Another Domino Falls For The Market
Over the past several months we have posted several pieces about the various indicators that we use to monitor and measure the "risk" of being invested in the markets versus being in safer alternatives such as cash and fixed income. Our most recent posting in this regard was "Market Bounce Or New Bull Market" as the markets were advancing into the end of August. We stated: "So far, none of this takes away from the larger fact that the economy is slowing down, corporate profits are weakening, and there is a lot of risk contained in Europe that could back-splash very rapidly into the U.S. This is clearly a bounce within a negative market trend at the current time and is not a new bull market to chase. With fundamentals of stocks deteriorating along with the economy, we see NO reason to take on excessive speculative risk at the current time." That position has not changed and with the most recent signal now going off it is a time to become much more alert to the overall risk in equity portfolios.
That posting, along with other "market analysis" postings, have primarily been about shorter term indicators. These indicators are like "construction ahead" signs on a major highway. When you see these signs these are warnings that you should slow down and become more alert as to what lies ahead of you.
However, the STA Intermediate term Buy/Sell indicator is more akin to a construction worker standing in the middle of the road waving caution flags and requiring you to slow to a crawl. Pay attention here folks...this indicator has only thrown off 5 signals in the last 11 years - 3 sells and 2 buys. The current SELL signal is the 5th of those 5 signals.
This doesn't mean that the markets can't bounce from a short term oversold condition as we saw the last couple of days but it does mean that the negative trend of the market is fully confirmed. The last time this indicator went onto a SELL signal was at the peak of the market in December of 2007. During the subsequent decline that followed that SELL signal there were several strong rallies. Each rally was met by the bullish media with throngs of joy that the worst was now behind us and it was time to "buy" equities - they were wrong. In July of 2009, after avoiding the bulk of the entire decline - the indicator signaled it was now safe to enter back into the equity markets. The same occurred at the peak of the market in 2000 and during the decline that followed that signal as well.
Investing Rules For A Negative Trend
- Hold higher levels of cash as a hedge and for short term trading opportunities from oversold conditions.
- Increase fixed income exposure as money flows from equities into bonds.
- Reduce high beta (speculative) equity risk in portfolios.
- Hedge long term, fundamentally strong, equity investments.
- SELL RALLIES rather than buying dips.
These are the rules of the road until the negative trend changes back to positive. Read about any great market investor that survived and prospered over the long term and their investing rules are functionally all the same. Each and every one focuses on limiting down side exposure, protecting investment capital and creating returns with the least amount of risk possible. This is because they all know two things: 1) you can't win at investing if you lose all of your investment capital during market downturns; and 2) never forget rule number one.
Investing and HOPING that the markets will rise over time is not an investment strategy. Investing requires a lot of work, discipline and above all patience. We use fundamental investment disciplines to determine "WHAT" to buy. However, once we find a fundamentally valued investment it is critically important that we also understand the "WHEN" to buy it. With an almost 80% correlation between the stocks in the S&P 500 and the index itself; it is highly unlikely that any investment we buy will not be negatively affected by a decline in the market. Our goal is not only to buy a fundamentally cheap investment but also buy it at the most reasonable price.
This is specifically why we follow a series of indicators that build upon each other. Each signal confirms the previous giving us a "road map" of the markets and the direction we should follow. Investing without some sort of ability to understand the overall direction of the markets (the trend) is like driving down the freeway with your eyes closed.
My mother's favorite saying was always "better safe than sorry". Sure, I missed out on some things being encased in bubble wrap and duct tape but serious injury was avoided. While I jest, just a bit, the point is valid. Indicators are never infallible. Neither is trying to predict the future which is what technical indicators are trying to do. However, providing some added layers of protection to your portfolio can help you survive market turmoil and unforeseen shocks and protect your investment capital from excessive losses.
Could our indicators be wrong this time? Sure. But is it really worth betting your portfolio on it?