Advisor John Benedict uses a proprietary index for identifying market trends and specific opportunities. He shares some ideas his method has identified, and tells MoneyShow.com why retail investors should not attempt shorting in this market.
Kate Stalter: Today’s guest is John Benedict of J2 Capital Management.
John, we have talked before. I know that you use a trend-following methodology based on some proprietary metrics. Maybe you could start out by telling us a little bit about some of the indicators that you use, and what they are showing you right now?
John Benedict: We’ve developed a number of proprietary indicators to help us determine more intermediate-term trends in the market.
The main indicator that we use here at J2 is something called the Risk Controlled Index. What this index does is, it tries to measure supply and demand inside the market, to give us a gauge of both the risk that is happening out there vs. the reward that anybody could take at a specific time.
Where we look now is, the indicators are actually pointing very strong, as they should. The markets have been up quite strongly since that October low that we experienced. Consequently, our indicators really shot up, and have remained strong since then. It has dipped down in the past week, but from a longer-term perspective, I wouldn’t be too concerned.
On a shorter-term perspective, if we look at that, I would currently say the market is at an indecision mode at this point, right now. What that basically means is, we are not quite sure if the markets are actually in a process of correcting here, either through time or through price. The markets could chuck sideways here to work off some overbought conditions that we have experienced since October, before it resumes a rally.
Another possibility is we could correct. But when I’m looking at the markets and looking at certain indicators, we could have a pullback of maybe 5%, 6%, or 7%, but I would assume it would stop there before we went back up.
In the short term, I would say there’s indecision at this point right now, so I would be a little bit neutral in the next couple of weeks. Longer term, though, the trend is up, and so I think you have to accumulate strong stocks on any pullback in the market.
At this point, quite frankly, a 5% pullback in this market would be terrific, especially for a lot of people that have remained out of the market for quite some time, as shown by the retail investors really not participating.
Kate Stalter: Let me follow up on that. What are some actionable steps that retail investors can take right now, keeping in mind that our listeners here use a range of strategies, everything from buy-and-hold to daytrading?
John Benedict: So the typical retail investor, obviously the volatility that we experienced last year, and really even the past three to five years, has probably scared most of these investors out of the market. And let’s just say it is probably a loss of confidence.
I would recommend that most retail investors do sit down and talk with a financial advisor that is knowledgeable about markets. Specifically, I would try to work those that are a little bit tactical, rather than buy-and-hold, because at least with the tactical manager, you might be able to take some of the downside edge off of the portfolio. That is where most investors get scared; it is really on the downside.
I would definitely be looking for a pullback to slowly start to get in the market. Really it makes sense even for the most conservative investor that is scared about the markets to at least have one-third to 40%, something like that, of their money in the market to participate.
Kate Stalter: What would be a shopping list then, or at least a watch list, that people should be looking into at this time?
John Benedict: That is a great question. When I look at the markets, there are two sectors that really stand out to me, really strong sectors, and they have been for the past couple of months. And that is technology and consumer discretionary. This is specifically companies domiciled here in the US that get the majority of their business in the US.
So in the technology space, there are a couple of stocks that I am watching for pullbacks here. Those could be companies like Rackspace (NYSE:RAX), Intuit (NASDAQ:INTU), ShuffleMaster (NASDAQ:SHFL), or MercadoLibre (NASDAQ:MELI), which is an international company.
There are quite a few technology companies that do look good. Obviously a lot of people will point to Apple (NASDAQ:AAPL) as a driving source behind technology, but I’m actually seeing a lot more companies other than just Apple.
There is an ETF out there, I think it’s iShares S&P North American Technology-Software Index Fund (BATS:IGV), and it is a pretty broad-based technology, that is a software index. And that has done very well. You could even look at an Technology Select Sector SPDR (NYSEARCA:XLK) or an IGV; those would be something I would probably point toward on the growth side.
On the value side, I think dividends could play an important part over the next few years for investors’ portfolios. There are a few names I’m watching here too, and that would be Berkshire Hathaway Class B (NYSE:BRK.B), McDonald’s (NYSE:MCD), and then a technology company called Microchip (NASDAQ:MCHP), a technology company that has about a 3% dividend yield. Intel (NASDAQ:INTC) and Microsoft (NASDAQ:MSFT) would be some other more value-oriented names, as well.
Even if you wanted to pare down the risk a lot more than that, the last time we talked I pointed out high-yield bonds. I still think high-yield bonds probably offer some of the best risk-reward value that is out there.
You are looking at 7% to 8% annual dividend yield on these; they tend to track the stock market with about a quarter of the risk of the market. So I think that is a very easy way for people that might be scared of risk to look at the market.
There are a few things I might avoid right now. I would probably avoid anything European, so stay away from maybe the EAFE Index, anything tied to Europe. I think that there is too much headline risk that is there right now.
Energy and commodities have also really lagged the market in the past few weeks and past few months, so that would probably be an area I would probably stay away from as well.
Kate Stalter: To take that idea maybe a step further, a lot of people, as the market was running higher were pretty excited about potential opportunities to short—with the idea of, “what goes up must come down, and I want to take advantage of the downside.” What do you think of that idea?
John Benedict: You know, this is so fascinating to me right now in a number of different respects.
When I look at sentiment data, a lot of people point to sentiment data running really rich or very bullish as reasons why they should short. To me, the sentiment data over the past year has really shifted very quickly to one side bullish or bearish or the other. I think it is very difficult to short on sentiment indicators these days, because people tend to switch.
My reasoning behind it is that it appears so many people are so short-sighted that they have consolidated and shrunk down their time horizons. So people that used to be long-term traders, even advisors I know that were long-term, have now become intermediate or short-term.
Short-term people become day traders. Everybody watches the market tick by tick these days, and the cynicism, or everybody is skeptical, and they have been for a number of years because of the volatility.
So I would say well over 90% of the people that I converse with about the markets all feel the markets will be correcting or should be correcting, or will be going down. And people want to take advantage of it, and markets have done nothing but go up in the face of that now for weeks and months on end.
I think it is very difficult, and the advice I give most people is that shorting is very difficult these days. In fact, I wonder to myself privately if more money has been lost going short the past two years than was lost going long the previous two years before that. And I would love to see statistics one day on that, because I have my guesses on that.
The reason why shorting has become difficult is because of headlines. On one side you have headline risk, whether it is the economy or specifically out of Europe. But the counterweight to all of this is the Federal Reserve and the global central banks that any given day can put those shorts into money-losing propositions.
So shorting becomes really, at best, a daytrading exercise. Anything longer than the day, and you are really asking for trouble.
Maybe these dynamics will change one day, and we will get into a structure in the market that is more normal, but that is not where we are today. So I think anybody looking at a short is really asking for trouble. I think going to cash is probably the next best option.
Kate Stalter: And that sounds so boring, so people don’t like to do it. But it is a way to protect your capital.
John Benedict: I know, I know. We live in a video-game sort of trading world that we are in now, but those sorts of trading methodologies that I have seen really don’t work, and they are money losers.