Cut n’ fill

Stock market bottoms require a “capitulation” moment, followed by some near termed relief rallies driven by “buy on the dips” retail investor mentality, and subsequent selloffs inspired by traders selling to the willing retail buyers. This action is similar to road construction, where an engineer will decide to “cut” through the peaks, and “fill” in the troughs in order to build a smoother highway. At some point, the retail buyer gets wise to these up & down actions, and stops buying the dips. A final washout occurs—which may or may not carry the market to a lower point than the original capitulation point. Rarely do we get a nice tidy “V” bottom. Bottoms are usually complex.

I recently noted on this blog  that the sentiment and breadth indicators that signalled a sell in 2011 are currently turning positive. At ValueTrend, we managed to sell out of the markets early in 2011 based on those signals. Those same signals inspired us to sell out in April of this year—and we’ve been  50% cash since. While the sentiment and breath indicators are signalling bullish again, it is important to realize that they are forward indicators. That means that they will signal ahead of the move—just as they did in March of this year (markets didn’t fall until August). Our job now, as technical analysts is to more precisely define the timing of our entry point to take advantage of this very likely resumption of the bull market.

If we review the developments over 2011, we can see the number of declines and rallies that it took to establish a bottom. Note the lowest low was at the end of the bottoming process. There was  a brief breakdown in December of that year that caused a bit of distress to market players after the bottom was put in, but we can probably be safe in saying that the true bottoming formation took place between early August and early October. Interestingly, that has been the case so far insofar as the recent selloff began in early August, and the market has been staging relief rallies and selloffs since then.
If history repeats itself, we might see more chop over the balance of September. Seasonally, that make sense. In 2011, the completion of the bottoming process was signalled by divergence in the MACD indicator. So it might not be a bad thing to keep our eyes on MACD for a similar occurrence. Whatever the case, I am not of the mind to believe that a relief rally, such as today’s (Monday Sept 8^th) will the beginning of a new up leg.
This is going to take a bit more time, in my opinion.

Does market timing work?
Here is a chart of our ValueTrend Equity Platform vs. the major world markets. Note how our platform (thick black line) has performed at a relatively flat pace during the recent market selloff. Note our drawdown in 2011 was also a fraction of the market’s losses. I believe this chart illustrates the value of technical timing of the markets. By utilizing technical analysis to reduce your equity and hedge your risk, you can maintain your capital during market selloffs. All else being equal (assuming you are never able to buy outperforming stocks, and simply perform at the market index rate of return), you can still outperform market indices – and do so at a lower rate of risk by selling out of the market if risk increases according to technical analysis signals. I believe this graph of ValueTrend’s performance illustrates this principal nicely. So hats off to you for incorporating technical analysis into your money management. And remember, if you don’t want to do it yourself, we are more than willing to talk to you about how ValueTrend can help you accomplish your investment goals.

The information contained in this report is for illustration purposes only and was obtained from sources that we believe to be reliable however, we cannot represent that is accurate or complete. The portfolio may invest in leveraged or inverse exchange traded funds and thus there may be exposure to aggressive techniques which may magnify gains and losses and can result in greater volatility and be subject to aggressive investment risk and price volatility risk. All performance data represents past performance and is not necessarily indicative of future performance. The North American Index is comprised of 85% S&P TSX300 total return index and 15% S&P500 USD total return index. WorldSource Securities liability shall only be attached to the accuracy of information contained in your official statement of account and information in your official statement of account will always take precedence over the information contained in this illustration. Worldsource Securities Inc. is a member of the Canadian Investor Protection Fund and sponsoring investment dealer of Keith Richards.