What market indicators, like Dow Theory, are telling us.
The long-term secular bull market.
Short-term risk in the market is high.
The sector leaders.
Managing money is similar to going on a trip. We have hopes and expectations. However, there are many variables, like bad weather or delays, that can alter our plan and cause the trip to fall short of our expectations. In the same way, as we evaluate our financial plan, we must sort through thousands of fluctuating factors that can impact results. This can be challenging to even the most seasoned investors, yet, if we want to make the best of the situation, we must be willing and ready to adapt to these unexpected circumstances.
With all that said, let's look at some of the factors that affect the current financial markets and how portfolios can benefit from current market trends. I'm going to ignore the hot topics like impeachment, Iran, trade wars, budget deficits and examine how the markets are responding rather than what could happen. For example, the Semiconductor (NYSEARCA:XSD) are currently leading the market and gained over 76% in 2019. This is followed by the Technology Sector (NYSEARCA:XLK), which was up more than 57% in 2019. Small and Mid-Cap Stocks, SLY and MDY, have been picking up some steam, and lastly, the Aberdeen Emerging Markets Fund (NYSEMKT:AEF) and the Emerging Markets (NYSEARCA:SPEM) have made some shorter-term highs. These are obviously more aggressive areas in the market. However, they are also considered to be leading indicators by many. In short, as people's appetite for risk increase, these sectors tend to perform better.
Dow Theory, The Secular Bull Market, and Market Risk
- As we move into the new year, both the Dow Jones Industrial Average (NYSEARCA:DIA) and the Dow Jones Transportation Index (NYSEARCA:XTN) have recently reached new highs. By my interpretation of Dow Theory, this indicates that the market remains on a buy signal.
- Many investors are not familiar with long-term secular market cycles and the impact they have on how their portfolio is managed. Throughout history, the stock market indices SPY and DIA have demonstrated longer-term secular bull and bear cycles, which are extended periods with a common trend. Knowing where we are within these cycles can make a substantial difference in how you choose to invest and whether to buy and hold or to actively manage your portfolio for risk. Long-term secular bull markets can last as long as 15 to 20 years. Some have stated that the current secular bull began as early as 2012. That would potentially make a halfway mark in late 2022.
- Despite being in a bull market, it is likely to encounter bumps in the road. Market risk has increased over the last couple months, and it would not be unreasonable for there to be a pullback sometime after the new year. The risk levels I monitor on my proprietary risk meter have not reached nosebleed levels. However, if things keep trending this way for a few more months, I will likely begin taking precautionary measures in portfolios. When risk reaches higher levels, active investors would begin trimming some of the profits from larger winning positions and selling laggards and losers. Ultimately, the goal would be to dodge some of the market volatility on the horizon and to have cash available while waiting for the next lower-risk entry point. On the other hand, buy and hold investors will likely benefit the most from indexing or managed funds that are more narrowly focused.
Sector Leadership, including the top two holdings in each of the categories:
Many investors have not trusted this bull market. Consequently, they have been quick to take profits rather than embracing the longer-term secular trend. Despite there being pullbacks and corrections along the way, there are still many opportunities for the buy-and-hold investor and for the more active investor to realign portfolios. Currently, market risk has picked up, and the potential for a pullback, or even a mild correction, has increased for the first quarter of 2020. Part of the portfolio management process, which is designed to enhance returns, involves beginning to trim laggards and losers from portfolios and even taking partial profits from positions that have become too large in portfolios. The end result is having cash available for new opportunities down the road.
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.
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