Stock Market Update: Locating the Nearest Exit


I had a post two months back that highlighted how I was worried about the health of the market. Well, that view continues and my assumptions have been correct so far. The one addition I would add to that post, in which I discussed how few stocks are participating in these new highs, is that there are fewer stocks participating in the all-time highs. On top of that, most of the names that are holding up are large caps, whereas small/mid-caps were leading up until the end of 2013. This is usually a tall tale sign that the market has gotten too risky to be in “speculative” names and participants are “hiding” their money in “safe” large caps. To top this all off, volatility has been extremely low, and I’m sorry to say, but historically, these long/low volatility periods don’t last for long. Just like the small/mid-caps have gotten crushed in the past few months, I’m expecting large caps to do the same. To dig further into why this divergence in large caps and small/mid-caps is disheartening, read this brilliant post. To highlight, an old client and good friend of mine, Craig Johnson, does a great dissection of why what we’ve seen over the last few months, historically bodes to a large pullback, usually 15-20%. You’ve been warned!

My prediction was a choppy/poor performance through the end of September, then Q4 the market would finish with a rally. At this point, I still stand by that prediction. To position myself to take advantage of that prediction, I’ve increased my positions in TLT, XLU, XLP, GLD, UUP, and SH.

I haven’t left the building, but I’ve identified where the nearest exits are.

“The continued divergence between the Russell2000 index and the popular large-cap indices (DJIA and SPX) is a clear indication of weakening breadth and slowing momentum, and suggests investors are making an attempt to reduce portfolio risk by rotating assets toward the traditionally defensive area of the market.

To gauge the size of a possible decline we have identified years where the DJIA outperformed the RUT (a strong possibility for 2014), and measure the size of the market pullbacks that occurred in these years…..Thus, should the median pullback unfold this year, it would suggest a deeper correction in the broader market back towards 1,600-1,650 on the S&P500 Index.”

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