2011Aug10 Don't fight the Tape

Recent days of market decline were driven by mutual fund redemptions and the fear of a U.S. debt downgrade. Mutual funds have had little cash requiring the selling of portfolio assets to meet investors’ requests to cash out. The recent market activity has caused changes in our Dynamic Asset Evaluation with Currency and International Equity changing places.

The long-term trend for Domestic Equity remains positive, but barely. However, asset classes 1, 2 and 4 all fail the “cash bogey” check for the short and intermediate term. Ninety percent of stocks on the NYSE are below their 50-day moving average. That is not a good trend.

The economy is probably not as bad as many investors assume though deterioration may be evident by early next year. The end of the Fed’s QE2 has closed the money pump supporting the markets. QE2 started last November. All of the impact on market prices has been given up with the S&P-500 negative nearly 13% from January through August 8^th. All the QE1 and QE2 money is still in the economy!

Prior stimulus bills and the Fed’s easy monetary policy have not created the hoped for economic results. It will be difficult for the Fed to implement another similar program given public demand for austerity measures even though the public does not understand the consequences of austerity. The Fed has announced it will not raise interest rates before 2013.

Demographics are working against normal policy intervention. Boomers are in their weakest spending stage, pre-retirement. Lower spending means lower sales, lower employment, lower taxes and lower wages. This trend does improve in the future, just not soon enough to resolve current government budgets.

The “debt limit crisis” was more a political and media crisis than a financial one. The amount we owe and how we will manage to repay it with interest caused the credit rating down grade. Authorizing more debt without addressing obligations was a Congressional failure. The only resolution is restructuring entitlements, eliminating base line budgets and an overhauling of the tax code. Austerity is painful. Just look at Greece or Great Britain.

Standard & Poors™ dropped another shoe by down grading Fannie Mae and 11,500 municipal bonds dependent on federal funds. There are more down grades on the way. Other government backed securities will soon experience the same fate. Having failed to properly evaluate credits in 2008, S&P appears to be taking its analytical role more seriously. Fannie and Freddie should have been down graded in ‘06 or ’07 with the increased purchases of sub-prime loans.

Our process has two main cornerstones: trend following and relative strength. Trend allows us to determine the direction of a given security, sector, country, market or asset class which is an absolute measurement. Relative strength identifies the magnitude of movement.  As the name implies, it is a relative measurement of performance. We combine these two characteristics when investing.

In markets where all equities are falling, trend indicators take on a more important role. Trends can serve as an absolute protection mechanism which resulted in our move to all cash early last week.

The Percent of Stocks in a Positive Trend for the NYSE and the Percent of Stocks in a Positive Trend for All US Stocks have deteriorated. The last time both indicators dropped below 50% was in November 2007, a full year before the Financial Market Meltdown. Indicators at this level cause us continuing concern.

Markets will not sell off forever. This correction, like every one before it, will find equilibrium and bottom out. Then, after careful evaluation, we will reinvestment capital. The lesson here is to listen to the market at all times. You can’t fight the tape. 

Between the market top in 2007 and the low in 2009 the S&P 500 lost over 56% of its value. The Market is nowhere close to losses of that magnitude, yet. Time will tell if it gets there. 

Again, this is the key. Listen to the market and be ready to invest when a sustainable trend forms, but not before.

Are you worried about what has happened to your portfolio over the past few weeks?

Are you waiting, again, for the market averages to restore your account?

Are you ready for a portfolio strategy that has a defensive plan included?

Are you ready for another opinion on your portfolio?

Call our office at 800-317-9119! Any staff member can schedule a meeting or a phone appointment on our calendars.