Not A Motion Of Concern, But Rather Potential Opportunity

Jul.28.14 | About: SPDR S&P (SPY)

Summary

A majority of investors remain cautious of the broader market, although sentiment remains bullish based on price action.

Between August and September market averages tend to under-perform.

A so called "market melt-up" will not happen.

Charts say we are possibly on the cusp of an impending dip or moderate sell-off.

The S&P500 Spyder ETF (NYSPY) is slightly above the 7% CAGR avg now at 8% YTD. Any noticeable sell-offs have been tamed to relatively modest pullbacks as we have not seen any alarming motion for concern. Leading indicators, the bond market, and valuations presume that an up-trend should continue for the foreseeable future. Although as always, most market participants, investment banks included, speculate on direction and flow of capital. In the last year, there has been roughly 10x the amount of money pushed into equities, mutual funds, and etfs compared to the year prior.

Leading Indicators

Large hedge funds that follow economic indicators, or the top down approach, use these to evaluate how things are doing. Looking at energy and metals specifically, generally we do not want major peaks or troughs but rather something in the middle. Copper for example, in tandem with other staple metals, is good to have around $3 or modestly above that level. Here is the chart of the last few years:

Click to enlarge

Everything checks out A-okay here. In early 2014, some managers were becoming concerned and switched available capital into more defensive positions. But it proved to be a hiccup (as I expected).

Otherwise, heating and crude oil appear to be sitting at relatively normal levels. Likewise with natural gas, though highly volatile, it may actually be a bit oversold at this point. If you are interested, see another SA contributor's piece here for a potential play: seekingalpha.com/article/2336385-natural...

The bond market also looks surprisingly favorable and is perhaps one of the best leading indicators of a major market downturn. During the tech bubble and prior to the financial crisis, the curves were practically flat and in some instances actually inverted (which is highly abnormal). As of right now, we have a relatively steep curve that has been bouncing between modest range over the last few years (artificially controlled by the Fed).

Seasonality

This year investors did not follow the 'Sell In May and Go Away' pattern as many had expected. Instead we continued to grind higher with virtually no volatility in US indexes, obviously not including foreign ones like the Russian etfs. August and September are historically the worst two months out of the year to be holding stocks, especially September down more than 1.5% on average over the last 100+ years.

Charting

Technicians usually follow trends on a week to week basis and also zoom out over the span of a few months and years to look for patterns and assess relative strength of the market. The MACD histogram is a relatively common indicator to pre-determine market movement:

Click to enlarge

While not fool-proof, it tends to have a pretty good accuracy rating. When the oscillator breaks to the downside, low to moderate selling occurs at minimum. If the bars do not break below, the trend grinds higher. If you look at June and July on the price chart you will see that candlesticks have become much shorter compared to the rest of the chart, indicating that the broader market is not quite bearish, but extremely cautious. I can say with pretty high confidence that this is evidence we will not see excessive buying in the near-term.

As a sidenote, here is one pattern that I have noticed. It may just be a coincidence:

What To Do?

The obvious, just keep a level head of risk management for your portfolio. Fortunately for us retail investors, we do not have liquidity issues like many institutions have so we can trim positions without any concern over spreads.

For now, I would recommend holding slightly more cash than average for one's portfolio (i.e. 15% versus the standardized 10%). Based on preference, others occasionally switch into bonds or preferred stock (I think preferred is better).

Outlook

While there are some who absolutely hate this current bull market and are waiting for the next sell-off to get in, this may or may not occur. No one knows. But given it does happen, I would recommend that people temporarily wait on the sidelines to avoid short term downside risk. Regardless I think the bull market will continue afterwards during October and well into the next year. The trend is your friend, right?

Bottom Line

I am not telling anyone to liquidate positions, especially value propositions based on market direction. But it is prudent to always be prepared for the future and not be susceptible to emotions of fear or greed. The Goldman Sachs (NYSE:GS) CEO, Lloyd Blankfein, recently said that one obvious but difficult principle people should maintain is to always prepare for the future and always know how to react on a present occurrence. For example, if we see a stock we like fall more than 5% that is already cheap, add more to that position, don't dump it! Planning ahead is key whether it's investments, personal finance, or life in general. Good luck to all.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.