Thursday, February 2, 2017

February Market Update

Let's look at price, sentiment and valuation as we enter the second month of 2017.


Price action based on monthly market closes shows that investors should be in stocks. A calender event known as the “January trifecta” has established itself at the end of January. Please read Sue Chang's article A Trio of Trends Points to More Upside for Stocks at MarketWatch. This trifecta is based on the so-called Santa Claus rally, the market’s direction in the first five days of January, and the January Barometer all showing positive market returns. Similar to last month, the monthly moving averages tell us to tactically avoid bonds (tracking ETF IEF). REITs, as represented by the ETF VNQ, show a mixed picture. VNQ is trading above its 12-month simple moving average and below its 10-month simple moving average. For the S&P 500, the month end price shows that the 5-month moving average remains above the 12-month moving average, which creates a positive environment to be long S&P 500. As we ended January market technicians saw an island top pattern in the market. This pattern frequently happens before a 5% correction. The market is also due for a 5% correction as it has been 7.2 months without one. The strength of the stock market rally since November is also fading. Corrections are extremely difficult to predict, but a pause in the rally is easily justified especially going into February, one of the historically dullest months for US markets.


Sentiment, as characterized by the CNN Money Fear & Greed index has shifted to neutral with a reading of 50. This is a drop from 70 last month. Short term sentiment indicators have turned weak, while mid-term and long-term sentiment indicators remain strong for the S&P 500. To keep this update balanced and to metaphorically throw some cold water on those of you who are inspired or euphoric about the current rally, John Hussman wrote in his January 23 weekly commentary:
"Last week, an unusual set of classifiers that we monitor raised red flags, with two of our three “crash signatures” now suggesting the likelihood of a market loss in excess of -25% in the months ahead (the last time these signatures were active was between April-October 2008). This would potentially represent the opening salvo of a more extended completion to the current market cycle. No single variable drives these signatures. Rather, they capture unsual combinations of market conditions that may include offensive valuations, dispersion across market internals, credit market weakness, lopsided bullish sentiment, Federal Reserve tightening, or other features. While these signatures are quantitative, my impression is that there is far more potential for economic and social disruption than appears to be reflected in the current speculative pitch. I should also be clear that these signatures are not forecasts but classifications that we’ve constructed to identify highly unusual events. The difference is that a forecast says “we expect this particular outcome in this specific instance,” while a classifier says “we identify the same signature of conditions that has regularly preceded this particular outcome in the past.” It’s a subtle distinction, but an important one. We needn't rely on forecasts. Rather, we continue to align ourselves with the prevailing evidence at each point in time, and our outlook will shift as the evidence does."


The market remains overvalued. Please read Mark Hulbert's opinion piece The Biggest Threat to Your Money Now? Ignoring the Scent of a Bear Market. Mark writes,
"To be sure, valuation measures exert only weak gravitational pull on the markets over the shorter term. So there’s nothing guaranteeing that a market drop is imminent because of the market’s current overvaluation. 
But someday we will look back at the World Economic Forum’s current sanguine assessment of financial risks with the disdain that we today view its doom and gloom assessment from 2009."

Price action remains positive for the S&P 500 and we have an accelerating economy as we start 2017. The market is due for a 5% correction and sentiment has weakened from the end of December. Valuation remains high. Tactically, only short-term traders should be adjusting their allocations. Nothing in the month-end data tells me to be on the lookout for a major correction (greater than 10%) in the month of February. I anticipate February could end up like the historical numbers above with very lackluster returns. Wise investing my friends and let me end this update with a quote from Charlie Munger:
"People are trying to be smart. All I am trying to do is not be idiotic, but it's harder than most people think." 

Please consult a qualified financial advisor before making any investment decisions. This blog is for educational purposes only and does NOT constitute individual investment advice.

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