Good morning. As I ran out for a quick errand on Wednesday morning, I couldn't help but take note of the fact that it was an absolutely gorgeous fall day in Colorado. There were crystal blue skies, bright sunshine, not a cloud in sight, and a temperature reading in the car that caused me to start planning for an afternoon bike ride. However, a few hours later it was clear that a change was in the air and my bike would have to remain hanging from its hook in the garage.
Such is life living in the foothills of the Rocky Mountains. One minute you are in shorts and a t-shirt and the next, well, you're digging around for the ski garb. With the temperature dropping like a rock yesterday afternoon, I was forced to adapt by heading to the closet for some layers. And once I was properly attired for the new forecast (some white stuff was starting to fall out of the sky) and back at my desk, it occurred to me that there was also a change in the air in the stock market - and perhaps I'd best think about dressing my portfolio strategy accordingly as well.
One of the keys to success in this business is to understand what type of environment you are in. I've long felt that the trick is to first identify the type of market you are dealing with and then to implement the appropriate strategy for the environment. This is a lot like having the right layers in your backpack when embarking on an early morning hike in October.
So, let's start with the environment. In looking back at the last couple of years, there have basically been two types of markets. I'm not referring to bulls and bears here. No, I'm talking about markets that have either been uber violent, roller coaster rides in reaction to external events (think each and every deadline relating to Greece, EU Summits, ECB meetings, credit downgrades, and Fed announcements) or, on the other hand, more pedestrian "trending" types of markets.
Cutting to the chase, I believe that we're now back in the latter environment where markets trend in either direction for a period of time before turning and going the other way. The next question, of course, is which direction the trend is heading. And in my humble opinion, the answer to this question tends to be driven by the market's various inputs. In short, each new input (earnings report, economic report, etc.) is fed into the market's collective computer and adjustments are made to prices based on the new outlook for the future.
Currently, stocks are "adjusting" to the W.T.E. theme that has developed where earnings and economic growth are weaker than had been expected. And from the looks of the charts, stocks are now in a modest downtrend. In other words, the recent consolidation phase appears to have morphed into a corrective phase. As such, one needs to play the game accordingly.
To clarify, I believe that the market environment is changing. First and foremost, I believe that we are in a trending environment, as opposed to a news- or event-driven reactionary environment. As such, it is appropriate to make some adjustments.
For me, these "adjustments" are handled by my systems. I have a series of market models designed to adapt to the changing environments as well as any accompanying trend changes. And given that there is clearly a change in the air right now, my models told me this week that some adjustments were necessary.
Although my main "Market Environment Model" - which is designed to indicate whether the odds favor the bulls, the bears or neither team - remained modestly positive coming into this week, another of our models effectively said, "Hey, the trend is changing so you might want to reduce your risk exposure." Thus, in the same way that I added a layer yesterday when the temperature dropped, we reduced our risk exposure in our more aggressively positioned portfolios in response to changing model readings.
Am I "talking my book" here? Yes, indeed I am. And for that I apologize because there is more than one way to skin a market cat. As I've mentioned a time or twenty, I prefer systems and models to guide my decisions. But the bottom line is that regardless of whether you use intuition, charts, models, or a finger in the wind, there is indeed a change in the air and you'd best make an adjustment - just in case a storm develops. (And based on the looks of things out my window, I'm glad I took my skis in for a tune!)
Turning to this morning ... After five days of declines for the major indices, a surprisingly strong GDP report in the U.K. and expectations for more easing in Japan has traders in a better mood this morning. However, there are several important economic reports to review before the bell and earnings from Apple (AAPL) and Amazon (AMZN) after the close today.
On the Economic front ... We will get the reports on Durable Goods, Weekly Jobless Claims, Bloomberg Consumer Comfort, and Pending Home Sales this morning.
- Major Foreign Markets:
- Shanghai: -0.66%
- Hong Kong: +0.21%
- Japan: +1.12%
- France: +0.57%
- Germany: +0.64%
- Italy: +0.22%
- Spain: +0.21%
- London: +0.28%
- Crude Oil Futures: +$0.76 to $86.49
- Gold: +$16.00 to $1717.60
- Dollar: lower against the yen, euro, and pound
- 10-Year Bond Yield: Currently trading at 1.845%
- Stock Futures Ahead of Open in U.S. (relative to fair value):
- S&P 500: +9.60
- Dow Jones Industrial Average: +70
- NASDAQ Composite: +21.0