Selling Weakness Into Strength

Includes: QQQ, SKF, SPY, VOO
by: Kirk Spano

The stock market appears to be entering another short-term topping process.

Earnings season is threatening to be very weak, economic growth is slowing globally and interest rates are inverted.

I am selling proportionally across the board, but culling my most vulnerable holdings to zero.

I went to the Money Show in New York earlier this year and took in a presentation from Bob Savage. He is the founder of Track Research and recently took a job as head of FX sales in America for BNY Mellon. His "little black book" includes some of the nation's most well known investors. Bob is one of the guys they go to for information and wisdom.

Mr. Savage made a point in his presentation that jived with something I have learned over the past three decades. If you think an investment or group of investments is going to fall in value, just sell. There's almost no amount of hedging that's good enough without resorting to outright speculation.

His description of one of his "moments of clarity" also rang a bell with me. In his talk, he described how he predicted the financial crisis and moved heavier to cash and did some hedging. Despite doing that, he said he still lost a bit.

For me, the financial crisis was about the same. For a year, I gave presentations with expensive meals telling folks to sell stocks and real estate. I got mostly ignored.

Given my belief in early 2008 that there would be a bear market soon, I raised my cash holdings to about 25% and traded the ProShares UltraShort Financials ETF (SKF) a few times in late 2008. Despite that, I was down about 12% for the financial crisis, though I was a heavy buyer in the spring of 2009 giving me a great 2nd half of the year in 2009.

Like around this time last year, I believe a lot of assets are about to fall in value, so, I am selling heavily. In particular, I am selling down to zero, all of my ETFs that are vulnerable to an economic slowdown. I am also trimming most stocks.

Reasons To Sell Equities

There are three core reasons to be an equity seller and one hidden reason.

First, corporate earnings are about to take a hit. According to FactSet, earnings growth for the S&P 500 will be negative 3% for Q2. This is happening at the same time the stock market has set a new record high.

FactSet Earnings FactSet

Second, virtually every agency, organization, government and central bank is warning that economic growth is slowing. The Fed is so concerned it has been telegraphing a rate cut for the end of the month.

Headlines on economic growth are ominous:

Virtually of the largest economies are either starting to slide (China, India, South Korea, Germany, U.K.), level off (U.S.), or in Japan's case (3rd largest economy for now) have a choppy pattern that looks like it could fall off a cliff.

We are seeing residential construction falling off a cliff not only in America, but globally. Manufacturing PMI is also unhealthy almost everywhere. I talked about these and other factors in my recent weekly webinars:

Third, the yield curve in the U.S. has been inverted now for 7 weeks. The longer is stays inverted, the more accurately it predicts a recession. According to the NY Fed, there is about a 1/3 chance of recession next year.

Inverted Yield Curve

By ARK Investment via Seeking Alpha

The hidden, or maybe not so hidden anymore, reason that equities could face headwinds is greater conflict in the Middle East. I cited the likelihood of war or conflict with or within Iran about two years ago. That conflict is continuing to heat up and draw closer. While I hope for better outcomes, my analysis was and is that there will be missile strikes on Iran at some point and that a greater regional conflict could erupt.

If oil supplies from the Middle East are disrupted, that would send a shock to oil prices. With 18mbd of oil flowing through the Strait of Hormuz, it wouldn't take but a week of disruption to eat away significant inventories. Nobody should put it past Iran to share their sanctions pain with the rest of the world. Oil shocks have accompanied most recessions since WWII.

Forecasting And Asset Allocation

Some people, like BuyAndHold2012, accumulate cash by saving their dividends during frothy times rather than reinvesting. That is a solid strategy.

I do not reinvest dividend automatically ever, but buy when prices are right. At the moment, there are very few "right" prices.

I also add cash by selling puts while markets are in uptrends. As they expire, I realize the cash. Sometimes, I end up owning a good stock that I can either hold, sell or sell covered calls on which generates more income.

I have stopped selling puts recently and have only a few left to expire. Again, there are very few "right" prices in the stock market right now, so, there are no puts to sell that would give me the cost basis on most stocks I would be comfortable with.

For most folks, investing is less systematic and involves a lot of hard buy and sell decisions. Right now is one of those decision times in my opinion.

While I don't think we are quite ready for a 30-40% market correction, a summer correction of 10-20% on the SPDR S&P 500 ETF (SPY) [Vanguard 500 ETF (VOO)] and the PowerShares QQQ (QQQ) makes a lot of sense.

The end of the Fed's QT program in September could be the catalyst for a rally off of a summer correction (though maybe it's not). This is the primary reason I am not completely bearish yet.

Regardless of forecasts, I urge you to consider your risk tolerance. Think about what various size corrections would mean to your retirement planning.

While I think a summer correction will be minor, I could be wrong. Feet to the fire, I think we get a warning correction in coming weeks and a worse version of 2018 in 2020.

Here are where our asset allocation models stand at Margin of Safety Investing:

Change Dates Asset Class Aggressive Moderate Conservative
April 9, 2019 Large Cap 20.00% 15.00% 10.00%
Mid Cap 20.00% 15.00% 10.00%
Small Cap 15.00% 5.00% 5.00%
Int'l Developed 5.00% 5.00% 5.00%
Int'l Emerging 5.00% 5.00% 5.00%
Corp Bonds 0.00% 0.00% 0.00%
Govt Bonds 0.00% 0.00% 0.00%
Int'l Bonds 0.00% 0.00% 0.00%
Cash 35.00% 55.00% 65.00%

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: I own a Registered Investment Advisor, Bluemound Asset Management, LLC, but publish separately from that entity for self-directed investors. Any information, opinions, research or thoughts presented are not specific advice as I do not have full knowledge of your circumstances. All investors ought to take special care to consider risk, as all investments carry the potential for loss. Consulting an investment advisor might be in your best interest before proceeding on any trade or investment.