Market Summary
The stock market has been volatile since China devalued its
currency in August amid concerns of sputtering growth in the world's
second-largest economy. The S&P 500 has had moves of at least 1% in 11
sessions since Aug. 20. Investors are awaiting next week's Fed monetary policy
meeting and news on whether it will raise benchmark U.S. rates for the first
time in almost a decade. "It's really Fed watch. That's what traders are
waiting for," said Tim Ghriskey, chief investment officer of Solaris Group
in Bedford Hills, New York. "There's speculation the Fed might hold off,
and if they do, I think we'll see stocks rally. But to us, it's not a question
of if the Fed raises rates but when. It's going to happen."
Horan Capital Advisors have noted that initial Federal
Reserve rate increases tend to not have a negative impact on stock prices.
Further evidence can be seen in the below chart. The red dots on the S&P
500 Index chart line denote the first rate hike in a Fed tightening cycle. The
yellow line represents the yield curve (30 year treasury minus 3 month treasury
bill) and one can see why investors focus on equity performance when the yield
curve inverts. As the red dots clearly show, the onset of a tightening cycle
isn't necessarily a precursor to poor equity market performance. The stock
market does tend to exhibit weakness initially; however, the weakness tends to
be short lived.
Investment Analysis
Large gains in excess of 2.5% occur primarily during
downtrends and they cause short squeezes and bull traps.
Recently we suggested “…Remain defensive,
and use any celebrations on Wall Street to buy puts and other forms of
insurance more cheaply…” The reason is that you cannot trust the markets
big “up days”. Typically, they occur when the market has already run into
trouble, and are often technical in nature. An analysis by Michael Batnick at
the Irrelevant Investor showed that 22 of the 25 best days since 1970 occurred
under the 200-day moving average. That implies they were oversold rallies with
some element of short covering. Traders may like them, but long-term investors
would much rather see three 100-point days than one 300-point day. The more
gradual gains reflect a healthier accumulation and not a reflexive reaction.
Selling into strength continues to be a good strategy to profit from short term
moves and to liquidate the biggest losers. According to Sentiment Trader
research with data going back to 1980s, whenever bearish newsletter advisors
outnumbered bullish ones for the first time in a year (as it does now), three
month stock returns were positive 100% of the time. The average return was
about 8% gain in the coming 12 week timeframe. In the graph below you can see
Treasuries are the only asset class with a quarterly gain as investors dump
equities and park the funds in bonds.
By Gregory Clay
Investment Strategist
Click here to
gregoryclay@theoptionplayer.com
P.S. click on http://www.theoptionplayer.com/ to sign up for a free trading newsletter
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