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The Week Ahead: Make Your Fall Portfolio Plans Now

Posted by on Sep 21, 2015

The Week Ahead: Make Your Fall Portfolio Plans Now

The Fed’s decision to stand pat on rates disappointed investors as those who have been finding fault with their strategy for many years had something more to complain about while others were understandably concerned over their cautious view of the economy.

The market weakness on Friday is likely a sign that the market’s rebound from the August 24th lows is over. I am still not expecting a major decline to significant new lows but it is possible. In my experience when the WSJ recognizes the flag or pennant formations it is less likely to be resolved in a classic technical manner.

I do think that the investors should be using the current market decline to start making solid plans for what they will do with their portfolio in the coming months. This is true for those who already have a stock portfolio as well as those who are in cash on the sidelines. The failure of investors to have a concrete plan for their portfolio often means that they end up reacting emotionally which adversely impacts their portfolio.

Let’s look at the likely scenarios over the month or so and why it will be important to take a proactive approach to managing your portfolio.

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The monthly close only chart of the S&P 500 goes back to 1989 and shows the powerful rally from the recession low in 1990 to the 2000 high. After dropping below the 20 month EMA in 2000 the S&P rallied back to its WMA in early 2001 before declining more sharply.

By the middle of 2003 the S&P was back above its WMA and the uptrend from the lows, line b, was not broken until late 2007. Subsequently the 20 month EMA was also violated. From high to low the S&P 500 lost 20% during the initial decline. In the spring of 2008 the S&P 500 rallied 14% as it moved back to its EMA before the selling once again accelerated.

The S&P 500 first closed back above its monthly EMA in November 2009 though it subsequently dropped back below it during both the 2010 and 2011 market corrections. Since October 2011 the S&P 500 has stayed solidly above its 20 month EMA which is being tested this month.

The break through the long term resistance, line a, In April 2013 I believe was significant. Since the early 1980’s I have found that moves above long term resistance or below long term support are quite reliable. The width of the trading range, lines a and d, still has upside targets in the 2480-2500 area.

The long term charts also illustrate that major tops take time to form. Therefore a close below the 20 month EMA (currently at 1967) in September would make the October close even more important. Two consecutive monthly closes below the 20 month EMA would be more negative and would suggest that a major top may be forming.

From the July high to the August low the Spyder Trust (SPY) dropped 14%. If these lows are tested or broken over the next few weeks the market is likely to then form a bottom. The following rally will be either a resumption of the major uptrend or an oversold bounce back major resistance as part of the topping process. In 2008 the ten week rebound from the March lows retraced 61.8% of the decline from the October 2007 high. In May 2008 the rally’s completion was clear on the charts.

For those that are already in the stock market or those that are now considering getting into the stock market it will be important to develop your plan before the next correction low.

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For those who are not currently in the stock market and do not have the time or interest to trade a traditional 60% stock and 40% bond portfolio could be considered once the current decline is over. This approach is followed by the institutional Vanguard Balanced Index Fund (VBAIZ) which has total assets of $25.5 billion. Even though it may not be available to the average investor I think its performance since the 2002 lows does illustrate what investors who follow this portfolio allocation can expect.

During the 2002–2007 bull market VBAIX gained over 50% before it dropped 13% from the October 2007 high to the March 2008 low. VBAIX rebounded 5% from the lows and moved just above the 20 month EMA before again turning lower.

On the chart I have added the performance of VBAIX from 2010 through 2014. Also according to Morningstar it was down 22.1% in 2008 and up 20.2% in 2009. For comparison the Spyder Trust (SPY) was down 36.8% in 2008 but up 26.4% in 2009.

On the chart you will note that VBAIZ had a 11.5% drop in 2010 and a 17% drop in 2011. Using the recent low the decline from the July high has been 9.5% so the current pullback is in line with the prior corrections in this bull market. The EMA of the performance will take several more months before it could turn lower.

New buying done near the correction lows will need to be watched closely for any signs that the rally is failing. For those who are already invested in stocks the rally will be an opportunity to further adjust your portfolio and determine what percentage you want in stocks should the rally fail.

In the coming weeks start to identify which of your holdings are lagging the market as they will be more vulnerable during a market decline and rally less when the market turns higher.

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The Euro zone markets were hit hard Friday with the FTSE down 2.6% and the DAX index was down over 3% on the day. The failure of the Fed to raise rates may push the ECB to add more stimulation to their markets and such a move could help stabilize their markets at lower levels.

I continue to think that the DAX may bottom out before the S&P 500 as it topped out before the U.S. earlier this year. The monthly chart shows that the uptrend, line b, from the 2011 and 2012 lows was tested in August. The recent low was well above the October 2014 low of 8354.

The monthly chart also reveals that the upper parallel trading channel (line a) from the 2009-2011 lows, line c, was tested earlier this year. This is reason for concern as often such resistance levels can correspond to a major high. The monthly EMA may flatten out his month and if the August lows do hold there is retracement resistance at 10,877.

The Economy

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Tuesday’s Retail Sales was a bit lower than expected but the sharp upward revision in July’s data is still a clear positive for the consumer. Of course the fall is typically a seasonally strong period for the consumer stocks.

The chart shows a clear uptrend, line b, that goes back to the 2009-2010 lows. It shows no signs yet of topping out. In 2007 the support at line a, was broken late in the year as Retail Sales dropped sharply in the last recession.

The Empire State Manufacturing Survey came in very weak for the second month in a row as it was the weakest reading since April 2009. Industrial Production was also weak and the drop in the Philadelphia Fed Business Outlook Survey suggested to Econoday ” There may very well be something wrong with the manufacturing sector, at least in the Northeast”.

The Housing Market Index released last Wednesday continued to show optimism from the builders. Housing Starts were a bit lower in August but permits were up which should be a plus in the months ahead.

The Leading Economic Indicators (LEI) were up 0.1% in August which was below expectations. It suggests that we may not see much stronger growth going into the end of the year but it does not indicate we are close to a recession.

On Monday we get Existing Home Sales followed on Tuesday by the Richmond Fed Manufacturing Survey. The flash PMI Manufacturing Index is out on Wednesday followed by Durable Goods and New Home Sales on Thursday. The final reading on 2nd quarter GDP comes out on Friday along with the month end reading on Consumer Sentiment from the University of Michigan.

Interest Sates & Commodities

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The yield on the 10 Year T-Note closed at 2.303% on Wednesday but finished the week at 2.130% as the short term uptrend was broken. The longer term uptrend, line a, was broken in late August.

The close this week turns the focus back on lower yields with the key support in the 2% area. Those looking to refinance may have one more drop in yields in the next month or so. The weekly MACDs has been negative since August 21st and the daily MACD looks ready to roll over this week.

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The Comex Gold futures were up over $21 on Friday and gained $34.8 for the week. The weekly chart shows a potential short term bottom formation, line c. The near term downtrend, line b, is now in the $110.65 area with the long term downtrend just below $120.

The weekly on-balance-volume (OBV) broke below important support, line d, in July which was a sign of weakness. The OBV still looks negative as it is well below its declining WMA. The daily OBV is above its WMA as volume increased over the past few days when prices moved higher.

As of last Tuesday’s close the technical studies suggested that crude oil and the SPDR S&P 500 Oil & Gas ETF (XOP) were bottoming. All they needed was a higher daily close to complete their bottom formations. Crude was higher in early trading Wednesday and then accelerated to the upside on a bullish inventory report. The market gave up its gains Friday as crude closed 4.7% lower to settle just a bit higher for the week. Technically crude oil still appears to be bottoming as this week’s action may be important.

Market Wrap

The sharp decline Friday on the third heaviest volume of the year erased all of the market gains early in the week. The volume was exceptionally high because of quadruple witching as option and futures expired.

The Dow Industrials were down 0.30% while the S&P 500 lost just 0.15% and the Russell 2000 was up 0.48% for the week. The star performer was the Dow Utilities which gained 2.83% for the week.

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The weekly outlook, basis the NYSE Composite, is still negative for the stock market as last week’s rally appears to have failed at 10,362. The declining 20 week EMA at 10,600 now represents more important resistance. On a drop below 9800 we could see a test of the August lows in the 9500 area.

The weekly NYSE A/D line dropped below its WMA on June 5th (line 1) which warned of the current market decline. The A/D ratios were positive last week so the A/D line has turned up but it is well below its WMA.

It would take a couple of weeks of strong A/D numbers to move the A/D line back above its WMA. There is next major support for the A/D line at line a. The weekly OBV is below its WMA but still above the important support at line b.

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The downside reversal on Thursday (see arrow) set the tone for Friday’s session as did the overseas markets. The close was just below the 20 day EMA with next support in the $193-$193.50 area. A break of this level will make a drop to the $190 area more likely.

The S&P 500 A/D line reversed sharply at the end of the week and closed on its rising WMA. A day of positive A/D numbers Monday is needed to avoid further deterioration. The daily OBV dropped to new lows for the month on Friday which is a sign of weakness.

The weekly and daily relative performance analysis indicates that both the PowerShares QQQ Trust (QQQ) and the iShares Russell 2000 (IWM) are acting stronger than the S&P 500. Once the current market decline is over these are the ETFs that are likely to lead the market higher. Therefore they will be favored for new long positions.

What to do?

The market is likely to stay nervous this week as it digests the Fed’s new weaker than expected appraisal of the economy. The sentiment picture remains mixed as the individual investor according to AAII does not reflect an extreme in sentiment. The bullish% is at 33.1% down slightly last week while the bearish% dropped 5.4% to 29.1%. The put/call data does suggest that bearish sentiment is quite high as the levels are consistent with a market bottom.

It is likely to be a tough period for investors but I think that it will present a good buying opportunity once the market internals turn the corner. For those not in the market this will be a chance to buy while those already in the market should use the next few weeks to prune the market laggards from their portfolio.

The high degree of volatility means that traders will have to stay nimble and take profits when they occur.