“The only “interpretation” or “opinion” regarding any fundamental topic that impacts asset price is the market. This was true yesterday, it is true today, and it will be true tomorrow. Charts/data/technical analysis help us monitor the market’s read of all the fundamentals.”
– Chris Ciovacco
Bottom Line: The stock market is going through a correction. I believe the evidence shows this isn’t the big one.
Summary: The weight of the evidence for stocks suggests that, while a correction in equities is underway, based on all of the evidence our view is any market pullback here is likely to present at least one more ‘buy the dip’ opportunity based on the expansion in the components of our PTI in June and November. Still, while the current sell-off could take weeks to unfold given how complacent readings of market sentiment were in the middle of January, a further up-leg in this cycle seems likely to me.
For the moment, we have raised cash levels and will raise it further by selling open positions. We continue to focus on stocks that hold up well in the current sell off and, over the coming weeks, we should be able to rebuild a core list of strong companies in uptrends in our portfolios. The market is still in a LT uptrend & pullbacks are part of the process.
In the Markets
First, let’s get it out in the open. If my grandmother was around, she would probably have heard of Gamestop this last two weeks.
I don’t want to waste too much ink on it so here goes. GME is a speculative bubble story but it appears it’s getting media traction because a) the media doesn’t report anything worthwhile and b) because it appears to be affecting rich people.
What happened in GameStop Inc., and should we be worried about the situation?
Well first, the powers that be locked everything down, which is hurting and bankrupting a lot of businesses, including a mall-based video game store called GameStop Inc.
As GameStop was struggling, a bunch of hedge funds shorted the stock. Shorting a stock is profitable if the stock declines in price, which GameStop (GME) was doing. Somehow, a bunch of small investors in a chat room, Redditt, decided to buy the stock and GME started going up. When you short a stock and it goes up, you are losing money.
The big boys and girls of the hedge fund world didn’t like that
What is a short-squeeze in plain English
The little guys buying the stock acted in mass which forced highly leveraged hedge funds and other big money short-sellers to head for the exits at the same time. This, in turn, pushed prices higher because there are only a limited number of shares available and if you are “short” you need to buy it back, or keep losing money. That forced buying became a vicious cycle driving the stock higher. The squeeze.
As for being worried, no … unless you own GameStop. It is highly likely that all investors in GME will lose all, or most of their money when this ends. The online brokerages, where most of this buying was done and which allow “free trading”, restricted trading in these stocks and prevented investors from buying the stock on their platforms. There is no such thing as a free lunch. If a business is providing you a product for free, then it is you who are the product.
This situation here is not all that unusual. Little bubbles and incredibly odd moves happen every year. In 2020 the price of oil dropped below zero for a short time, and no one outside of the financial industry heard much about that. I think that is probably because this is affecting the Wall Street power brokers and big money players and politicians. Even Nancy Pelosi is talking about it on TV for goodness sakes. I guess one of her hedge funds are being hurt by it.
Citadel is a multi-national financial services company which was wrapped up in the GameStop saga. The newly appointed Secretary of the US Treasury is Janet Yellen. She received $810,000 in speaking fees in 2019 and 2020 from Citadel. Citadel has spent $240k per year lobbying Congress and the Treasury Department.
If you think she is was paid for her wisdom and economic knowledge, well be careful of those wanting to sell you a bridge.
What’s important for us is that we don’t let it confuse us and don’t let it get in the way of what’s important, which is just making good decisions. That’s it, not much to see here, and nothing to worry about.
Current Market Condition
After the markets moved higher through the end of 2020, cracks have begun to show, and the market is going through a needed correction.
While corrections are a normal part of the ebb and flow of uptrends, we never know how long they will last, or if it is a correction that will turn into an actual bear market.
Because of that reality, we have a process for raising cash when volatility rises in context of our indicators. In January those indicators included:
1) Measurable levels of complacency by market participants.
2) Our Buying Power Indicator was already weak coming into January.
3) While our PTI has been strong up until late January, there are now signs of stress on the short-term indicators.
4) This means it’s time to take some action to reduce the potential that conditions get worse as we have been doing.
It’s never simple and it’s really difficult to make the decision to reduce exposure to stocks, that is if you don’t have a process. This is why the vast majority of advisors and portfolio managers will simply ride out bear markets and tell you that it will always come back, something we aren’t willing to do with our own money, so why would we do that with yours?
Of interest is that we are in the turn of the month cycle when the market displays strength, very dependably, from the last four days of the current month to the first four days of the next month. As new money is put to work for the coming month fund managers front run this expectation in the last few days of the month creating a bullish bias, relatively speaking. We are likely to sell more stocks on Monday or Tuesday, and I’m expecting some strength to start the week. Aside from that we are unlikely to take any major positions with our cash until volatility comes down and the picture clears up.
Why I think this correction can last for a little while longer.
Chart 1. was built by an American analyst I know named Joe Fhamy. It shows the S&P500 in the top pane. In the bottom pane it shows the RSI Index.
Indicators like this RSI are technical analysis tools used to determine the strength or weakness of a security’s price. Ultimately, RSI is a tool to determine low-probability and high-reward setups.
In the middle pane, the green line shows the number of days the RSI has traded above the 50 level. When the green line drops vertically it mark times when RSI held above 50 for at least 49 consecutive days and then moved below 50.
A strong uptrend is present when RSI holds above 50 and the dip below 50 shows the first signs that the uptrend is under pressure. The yellow/brown shading next to each vertical line shows what happens in the following three months. Most of the time the market went sideways for a couple of months except for two times (Sept-Oct 2018 and Feb-Mar 2020) when the market fell sharply.
Overall, the recent move below 50 (after an extended time above 50) shows that the uptrend is under pressure and a corrective period could unfold.
Why I don’t believe this will turn into a March 2020 type decline.
A review of our Primary Trend Indicator Inputs
Chart 2 is a chart I like to use to visualize the longer term condition of the S&P500.
Top pane: Shows the S&P500 in blue. The black line is a cumulative total of stocks hitting new 52 week highs. Rising is good, declining is not good. When it declines precipitously it’s a bad sign. When it crosses the red line, which is the 20 day moving average (DMA) of the black line (net new 52 wk highs) you should already be taking steps to reduce market exposure.
You can see how, during the ten percent market corrections in Sept. and Oct. the black line declined only slowly and bounced off the 20 DMA. It’s not a law, but it’s a good indicator. Current Condition: Still confirming up trend.
Second pane: A/D Line is the cumulative total of advancing vs. declining stocks. This is very often a good heads up as to market weakness should the AD Line.
It certainly did not give a heads up in February 2020 but on balance has historically been a good tell. Current Condition: Not diverging negatively, yet.
Third Pane: The Percent Stocks above their own 200 DMA. Clearly we want that to be rising.
In Feb 2020 this was also clearly diverging negatively as the number of stocks above their own 200 DMA were declining, like leaves turning brown and falling from the trees, one by one, as autumn turns to winter.
At over 90%, there isn’t much upside for this indicator to move. As the market made a new high recently this indicator was not falling. Still, now it is and in context of where it was in November, this indicator is in question. Current Condition: Mixed.
Bottom Pane. Advancing Volume vs. Declining Volume. While the A/D Line shows the number of stocks moving up or down, the AD Volume Line shows how much actual volume was moving into rising or falling stocks.
Bigger picture, if the 50 DMA of this line (the blue line) is rising, odds are we are not yet entering a bear phase. Current Condition: Marginally positive.
A quick review of these indicators shows that, while the uptrend in stocks is under some strain the odds still suggest that this correction is unlikely to be much worse than Sept/Oct. Corrections which prevented us from making much progress but which not many people noticed.
Primary Trend Indicator (PTI)
Here we apply three observations to each major US market Index, the S&P500, the Nasdaq 100, the S&P100, then the Mid and Small Cap indices.
On the shorter term table we consider trend strength and thrust issues. The table shows the dates that these indicators switch from positive to negative (green or red).
When 2 of three indicators turn red, that market is under short term pressure and if flips the Net Bullish or Bearish position red or green.
When 3 of five of these turn Net Bearish (red) we are already taking action to reduce some exposure.
A breakdown in the short term table will not cause us to move to 70 – 100% cash levels as we need to see the longer term PTI Inputs (below) under pressure first.
Long Term PTI
Below we see five indicators that measure, uptrend participation, Up Trend Confirmation, and Thrust on a longer- term basis.
When even one of these turns Net Bearish, we are likely to have already been taking action to reduce exposure to equity.
We expanded this table, our Primary Trend Indicator, to five indicators on five separate US indices. Below shows this table in February 2020. It read Net Bearish on February 26th.
I screen the markets every night and look a lot of charts to get a true feel for the market. Over the past 3 to 4 weeks many stocks were extended but last weekend, I found a decent number of stocks that looked ready for an up-trend resumption, but most of them failed to follow through this week. It’s ok because these things are a normal part of doing business in the markets, and I just view this as information that the market needs time to consolidate.
Like a boxer in the ring, Mr. Market has been hit. He’s groggy and may take a bit to clear his head, but he’s not been knocked out. That is how the data reads to us at the end of January 2021.
We have the highest level of cash I’ve had in a while. I’m not bearish, just defensive until the market provides better opportunities. Please note that cash is an asset class and if we hold cash it is not just “sitting there unproductively.” Sitting and waiting for better entry points is a productive use for dry powder. The time will come when we are fully invested again.
If we get a 5-10% pullback, I think it will be buyable. If it happens, there will be strong opportunities. We are just going to be patient.
We remain completely open to any eventuality that the markets bring. Our strategies, tactics and tools will help us to successfully navigate whatever happens as we focus on monitoring supply and demand signals that the market provides us.
I hope you are having a very good weekend. If you have any questions about this update, or anything else please do not hesitate to reach out.
Peter Schenk, CMT, CIM | Portfolio Manager
Words we operate by:
“Deliver to the world what you would buy if you were on the other end. There is huge pleasure in life to be obtained from getting deserved trust. The way to get it is to deliver what you would want to see if you were on the other end.”
“Strive not to be a success, but rather to be of value.”