Insights & Advice


Flashing lights for the stock market

I made some trades last week. I did different things in different portfolios. I believe that readers will be best served with a summation rather than a specific list of what I did in each. The result is that I got more conservative. I shifted about 4-8 percentage points from position to position. I did not raise cash.

I reduced (but didn’t eliminate) my small-cap and homebuilder stock positions and shifted back toward large-cap stocks and high-yield corporate bonds.

In last week’s column, I teased out this consideration in the “You’re Too Happy” sub-heading. I cited there, “I have some holdings that are trading below their 50 Day Moving Average (DMA) … with the stock market at lofty levels … I may begin to reduce or eliminate positions.”

I’ll share the additional reflection I had since I wrote that column that nudged me to make some trades. That way, you can use this information to decide if you want to make a change. Remember, my shifts were small. I am not advocating for anything significant at this moment. I am a cautious fellow, and caution often means that steps are deliberate.

Consider this scenario. You’re driving down the road, and off on the horizon, you see some flashing lights. What do you do? Slam on the breaks, right? No, of course not.

You don’t know what’s ahead, but you know something is wrong. So you instinctively ease off the accelerator and slow down a bit, getting ready for what may be ahead. Is the road shut down? A detour yet to be mapped out?

There’s not too much to lose if you pull over and let everyone pass you until the flashing lights are removed. But maybe it’s only a fender bender, and the road remains passable. So if you pull over and stop, you get left behind. You lose out on the opportunity because you were trying to avoid something that was only mildly irritating once you pass it.

But, either way, fender bender or blocked road, you approach with caution so that, if necessary, you can stop more safely. Sure, you can slam on the brakes any time you want (just as you can go entirely to cash any time you wish to), but you don’t see a cliff; you see flashing lights on the road.

I am seeing some flashing lights in the stock market. Since I wrote last week’s article, I inched up a bit closer to get a better sense of its seriousness. But whatever happened is still around the corner. Or over the hill. Obscured. Whatever it is, I am hesitant to whiz by at 10 miles per hour over the speed limit.

The good news is that those signs that I saw more clearly don’t appear to be serious. That is why I’m taking my foot off the gas as opposed to tapping the brakes.

Demand for stocks has been falling, as measured by reduced volume. That’s a bad sign, a flashing light. Less demand leads to fewer stocks lifting the indices higher. Since May, fewer stocks in the S&P 500 have been making new highs. The good news is that the number of stocks making new lows have been negligible. But it’s a flashing light.

The Advance/Decline Line has also become more negative. The A/D Line plots the difference between the number of advancing stocks and declining stocks daily. It’s a cousin to measuring new highs and new lows, but it catches the direction instead of the level. The A/D line tends to drop gradually and often months before a decline in stock prices. The good news is that the A/D Line (using the 30-Week Moving Average of New Your Stock Exchange issues) began to diverge mere weeks ago. When stock indices are trading near their highs, as they are now, a healthy market has about 75 to 90 percent of its components trading higher. When I decided to make some trades, it had dipped down to 72.22 percent. Admittedly, that percentage is well above the 60 percent threshold that might usually signal defensive actions. But it’s a flashing light.

Any of those flashing lights, on their own, would mean very little. But taken together, they are a bit more serious.

So far, these appear to be short-term divergences. And short-term divergences suggest short-term disruptions. My moves are out of an abundance of caution. If I am wrong and the stock market turns on a dime, and stock prices speed up, I’ll be in the far-right lane, looking to merge back into the passing lane. If things get worse, it’ll be easier for me to pull off and take a rest.

But let me put my concern into perspective. The economy is hot, hot, hot! It’s just that growth is peaking out. The stock market tends to react to the changes more than the magnitude. Growth rates peaking in the near term doesn’t mean that the economy will perform poorly. In 2022 maybe it’ll shift from hot, hot, hot to just a couple “hots.” It’s a positive backdrop for the long-term. These trades are short-term insurance.

Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing investments of more than $500 million. Unless specifically identified as original research or data-gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Adviser’s clients may or may not hold the securities discussed in their portfolios. Adviser makes no representations that any of the securities discussed have been or will be profitable. Full disclosures. Direct inquiries: email hidden; JavaScript is required.

This article originally appeared in The Berkshire Edge on July 26, 2021.