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Technically Speaking: The Month Of April

  • Written by Syndicated Publisher No Comments Comments
    April 13, 2016

    In this past weekend’s newsletter, I laid out a case for being “cautiously optimistic” as technical action had improved and short-term buy signals had been triggered. To wit:

    “By the time “buy” and “sell” signals are triggered, the initial recovery has already completed most of its initial move. This is completely expected.  Importantly, if the markets are indeed reversing course, the entry back into the markets will still be very early into the next overall advance. 

    The importance of waiting for confirmation of a change in market dynamics, even for shorter term traders, is to establish a higher reward-to-risk ratio when putting investment capital to work. This methodology, while you will not “buy the bottom” or “sell the top,” reduces the probability of speculating incorrectly and then becoming emotionally trapped into a position that becomes detrimental to portfolio performance. 

    In the chart below, you will note that the previous rallies which took the markets to very overbought short-term conditions (top part of the chart). However, those rallies did not reverse the sell-signal in the lower part of the chart. Each of these previous rallies subsequently failed taking stocks lower. This is why the allocation model remained exposed to lower levels of equity risk during this entire period.”

    SP500-MarketUpdate-040116-4

    “Currently, as shown above, the short-term dynamics of the market have improved sufficiently enough to trigger an early “buy” signal. This suggests a moderate increase in equity exposure is warranted given a proper opportunity. However, to ensure that the current advance is not a “head-fake,” as repeated seen previously, the market will need to reduce the current overbought condition without violating near-term support levels OR reversing the current buy signal. 

    Again, let me reiterate, the commentary above is for shorter-term, active investors, looking for a set up to take on equity risk. There is currently a HIGH PROBABILITY that the analysis above will be reversed in very short-order. 

    As a portfolio manager for individual’s retirement assets, where risk must be substantially mitigated, there has been NO improvement in the intermediate-term technical structure of the market currently.”

    SP500-MarketUpdate-040116-5

    “With relative strength, momentum and price deterioration still on the decline, there is currently little reason to become aggressively exposed to market risk. This is particularly the case given the extreme technical similarities to previous major market peaks.

    Furthermore, if the “bulls” have indeed returned to the market, as is being suggested by the mainstream media, we should see longer term measures of market momentum and relative strength turning more positive as well. This isn’t happening either.”

    With earnings season fast approaching, volatility at extremely low levels, and the majority of Central Bank announcement now behind us, the risk of a market failure at current levels remains elevated. Therefore, even though the very short-term technical underpinnings have improved, I remain more cautious currently for several reasons:

    1. The market is GROSSLY overbought in the short-term and must either consolidate at current levels or correct to lower levels to resolve it.
    2. Negative trends are still in place which suggests the current rally, while significant, remains within the context of a reflexive rally.
    3. Volume is declining on the rally suggesting a lack of conviction.
    4. This rally looks very similar to the rally last October except the fundamentals are substantially weaker. (ie profits)

    SP500-MarketUpdate-040116

    APRIL STATS FOLLOWING MARCH GAIN

    The month of March was a boomer. The media has been rife with commentary on the “biggest comeback in history.”However, a strong reflex rally, as we saw, is not uncommon during “bear market” cycles, as short-covering fueled rallies spark sharp price increases The problem is the sustainability of the push higher. So, as we leave March behind and enter into the second quarter of the year there are several things that we need to focus on:

    1. Seasonal adjustments, which have given a massive boost to recent economic reports due to the unseasonably warm winter cycle, will begin to revert as temperatures realign with more normal seasonal patterns.
    2. While earnings estimates have been dropped markedly to allow companies to play the “beat the estimate”game, profits and revenues will likely show a sharper contraction that currently expected which will push current valuations higher.
    3. April winds up the seasonally strong time of the year and summer months tend to be weak particularly prior to Presidential elections.

    Let’s take a look at the statistics of April performance and particularly when it follows a March gain.

    First, if we look at the month of April going back to 1960 we find that there is a bias for the month to end positively 66% of the time. In other words, 2 out of every 3 April months finished in positive territory which is why it is included in the seasonally strong period of the entire year.

    April-Performance-Daily-040516

    Unfortunately, the declines in losing months have wiped out the gains in the positive months leaving the average return for April almost a draw (+.01%)

    April-GrowthofDollar-040516

    However, a look at daily price movements during the month, on average, reveal the 5th through the 10th trading days of the month are the weakest followed by the end of the month. It is during this middle part of the month that either the market holds support begins a deeper corrective action.

    April-Daily-PriceMovement-040516

    Importantly, going back to 1957, it should not be a foregone conclusion that April will end in positive territory. While the statistical odds currently favor such a scenario, it does not mean it will be the case. If we look at April performance following a March gain, a slightly different picture emerges.

    April-Performance-Following-March-Gain

    April has had a positive performance 26 times following a March gain, but lost 18 times. In other words, the risk of a negative April rises to 41% when the preceding month was positive.

    SO, WHAT IF I’M WRONG?

    I recently penned a piece on the problem with “Buy and Hold” investing. The crux of the article is that spending a bulk of your time making up lost gains is hardly a way to build wealth longer-term. More importantly, is the consideration of “time” in that equation. Unless you discovered the secret of immortality, “long-term” is simply the amount of time between today and the day you will need your funds for retirement.

    Of course, such articles always derive a good bit of push back suggesting that individuals cannot effectively manage their own money, therefore, indexing is their only choice. I simply disagree.

    Yes, managing risk in a portfolio will create underperformance over short-term periods BUT much less than being overly exposed to equities during a period of decline.

    Let’s assume that I am wrong in my current downside risk assessment and the markets reverse course and begins to rise strongly. The market will have to effectively hit all-time highs at this point to reverse the bearish trends that are currently in place.

    However, if the market does re-establish the previous bullish trend, I will certainly recommend strongly increasing allocations to equity-related risk. Any differential in performance which currently exists will be quickly absorbed.

    But what if I am right and this is just a bear market rally?

    If I am right, the preservation of capital will be far more beneficial. As I have stated previously, participating in the bull market over the last seven years is only one-half of the job. The other half is keeping those gains during the second half of the full market cycle.

    If the market breaks support, the subsequent decline will quickly wipe out the March recovery. The probability of such happening in the months ahead is still very high. The purpose of risk management is to protect investment capital from destruction which has two very negative consequences.

    First, when investment capital is destroyed, there is less capital to reinvest for future gains. The second, is the destruction of compounded returns. Small losses in principal can quickly erode years of gains in wealth.

    Raising cash and protecting the gains you have accrued in recent years really should not be a tough decision. Not doing so should make you question your own discipline and whether “greed” is overriding your investment logic.

    While the financial press is full of hope, optimism and advice that staying fully invested is the only way to win the long-term investing game; the reality is that most won’t live long enough to see that play out.

    You can do better.

     

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Real Investment Advice

    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.

    Real Investment Advice: Bringing the complex world of politics, economics, investing and personal financial wealth building to you in simple, easy and informative way.

    Real Investment Advice is the home of the daily blog and weekly newsletter from Lance Roberts, Chief Portfolio Strategist for Clarity Financial. If you want to understand how money and the economy really work, this is your place to start.
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