The Goldilocks Warning


Market Review & Recap

Over the last couple of weeks we discussed the “wild swings” in the market in terms of price movements from overbought, to oversold, and now back again. The quote below is from two weeks ago but is apropos again this week.

“Despite the underlying economic and fundamental data, the markets have surged back to extremely overbought, extended, and deviated levels.On virtually every measure, markets are suggesting the fuel for an additional leg higher in assets prices is extremely limited.”

Just for visual's sake, the chart below compares the last three weeks of wild gyrations. (Click To Enlarge)

The chart below also shows the short-term reversal of the market as well. Note how in just a few days the market went from overbought, to oversold, back to overbought. 

Importantly, as I specifically noted last week:

“This short-term oversold condition, and holding of minor support, does set the market up for a bounce next week which could get the market back above the 200-dma. The challenge, at least in the short-term, remains the resistance level building at 2800.”

On that analysis, we did increase equity exposure early last week in both our ETF and Equity Portfolios. In the RIA PRO version of this letter we gave specific recommendations to add exposure particularly to Healthcare due to the recent sell-off over concerns of Medicare for all.

Despite the rally, the bounce is still largely at risk for the three following reasons:

  1. As noted previously, the market has not reversed to levels which normally signals short-term bottoms. The red lines in the bottom four panels denote periods where taking profits, and reducing risk, has been ideal. The green lines have been prime opportunities to increase exposure. As you will note, these indicators tend to swing from extremes and once a correction process has started it is usually not completed until the lower bound is reached. 

Important Note: This does not mean the market will decline sharply in price. The current overbought conditions can also be resolved by continued consolidation within a range as we have seen over the last two weeks. 

2) The divergence between stocks and bonds still signals that “smart money” continues to seek “safety” over “risk.” Historically, these bond market generally has it right.

3) As discussed in “Will The Next Decade Be As Good As The Last,” the weekly chart below shows the S&P 500 hitting an all-time high last September before falling nearly 20% into the end of 2018. While the first two months of 2019 has seen an impressive surge back to its November highs, the market is starting to build a pattern of lower highs, and lower bottoms. More importantly, both relative strength and the MACD indicators are trending lower and negatively diverging from the markets price action.

As John Murphy noted last week for StockCharts:

  • The bull market that ended in March 2000 preceded an economic downturn by a year.
  • The October 2007 stock market peak preceded the December economic peak by two months.
  • The March 2009 stock upturn led the June economic upturn by three months.
  • Historically, stocks usually peak from six to nine months ahead of the economy. Which is why we look for possible stock market peaks to alert us to potential peaks in the economy that usually follow. And we may be looking at one.

If you are a longer-term investor, these issues should be weighted into your investment strategy. While we did add exposure to our portfolios early last week, we are still overweight cash and fixed income.

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