- Low volatility periods in stocks can be followed by big gains similar to 1995-2000.
- While waiting for a correction to invest cash is a prudent concept, it is also a form of forecasting; a difficult task in the markets.
- The Fed just made the "waiting for a better entry point" process even harder.
- An alternative approach to cash deployment involves a staggered or feathering approach in an attempt to mitigate/manage reversal risk.
Not Easy To Wait For Better Entry Point
Regular readers know we are not big fans of attempting to forecast where the extremely complex organism, known as the market, is headed. If those sitting on cash take an "I am waiting for a better entry point" approach with stocks, that is a form of forecasting since it makes an assumption that a better entry point is coming soon. A better entry point may be right around the corner, but nothing says stocks have to make things easy on anyone, including those sitting on large piles of underinvested cash. The blurb from Yahoo Finance below reminds us how difficult it was to wait for a better entry point between 1995 and 2000:
On Tuesday, the benchmark S&P 500 index had its 42nd straight session without a one percent change, either on the upside or downside. The last time the market went this long without such a move was in 1995, when the S&P 500 went 95 days without a one percent move in either direction. For those who may have forgotten, both the S&P 500 and the Dow Jones Industrial Average ended up tripling from 1995 to 2000.
One Approach Is To Feather In Funds
If you are sitting on cash, there is no perfect method to get it invested in stocks. However, we use a feathering approach that allows us to handle the two important questions outlined on February 21:
Do I have specific plans in place to handle these extreme investment cases?
- Case A: stocks rise an additional 91% over the next three years as they did during the final leg of the dot-com bubble (1997-2000).
- Case B: stocks drop over 50% as they did in the 2000-2002 and 2007-2009 bear markets.
The Fed Just Made It Even Harder On Bears
In a June 17 article we noted consumer prices last month posted their sharpest increase in 15 months as inflation continued a recent acceleration from unusually low levels. Did the Fed seem concerned Wednesday? From CNBC:
Fed Chair Janet Yellen told a news conference that inflation was expected to move gradually back to the central bank's 2 percent target. Some traders said they were surprised the Fed did not say more about inflation, after Wednesday's CPI showed inflation running at 2.1 percent over last year. Bonds yields rose on the inflation data but were lower Wednesday. "The Fed is deathly afraid of a rise in rates stomping out the recovery. It's clear they will allow inflation to run higher than it should be in order to achieve that," said Peter Boockvar, market strategist with Lindsey Group. "What's going to be the end result is the bond market is going to start dictating policy."
Low VIX Warnings Not Helpful So Far
In Stop Wasting Energy On The VIX, we noted:
The VIX Fear Index is arguably the most over-analyzed tool on Wall Street relative to its real-world predictive powers of where stocks are headed.
Have the "be careful with stocks" low VIX warnings helped stock investors? Not yet. We published the research warning against losing too much sleep over the low VIX on May 29. Since then, as shown below, stocks have continued to climb in the face of "excessive complacency".
For the record, the CBOE Volatility Index (aka the VIX) dropped to its lowest level in 7 years after Wednesday's Fed announcement, which means we can expect to see more low VIX warnings in the days ahead.
Investment Implications - We Continue To Hold Stocks
Has the observable evidence been helpful in recent weeks? Yes, we penned the following on May 25, after a week of observable improvement in the market's risk-reward profile:
Our market model uses numerous inputs to assist us with a "monitor and adjust" approach, which is quite a bit different than an "anticipate and hope" strategy. The observable improvement that occurred over the last five sessions enabled the model to recommend a slight increase to the growth side of our portfolios. Therefore, Friday we added to our stock holdings and reduced our money market balances.
Since May 25, the S&P 500 has gained 56 points, and checked more bullish boxes in our model. As long as the evidence allows, we will continue to hold positions in stocks (NYSEARCA:SPY), leading sectors (NYSEARCA:XLI), and a relatively small stake in bonds (NYSEARCA:TLT). Based on the evidence, we reduced our bond holdings on June 5, and shifted some of those funds to stocks on June 6. We may make a similar pair of chess moves this week if the bulls continue to carry the week. There are still two days to go, meaning we will keep an open mind about where the complex pricing mechanism heads next.