Saturday, May 4, 2013

Weekend Update: Acceptance

BREAKOUT!!!

The SP500 finally broke out significantly above the all-time high resistance on Friday after a better than expected jobs number for April. Also this week both the Fed and the ECB ( European Central Bank) added to or hinted at more liberal easy money policies going forward. The combo of extra stimulus with an improving economy was just what the bulls needed to finish the week at historic levels.


This is a shorter time frame looking at the past month and the breakout today. Just a very strong open to the day and the gains held very firmly.

There are a couple things about this move that makes it unique. First it creates a weekly closing price higher than we have ever seen. There are many longer term investors that consider weekly closes a much more significant accomplishment than simply a daily close. Second, it clears the S&P above a psychological level of 1,600 which was a target many traders and investors were focusing on. Now that it is broken it should create a momentum trade higher from here.

Along with the positive momentum caused by breaking above the 1,600 level comes a sort of collective sigh of relief from traders and investors alike. This level had stopped epic bull markets dead in their tracks twice before; the "Dot Com" bubble in 2000 came to an end at S&P 1,552 and the Housing euphoria which topped out at 1,576. Now we have eclipsed that prior resistance and continued to push higher.

Except this time the mood of the market is not nearly in the same place as it was in 1999 and 2007. If you recall from both of those markets participation was broad. You had people at parties giving stock tips like they were the next Warren Buffet, or telling you that housing in America NEVER goes down. The largest demographic in our history, the baby-boomers, were all fully invested in their pensions and retirement accounts, were taking out bad debt and buying new things hand over fist.

But what is the mood right now? Are we Euphoric? In my personal opinion we are no where close to euphoric. Look at what the news focuses on and discusses: China is in a slow down, Europe has been in recession for a couple years now and is on the verge of collapse, QE is single-handedly propping up markets, etc. I mean Consumer Staples and Utilities have been market leaders all year, typically very defensive groups. Gold has undergone a parabolic move since November 2008 until August of 2011. It has only been until recently that gold finally showed some weakness which signaled less fear around the market.

You see, markets trend in cycles, they have for as long as humans have been speculating. There was the "Tulip Mania" that the Dutch got themselves tangled in, and many other peaks and crashes throughout history, including our most recent stock market events in 1999 and 2007. To get an idea of how silly these waves can be, think back several years ago, remember Beanie Babies and Tickle Me Elmo? Those are also examples of asset bubbles and crashes, these don't only occur in financial markets. Retail investors just simply don't trust this market because they expect history to repeat itself and crash on them again. It is possible that the QE inflated markets will or are creating their own bubble in equity and bond prices, but the typical emotions associated with a major peak are simply not present. These sorts of runs always end badly and this one will too, but being too early to the party can be just as damaging to your investing accounts as being too late.

Where we are in the market psychological cycle is largely up to interpretation, but where I feel we are today is just over the mid way point of this bull run. I think Friday's breakout signaled a transition from a mentality of Doubt and Caution to one of Acceptance.

Here is what I mean by the market psychological cycle: courtesy of RMB Unit Trusts

Market participants go through the same basic emotions when speculating the value of any asset. The uptrend begins tentatively as those who recently lost most of their savings in the prior down swing tend to look at any positive development very suspiciously. But as the trend continues to gain traction, participants start to dip their toes back in but are going to have one foot out the door for when the next shock lower arrives. After conditions continue to improve and prices keep rising, there comes a breaking point where the cautious approach is proven lacking and a confidence and acceptance phase comes to the forefront. As confidence builds and momentum increases, players continue to get more liberal with their investment choices and start reaching for riskier and riskier assets. Then comes the final phase of the move where everyone owns stocks and feel that they can do no wrong. That is the point where things change. If everyone owns the asset in question then there is no one left to convince to get in and push prices higher, those people are already in and fully invested. 

Once things turn for the worse, the cycle downward is very similar to the way up. In the early stages of the correction investors feel that its nothing to be concerned about. They will just ride this little wave out and higher prices will continue. But then what happens is that the downtrend persists and investors start to get weary and fearful. Once things turn bad there is not much time left in the swing lower as people are panicking to dump whatever they own for whatever they can get for it. That panic and loathing phase very typically signals a major bottom and the cycle starts over.   

I am of the opinion that we have, as of Friday, crossed out of the Doubt and Caution phase and will now be entering the Acceptance and Confidence phase. In accordance with my view here and the market's breakout I have increased my holdings to now just under 70% invested in stocks and 30% cash. I consider a fully invested position for my accounts to be 80% stocks 20% cash; I continue to use the 20% cash for short term trades. 

My game plan going forward is to remain heavily invested above the 1,600 level on the SP500. If the market fails this breakout and trades back below 1,600 I will then go back into a cautionary position and reduce my holdings back below 50%. When the signals change we have to change with them and this week we got a new signal to work with. I have adjusted my allocations in my accounts to a more aggressive position and sold off my lagging assets and added to my winning ones. As a general rule I like to have my biggest positions be in my longest winners and strongest setups, and my smallest positions in my newer holdings or weaker positions. 

This week I made the following adjustments to my accounts:

Sold: TLT, JPM, ARUN
Reduced: AGNC

Added To: HAIN, HD, F, PBW, CSX, ROST
New Buys: GLW, GLL(short gold), SSO (2x Long SP500), EEM (Emerging Markets)

My other current positions:
DDD, GOOG, PPG, ENB, ABT, INTC

I will be looking for pullbacks to add to these positions further.   



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