Last Friday, I tweeted that I moved the Covestor Model Portfolio 100% into cash. Since I received some comments, I probably should explain the move.
Let’s start simple & take a look at the obvious: the S&P500 price chart.
I’m using charts in a pretty simple way and don’t like to “over-interpret”. The message is quite clear, though: stocks had a great run in the last months, but momentum, as measured by the 12-day rate-of-change (“ROC”), has been constantly declining throughout the rally. So the only message I get from the chart is that fewer and fewer buyers (or more and more sellers) have been coming in. Does that mean prices will decline from here? Not at all. The market needs a new impulse to bring in new buyers or sellers and push him in either direction.
As a trader, I could anticipate a direction or (and that’s what I prefer at this point) simply wait for the impulse to happen and then trade in that direction. Remember: small investors have an incredible advantage over big money managers: they can move funds very quickly. Let’s assume we break to the upside: I will loose some basis points in outperformance, but I’m happy to pay that toll to get a lower risk entry. Good trading often means to wait and do nothing.
Obviously, there are two events this week, which will have a strong effect on stock prices: election results and FED meeting. If you want to trade these events, you need to be right four times since outcome as well as effect on the markets has to be estimated for each of the events. Has “QE2″ been priced in? Maybe. But what if the FED turns out to be less aggressive than the markets want it to be? Recent economic numbers haven’t been too bad and probably do not justify heavy intervention. If the FED will make any comments in the direction of “recent economic developments justify flexible (instead of aggressive) use of monetary tools’, the Dollar will rally.The big question is how stocks will react. Recently, there has been a strong inverse correlation between both, so equities could sell-off. Unless this correlation changes (which it did in the past).
This leads to the core of my current market thesis: the US economy is indeed recovering and we start to see this in some of the leading indicators (for example, the ISM showed a better than expected reading today). If the markets start to turn its focus from “we need more QE” to “the US economy is getting stronger”, stocks could rally while the Dollar is getting stronger and Bonds decline. This shift of sentiment would create the “impulse” I was talking about at the beginning of this post and could fuel a strong rally until the end of this year.
We could see signs for the validity of this thesis very soon and I will aggressively go long in that case. At this point, it is important to keep watchlists up to date to be able to act quickly.
