If you have ever been on a cruise then you know the first thing they do shortly after boarding is to conduct a drill by escorting you to your designated lifeboat.
The idea, of course, is to help prepare you before an actual emergency should it occur.
Consider this your lifeboat drill.
Our ETF models did a good job of protecting investors prior to the February decline that lead to a 34% loss in the market.
Since the March lows, the stock market has been on a tear. The Nasdaq 100 is up over 40% while the S&P 500 and the Russell 2000 have each recovered about 28%.
The models, which use a combination of factors that include absolute momentum and volatility kept the portfolios fairly defensive throughout this period. With volatility skyrocketing and trailing returns negative, the algorithm simply could not rank equity ETFs above lower risk bond ETFs and cash.
Not that I am complaining. Across the board, the Drawbridge ETF models have produced modest gains or only small losses during one of the most tumultuous periods of market history. For that I am happy. The white knuckle ride that many investors have been on still has not gotten them back to even.
During the July rebalance, the algorithms shifted to a more “risk-on” posture. The strong returns of April, May, and June, combined with the diminishing volatility, allowed equity ETFs to rise to the top of the rankings.
Those who read my comments regularly know that I have a list of concerns beginning with the growing disparity between the stock market and the actual economy.
I have also cited on several occasions the weak internal measures, the disparity of performance between a handful and the majority of stocks, and the the fact that the vast majority of stocks rest below their 200 dma.
The ONLY reason the market is where its at is because of Fed liquidity. But as I have said in the past, Fed liquidity to buy securities does not create jobs nor does it stop the coronavirus from doing whateve the hell it wants to…which it is.
Which brings me now to the point of this post.
I said this is a lifeboat drill. Here is why.
As I sift through the many charts I view each and every day, I see storm clouds approaching. I think the seas could again get rough.
When I look through many of the risks positions that the models took on this month, I see a common theme. Many show a negative divergence where a new price high has been made but with lower relative strength. Here are a few examples.
Also, the volume on the rally higher has been nothing too special, especially when compared to all of the downside volume we saw in February and March.
Here’s the Russell 1000 Growth. Ditto.
Also note, that today was nearly an outside day reversal where the market trades above and below the prior days range and closes lower than the prior day. This usually suggests distribution.
Now the internet stocks.
And I see the same thing outside the U.S. markets.
The one exception being iShares MSCI All Peru (EPU) which is highly correlated to the precious metals markets.
How to handle a lifeboat drill
I, of course, cannot give each of my members individual advice. How you handle a lifeboat drill must be left up to each of you. But I can offer some suggestions.
You can do nothing at all. Rules-based investing is after intended to be mechanical and unemotional. I probably understand this better than most.
But this is an unusual period. The market is stretched to historical extremes in both valuations and sentiment. When a correction comes, I think it is going to be swift and could again be deep.
William O’Neal always suggests 7% stop losses from entry. That’s one consideration.
If you are sitting with gains…maybe even a stop at breakeven. That’s a tight leash…but it could be better than turning a gain into a loss.
Each of the charts also have a number of moving averages. They can be useful for defining a line in the sand.
The key and this really is why I am presenting to you this information, is for you to know where your lifeboat is. When and if the storms hit, you should know exactly what you are going to do and have it already planned.
Please don’t hesitate to contact me if you have any questions or concerns. This is a challenging market and my goal is to get everyone through this and protect portfolios as much as possible.