On Monday evening I said that the market was due for a “reflex bounce” as soon as Tuesday. While Tuesday’s bounce is being attributed to further interventions by the Chinese government to try and forestall the bursting of the equity bubble in their market, the reality is that the markets were just oversold following five straight days of selling.
As human beings, we always need a “reason” for actions. It’s just how we’re wired. If we stare at a series of random dots long enough, our brain will begin to find patterns and shapes in the randomness. The same is true for the market. News headlines are used by our brains to attach a reason to the randomness of market actions. However, turn-off the media drivel and look at price action itself and a clearer picture emerges.
As shown in the chart above, the recent market “sell-off” exhausted the “sellers” in the market on a very short-term basis. This “oversold” condition (yellow highlights) provides the catalyst necessary for a reflexive bounce in the market.
Importantly, the markets, have been able to find support at the 200-day moving average (dashed red line), which keeps the markets defined within the cyclical bullish trend. The 150-day moving average (dashed blue line), which had previously been very strong support for the bullish trend going back to December of 2012, has now been violated.
This support at the 200-day moving average keeps portfolio allocation models at, or near, fully allocated levels currently. This is because, up to this point, the longer term bullish trend has not been violated. As I discussed in this past weekend’s missive:
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“The decline this week keeps the market contained within the broader declining consolidation which suggests a lack of strength by bulls currently. However, the long-term bullish support (red-dashed moving average) now resides at 2085 which should afford some near-term support. However, a failure of that level will likely push the markets back towards 2040 once again.
If we step back and slow volatility down by using a WEEKLY price chart, a clear picture emerges.”
Chart updated through Monday’s close.
Since this is a WEEKLY chart, it only matters where the market closes on Friday. If the market can reverse Monday’s slide and climbs back above 2085, the previously broken downtrend resistance will remain new support for the markets. A failure to rise above that resistance level will bring 2050 into focus short term which only provides minor support to a potentially deeper corrective action.
With the previous rising bullish consolidation, (dashed blue lines) now resolved negatively, the current downtrend (dashed red lines) is keeping pressure on stocks.
Furthermore, the failure of the market to break out to sustained new highs for a third time, and the subsequent decline back into the current downtrend, reinforces that overhead resistance. This suggests that the markets may have entered into a more significant topping process.
Lastly, as shown in the chart above, and expanded below, the markets are registering their first SELL signal since 2007. The deterioration in momentum and breadth of the market has previously PRECEDED more significant market declines.
With that warning issued, and while many will just simply assume I am “bearish,” I want to remind you that the trend of the market is still “bullish.” This is why the portfolio model is still primarily fully exposed to the market with respect to equity-related risk.
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However, this does not mean that such allocations will not be aggressively adjusted downward at some point; it is just not needed as of yet. As noted in the final chart below, the bullish trends of the previous two bear markets were violated relatively early in the reversion process. For those paying attention, there was plenty of opportunities to exit the markets while retaining a bulk of the previous gains. As noted, the current bullish trend has not been violated as of yet which keeps portfolios currently allocated toward risk.
Our job as investors is NOT to try and “. Investing is not a “competition” that you “win” a trophy for. Investing is about growing your “savings” to sustain the purchases power parity of those “savings” in the future. Nothing more. Nothing less.
As I have repeatedly discussed over the last several weeks, prudent portfolio management practices reduce inherent portfolio risk thereby increasing the odds of long-term success. Any rally that occurs over the next few days from the current oversold condition should be used as a “sellable rally” to rebalance portfolios and related risk. These practices align with the most basic investment rules/philosophies that have been followed by every great investor/trader in history. To wit:
- Sell positions that simply are not working. If they are not working in a strongly rising market, they will hurt you more when the market falls. Investment Rule: Cut losers short.
- Trim winning positions back to original portfolio weightings. This allows you to harvest profits but remain invested in positions that are working. Investment Rule: Let winners run.
- Retain cash raised from sales for opportunities to purchase investments later at a better price. Investment Rule: Sell High, Buy Low
There is no magic formula for long-term investment success. It has always been achieved by following simple processes and disciplines that have managed investment risk thereby reducing emotionally driven decisions during times of increased volatility.
As Warren Buffett once quipped:
“There are two rules to investment success:
- Never lose money;
- Refer to rule #1.”
It really doesn’t get much simpler than that.