Round Trip

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On Tuesday, I discussed the loss of the “Beer Bet” with my dear friend Doug Kass.

Done https://t.co/7d2PhOK9SA

— Douglas Kass (@DougKass) June 25, 2018

The important lesson learned from my bet with Doug is to be careful how you “word” the bet.

The market did indeed break the 100-dma briefly before rebounding by the end of the day on Monday. However, on Wednesday, the market crashed back below the 100-dma pushing the market into a deeply oversold short-term condition. On the “Real Investment Hour”  I stated the market would likely rebound into the end of the week as it was both the end of the month, and quarter, and fund managers would be “window dressing” their portfolios for reporting purposes.

.@LanceRoberts: “The rally we expected was’t a great one, but at least we got a bounce. Watch out for corporate yield curves!” Lance Roberts’ Market Wrap for Thursday 6 28 18 https://t.co/2qZ1UKmBZU via @YouTube

— brentclanton (@brentclanton) June 29, 2018

Such turned out to be exactly the case the market virtually “round-tripped” back to where we started finishing the week only 2.06 points, or 0.08%, higher. In other words, if you happened to sleep through last week, you didn’t miss anything except a lot of price volatility.

But last week’s volatility is simply a representation of what we have witnessed since February.

However, despite the market not going anywhere price wise, internal participation continued its decline. As Bob Farrell’s Rule #7 states:

“Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.”

Of course, what spurred the bet between myself and Doug was last weekend’s newsletter wherein I stated the “bulls seem bulletproof:”

“While it certainly seemed as if the ‘bulls are bulletproof,’ it is worth noting that much of the action not only surrounded a few number of participants but also money was chasing the most shorted of stocks.

Nonetheless, in the very short-term, bulls do remain in charge and our investment discipline requires us to ‘follow the action’ regardless of how we ‘feel’ about it.”

Look for a rally early next week as the new quarter starts. The first test will be a break above 2740 which, if successful, would put 2780 back into focus. Use any rally to rebalance portfolio risk for now. 

Let’s review where we are now on a short, intermediate and longer-term outlook.

Short-Term

This past week, the market failed twice in trying to climb back above the 61.8% Fibonacci retracement level which kept the market confined to the same tight trading range we saw in May.

Because of the breakdown on Monday, we DID NOT increase equity exposure in portfolios as of yet. With 50% of portfolios currently in cash and fixed income, the damage from last week’s sell-off was mostly mitigated. (This is the advantage of cash and fixed income in a volatile market.)

The good news, if you want to call it that, is the cluster of support at the 50, 75 and 100-dma did hold this week. However, these levels are critically important now and a break below will quickly lead to another test the 200-dma.

On Tuesday, I updated the pathway chart above to take into account these potential outcomes.

Pathway #1: Given the recent tendency for bulls to rush in to “buy the dips,” the current oversold condition on a short-term basis provides enough “fuel” to support a rally back to recent highs. (30%)

Pathway #2a: Given both the short-term oversold condition AND the confluence of support at the 100-dma, the market is able to rally back to 2740 remains confined to a tight trading range between the 100-dma and 2740. (30%)

Pathway #2b: follows the path of #2a but fails to hold support at the 100-dma and quickly falls to test support at the 200-dma. The market will be deeply oversold at that point, so a rally back to the 100-dma is probable. If the market fails to move above 100-dma then a break below the 200-dma becomes probable and brings Pathway #3 into focus.  (40%)

And just like the first rule of “Fight Club” – we do not talk about “Pathway #3.” 

Actually, we will, we just aren’t there yet.

Should a break of the 200-dma occur we will be discussing much more about the onset of a cyclical bear market, risk reduction, and hedging.

“While I remain ‘hopeful’ the market can regain its stability and continue to quickly compensate for Trump’s trade rhetoric, ‘hope’ is not an investment strategy.”

Remember, these “pathways” are how we assess the risk of potential outcomes in a market that is experiencing much higher levels of price volatility than what we have seen previously. As longer-term investors, we “hope” to invest capital that will grow over time, but given the rising risks of a late stage market cycle, reductions in market liquidity, and tighter monetary policy we maintain a focus on capital preservation.

Intermediate-Term

The market has continued to remain within its bullish trend channel from the 2015 lows which is why we only mildly reduced our overall equity exposure in February of this year.