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Buy, Sell, Or Hold In This Volatile Market?

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The Dow Jones Industry Average and the S&P 500 both saw record highs last Tuesday while the FTSE was at a ten month high.

Dividends are paying record lows at the moment, and so investors are turning to high-quality stock options for better money-making opportunities.

This article goes through the different factors you should consider when deciding whether to hold, buy, or sell.

S&P 500 chart

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As you can see from the chart above, there has been a breakout to a new high (green label).

A measured continuation upwards will extend our new range by around the same amount as that of the prior range: our target of the move is around 2448, which would represent a move of around 15%.

It has to be said that the prior range had held for a very long time, and the market tried several times to break through the initial resistance.

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Classical technical analysis indicates that, in this sort of breakout, there should then ensue a period of high confidence among investors and traders.

Alternatively, this could be indicating that tradition is just that: tradition, and it is no longer up to date and needs revision.

It may no longer be as relevant as it once was.

We are all familiar with false breakouts which have become increasingly common.

This is because, thanks to faster sharing of expertise in the information age, almost everyone is aware of this technical analysis, and thus everyone is trying to game it, or at least enough are that its truthfulness is diluted.

So we could conclude that based on the chart alone we cannot guarantee a period of high investor confidence.

Peaks and Troughs

Earnings prove to be the most important determining factor affecting whether a market will rise or fall in the long run.

And as we and everyone else has noticed, they have been declining for the best part of the last few years, as recorded each quarter.

The graph below shows the relationship between earnings and stock returns:

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In fact, this quarter doesn’t look like it is going to be an improvement at all.

We say this because the last few months have seen one of the record-lows in terms of pre-announcements.

This tells us that earnings in the second quarter of 2016 will be near trough levels, or directly at them.

Historical technical analysis tells us that it pays well to buy aggressively in cases of earnings being near or at trough-like levels.

The difference with the current case is that the market is not actually at an all-time high.

Normally when earnings are as low as trough levels or near trough levels, it is the case that the market figures show it to be at a record high.

Looking at earnings alone would indicate that there is more reason for the S&P chart to read at 1600, instead of 2100 that it is at.

Thus, don’t hold your breath waiting for a strong correlation between earnings season commencing now and the market’s direction in the medium or long term.

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It’s the economy

When talking about economic indicators in relation to stocks, we break them down into three categories:

  • Leading economic indicators
  • Coincident economic indicators
  • Lagging economic indicators

Leading are the most important and are thus the focus of the article.

The ones we’ve looked at from 23 different countries neither back up claims of a bull market nor do they those of a bear market.

Sentiment and feeling

Whilst you might feel it in the air, sentiment is better observed through plowing through droves of emails, social media, analysts’ writings, trading data, and announcements.

These combine to form what we call sentiment indicators.

Having looked at these sentiment indicators, it’s clear that the current market sentiment is firmly in the negative camp.

This is actually bullish for the market.

A situation of negative market sentiment ensures there are plenty of market participants waiting on investment who represent money-making opportunities; it also means there is plenty of cash lying around.

Should the market continue rising as it currently is, money-holding managers who, regardless of sentiment are always aiming to beat benchmarks, will buy into the market leading to a further rise.

Valuation of the stock market

At the moment and in absolute terms, the market right now is trading at a higher valuation, and so it does not, for the moment, merit a further rise.

Conversely, if we compare it to the relative price of bonds and treasuries in that market, it is very affordable.

Having said these, we would advise not to look at valuation excessively as it does not shed much light on what decision one should take with regards to allocating investments in a shrewd manner, at least not for the near to medium term future.

Central banks and the geopolitical sphere

The geopolitical risks coming up are numerous.

They include:

  • The future of the European Union, or at least Britain’s unfettered access to its markets, after the British voted 52% to 48% to leave the political and economic union: economic union is still possible but no negotiations have begun, and most experts see a retention of tariff-free economic ties as unlikely
  • The South China Sea: an international tribunal recently ruled China’s actions there illegal, and its claims dispute with the Philippines over, and island ruled in the Philippines’ favor
  • The potential election of a populist candidate, Donald Trump, who has promised a myriad of radical economic reforms, tax cuts, and wildly protective measures
  • Currencies fall
  • Central bank policies including zero to negative interest rates in an attempt to stimulate growth.

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Based on all of these, a bearish stance is advisable.

Final word: what to do?

These aforementioned factors, along with the latest in market modeling (which we won’t go into as the jargon is mind-boggling) dictate that a prudent middle path should be taken.

Hold on to existing strong positions, hold large amounts of liquidity, and make investments in particular situations.

Up until now, we would have produced a more bullish conclusion, but Brexit and its immediate effects on sentiment have made everyone more conservative.

We would advise 28-38% cash or treasuries in your portfolio right now with some low-costing hedges.

Get on the upside without too much risk.

Lots of cash means an ability to get in on those opportunities when they pop up.

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