Market Finally Cracks. Is The Bull Market Rally Over?

In this issue of “Market Finally Cracks. Is The Bull Market Rally Over?”

• Market Finally Cracks
• Signs, Signs, Everywhere Signs
• Momentum Is Hard To Kill
• Portfolio Positioning Update
• MacroView: 5-Reasons The Fed’s Policy Won’t Get Inflation
• Sector & Market Analysis
• 401k Plan Manager

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Catch Up On What You Missed Last Week

Market Finally Cracks

On Thursday, it was this:

When markets are pushing extremes, it seems like it is a “no-lose” scenario for investors. It is at those moments when “selling high” becomes opportunistic, but is incredibly hard to do for the “Fear Of Missing Out (FOMO)”

The question now? Was it a one day blip, or the start of a more significant correction process.

Signs, Signs, Everywhere Signs

Over the last three weeks, we have been publishing “signs of exuberance,” which have ranged from incredibly high options speculation to investor positioning. Some of these indicators are now at levels only seen in 1999.

If you have 3-minutes, this video covers quite a few of the current indications which suggest risk continues to outweigh the reward.

(We publish “3-Minutes” Monday-Thursday. Click here to subscribe to our YouTube channel for email notification of all of our video postings and live-streams.)

I shot that video Thursday morning before the market opened.

So, did the Thursday/Friday selloff reverse the majority of those excesses back to levels where reward now outweighs the risk?

The short answer is “no.”

On every level, the market remains overbought and extremely extended from intermediate moving averages. A one or two-day correction will not reverse those levels back to a “buying opportunity.” 

However, there is currently a tremendous amount of “bullish sentiment” in the market, which may lead to several attempts at “dip buying” before a correction is complete, which we saw on Friday.

Was that the 5% correction we talked about last week?

“None of this data means the market is about to crash.

What it does mean, as discussed in “Winter Approaches,” is that a correction of 5-10% has become increasingly likely over the next few weeks to two months. While a 5-10% correction may not seem like much, it will feel much worse due to the high level of complacency by investors currently.

All of the data suggests that “Winter Is Coming.” Therefore, this is why we are adding “value” to our portfolios to prepare for colder weather.”

Not surprisingly, the selloff on Thursday and Friday shocked a lot of inexperienced investors that thought it couldn’t happen.

Momentum Is Hard To Kill

There is one crucial aspect of the market, which you should not dismiss – “momentum” is extremely hard to kill. 

Many “retail” investors will immediately view the selloff on Thursday and Friday, and the media, as a reason to pick up “stocks on the cheap.” The general bias in the short-term is that you should buy every “dip,” and for a brief period, they may indeed be proved right.

We can validate that view by looking at speculative call buyers, who, despite the pullback, increased their leveraged market bets. (Chart via Sentiment Trader) Furthermore, this amount of speculation is historically unprecedented. The eventual outcome when this all unwinds is obvious.

However, in the short-term, the market has pulled back to very short-term support. We suspect the pullback will entice a lot of the momentum buyers, and those who “missed out,” to jump back in. A sellable bounce next week, in lighter post-holiday trading, is very likely.

Furthermore, as we noted previously in a “Tale of Two Bull Markets,” the deviations longer-term are still problematic. The extensions are so large it will require several days to weeks of a correction to work off the extremes. As shown, last week’s decline is barely noticeable and did little to reverse the longer-term overbought conditions.

Portfolio Positioning

Currently, we are trapped.

In the longer-term, markets are overbought, overvalued, and extended against a backdrop of weakening economics, a potential political upheaval, and poor earnings outlooks.

On the other hand, we have an exceedingly bullish market, extreme momentum,  and a shorter-term defined bullish uptrend.

So what do you do? The same as do you with a “porcupine.”

You deal with it very carefully. 

On Friday, we used the early market lows to add to some of our technology positions that we had discussed reducing recently:

“Consequently, given the more extreme short-term overbought conditions and deviations, the risk of a short-term reversion has risen. Therefore, we spent this past week harvesting some of our gains (AAPL, MSFT, CRM, ADBE, AMZN) and planting a few seeds for our ‘Fall’ garden (VIAC & T)

Importantly, this does not mean we sold everything and went to cash. We continue to maintain our equity exposure to the markets. We are just reducing risk by ‘hedging around the edges,’ adjusting our bond duration, and adding more ‘defensive’ names to our equity allocation.”

The additions on Friday are only moving us back to target weights in some of our holdings from being underweight before the correction.

Importantly, we remain “bullish” on the markets currently as momentum is still in play. However, we also realize the tremendous amount of risk that remains due to overvaluations, extensions, and deviations. 

If the short-term trend of the market changes from bullish to bearish, we too shall change our positioning accordingly. 

The problem for most investors is either a lack of a discipline to manage capital or an unwillingness to acknowledge that what was working no longer is.

We prefer to acknowledge change and have the discipline to deal with it.

The MacroView

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO

Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

S&P 500 Tear Sheet

Performance Analysis

Technical Composite

Sector Model Analysis & Risk Ranges

How To Read.

• The table compares each sector and market to the S&P 500 index on relative performance.
• The “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
• The risk range is a function of the month-end closing price and the “beta” of the sector or market.
• The table shows the price deviation above and below the weekly moving averages.

Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels.

Sector-by-Sector

Improving – Financials (XLF), and Industrials (XLI)

During the correction this past week, Financials finally outperformed the S&P 500 by not falling nearly as much. Likewise, Industrials held up well, also. The outperformance during the correction was not surprising, as they have lagged the S&P 500 on the way up. The sectors are still way too overbought to buy into, so we may see more of a correction in the near term.

Current Positions: XLI, IYT

Outperforming – Materials (XLB), and Discretionary (XLY)

Discretionary stocks, which were being primarily being driven by AMZN, had a sharp correction back towards the 50-dma. The correction was not surprising, as we have been talking about the risk for the last few weeks. After taking profits previously, we are now looking for an opportunity to build back into our holdings.

Current Positions: None

Weakening – Technology (XLK), and Communications (XLC)

Technology and Communications holdings are also finally corrected. After having taken profits previously, we used the dip to add back a small amount to XLK on Friday morning. We are maintaining tights stops currently.

Current Position: XLK, XLC

Lagging – Energy (XLE), Healthcare (XLV), Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Energy continues to underperforming for the time being, so we are not currently increasing exposure. There is value in the sector, but it has not yet become recognized by the market.

We continue to maintain our core defensive positions Healthcare, Staples, Utilities, and Real Estate, which performed better than the market during the correction. We are looking for opportunities to add to our positions we took profits in previously.

Current Position: XLU, XLV, XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Both of these markets continue to underperform, and declined back to their respective 50-dma’s last week. These markets need to hold here if they are going to get a bid. We had suggested taking profits previously. If these markets can remain above critical support and work off the overbought condition, we may have a reasonable entry point to add exposure for a trade. We will need to see what happens next week.

Current Position: None

Emerging, International (EEM) & Total International Markets (EFA)

Emerging and International Markets have performed better recently. However, last week they also corrected back to their respective 50-dma. They must hold these levels next week. There may be an opportunity to add to these names short-term, but the risk is high. Furthermore, the dollar remains extremely oversold, which is also a threat to international exposures.

Current Position: None

S&P 500 Index (Exposure/Trading Rentals) – We currently have no “core” holdings.

Current Position: None

Gold (GLD) – We added to our gold and gold miners positions previously. They did hold up better than the overall market correction and are testing the necessary support.

Current Position: IAU, GDX, UUP

Bonds (TLT) –

We continue to hold our bond holdings as a hedge against market risk. As noted, we had an excellent rally going in bonds that were defending against the selloff on Thursday. On Friday, we did take some profits out of Treasuries, which got hit on news the Chinese threatened to sell bonds. They are unlikely to do so, and we should see bonds rally next week. (Lower rates.)

Current Positions: TLT, MBB, & AGG

Portfolio / Client Update

Over the last couple of weeks, we have discussed the changes to portfolios to become a bit more defensive. We have been adding “value” to the portfolio both for relative “safety” and “dividend yield.” As noted in this week’s newsletter, the deviations from long-term means are at extreme levels.

This week, that correction came sharp and swift on Thursday and Friday. We suspect that we are not finished with the correction process just yet, but we did use the lows Friday morning to add some small exposure to our technology holdings for a trade.

As noted in the main body of this missive, “momentum” is tough to kill, so we are looking for a short-term trading opportunity to add some performance to portfolios. We are also maintaining very tight stops just in case.

We had also recently added to our bond holdings, which worked well until Friday. The Chinese have threatened to sell their bonds in retaliation to President Trump’s threats. Such is an empty threat from China for many reasons, but it is less of a threat to the bond market as the Fed needs the bonds to keep their monetary stimulus going. Very likely, we will see rates decline again next week as the bond market figures that out. We did take some profits in our latest position on Friday. 

Portfolio Changes

In the equity model, we added a new value position in DOX. Our analyst Nick Lane has provided updated analysis supporting our purchase.

Over the last couple of weeks, we have been prepping portfolios for this decline. Now, with a pretty brutal 2-days of selling, we are going to add some trading positions for a potential bounce next week.

Given the momentum markets are tough to kill, it is likely we will see some attempts to jump back into the previous leaders next week. So we are going to add some small amounts to our momentum trades and counter that exposure with additional value trades.

EQUITY PORTFOLIO:

BUY

• 1% DOX – New portfolio position
• 1% KHC – New portfolio position

Furthermore, we added 0.50% to:

• AMZN
• AAPL
• MSFT
• COST
• CVS

ETF PORTFOLIO:

BUY

• 1% of Portfolio Value into XLK 

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO