Lean in the wind, so it won’t blow you away
- There has been a tremendous jump in stocks this year.
- Monday’s rally was predicted by dire investor sentiment.
- Volatility remains, so lean against the wind until there is more conviction.
The hardest part of investing isn’t that; when is it.
Knowing when to buy or sell a stock in a trending tape is less important because a favorable market absolves itself of sins.
However, when there is no trend to follow like this year, it is necessary to buy or sell “when” (the S&P 500 is essentially flat where it traded a year ago).
In a trendless tape it is wise to adopt a contrarian mindset as volatility can be like an ax that sways away from accounts.
bow in the air
No one rings the bell, indicates up or down.
Instead, you need to rely on experience, technical tools and broad sentiment to alert you when the market is overbought or oversold.
“So you’re telling me there’s a chance (of a market rally)?” Real Money ProK Doug Kaas explains how experience and emotion shifted his opinion from net short to net long last week.
First, Kass explains why he’s bearish:
“Many believe we are just entering a bear market… based on the extended share price collapse of many individual equities and sectors – profitable and unprofitable technology, media and telecommunications, cyclical (eg. automobile manufacturers) and many others – this is my view that we are in a vicious bear market … the loss is deep
* Over 45% of Nasdaq stocks are down -50%
* Over 22% of Nasdaq shares are down -75%
* Over 5% of Nasdaq shares are down -90%
The prospect of higher interest rates eroding demand as well as resetting valuation models has, in a typical fashion, outpaced investors’ willingness to pay for future growth. As a result, the losses to growth stocks are significant and reminiscent of the Internet Bust and Great Financial Crisis.
Indeed, going against the grain by shorting stocks has paid off well, so why is Cass getting bullied? He writes:
“Valuations bloom is far from rosy… As noted by Liz Ann Saunders this morning, economic results coupled with the adoption of a more skeptical consensus of the market and the recent market downturn drove the mixed price-earnings ratio back to 2015 levels. is gone.”
Valuations didn’t matter during ZIRP (zero-interest rate policy), so unprofitable shares traded at obscene levels relative to selling. Now, however, there is little additional valuation being baked into stock prices, which could create opportunities for the long run.
Back to Cass:
“Bear markets and rapid corrections sow the seeds of opportunity … By being defensive – until recently – and not experiencing a large portfolio downturn this year and maintaining broad reserves, attractiveness to an investor with positive prices is possible.” Prices offer an opportunity to buy equities. Reward versus downside risk characteristics and, most important, with “margin of safety… Those positions are approaching fast… about 10 days ago,” when it’s time to buy “You wouldn’t want to,” I began partly to increase my net long exposure based on the expectation that many of my previous concerns were starting to be discounted in share prices.
If you haven’t read Kass’s take on the early change in opinion, I’ve covered it here in Smart. Cass is buying more during the selloff to increase his long exposure, but he is still losing strength using shorts. His recipe requires full-time resolution.
“I plan to be patient and act as a gradualist to add to my long equity exposure as we will only know when the market will take advantage of a downtrend… I personally prefer to assess equities, rather than whether or not the market will climax emotionally, as Warren Buffett suggested at last weekend’s Berkshire Hathaway Annual Meeting in Omaha, Nebraska. Provided financial education, disciplined and fundamentally based analytical thought where some stocks represent value… when others may lose their heads, suffer massive investment losses and emotionally liquidate holdings I plan to gradually continue to expand our long equity exposure in the times to come.”
A recipe for rallying?
There’s certainly a lot of negative sentiment that suggests a purchase may pay off when the public is selling.
Last week, I wrote that based on the AAII Weekly Sentiment Survey, Put/Call Ratio and Volatility Index (VIX) bullish levels are at very low levels. They are all contra-indicators suggesting that a rally is imminent.
Source: Helen Meisler, The Street Top Stocks.
On Monday, the VIX intensified even more as it climbed above 36 from the day’s low. Typically, readings above 30 are actionable, and readings above 35 are arguably, very actionable
Toss into the mix how many stocks are trading below the 200-day moving average, and you have a compelling argument for fighting a bearish trend.
In “Not a Bull in the House”, Top Stocks’ Helen Meisler wrote that the bulls were hard to find at the Chartered Market Technicians Association symposium last week.
The absence of bullish momentum in the conference reflected the general market aversion evident in sentiment indicators. For example, Meisler notes that the percentages of bulls and bears in the latest Investor Intelligence Survey were split roughly equally at 33% and 32%. A similar gap last time was near the bottom of the COVID-crisis.
Meisler also provided humorous anecdotal evidence of the recession, citing his mother as a contra-trend indicator:
“My mother, who has resisted asking about the market for so many months, was finally forced to ask about it on a Wednesday evening last week. For those who don’t know, my mother is probably one of the biggest contrast indicators, as I have yet to see her ask about the market and the market has not gone up after that. Oh, sometimes she closes for a few days, but she never inquired and the market continues to fall. Sure, a first for everything, but also consider that the 10-day moving average of the put/call ratio is now moving towards its March 2020 high. ,
If you’ve been in business for a long time, someone might even act as a counter-indicator to you. It wouldn’t be a surprise if they arrived recently (if they did, I’d love to hear your story. My Twitter is ,
Don’t be complacent.
Investors were wise to buy in bearish conditions due to the dire sentiment, but they should still be cautious, especially if we stop at resistance.
Where can this happen?
Meisler is looking at $4170 to 4200 on the S&P 500 and $190 on the Russell 2000 ETF.IWM, It is close to those levels (depending on how thick you draw your trend lines) that trapped sellers (overhead supply) can regroup and short the shares.
At 4200, the S&P 500 would have gained about 3.3% from Monday’s low, while at $190, the IWM would have gained about 4.4% from its low.
smart play
We are not out of the woods yet.
We got a good oversold rally, but it’s important to play defense until the conviction is in place. Sustainable rallies, as we saw this week, are born out of short-covering, but they mature on institutional buying. Unfortunately, it is not clear whether big money buyers like mutual funds and pension funds are bullish.
If you’re new to SMART (thanks!), here are some links to previous SMART articles where I discuss how to play defense this year.
Should you use stop loss?
business cycle is alive and well
A way to protect yourself in a volatile market
buy stock? Check this evaluation rule first
Overall, use trailing stop losses to protect profits, and traffic in stocks that perform best during this phase of the business cycle, focusing on low beta stocks and not overpaying on valuations. Of course, cash is also a position.
What would indicate that a more sustainable rally is underway?
I’ll see how the market reacts after the Fed meeting tomorrow.
The CME FedWatch tool forecasts the possibility of a 0.50% increase in the fed funds rate to 98%, and anticipates that reducing bonds on its balance sheet will begin this month in earnest. So it will be bullish if the market reacts favorably to tightening (buying bad news), pushing shares up through resistance.
I’m also on the lookout for a William O’Neill-style follow-up to the day.
Following an oversold bounce, follow-through days are when the market moves significantly higher by more than 1% of the volume from the previous day’s close. This should be four days or so after the surge, with best success if it occurs between the fourth day and the seventh day.
Although not all follow-through days are successful, this will be another data point for bullishness.
