What Do Central Bankers Know?

In last week's missive we discussed a critical point concerning the bull run so far.


“Despite the underlying economic and fundamental data, the markets have surged back to extremely overbought, extended, and deviated levels. The chart table below is published weekly for our RIA PRO subscribers (use code PRO30 for a 30-day free trial)

You will note that with the exception of bond prices, every market and sector is more than 5% above its 50-day moving average and year-to-date performance is pushing more historic extremes both in price and in extreme overbought conditions. 

On virtually every measure, markets are suggesting the fuel for an additional leg higher in assets prices is extremely limited.”

The chart below compares last weeks analysis to this week. You can see the sharp difference between the two periods as much of the overextension last week has now been reversed. 

The chart below also shows the short-term reversal of the market as well as the test of minor support at the initial October lows. 

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.

However, the next two charts suggest there is a decent probability any bounce will fail in the short-term and should be used for rebalancing risk.

  1. 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) There is historically a very high correlation between what happens in the transportation sector (a view on the economy) and the market as a whole. Watch for a rally in the transportation sector to signal an all-clear for the markets. 

The current set-up suggests that the correction that started last week is not yet complete and any bounce will likely be a good opportunity to re-position portfolios in the short-term until a better entry point to increase exposure is achieved. 

The problem with statements like these is that those of the permanently bullish” mindset tend to extrapolate the analysis into the onset of the next major bear market.”  Such is certainly not the intent, nor is it a suggestion to sell everything and hide in cash. 

What should be readily apparent is that paying attention to price can help alleviate our natural tendency to “buy high” and “sell low.”  Managing a portfolio of investments is simply measuring risk and reward and placing bets when reward outweighs the potential risk. Tweaking exposure torisk” over time can pay big dividends over the long-term which is our goal of investing to begin with. 

This is why every great investor throughout history has basic investing rules which all revolve around limiting losses to capital. Here are James Montier’s 7-Immutable Laws Of Investing:

  1. Always insist on a margin of safety
  2. This time is never different
  3. Be patient and wait for the fat pitch
  4. Be contrarian
  5. Risk is the permanent loss of capital, never a number
  6. Be leery of leverage
  7. Never invest in something you don’t understand
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