I’m a nervous bull, no doubt about it.
Some analysts that I deeply admire are calling for big trouble and doing so with conviction.
Yet my gut says that the current market turmoil is building up energy for the next leg higher.
As I wrote on Tuesday, however, succeeding as an investor doesn’t have nearly as much to do with “being right” as most people think. One of my all-time favorite financial book titles is Being Right or Making Money by Ned Davis. I keep it in mind every day.
I’m positioning myself to do well if I’m right and not do too bad if I’m wrong. That’s pretty much as good as it gets.
So … while I may be wrong, let me show you why I’m feeling like the “worst start to the markets ever!” does not likely imply that a forty to fifty percent correction in US stocks is right around the corner.
First, we’ll look at the S&P 500.
Ever since the S&P 500 hit its Smart Trailing Stop in August of 2015, I’ve been calling for sideways market action. We’re about five months into that range-bound action now – no new highs and no new lows.
The most concerning thing in the chart above is that the Smart Moving Average is starting to roll over but it’s far from suggesting that the end is nigh.
If you want to see what a market looks like that you should stay away from at all costs, take a look at the recent action in China as represented by the SSE Composite:
This is classic “keep your distance” behavior. Price has risen two or three times now to touch the Smart Moving Average from below only to be sharply turned back down. That’s what a good trend indicator can do for you – support your rallies and turn back your dead-cat bounces.
That’s not what we’re seeing in the S&P 500. If you look back at the chart I posted above, you’ll see that price rose back above the Smart Moving Average, stayed there for a while and has now dropped below. The Smart Moving Average remains in a sideways trend for the S&P 500.
It is very important to note, however, that the S&P 500 has not yet triggered a Re-Entry signal. The coast is far from clear.
The recent action in the S&P 500 definitely has me on hold as far as new long positions are concerned. I had a couple of bullish looking stock charts picked out to share with you this week but I decided to hold off so that you know that I’m taking the possibility of a more severe correction seriously.
Instead of new bullish stocks to share this week, I’ve got an example of a stopped out stock –United Parcel Service (UPS). We highlighted the bull case for UPS on December 18, 2015 when UPS dipped into its Low Risk Zone. Here’s what the chart looks like today:
With the Smart Moving Average rising and UPS dipping into its Low Risk Zone in mid-December, it seemed like a reasonable risk to take. Unfortunately, UPS never got off the mat and was recently stopped out.
It’s a good illustration of a couple of key points.
First, using the Low Risk Zone limited the risk taken on UPS. The full Volatility Quotient (VQ%) on UPS is 11.5% but the paper-loss on this entry and exit was only about 7%. By using the Low Risk Zone we didn’t have to take the full VQ risk.
When volatility rises and the markets start to thrash about, it’s a good idea to trim your sales, honor your stops and do one of the most difficult thing an investor has to do – sit tight and do nothing until the sky starts to clear.
Stay safe … and calm,
Richard M. Smith, PhD