Trading was so slow this week that you could almost watch those “green shoots” everyone is talking about start to sprout leaves. To me, that’s a good sign. I’ve often said less volatility is what the markets need after months of 2-3% moves every day. Boring, in my opinion, is good.
Monday was the only day we saw real action when stocks registered their biggest drop in a month. Call it profit taking or testing the levels since 900 on the S&P500 Index that seems to be an area of support. Actually I believe it is a bit lower but technical levels are always more of an art than a science. For the rest of the week we simply tried to regain what we lost on Monday.
Friday was a “quadruple witching” day when contracts for stock index futures, stock index options, single stock options and single stock futures all expire. It is a time when investors unwind whatever hedging strategies they may have been carrying over the quarter. For example, an investor who may have sold a put against a stock position they held may unwind that position or decide to “roll it over” for another few months. Billions of dollars are involved in this on-going process. As such, markets move up and down, not on fundamentals, but on supply and demand. During last month’s expiration week the markets declined throughout the week and this month appears to be following suite.
What I hope is happening (which would be the best case for investors) is that the markets are working off some of the overbought conditions. “Over bought” is a term we use when markets go straight up with no corrections like they have done since the March low. By backing and filling, like markets have done over the last month in a fairly tight trading range between the high 800s and 950 on the S&P 500, the markets are processing the gains we have made thus far. Think of your own behavior after Thanksgiving dinner. Most of us sit on the couch in a semi-catatonic state watching football or “It’s a wonderful Life” until we digest our dinners.
If you think about it the markets are acting pretty well given international tensions (Iran and North Korea) and worries over how fast or slow the recovery will take place. Bears argue that markets are way ahead of themselves and vulnerable to a big correction about now. My position is that if investors can break through the 950 level of the S&P I will give this rally the benefit of the doubt for at least another 50-75 points. Some readers may be frustrated that I am taking this incremental approach rather than screaming “Buy, buy, buy” or the reverse, but I believe we are on fragile footing right now. Too many people have lost too much money to bet the house on a full blown recovery just yet. Instead I have advised a gradual re-investment strategy where exposure to the stock market is one element. I’ve recommended purchasing bond funds (or exchange traded funds) preferred shares and high yield bonds; Inflation Protected Treasury bonds, called TIPs, and allocating some exposure to gold and silver.
“So what do I do if the market pulls back?” asked one client.
If the markets experience a 5-7% pullback from its recent highs (around 880-900 on the S&P) I would add more exposure to commodities and commodity-related stocks. Agriculture and basic metals also come to mind and for speculators, consider nibbling in the natural gas sector. However, we remain in a trading market, which means buy and sell. Unless circumstances change, (and they can) I fear we may be in for a larger correction sometime before the end of the year so stay alert out there.