Just a Simple Rule

Unfortunately for the bulls, the S&P500 returned to it’s losing ways last week, when it gave up just a little over 2%. The problem for US equity bulls is that the bounce has not fully restored all the big losses incurred at the beginning of February, so that if stocks start to turn down again from current levels, many technicians will point to a failed, or “dead-cat” bounce and start to become more bearish going forward. But on the positive side, bulls can point to weak volumes—in other words, investors were not rushing to sell, and they can point to very mild rise in volatility, meaning investors were not showing any signs of panic during last week’s sell-off.

Meanwhile, on Main Street, the economic news was also disappointing. At least ten reports missed their respective consensus estimates. These misses included the Chicago Fed National Activity Index, new home sales, durable goods orders, international trade, the FHFA house price index, Chicago PMI, pending home sales, construction spending and the PMI manufacturing index. On the positive side, the Dallas Fed manufacturing survey, consumer confidence, personal income, and ISM manufacturing all beat their respective estimates. But the ratio of misses to beats was definitely in favor of the misses…..suggesting a slight slowdown in recent economic activity.

On a weekly chart, the recent turmoil in the S&P500 is still barely noticeable. This is indicative of just how big and powerful the upward move from the last 2-3 years has been. But on the daily charts, the most recent “correction” is most definitely visible. And as mentioned above, the S&P500 needs to resume its bounce very soon, or else a lot of recent stock market entrants will be among the first to rush for the exits. Why?  Because the joined the party late, they may not have enjoyed big gains that would naturally more than offset the recent paper losses. If instead, the entered the US stock markets—as many retail, or mom-and-pop investors did—sometime in 2017, then it wouldn’t take much more of a retreat to cause many of these recent entrants to be sitting on net losses. So from the desire to protect capital, these recent entrants could start to head for the exits first and in large numbers.

More importantly, wouldn’t it be nice if investors could take advantage of a simple signal to alert them to LEAVE the US stock markets if major losses, for example losses greater than 10%, were likely to hit their portfolios?  Assuming that most people would prefer—if they could—to avoid the massive ups and downs (over 50% losses in each of the past two bear markets) that we have witnessed in the S&P500 over the last 50+ years, one can develop simple rules that a) tell them to EXIT the US stock markets when bear markets are likely to occur, and b) tell them to ENTER, or REMAIN in, the US stock markets when these same markets are likely to rise.

Over the last several years, we’ve developed such a rule.  It’s optimized only for the S&P500 (not, for example, the NASDAQ or the Russell or any bond or commodity markets) and it keeps us in the S&P about 85% of the time.  Over the last 50+ years, it would have kept us out of every major bear market…missing not all of the losses, but the vast majority of each bear market’s losses.  More importantly, it would have captured the bulk of the gains in every bull market.  At major market turns, it’s slower to exit than to enter, so it’s biased to remaining invested….which is good because statistically, on most trading days, the S&P500 tends to rise, rather than decline.

As of Friday’s close, this indicator is bullish, meaning investors should remain in the S&P500.

 

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: