The Lows Appear To Be In... What's Next?

| About: SPDR S&P (SPY)

Summary

Following a buy and sell discipline can alleviate the emotional aspects of when to buy and when to sell.

The market reversal appears to have occurred on 01/20/2016 and confirmation of said reversal appears to have occurred on 01/22/2016.

What’s next?

Market Leadership.

Much has happened over the last few weeks and my buy and sell discipline has given the green light to begin taking new positions and allocate more assets back into the market. There are times when this methodology tells me to buy when it doesn't feel good and conversely sell when I don't want to sell. Having a quantifiable approach to asset allocation helps identify what is and isn't working properly and when adjustments are needed to the discipline. Following a buy and sell discipline not only helps with what to buy but, can also alleviate the emotional aspects of when to buy and when to sell. This is precisely the reason for having a buy and sell discipline.

Market Risk Meter 01/22/2016 Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

About The Market Risk Meter:

The entire premise for the Market Risk Meter, in the first diagram, is that the market can be viewed much like the ocean tides. We know that the tides will come in and go out and what I attempt to do is to identify, as quickly as possible, when that change occurs. Adding to this analogy, sometimes the tides come in further than normal, which would indicate higher risk and the need to take precautionary measures in portfolios. Sometimes the tide goes out further than normal, which is indicative of lower risk. The Market Risk Meter is not a predictive tool, in and of itself. However, it is used to determine what is and what has occurred, in terms of market risk. Those results, which are not subject to change, must be extrapolated against other market variables and indicators.

What The Market Risk Meter is Saying:

Much of the built up market risk, that has accumulated over the last two months, has been released and the Market Risk Meter has declined substantially from approximately 22 to -27.21. Market risk is now at the lower end of the spectrum and when coupled with a buy and sell discipline, can be used to confirm a Lower Risk Entry Point and near term market lows.

Confirmation of The Lower-Risk Entry Point

Back in August 2015, the markets had recorded short term lows in both the S&P 500 and the Dow, resulting in a brief lower level risk reading of -27.6 according to the Market Risk Meter. The markets tested said lows in September and then quickly bounced by Mid November 2015. Both the Dow and the S&P 500 failed to create new highs during the ensuing months and consequently, being weighed down by news of North Korea, China, the Middle East, Interest rates, and Oil prices, retested the August 2015 lows. These lows have been successfully retested as of 1/20/2016 and confirmed on 1/22/2016.

S&P 500 Click to enlarge

What's Next?

Now that a Lower Risk Entry Point has been identified, equity exposure can be increased as long as the Market Risk Meter is reading at negative levels and while the tide is out. A prudent investor can continue to make purchases up until 10 and with greater caution up until 20 before turning more defensive. Bear in mind that it is not encouraged to purchase when the meter is declining or until a reversal has been identified and confirmed.

For those that didn't identify the reversal day and 2 subsequent follow through days, don't fret. With the exception of those who enjoy the thrill of bottom fishing, there will be plenty of time to increase equity exposure over the ensuing days or weeks. It is also likely that there will be continued market volatility providing additional opportunities as the market attempts to test the recent highs.

Despite my belief that we are still in a secular bull market, as discussed in the article "How Can You Adjust Your Investment Strategy to Enhance Returns?", and updated in "Is Something Really Wrong With The Market? This is Why Secular Bull Market Trends Matter", there is one caveat: over the ensuing months, the market indices need to register new highs in order to confirm this bull is alive and well. Failure to create new highs will have potential consequences including continued volatility and more potential tests of previous lows. Furthermore, failure of the Dow Jones Industrial Average and the Dow Jones transportation Average to move on to new highs have implications related to Dow Theory as discussed in the article "How Can You Identify Market Turning Points?... Reloaded"

Previous Cautionary Notes still remain in place

If any of the following events occur, I will be forced to revise my positive market outlook and consequently become more defensive with portfolio holdings: If the S&P 500 closes and remains below 1867 or if the Dow Jones Industrial Average closes below 15,666.

Leadership

Now that a confirmed reversal has been identified, it's time to allocate into leading positions. This is done by identifying how the market is performing versus a number of different variables. For example, one can compare the S&P 500 index to cash or bonds to determine whether one asset class is performing better than another. If equities are performing better than cash or bonds, then further comparison into the market versus other categories would be the logical progression. By drilling down further, the S&P 500 index can be compared to any number of other categories including, foreign versus US equities, or whether there is a particular sector that should be held or not.

The diagram below illustrates the categories that are in favor versus the S&P and there are a few points of interest. First of all, the S&P 500 turned negative against both bonds and cash. This is normally not a good indication but, given the rapid selloff coupled with the 01/20/2016 reversal, the shorter term readings are very positive and this will be closely monitored going forward. It is also worth noting that technology is continuing to remain strong at these levels.

Other points of interest are that the energy sector and small caps are showing some near term strength and have the potential to move into favored status. There is also some short term evidence that the S&P 500 is gaining strength against financials and industrials and potentially moving those sectors out of favor.

Click to enlarge

These performance charts have been provided for informational purposes only, and should not be used as the sole basis for making an investment decision. Investment decisions must be made on your own individual needs and risk tolerance. The content you gather from any performance chart is just one of the factors that should be considered before making your investment decision. Past performance is not a guarantee of future performance, and the performance of these diagrams are subject to a number of market factors that may cause the price to fluctuate.

Conclusion

In summary, risk has been released from the market per the Market Risk Meter. The market reversal appears to have occurred on 01/20/2016 and was confirmed on 01/22/2016, signaling the lower-risk buying opportunity that we've been looking for.

Although the market outlook remains positive, the indices need to move on to new highs over the ensuing weeks and months in order to confirm this bull is alive and well.

Includes: DIA, IWM, QQQ, SPY, AGG, EFA, RSP, XLE, XLB, XLI, XLV, XLF, XLK, XLU, $RUT, $RMC

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The information contained in this report or information provided does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered reliable, but we do not guarantee that the foregoing material is accurate or complete. Expressions of opinion are as of this date and are subject to change without notice. This information is not intended as a solicitation of an offer to buy or sell any security referred herein. Past performance may not be indicative of future result. Christopher DeMaria is registered with and securities offered through Kovack Securities, Inc. Member FINRA/SIPC. 6451 N. Federal Highway, Ste 1201, Fort Lauderdale, FL 33308 (954) 782-4771. Investment Advisory services are offered through Kovack Advisors, Inc. DeMaria Financial Services is not affiliated with Kovack Securities, Inc. or Kovack Advisors, Inc.