EC Reviewing Market Signals As Warnings Increase

Over the last several weeks, we discussed evaluating the recent “buy” signal and concerns about a potential summer correction. We will review that bit of history and discuss our reduction of equity exposures this past week. 

May 7th:

“The uptick in money flows did allow us to add some exposure to portfolios in holdings we took profits in previously. Overall, the market trend remains bullish, so there is no need to be overly defensive. Just a regular process of tweaking risk and managing exposures is all that portfolios require for now.”

May 14th – things didn’t work out as planned:

“Well, that follow-through failed to occur. Not only did the “buy signal” not trigger, but the market also broke down through the previous consolidation range. The last exposure we took on is now pressuring the portfolio momentarily, but we should benefit from the turn if we are correct.”

May 21st – the rally gets underway:

“We do expect a counter-trend rally due to the liquidations occurring by institutional investors over the previous few weeks. We will hold exposures at current levels for now. However, instead of looking for a more extended rally into mid-summer, we suspect this rally will be fairly short-lived.”

That week we also began to build the case for a 5-10% correction by mid-summer.

“The risk of a more significant drawdown outweighs the reward longer-term, but we are willing to trade short-term opportunities.”  

Jumping ahead, last week, the signals returned to overbought short-term conditions.

“The good news is that we did indeed get the rally we were expecting. The not-so-good news is that the rally already consumed a majority of the ‘buy signal.’ Such does not mean the market is about to correct; it does suggest that upside remains limited near term.”

Market Struggles At Highs As Signals Peak

While the market did hit all-time highs this week, it was a feeble rally. Both Thursday and Friday saw the market drop into the red intraday only to be saved by end-of-day buying. Unfortunately, as shown, money flows continued to decline until there was “distribution” as the market hit highs. Such is not a sign of confidence the “highs” will stick.

On a weekly chart, the picture improves somewhat with the “buy signal” still intact. However, it is just barely the case, and if we get selling pressure next week, it will trigger a “sell.”

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Dr. Duru 1 month ago Contributor's comment

I think August being seasonally one of the most "dangerous" months of the year in terms of drawdowns is sufficient for a case of imminent downside risk.

Herbert Blank 1 month ago Contributor's comment

Since we're discussing seasonality and to bolster your point, Dr. Duru, September has been the worst average monthly return month of the year, so if one adopts a more defensive posture in August, maintaining it through September probably makes sense. Historically turbulent October is a more complicated issue because the turbulence has run both ways. It has been a month of crashes in some years and big upward moves in others.

Dick Kaplan 1 month ago Member's comment

Agreed.