7 Reasons Why The Recent Rally Was Not A Surprise
Chris Ciovacco | Oct 10, 2013 04:40PM ET
Hard Evidence Says Be Open To Bottoming Process
If you were willing to examine the investment landscape without bias, there were seven reasons to remain very open to a big rally in stocks, rather than a 2011-like plunge:
- Markets need hope, not a solution
- Yellen was a shoo-in
- Fear peaked at a logical level
- Investors cooled on bonds
- Defensive assets were not in great demand
- Cyclical assets were holding up well
- Buyers stepped in near logical S&P 500 support
2012 Taught Us To Look For Cooperation in D.C.
The fiscal cliff was a good primer for the political theater that has been revolving around the debt ceiling and government shutdown. It was mid-November 2012 and the S&P 500 had dropped 131 points as fears of the over-hyped fiscal cliff approached. Politicians were doing a lot of talking in front of the cameras, but little-to-no progress was being made to address the core issues (sound familiar?). The markets were looking for any ray of hope. They got it on Friday, November 19, 2012 when leaders from both parties stepped to the microphones together as a sign of good faith. The markets did see some volatility over the next six weeks, but a new low was never made. As the negotiations continue, volatility is probably here to stay for a time in 2013, but a low or bottoming process may be at hand.
On October 9, we pointed out any good news on the 2013 “crisis” could bring buyers off the sidelines. They came out in full force Thursday.
A Break In The Standoff
Thursday’s monster rally in stocks was very similar to the “light at the end of the tunnel” rally that followed the November 19, 2012 joint press briefing. From analysis compared 2011 and 2013 from an offensive, rather than defensive, perspective. The basic takeaway is captured in the segment below:
Charts allow us to monitor the never-ending battle between bullish economic conviction and bearish economic conviction. Experienced traders know higher beta and more economically sensitive ETFs tend to outperform when bullish confidence is greater than bearish concerns… reflecting a bullish stock market. So where are we now?… Instead of avoiding higher beta and economically sensitive sectors, traders are favoring those assets over the broader market. The chart below does not discount the possibility of short-term volatility and weakness as politicians follow their “I am fighting for my constituents and want to get re-elected” script, but it does tell us to keep an open mind about bullish stock market outcomes once things calm down.
Get The News You Want
Simple Support and Resistance
One thing that is often lost when critiquing the value of analyzing stock charts (aka technical analysis) is the charts help us understand and monitor economic conditions and fundamental concepts. For example, the concepts of support and resistance monitor the perception of economic value of all market participants. Investors tend to buy when they perceive value (or near support) and they tend to sell when their assets reach what they believe is an overvalued level (or near resistance). We tweeted the chart below Wednesday noting the “importance of being open to all outcomes, including bullish outcomes.”
Investment Implications – Are You Sleeping Well?
If you are tossing and turning at night hoping the market will bail you out or allow you to “catch up”, your allocation between risk assets and conservative assets is probably out of balance. Our market model is designed to keep us properly aligned with the market’s tolerance for risk. Why the market’s tolerance? Because the market sets asset prices.
During the recent pullback, the market model allowed us to keep positions in emerging markets (EEM), foreign stocks (EFA), technology (QQQ), and small caps (IWM). The model balanced this downside risk with a large cash position, but it never recommended bonds (AGG) or hedges (SH). The ETF short list from Wednesday told us to focus on emerging markets and foreign stocks in the event of a breakthrough in Washington. Consequently, we added to our emerging markets and foreign stock positions during Thursday’s session.
The game plan from here is simple. If the market’s tolerance for risk continues to show observable improvement, we will continue to scale back in with our cash. If the political process becomes dysfunctional again, we are happy to incrementally scale back toward a more conservative stance. The market will bring us to a prudent allocation if we are willing to monitor the battle between economic conviction and economic fear with an unbiased, flexible, and open mind.
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