“You’ve got to know when to hold ‘em. Know when to fold ‘em. Know when to walk away. Know when to run.” — Kenny Rogers, country music singer
“Go on take the money and run.” — The Steve Miller Band, American rock band
Risks around stocks have risen considerably, and even long term investors should now substantially underweight equity exposure. Due to the unique characteristics of this stock market, my best advice is to now treat it as if in the onset of a bear market, regardless of near term price action. At this point in 2014 many warning signs are flashing red—the bond market is signaling weakening growth and greater risk of default, while stock market breadth has deteriorated with many stocks, including small cap and foreign indices, exhibiting extended weakness, while fewer, very large stocks were supporting the market until the recent sell off. The risk versus reward of stock exposure has become too high for an even normal stock allocation, let alone the aggressive allocation most currently posses. It’s time to under weight stocks by taking money out of the market or hedging equity exposure with relation to key technical levels.
As the stock market struggles to make new highs, investors are increasingly complacent despite worrisome developments. Yet, the U.S. stock market itself is looking increasingly shaky. Worrisome signs are also growing around the U.S. housing sector critical to America’s economy and China’s economy, which has been an engine of growth for the global economy. Although the price action of this stock market remains healthy enough to justify holding a substantial amount of stocks in a long-term portfolio, this does not justify complacency or in my view significant stock exposure for investors with shorter-term time horizons, particularly in light of growing bearish signs.
Unwilling to yet call a bear market, I have nevertheless become increasingly negative on this bull market. But despite a rough January, the stock market, as measured by the S&P 500, remains above its 125-day moving average—a level it has held for over a year. As such it would still be premature to call the current bull market over. But it’s not too early to examine why a meaningful move down with a breach of important technical levels, such as the 125-day, will be a reason to adopt a defensive posture, rather than “buy the dip” as so many are already advocating. In the spirit of my first “A Scary Looking Market” post I’ve included some new charts that argue against many of the currently popular bullish arguments. There is good reason to believe that optimism for the ability of the Federal Reserve through monetary policy to engineer strong economic growth is misplaced. Also unlikely to be realized is the hope that stock price multiples will grow further in a Great Rotation of investors moving from cash and bonds into stocks.