by Lance Roberts
Since I was traveling this past weekend for the 2015 World Economic Conference, I did not have a chance to analyze the short-term market dynamics thoroughly in this past weekend's X-Factor Report. However, there is some excellent commentary worth your reading from Authur Hill, Bill Gross, and Crispin Odey.
However, I did want to send out a quick note on the very short-term oversold condition of the S&P 500.
The bounce at the end of the day yesterday, driven by news flow out of Greece, was likely the beginning of a short-term oversold retracement of the recent decline. It is important to keep in context that the recent decline, despite the media's incessant hand-wringing and panic, has been a mere 3% since the beginning of this year.
Nonetheless, during any correction, or more importantly during a mean-reversion process, the financial markets do not move in a singular direction but rather like a "ball bouncing down a hill." For investors, it is these short-term bounces that should be used to rebalance exposure to "portfolio risk."
As shown in the chart below, the S&P 500 has gotten oversold on a short-term basis and is due for a bounce to the current downtrend resistance line. Importantly, the market is sitting on what has been very important support in recent months at the 150-day moving average. A failure of this support will lead to a retest of the October, 2014 lows.
A rally from this support line could last several days to a couple of weeks. It is advisable to use the rally to "clean up" existing portfolios by selling laggards, reducing high-beta risk and rebalancing winners by taking profits and rebalancing back to target weights.
(Important note: Notice that I did not say "rebalance portfolios" which implies selling winners to buy losers. The goal here is to let winning positions continue to flourish by simply "pruning" the position, and "weeding" the portfolio by selling the losers dragging on overall performance.)
The chart below shows a listing of the major markets and sectors in terms of relative performance to the benchmark index. This helps to identify areas that should be paid attention to in portfolios currently.
As shown the areas to pay the most attention to in terms of laggards are:
- Financials
- Technology
- Energy
- Emerging Markets
Areas to focus on for positions to hold, or remain underweight, at the moment are:
- Basic Materials
- International
Lastly, clear winners to hold/take profits and rebalance back to portfolio weights are:
- Industrials
- Mid-Capitalization
- Small-Capitalization
- Discretionary
- Real Estate
- Staples
- HealthCare
- Utilities
- Bonds
Importantly, it is worth noting that the bulk of the winning sectors have been, and continue to be, defensive areas in nature that are primarily large cap and dividend yielding.
The chase for yield over the past couple of years has pushed these sectors to extreme deviations from their long-term means. This suggests that during a major market reversion, when it occurs, that the defensive sectors are at risk of not providing the "shelter" that is suggested by their historical tendencies.
Lastly, the long-term chart of the markets are beginning to flash warning signs that this extremely long bull-market cycle may be at risk. While it is still too early to make a more defensive call now, there are signs of significant deterioration in the overall "momentum" of the market. In the weekly X-Factor Report, I run a model for managing 401k plans that consists of the three (3) buy/sell indicators. (Subscribe for free e-delivery)
The chart below shows two of the three indications on a monthly basis labeled S1 (sell signal 1) and S2 (sell signal 2). There have only been three periods since 1998 where the S1 indicator has been triggered. The first was in late 1999 as the markets climaxed toward their peak in 2000; the second was in late 2007, and the third was in January of this year.
Considering that market momentum is waning, deflationary pressures are rising and economic growth is slowing on several fronts (along with a rather rapid decline in corporate earnings) it certainly suggests that risks are beginning to significantly outweigh the rewards. Is this suggesting that the next major bear market is underway? No. It does suggest, however, that investors should pay much closer attention to the inherent risk in portfolios currently.
The S1 signal could be reversed with a very strong rally that propels the markets to new highs. While this is certainly possible, it has historically not been the case. However, the market over the last few years, due to massive Central Bank interventions, has repeatedly defied statistical analysis and historical comparisons.
The next couple of weeks will be extremely important for the markets to regain their "mojo" otherwise the risk of a much larger correction remains a dominant threat. As we saw with the Seattle Seahawks during the SuperBowl, making the wrong call late in the game can have disastrous consequences.
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