Weekend Reading: Beach Reading

By Lance Roberts of Real Investment Advice
Friday, July 22, 2016 12:03 PM EDT

Beach-Reading

Well, my annual family vacation at the beach is coming to an end and soon I will be winging my way back to Houston. While I do love taking time out of my normally busy schedule to focus on those that I most adore, it is always comforting to return home.

I wanted to update a couple of points from last week as we continue to manage risk in portfolios.

While the markets have indeed broken out to new highs, as I addressed earlier this week, it has done so without a significant improvement in the fundamentals. However, the breakout, such as it is, should not be dismissed or ignored.The technical underpinnings have improved enough to warrant an increase in equity related exposure given a proper entry point in the days or weeks ahead. Such an entry point would require a relaxation of the extreme short-term overbought conditions that currently exist. But a violation of critical support would negate the breakout and return the market back to a more bearish posture.

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SP500-MarketUpdate-072219

The potential for such a pullback is extremely high. As Tom McClellan noted recently, the “14-day Choppiness Index,”which tracks the path of a short-term trend, suggests Wall Street’s “uptrend is getting tired.” As McClellan notes, the very linear path for the index implies that the trend is likely to come to an end soon, while more volatile, or choppy, action suggests the opposite. A low reading in McClellan’s index signals a fairly straight-line, or linear, move. And presently, his choppiness index is at its lowest level in two decades.

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MW-ES000_mccell_20160720113502_NS

“The reading on Monday was the lowest since Feb. 12, 1996 (yes I scrolled all the way back that far to find a lower one). And in case you are interested, that 1996 instance marked a price top which was not exceeded until 3 months afterward. Linear trends either upward or downward are very exhausting, requiring a lot of energy from either the bulls or the bears to keep everyone in formation and marching together. The market tends toward entropy, so excursions like this toward extreme organization cannot last for very long.”

Furthermore, with volatility levels at extremely low levels the probability of a further advance, without a pullback first, is extremely limited. My friend, Salil Mehta made a great comment on this recently noting that at current levels of volatility there is only about a 20% probability of further declines.

“At 11 [in the VIX] you are really close to the floor. chances are higher that you won’t go lower on VIX and will instead pop up on some risk-off day,”

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MW-ES057_Vix_sa_20160720154103_NS

As I stated in last week’s missive, the safest course of action for those more “bullishly” inclined is to wait for a pullback in prices to further increase equity allocations in portfolios. However, as I also noted, the current setup is extremely weak and the potential for a sharp pullback in August/September could quickly extinguish the bullish exuberance.

Caution remains highly advised.

Here is what I will be reading on the way back home.

Interesting Stuff

Markets

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Disclosure: The information contained in this article should not be construed as financial or investment advice on any subject matter. Streettalk Advisors, LLC expressly disclaims all liability in ...

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