07-20-2021 - Histo-what?
The downturn in the markets that happened last Friday and yesterday have been almost fully erased by today’s strong up moves in the market. We had a good day today, but the only buy we made was in the Diversified Income strategy. Why didn’t we go back in since it looks like the markets are more “back to normal”? Well... a one or two day move in the market is not a trend and what I am about to share with you is how we differentiate between short-term volatility and tradeable trends.
First, let's look at a snippet of a chart that we like to use any time we are evaluating where the market (or sector or stock) is.
The chart on the left shows the "internal condition" (Histogram) of the S&P 500 going back a few months. What you are seeing is a moving average convergence divergence indicator that shows the relationship between two moving averages of a security’s price. We use this histogram to help identify when bullish or bearish momentum is high for an index, sector and/or individual stock.
You’ll notice that there was a strong move higher as shown by the green bars stepping higher (the width of each bar is one week) and that was followed by the histogram stepping lower until it turned negative as shown by the orange bars.
Right now, we are most interested in the last few orange bars. Last week (next to last orange bar on the right), the histogram stepped lower (this is a big signal that market momentum is shifting and potentially shifting to the downside). As of the close today, the last orange bar on the right is even lower. This in spite of the fact that the market moved higher today. This step lower is a non-trivial indicator and it is the reason that we moved to 100% cash in our Leveraged Index model this morning that only holds two positions; one in the 2x S&P 500 and one in the 2x Nasdaq. We are not ready to jump back into the market unless we see this histogram start stepping higher.
Does this mean we are bearish? Not by a long shot! But, the market is certainly showing signs of weakening. Could the market fix itself and move back into a bullish trend (more than a one day jump higher)? Absolutely... but we will wait until we see it happen and will NOT guess when it will happen.
The above histogram is just one set of indicators that help us quantitatively assess risk. The lower the risk, the more capital we put in play. The higher the risk, the less capital we put in play and the tighter we set the stops. But, those decisions are made on actual measurements of historical data; not data prognostications.
Even though the market moved higher today, the internals (strength of trend) are telling us to be careful. After all, even with today’s big move up, the market is still lower than where it was just a week ago.
I mentioned in the my Client Letter we sent yesterday afternoon, that we are using overall market and sector conditions to help us manage the positions we currently hold, as well as, those positions that we might want to add. When we begin to see the momentum of trend conditions improve, we’ll begin to get back into the market. We’ve already identified several stocks we’d like to buy when we get the bullish-bias signals.
The financial media is loving this market action with talks of “red seas” and the markets in turmoil. Maybe that will happen, but the signals we follow aren’t telling us that it’s time to move to cash. Yes, several of our holdings have triggered their respective stops and we are holding more cash right now, but the data do not support a wholesale move to cash... not yet anyway. We are data dependent. If the market trend weakens and/or turns bearish, we will simply move to cash as stops fire. If those trends continue to move from upper left to lower right, we will move into inverse ETFs and look to grow capital in a bear trending market.
Unlike the buy-and-hold crowd or the even worse investment strategy of listening to analysts and talking heads and their sage advice (aka, wags), we rely on what the market is actually doing. The beauty of that process is the market ALWAYS tells you where it is. And, everyone knows that the current trend in the market will continue until it doesn't. And, guess what? When that time occurs, the market will tell us. It is all just math... and historical data... not future data... not guesses about the future... not political rants... and certainly not analyst opinions.