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Summary

  • We're going to see bumps in the road, even though we're in a bull market.
  • Volatility is due to revert to the mean and bullish percents are at the upper range, warranting caution.
  • Here are some simple ideas to weather the storm and be prepared for the next leg up in the market.

Mr. Market has an impeccable ability to fool the greatest number of people at exactly the right time. Investors sell in droves when Wall Street is bleeding red. Consequently, they not only miss historically low-risk opportunities to buy discounted investments, but also lament the sale of their investments at or near the worst time possible. Conversely, many investors also make the mistake of buying heavily into markets that have already run up in value. This is the most frequent question we hear today: "Is the market too high?" Although we believe we are in a long-term secular bull market, there are some near-term opportunities for more active investors to keep some powder dry for the next low-risk entry point.

Some have criticized our belief that the market is in a long-term secular bull phase, which can generally last from 10-15 years. There are many opinions on Wall Street and many take pride in being right. However, it is more important to prudently manage expectations and the risk of losing money than it is to accurately predict how the market is going to perform. Even in a secular bull market, investors will experience periods of higher volatility. This can set them off course and cause them to become discouraged or lose money.

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We don't want investors to panic sell when they should be buying, and conversely buying when they should be selling. One way we know to prevent this is to begin making preparations for what we think is a little storm on the horizon. More specifically, we are preparing for a mini pullback between 8% and 15% over the next few months. It's easier to make those preparations now while market conditions are quiet and before volatility returns to the mean as can be seen in the CBOE Market Volatility Index ($VIX). The $VIX has more recently traded at lower levels not seen since late 2006, and it is our opinion that we are long overdue for an increase in volatility. Once volatility returns, we will be watching for the peak of the storm, ideally between September and October. This should be a lower risk opportunity to purchase or repurchase your favorite investments.

October: This is one of the particularly dangerous months to invest in stocks. Other dangerous months are July, January, September, April, November, May, March, June, December, August and February. - Mark Twain

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One other measure of where the market stands is the bullish percent. In our example, we look at the S&P 500 Bullish Percent Index. This indicator can be compared to ocean tides as they ebb and flow. A reading of 50 would indicate a somewhat fairly valued market. Readings over 70 suggest that the tide is in and we are in a higher risk environment. The current reading on the S&P 500 Bullish Percent Index is at 84 and this warrants us to take caution at this time.

Conversely, a reading under 30 would suggest that the market is oversold and that a buying opportunity may be present. As it stands, the tide is almost all the way in and we are at a level where the market, based on historical observations, typically has had a pullback. We do not expect to see the readings decline below 40-50 during the aforementioned mini-pullback, as we do believe we are in a secular bull market. History has shown that the lower range of bullish percent readings tend to only appear during major market corrections.

If you're an active investor, you can begin by trimming some or all of the profits from your winning positions. This is also a good opportunity to sell some of your losing positions. You can always buy them back if you still believe there is opportunity. For taxable accounts, you can realize a loss as long as you wait at least 30 days before repurchasing. At some point during the next four months, you might actually decide that there are better opportunities than the losers you sold. Ultimately, the goal is to dodge some of the market volatility on the horizon and to have cash available as you begin preparing your shopping list for the next low-risk entry point. We believe that opportunity will arrive sometime between mid-September and mid-October.

Although we don't know exactly when the storm will arrive or when it will end, we are fairly confident that one is on the way. We believe that there will be a mini-pullback between 8% and 15% and that there is a decent opportunity to take some profits and trim some of your less desirable positions. We also believe that there will be a good buying opportunity between September and October to purchase investments at more desirable prices than what can be found at this time. Bear in mind that we are in a long-term secular bull market and we expect to have some bumps along the way. By following some or all of the simple steps above, you might find yourself sleeping better at night and being better prepared for when the storm has passed.

Source: The Quiet Before The Little Storm