I’ve noted before that my technical indicators currently suggest greater downside than upside. Markets ALWAYS present potential for risk and potential for reward. Will markets rise, fall or meander? Nobody knows! But at ValueTrend, we CAN say that we use some quantifiable rules and indicators that can give us guidance on positioning for the potential of risk and reward potential. Right now the factors we watch are skewed bearish—although a few factors are bullish.
- Short termed bullish trend – no arguments, markets have been rising since February. The market is over its 50 and 200 day Moving Averages—a key indicator we use for trend analysis.
- Cumulative breadth (broad market participation by a large group of stocks or sectors) is bullish. This is a diverse rally.
- Confirmation of neartermed strength by transport stocks. This has changed from a bearish condition back in January. You want to see industrials and transports move together—they weren’t before, now they are.
- Moneyflow on the S&P 500 (top, bottom panes) is bullish.
- Put/Call ratio is 1.2 – that means there are lots of options traders betting on downside—contrarian thinking suggests this is a buy signal.
- Intermediate termed bearish trend — no new highs since May 2015 and a lower low in January 2016. This is our prime long termed trend rule. You must have higher highs and higher lows on the weekly chart to be in an uptrend.
- Trailing Price to Earnings ratio on the S&P500 is 24. That’s historically very high. Read this blog for more information on market valuations.
- Sentiment – as measured by Smart/Dumb money movements – is bearish. The dummies (retail investors) like this market and smarties (sophisticated investors) are selling.
- Volatility is historically too low. A VIX (volatility index) level of 13 was seen a month ago. It’s just under 15 right now. The normal range is usually 12 (very low) to 28 (very high). This index rarely stays at one end of the range for too long. That means that volatility is likely to return in the near-term.
- Markets are overbought. Some important momentum studies we follow suggest things have moved too fast. NYSE New high low, NYSE % over 50 day MA, Stochastics, MACD and (less so) RSI are overbought – or approaching that level – and may be pulling back. See charts at top of this blog.
- Sell in May and go away. Now is the risky time of the year to be fully invested. Markets are weaker during the next 6 months 72% of the time.
- Technical resistance of 2135 was approached last week, and once again failed. Markets have unsuccessfully tried to approach 2135 on 7 different occasions since early 2015. Since that high, they haven’t even reached 2135 again, let alone breached it. That’s technically bearish. See the chart below – sent to me by Brooke Thackray.
Our game plan
Our rules are straight forward. If a lower low is reached and the 200 day Moving Average is cracked – we’re out. We had to follow that rule in January after a lower low than the summer of 2015 was reached and the 200 day MA was broken. We sold some stocks at a loss. This wasn’t fun. But rules are rules. If the S&P 500 breaks above its 2135 lid (higher high) , and stays there for 3 weeks, we will move back in and remove our hedges. That’s a rule too. These same rules saved our clients from the fate of their neighbors (invested with buy & hold managers) in 2008, 2011, and 2015. We don’t know if it will work this time, but the rules have worked well enough to merit faith in following them over the long run.
Right now, our ValueTrend Managed Equity portfolio is positioned as follows:
- Cash 30%: we hold 30% + cash/cash equivalents
- Low beta stocks 35%: Low beta means low price fluctuation in relation to the market. We hold 35% exposure to lower beta stocks.
- Market beta to higher beta stocks 22%: We hold a few stocks like Google and the energy sector with higher growth, but higher volatility.
- Hedge positions 13%: We hold positions that will typically rise in a falling market, and fall in a rising market (inverse, short and VIX). We also hold gold, which can act “non-correlated” meaning it has no relationship to the market. Currently we hold Inverse, short, VIX and gold bullion ETF’s to form that 13% portfolio hedge.
By holding cash, hedging, and focusing on low beta stocks, you end up with relatively (not perfectly) flat performance. Remember, you can’t have your cake and eat it too. You will make less in a rising market, and lose less if it falls. Based on the bullish vs. bearish head-count above, we are comfortable with such a stance….Let the chips fall where they may.