Nothing seems to be able to slow down the current stock market uptrend. Not sovereign debt worries, not increased global strife, not earthquakes debilitating one of the world’s largest economies, not even $110 oil. So, everything must be great! What could stop a market rally that shrugs off these potential concerns?
We don’t know exactly what could stop this market, but experience and some technical analysis leads us to believe that something will. When bad news is greeted happily by the market, bells start going off in our minds. It doesn’t mean that a terrible market drop is about to come, but it does show that investors are not looking at risk with enough respect. Not worrying about risks can lead to an overheated market which needs to have some air let out. The longer the air builds up, the bigger the potential pop.
From a technical perspective there are at least two points we see as being important now. The first is that the S&P 500 volatility (as measured by the VIX) is hovering at multi-year lows. This means that stocks have pretty much just been going one direction – up. The second is that volume is showing signs of tapering off. When volume goes down while a trend one direction continues this can mean that support for that direction is waning and a turn can come about. In short, both of these are technical warnings that the current uptrend could be in danger.
We have certainly been happy to harvest the gains from the strong stock market. However, we would actually like to see stocks take a short break from their upward motion. We hope that something stops the current uptrend without a significant downwards move, simply slowing things down for a period of three to six months. This would help mitigate any bubble creation, and would allow for a strong base from which the uptrend could continue.
Put differently, we see that stocks may be set up for a bit of a decline, and believe that this decline would be healthy as long as it doesn’t become large enough to induce panic.
There was a dip in February this year, which was quickly erased (too quickly in our view). A few more dips like that over the coming six months or so would be a healthy sign. A bit of treading water, coupled with good earnings results, would set the stage nicely for a year-end rally and a good year of investing overall. If stocks just continue to charge forward it becomes more likely that there will be a significant decline (more than -10% or so) along with some potential for panic, which could lead to an even larger decline.
As you have probably gathered, although we remain fully invested, we are cautious regarding stocks at this time. Put differently, we see that stocks may be set up for a bit of a decline, and believe that this decline would be healthy as long as it doesn’t become large enough to induce panic. Indeed, the higher stocks go without a decline the more we will become concerned.
Currently our goal is to continue to ride the uptrend, with the acknowledgement that we have concerns for its longevity. It is times like this when we must draw on our past experience. We have seen that our portfolio allocations and the Active Hedge strategy will serve you well in a continued uptrend, while still working towards our goal to provide some insulation from the rough patches that may lie ahead. We look forward to seeing what the future will bring.
Sol is president of Highlander Financial. He has over 20 years of experience in financial markets and managing businesses.