It’s time to put aside what you “think” and listen to what the market is still telling us
I am a technician (chartist) through and through. My late father taught me when I was 16, 40 years ago. In markets like this, using technical patterns as a “decider” amid conflicting economic sentiment and valuation indicators has been a guiding light for me as an investment manager for decades.
Applying that to this year’s market environment, charting helped to identify the severe potential for a major market decline. This was the case even before the current global health crisis reached the United States. The key to any type of investment analysis is NOT to predict what will happen in the future. Rather, it is to gauge the trade-off between potential reward (upside) and risk of major loss.
The S&P 500 is currently in the process of trying to recover from losing about 1/3 of its value. So, where are we now?
Full recovery to old highs? Unlikely for now. What to do?
This environment has caused me to make some disciplined, but rare shifts in portfolios I manage: much higher cash and US Treasury positions, much higher use of options (puts to protect, calls to exploit rallies) and greatly reduced stock market exposure. I have also incorporated what I refer to as “arbitrage” strategies, as I described in a recent article here.
The key at times like this is to understand that you don’t have to make all-or-nothing decisions. Its about finding that reward-risk balance. So, like a spring, your stock market exposure can be expanded or contracted.
Strong, powerful bounces of 10%, 15% 20%? Expect them.
Nothing says “bear market” like urgent buying. Monday’s rally was a good sign in that the S&P 500 was able to cross through one significant level (2,640) that had been a barrier recently. But this is all still new, and short-term.
Furthermore, the market, the charts, fundamental analysis and just about anything else that works in “normal” times can be thrown off for periods of time. That in itself is a good enough reason to be investing with above-average caution for a while.
The risks are right in front of us…do we see them?
But “buying the dip” and hanging in there” will get old very, very quickly. So will chasing monster rallies, like Monday’s, if they run out of steam quickly. And in bear markets, they typically do. The stock market is not your financial enemy. At a time like this, complacency and overconfidence are.
Important technical levels to monitor
I closely track a variety of indicators, technical and otherwise. But for the sake of brevity, here is a short list of S&P 500 price levels that I consider to be milestones on the way to busting out of the bear market, or dragging us further into one.
The S&P 500 gets more bullish-looking if…
…it gets to above 2,880 and then 3,130. The latter figure would be about 10% below the February peak.
The S&P 500 gets more bearish-looking if…
…it drops below 2,600, then heads to and through 2,200, the recent low. That’s about 35% below the S&P’s all-time high. At that point, the media will be filled with cries of a “failed re-test of the lows.” And you know what? They’d be right to be concerned! The next solid targets I see below 2,200 are 1,800 and 1,600.
1,600 – you mean, like Pennsylvania Avenue in Washington D.C.?
Actually, it’s just a coincidence. But the 1,600 level in the S&P 500 is plenty significant for technicians. That would be just over 50% down from the all-time high.
The last 2 bear markets (Dot-Com Bubble and Financial Crisis) fell by roughly 50% each. Something for all investors to consider, unless they just assume that this is all a blip on the radar. That’s a chance no investor should take.
I hope that chart perspective helps you size up your own portfolio, or those you oversee for others. These days, rules and records are being broken everywhere in the stock market. But that doesn’t mean we should ever lose sight of the baseline: have a process, have a plan, and follow it.