With war rhetoric taking center stage this past week, the geopolitical risk for investors certainly increased. At times like these, it’s very easy to let your emotions take over your investment plan.
Which is why I love adaptive, rules-based investing. We can leave out emotions at the door knowing good and well that our portfolio will get adjusted…IF IT NEEDS TO BE.
With that said, I still do like to keep an eye on the markets. After all, our models must operate within the market environment we find ourselves in, so any insight to market activity, in my opinion, helps provide understanding to model adjustments. Further, and as I will explain, our attention to the market can help us make portfolio “tilts” which are smaller adjustments within our portfolio.
Clearly, it was not a good week for stock market investors. The S&P 500 lost 1.4% and the MSCI All World Index lost 1.5%
The beneficiaries of all of this were gold (GLD), up 2.34% for the week, and US Treasuries (TLT), which gained 1.09%.
With that as our background, here are a few charts of interest.
Some of my favorite kinds of charts are that which depicts what is going on beneath the surface of price action alone. Trends are less likely to be sustained unless the market as a whole is in synch. And when evidence suggests otherwise, its good for investors to be at least cautious.
On Wednesday of this week, I posted the following chart to my Twitter account. It is the Bullish Percent Indicator the S&P 500. What is shows is that the Bullish Percent has been weakening as the market was rising, meaning fewer and fewer stocks have been participating as the market was making new highs. This generally, is never healthy.
Another way of looking at this in a similar fashion is to measure the number of stocks trading above their 200-day moving average. If this number is rising, stocks are in demand and generally, prices should be rising. Conversely, if this number is falling, it tells us that more stocks are succumbing to selling pressure.
What we look for are divergences and recently the market has been rising but the indicator has been falling.
So based upon these market breadth indicators, I believe that investors have reason to be cautious. By and large, it has been the mega cap and high-quality stocks pushing the popular averages higher. (And incidentally, exactly how Portfolio Cafe models have been positioned for members)
Price action confirms this view, at least for the near term.
Price action for the S&P 500 SPDR ETF shows prices below the 21-period moving average and also the 8-period moving average has crossed below the 21-period. According to successful trader John Carter, this set of conditions shifts the short-term trend from up to down, however at this time, price still remains above the long-term moving average.
Where the real damage is being done is in the Small Caps. Here both the short-term and the long-term trend have turned negative. Small caps have been dramatically underperforming for all of 2017 and there is nothing to suggest this is about to change anytime soon.
This is where, as I said at the beginning of this post, that this information can be useful to make small adjustments to your portfolio. Personally, when I see what I see happening to the Russell 2000, I would be minimizing my exposure to Small Caps. This even means I would be minimizing exposure to Portfolio Cafe models that emphasize Small Caps because, in this environment, you are fighting a headwind to do otherwise.
To step back and take a look at the long-term trend, a very simple but effective chart that I like to look at is the Vanguard Total Market Index on a weekly time frame with a 13 and 34 period moving average. When these cross investors need to pay attention. In 2008, this simple indicator would have gotten you out of the market in plenty of time to avoid the losses that were to come.
The present situation shows we are nowhere close to seeing this pair crossing.
So at the moment, this looks like a short-term correction within a long-term uptrend. But don’t let that fool you. That could still mean a 5-10% correction as I see it.
The best-performing markets YTD have been the international markets, so let’s see how they now look.
The MSCI EAFE index shows price action below the 21-period moving average and the 8/21 very close to crossing. Short-term this is a caution.
The picture is the same for the MSCI Emerging Market Index.
So yes, I anticipate that the correction has further to go. The market is now in a seasonal period when weakness often occurs – which often shows up when complacency is high, markets are overbought and sentiment is very bullish. These conditions all existed at the start of last week.
Over 18 months have now passed since a meaningful pullback.
That is the longest period during this bull market.
Looking back over the last 60 years, that is also one of the longest periods without even a 5% correction.
Complacency reigns in the credit market too. Currently, Euro Junk debt is yielding the same as 10-Year U.S. Treasuries. This is insane. Risky assets are being priced beyond perfection.
But please remember. While technical analysis can provide a view into the market, and warning signs do exist, they aren’t perfect predictors and the future is unknown. We can only approach the “unpredictable future” with our “predictable process” that never varies.
That is the power of rules-based systematic investing and adaptive allocation. And it leaves time for us to breathe.