In last week’s update, I discussed the markets entrance into the “Seasonally Strong”period of the year to wit:
“The table below shows the statistics of the seasonally strong/weak periods of the S&P 500 from 1957 to present using the data from the Federal Reserve (FRED).
As noted above, there is a statistical probability that the markets will potentially try and trade higher over the next couple of months particularly as portfolio managers try and make up lost ground from the summer.
However, it is important to note that not ALL seasonally strong periods have been positive. Therefore, while it is more probable that markets could trade higher in the few months ahead, there is also a not-so-insignificant possibility of a continued correction phase.
Furthermore, the probability of a continued correction is increased by factors not normally found in more “bullishly biased” markets:
- Weakness in revenue and profit margins
- Deteriorating economic data
- Deflationary pressures
- Increased bearish sentiment
- Declining levels of margin debt
- Contraction in P/E’s (5-year CAPE)
(For visual aids on these points read: 4 Warnings)
Return Of The Bull, Or Bear Trap
The rally, driven by the highest level of short interest since 2008, has once again ignited “bullish optimism.” As shown in the chart below, the number of stocks on “bullish buy signals” has exploded in recent weeks.
While the “bulls” are quick to point out the current rebound much resembles that of 2011, I have made notes of the differences between 2011 and 2008. The reality is the current market set up is more closely aligned with the early stages of a bear market reversal.
However, with the markets extremely oversold following the August-September declines, the rebound in the markets was not unexpected. As I have repeatedly noted over the last couple of months, these strong reflexive rallies should be used to rebalance portfolios and reduce areas of excessive risk.
With the markets currently pushing extreme short-term overbought territory and encountering a significant amount of overhead resistance, it is likely that the current reflexive rally that began four weeks ago is near its conclusion.
During the summer rout, many investors were reminded of what the term “risk” truly meant. Reflexive rallies of the magnitude witnessed as of late is a “gift” that should be used by individuals to rebalance and realign portfolios with personal risk tolerances.
(In other words, if you didn’t like what happened during August and September, it was a warning you have too much risk in your portfolio. The next time, the market will likely not be so forgiving.)
As shown below, the current sell-off, and reflexive rally, has occurred with both major market “sell signals” registered. Since the turn of the century, the combination of these technical indicators has only occurred at the onset of more meaningful corrections.
[NOTE: This is a monthly chart. Therefore, only the month-end close of the market will matter in determining what likely happens next. A failure of the market to close above the short-term moving average may suggest more corrective action to come.]
It is too early to determine whether the “bull market” has resumed. While the markets have indeed entered into the “seasonally strong period,” there are many external risks still weighing on sentiment. These keeps my statement from last week valid:
“For longer-term investors, and particularly those with a relatively short window to retirement, the downside risk still far outweighs the potential upside in the market currently. When a more constructive backdrop emerges, portfolio risk can be increased to garner actual returns rather than using the ensuing rally to make up previous losses.”
The “Fed” Effect
In a more normal market, I would already be well convinced that the bullish trend had ended, particularly against the backdrop of an earnings recession and weak economic data. But this is by no means a normal market given the ongoing interventions by the Federal Reserve to support asset prices.
This is a point I noted earlier this month.
“It is worth noting that contractions/expansions in the Fed’s balance sheet has a very high correlation with subsequent market action as liquidity is pushed into the financial system.As shown in the chart below, the Federal Reserve has already once again began to quietly expand their balance sheet following the recent downturn. Not surprisingly, the market has responded in kind with the recent push higher. My suspicion is that if such minor interventions fail to stabilize the market, a more aggressive posture could be taken.”
This afternoon, the Fed will announce their latest FOMC rate policy decision. My expectation is that they will once again forgo hiking rates with few changes to their verbiage of their decision. However, any indications that recent economic weakness will push rate hikes further into the future will likely be cheered by the“bulls” pushing the index back towards recent highs.
Such an event, however, would not change the risk/reward stance in the market and would only exacerbate the extreme overbought condition that exists currently.
However, a subsequent correction to support that allows for that overbought condition to be reduced could provide a short-term trading opportunity through the end of the year. Such an outcome would be well within the confines of performance of both the year prior to a Presidential election and the 5th year of a decennial cycle.
Unfortunately, statistically speaking, 2016 and 2017 are aligning to far less optimistic for investors.
“The statistical data suggests that the next economic recession will likely begin in 2016 with the negative market shock occurring late that year, or in 2017. This would also correspond with the historical precedent of when recessions tend to begin during the decennial cycle. As shown in the chart below the 3rd, 7th and 10th years of the cycle have the highest occurrence of recession starts.”
However, that is a topic of discussion we will delve more deeply into as the year end approaches.
The important point to understand is that I am not making a prediction about future events. The purpose of price analysis is to identify potential risks to investment portfolios in advance of them becoming a problem. These are warning signs, nothing more. But warning signs unheeded tend to lead to very poor outcomes.
This is why Andrea Orcel’s comments recently, as President of UBS’ investment banking arm, are so relevant:
“Nothing is good in general. We are in an environment where nothing is good.
At some point, it will disconnect, and it disconnects very aggressively. And the repercussions are very significant. It’s very difficult to hedge or prepare for that. We can’t take anything for granted.”
The point here is simple. No professional or successful investor every bought and held for the long-term without regard, or respect, for the risks undertaken. If the professionals are looking at “risk,” and planning on how to protect their capital from losses when things go wrong, then shouldn’t you be doing the same?
Then again, maybe this time is indeed different? Maybe the two major bear markets of this century were simply anomalies? Maybe. But are you willing to bet your retirement savings on that?
Images: Flickr (licence attribution)
About The Author
Lance Roberts – Host of StreetTalk Live
After having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.
Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.
Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.