Lance Roberts | May 05, 2019 12:30AM ET
Fortunately, the market rallied on Friday as traders scrambled to hold important support levels following confirmation from Richard Clarida that the Fed has no intention of moving interest rates anytime soon. Via Bloomberg:
Despite headlines to the contrary, the employment report on Friday was NOT good and we will likely see a good bit of payback next month. David Rosenberg summed it up well:
Nonetheless, the market did rally keeping us in the same place as last week.
“While that break to the upside was indeed bullish, the market remains very confined to a rising consolidation pattern and failed to close above the intraday all-time highs from last September. With the markets trading on VERY light volume on Friday, combined short-term ‘sell signals’ forming, and pushing more extreme overbought conditions, it is too early to completely remove all risk management controls in portfolios.”
The chart below is updated from last week.
While the market did hold inside of its consolidation pattern, we are still lower than the previous peak suggesting we wait until next week for clarity. However, a bit of caution to overly aggressive equity exposure is certainly warranted. I say this for a couple of reasons.
With respect to earnings, and as we have stated many times previously, estimates continue to be revised lower and have now exceeded our original revision target (red dashed line) set out in early 2018.
Note: The Q4-2019 hockey-stick earnings jump WILL BE revised down markedly over the next few months.
Why do I say that?
Because 2020 estimates are already being revised down rather sharply as well.
This is important as markets push all-time highs at a time when forward earnings estimates for the next 18-months are all lower than previously estimated. Despite the rise in expected earnings in 2020, the peaks of those expectations (which are predictably about 33% too high currently) are all lower than the 2018 earnings peaks.
In other words, further increases in the markets over the next two years will be a function of multiple expansion rather than increased “value.”
Such an environment tells us a few things about the market.
As noted above, the market’s stellar run is set for a breather over the next couple of months. Specifically, as we approach the end of the seasonally strong period, the odds of a “reset” rise markedly. As noted on Thursday by StockTraders Almanac the seasonal “sell” signal has also been triggered. To wit:
h2 Never Hurts To Ring The Cash Register/h2“Yesterday after the market closed, we sent out our Tactical Seasonal Switching Strategy Sell Alert for DJIA and S&P 500…we are shifting the ETF Portfolio to a market-neutral position by adding some exposure to short and longer duration bonds.”
“A common theme through today’s report is ‘Profit Taking.’ Over the last couple of weeks, we have continued to discuss taking profits and rebalancing risks. Yesterday we sold 10% of our many of holdings prior to earnings to capture some profits. We also added to some of our Healthcare holdings which have been under undue pressure and represent value in a market that has little value currently.”
This was also a point Jim Cramer reiterated on CNBC on Thursday:
“Any time you have a remarkable run, it never hurts to take something off the table. Nobody ever got hurt ringing the register,” – Jim Cramer, CNBC
As the old Wall Street saying goes:
“Bulls make money. Bears make money. Hogs get slaughtered.”
Yes, markets are hovering near all-time highs and everything certainly seems to be firing on all cylinders. However, such is ALWAYS the case before a correction begins. Such is the nature of markets.
Currently, the markets have had a stellar run since the beginning of the year, and as we wrote previously if you sold everything today, and went to cash, it is unlikely you will miss much between now and the end of the year. (We aren’t recommending you do that, it is just to illustrate a point)
The reason is because of a chart we posted earlier this week in “A Warning About Chasing This Bull Market.”
“At almost 7% above the long-term weekly moving average, the market is currently pushing the upper end of historical deviations.”
The important point to take away from this data is that “mean reverting” events are commonplace within the context of annual market movements.
Currently, investors have become extremely complacent with the rally from the beginning of the year and are quick extrapolating current gains through the end of 2019.
As shown in the chart below this is a dangerous bet. In every given year there are drawdowns which have historically wiped out some, most, or all of the previous gains. While the market has ended the year, more often than not, the declines have often shaken out many an investor along the way.
Let’s take a look at what happened the last time the market started out the year up 13% in 2012.
So far, it looks a whole lot like this year.
“From a portfolio management standpoint, the reality is that markets are very extended currently and a decline over the next couple of months is highly likely. While it is quite likely the year will end on a positive, particularly after last year’s loss, taking some profits now, rebalancing risks, and using the coming correction to add exposure as needed will yield a better result than chasing markets now.
Given that every given year has some sort of corrective action in it, betting this year will be different is a low probability event.
So, what could cause such a correction?
Doug Kass laid out a decent laundry list of non-trivial risks that not only currently exists but in many cases are expanding.
It’s a lot.
However, where that laundry list of worries is long, none of them are going to be the “one” which gets the market. It is the combination of these issues which provide the “fuel” to amplify the impact of an unexpected, exogenous event which ignites selling in the markets.
Since it is ALWAYS and unexpected event which causes sharp declines in asset prices, this is why advisors typically tell their clients “since you can’t predict it, all you can do is just ride it out.”
This is not only lazy but ultimately leads to the unnecessary destruction of capital and the investors time horizon.
h2 /h2 /h2
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