moving our allocations accordingly to participate with the rotation.
We are adding to our real estate exposure, which is interest rate sensitive, and we are overweighting our defensive holdings in utilities and staples.
After recently lengthening duration in our bond portfolios, we will look for a short-term reversal in rates, which will coincide with a counter-trend market bounce, to add further to our position in IEF.“
Importantly, we still maintain a long-bias towards equity risk, but that exposure is hedged with cash and bonds which remain at elevated levels. (I published an investing resource for you last week: 10 Illustrated Truths About Investing & The Markets)
Looking Forward
Currently, on a very short-term basis, the markets have worked off some of the overbought condition from last month and, importantly, has held support at the Oct-Nov 2018 highs. There is additional support at the 200-dma just below current support at 2775. These are key support levels for the S&P 500 as we head into the summer months and, if the bulls are going to maintain their stance, must hold.
The reason we maintain a more defensive posture is the triggering of the intermediate-term “sell signal” (yellow highlights above) suggest that prices will remain under pressure for a while longer. (Hence the rotation to defensive positioning.)
Let me reiterate four very crucial points the markets have NOT factored in just yet:
- There will be NO TRADE DEAL any time soon. (China is buckling down for a long fight.)
- Earnings estimates are still far too high going into the end of 2019 and 2020.
- The economy will weaken further as the latest rounds of tariffs, which take effect June 1st, begin to impact the economy headed into the last half of 2019.
- The Fed is unlikely to lower rates, or increase their balance sheet, prior to a recessionary start or a substantially deep correction in the market. (i.e. more than 20% from current levels)
For now, as stated, the market is working a corrective process which is likely not complete as of yet. As we head into the summer months, it is likely the markets will experience a retracement of the rally during the first quarter of this year. As shown in a chart we use for position management (sizing, profit taking, sells) the market has just issued a signal suggesting risk reduction is prudent. (This doesn’t mean sell everything and go to cash.)
Just one other thing, I don’t like market comparisons because no two market cycles are alike. However, price patterns are important because they represent the “psychology of the herd.” The chart below shows the market in the months leading up to the Dot.com crash, the Financial Crisis, and where we are currently.
Again, no two market cycles are the same. The drivers which facilitate the bull run, and the catalyst which ends it, are ALWAYS different.
It is just investor behavior which is always the same.
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