In today’s edition of “Thoughts From The Beach (TFTB),” did Monday’s rally change anything? Over the last couple of weeks, the markets have been rocked by a dramatic plunge in the Shanghai index and fears of a “debt crisis” in Greece. Investors, who had become extremely complacent in a low volatility market over the last couple of years, were suddenly rattled by rather violent swings in asset prices.
However, as has been the hallmark of the financial markets, Central Banks, and Government officials “raced to the rescue” to ensure a continuation of “market stability.” In the case of China, a swift intervention of liquidity, a trading halt on almost half of all securities and a ban of selling of securities stalled the 30% dive in the index. (Of course, it did.)
For Greece, it was the brute force of Government pressure that brought the Greek Prime Minister to his knees. In a deal that will leave Greece in ruins for decades, the crisis was brought to a temporary end as the proverbial “can” was kicked down the road for a third time. Unfortunately, for Greece, when the debt comes due next time, the situation will be far worse and a similar outcome much less viable.
But that was just the latest headlines. The question that investors must answer is whether the rally that started last week, and continued Monday, put an end to the correction that begin several weeks ago? To answer that question, we need to step away from the headlines and media driven diatribe and focus solely on the current price action of the markets.
Let’s begin with a daily price chart of the S&P 500.
The red dashed line is the long-term bullish moving average. This market has primarily adhered to this support since QE3 began in December of 2012. However, beginning earlier this year, the market began a bullish consolidation process, which after two breakout attempts, eventually failed as the debacle in Greece and China gained traction. That correction (highlighted in red) violated the long-term bullish moving average. The market then made two attempts to rally back above that level, now acting as resistance, but failed to do so. That is until Monday’s “short covering” surge as the Greek drama found its inevitable conclusion. With asset prices very oversold, the market was primed for a sharp rally on any catalyst that cleared the way.
Unfortunately, that rally was unable to clear the 50-day moving average, or the psychological 2100 level, on the index. To re-establish the longer-term bullish trend, the market will need to move to new highs. Any failure to do so will simply keep the markets trapped in the ongoing topping process that began earlier this year.
While the rally on Monday certainly gave a relief to the “bull” camp, it has not been enough to completely shake the “bearish” grasp on the markets currently. By stepping back and viewing a weekly chart, we can get a clearer picture of the recent deterioration in the markets.
This is why I prefer weekly and monthly charts when it comes to portfolio, risk and allocation management. By viewing price data on a weekly basis, the picture is “slowed” to reveal the price trends of the data by removing the daily “noise” of volatile price data.
As can be seen, the bullish rise in the market that began last October, as QE3 came to its conclusion, ended in May as price action deteriorated and violated upward trending bullish trend line. While the recent correction only briefly violated the longer-term bullish trend support that began in 2012, the rally on Monday was not sufficient enough to reverse the current downtrend. Importantly, since this is a weekly price chart, the market must move above that downtrend, and hold it, by the close of trading on Friday for the reversal to be valid.
Importantly, as shown, the market has registered its first “sell signal” since 2007. While “sell signals” do not mean that the markets are about to have the next major market crash, they do suggest that enough damage has been done where the easiest path for prices is currently lower. Therefore, investors should maintain a more cautious investment posture until the overall market environment improves.
In a recent debate with another advisor on the importance of “risk management,” I was confronted with a rather interesting remark.
“Don’t investments always have risk? So, why does it matter.”
Yes, all investments contain an element of risk. However, as investors should have learned in 2001 and 2007, there are times when investments carry substantially more risk. What investors tend to forget is that “risk” is a function of “how much you will lose” when things inevitably go wrong. And, more importantly, this brings up rule #2 of risk management: “getting back to even is not a long-term investment strategy.”
The chart below is a longer view of the weekly chart above showing the running support trend lines that have held the markets to their bullish advance since the beginning of QE3. As shown, the recent correction tested the lower of the two primary trends confirming current bullish trend support at 2050.
For now, the “bulls” remain in charge of the markets. This suggests that portfolios remain tilted toward equities currently.
However, the deterioration in momentum has triggered a “confirmed sell” signal which suggests that while investors should remain invested, they should be much more cautious about the “risk” undertaken in their portfolio. Unfortunately, the majority of investors have no idea about the inherent risk in their portfolio until a decline occurs. It is only as prices plunge that the realization of the mismatch of “risk tolerance” sets in which eventually leads to “panic selling” at the most inopportune time.
The market is clearly sending a warning currently. While the markets did rally nicely on Monday, it was not enough to cause the “bears” to release their grip just yet. For the “bulls” to regain their footing the markets will need to rally to new all-time highs. Given the length of the current bull market advance, the deterioration of momentum and a still weak economic environment – the “bulls” definitely have their work cut out for them.
But that’s just my view from “the beach.”