Be a Trend-Follower, Not a Trend-Fighter

This past week, I’ve been in the San Francisco area for a conference that Donna and I extended and turned into a vacation.  As in the case of all our trips, I get up early in the morning before the sun comes up and start poring over several charts; from big-picture macro analysis to individual stocks and ETF’s.  One of our clients contacted me last week, saying how much he appreciates these updates and that they really help.  It’s my hope that more people will read it so that we can spread even more authentic education, all while making sense of the market, which by the way, is now face-to-face with a potential long-term trend reversal.  

This week, I watched each day as the market closed above its 200-day moving average (rose-shaded area below), which marks the long-term trend, by only 1-point on Tuesday and by a couple more points on Wednesday.  It then crossed back below it again on Thursday, but managed to regain that level for a third time in three days by the close of the market at 4pm.  Today (Friday), I’m writing this market commentary after the open and so far, we’re decisively above the rose-shaded, long-term trend for now.

All that being said, here are the potential signs of trouble I see in the chart below:

  1. Looking at the chart of the market all by itself, we still have yet to see a higher-high or a higher-low.
  2. The yellow “caution” area below represents the point between where we sit today and the Oct/Nov highs, which could be a ceiling of resistance that throws the market back down again.
  3. In the lower-middle-pane, while the market has headed higher, since mid-January, short-term momentum has been weakening.
  4. In the bottom-pane, longer-term momentum has yet to reclaim the 70-level, which would tell us that the market is in a healthy, bullish range.

Another sign of concern lies below.  In this chart, you’re seeing a comparison between the unemployment rate and the S&P500 going back to 1999.  You don’t have to be a rocket scientist here to see how:

  • Downward reversals in unemployment have led to upward reversals in stocks, and
  • Upward reversals in unemployment have led to downward reversals in stocks.

Below is a bar graph that shows the percentage of investment assets that have been allocated to cash since 2001.  As you can see, today’s investors are now holding their biggest position in cash (money market) since the last market crash.

Lastly, here is a chart I shared with my team earlier this week.  I didn’t plan on including it in this week’s update on the market because it’s a little nerdier than I’d normally share with the average investor.  However, I think it’s timely, educational, and might put today’s market into a longer-term perspective, so let’s take a stab at it.

First, recall the rose-shaded area is the long-term trend represented by the 200-day moving average (200DMA), which is simply the market’s smoothed-out trend over the course of the last 200 days.

Secondly, if you haven’t read any of my commentary in the past, the middle-pane below represents market momentum, which tells us the market is healthy if it’s moving up and down between 40 – 100… or if its unhealthy, it tends to move in a range between 0 – 60.

The blue arrows in the upper-pane point to times when the market has crossed below its 200DMA, which is one of the main pieces of evidence that suggests that we are not in an uptrend.  While the 2007-09 and 2000-02 market crashes are not shown, I included the 2015-16 double-double dip (notice the two, “W” formations under the rose-shaded area).  Today, the market has closed above the 200DMA for three days, which is evidence that the long-term trend could be reversing upward.

However, if you look at the lower-pane, I’ve included a different momentum indicator to show my team how, even though the recent market action is constructive and worthy of some cash deployment, when this indicator has reached its current level, it has had a tendency in the past to reverse downward, at least in the short-term.

To summarize, the market is starting to show signs of health, but we’re not out of the woods yet.  The current risk-reward landscape suggests that dipping our toes into the markets makes sense, but going all-in here would be foolish and would also represent more of a gambling attitude than one of risk management and capital appreciation.  As I always say, whenever we put our hard-earned retirement dollars into any investment, we always know where we want to get out before we even get in.

For the physics junkies, recall Newton’s 1st Law (inertia):

“An object in motion stays in motion with the same speed and the same direction unless acted upon by an unbalanced force.”

The market is run by buyers and sellers.  That’s it.  When the buying enthusiasm wins, the market heads higher – but when sellers take over, prices go down.  So, what we’re trying to do here is follow the trends put in place by the battle between these buyers and sellers and ensure we’re investing with the trend and not against it.

As the saying goes, “The market takes the stairs up, but takes the elevator down.”  And with all these quotes, I think it’s appropriate that we end on this one:

“I’m a trend follower, not a trend fighter.  I’m smart enough to realize that a slap is easier to recover from than a beating.”  ~ Martin Zweig

Till next time…

Adam

Categories: Adam Koos, CFP®,CMT®, Market Commentary

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