Technically Speaking: This Is Nuts – Part Deux

<< Read More: This Is Nuts & Why We Reduced Risk On Friday

In this past weekend’s article, we discussed the exceedingly deviated price, and overbought conditions, not to mention valuations, as key reasons why we slightly reduced risk in our portfolios.

“On Friday, we began the orderly process of reducing exposure in our portfolios to take in profits, reduce portfolio risk, and raise cash levels. 

In the Equity Portfolios, we reduced our weightings in some of our more extended holdings such as Apple (AAPL,) Microsoft (MSFT), United Healthcare (UNH), Johnson & Johnson (JNJ), and Micron (MU.)

In the ETF Sector Rotation Portfolio, we reduced our overweight positions in Technology (XLK), Healthcare (XLV), Mortgage Real Estate (REM), Communications (XLC), Discretionary (XLY) back to portfolio weightings for now.”

Not surprisingly, I received more than a few emails chastising me for “bailing on the bull market, which is clearly going higher.” 

Such is hardly the case. We simply reduced our weighting in some of the companies which have had substantial gains over the last year. We remain primarily long-biased in our portfolios, but given the extreme technical overbought, and deviated conditions, it was prudent to raise some cash and protect our gains.

However, it wasn’t just the conditions we discussed which have us concerned about the markets in the short term. Investor positioning has also reached rather extreme levels. As Bob Farrell once wrote:

“When all experts agree, something else is bound to happen.”

Currently, with investors all extremely long equity exposure, the risk of a correction has become elevated.

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Our composite “fear/greed” indicator, which is comprised of investor positioning, shows much the same as “bullish sentiment” has become rather extreme.

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This composite gauge combines extension, deviation, and momentum into a single weekly measure. Readings above 90 (Currently 92.31) are always associated with corrective actions in the market.

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With all of these conditions aligned, the “probability” of a short-term correction has increased. Given that risk outweighs reward in the short-term, we decided it was prudent to reduce the numerator of that equation.

Why We Reduced Risk

It may seem irrational that we would reduce our risk exposure as the market continue to rise. Less exposure to equities, means less upside performance of the portfolio, or rather, “opportunity cost.” As I noted:

“While the markets could certainly see a push higher in the short-term from the Fed’s ongoing liquidity injections, the gains for 2020 could very well be front-loaded for investors. Taking profits and reducing risks now may lead to a short-term underperformance in portfolios, but you will likely appreciate the reduced volatility if, and when, the current optimism fades.”

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