Assessing Risk As the Market Figures Itself Out

Mike Turner |

My data indicate the market is in a transition period where the it could break one way or the other at any time, with a slight leaning toward the downside. However, there are just not enough bearish indicators for me to put any more of our money to work on the bearish side... not yet, anyway. In fact, I am concerned that we do not have enough exposure to the upside (remember not all stocks go down in a bear market and not all go up in a bull market). As such, I am adding 3 new long-biased trades to our portfolio this week if we can get my entry price and if the market continues to look strong enough to support these trades.

In my opinion, the biggest market mover continues to be the US Federal Reserve. Agree or disagree with what they have done with their so-called 'Quantitative Easing" and "Tapering" policies, the result has been to create an artificially strong market while at the same time, doing almost nothing for their dual mandate of low unemployment and moderate long-term interest rates. Unemployment (including those that have quit looking for work for reasons including the fact that it is easier in some cases to live off the government than to work for a living) is still way too high. Interest rates are way too low and are not inducing banks to lend and not inducing companies to borrow.

On top of their dual mandate, the Fed also tends to react or overreact to the movement of inflation and/or deflation.

There is a strong argument that the Fed does more harm than good, but since neither you nor I can do anything about their existence, we have to learn how to deal with them as long as they are on our playing field... the stock market.

It wouldn't surprise me if the market is 20% to 30% or more inflated due to artificial stimulus and price-fixing of interest rates by the Fed. It appears the Fed is trying to figure out how to get control of an unlimited quantity of money that it can be create out of thin air via its Balance Sheet, without losing control of interest rates and without crashing the stock market. It is quite possible that they will not be able to withdraw the crack-cocaine of massive market liquidity and free money unless the economy begins to dramatically improve. At the moment, there does not seem to be anything on the horizon that would indicate that the economy is about to boom higher, unemployment abate, class warfare come to an end, the government become more of a solution than a problem, etc.

My assumption is that as long as the Fed continues down its current path of tapering, the market will continue to stay on its path of 3-days higher and 5-days lower... or similar. The key, therefore, is to find stocks that will flourish in this artificially stimulated, but now artificially tapered market. If I get my entry prices, you will see that two of my picks for our Signal Investor portfolio are long-term winners that have done well in the world of artificial stimuli and have even done well in the tapering of that stimuli.

However, it is important to consider that should the Fed continue to taper and force the market to function purely on economics, we could see a severe correction. As such, I am reluctant right now to put too much of our cash into the market... at least for this week.

As always, I am taking this one week at a time.

Since inception (January 1, 2013), our Signal Investor portfolio is nicely beating the market. We are up more than +34% while the S&P is up about 26% (lifetime). Year to date, we are about 0.80% below the market, but at far lower risk exposure.

My goal is to look for opportunities for the Signal Investor portfolio where we can make money in both bull markets and bear markets. When the market is in transition (as it is now), sometimes the better course of action is to be patient, stay small and wait to see which way the market will break.

Closing Thoughts

I continue to wonder why, with so much cheap money, there aren't more new businesses starting up? I wonder why big, established businesses are not expanding, creating new products and hiring more people? It concerns me that our economic climate is so slow to improve. There are any number of possible reasons: global economic malaise; too many countries spending more money than they can justify; too much uncertainty with regard to Obamacare; too much over regulation by government... just too much uncertainty.

When looking at the data from both a micro and macro level, it is important to keep everything in perspective. Analyzing data in light of a global and domestic 'big picture', economically, is a non-trivial task and certainly can sway the interpretation of the data.

I have learned that emotions and opinions are fallible and unreliable. Data and unbiased analysis of data tend to be far more dependable and certainly more trustworthy.

Right now, my data are telling me to be very, very careful. When the data are saying that no discernable trend is being detected, it is best to not guess. It is best to ignore the talking heads. It is best to seek the counsel of unemotional data and not the counsel of emotion and ego.

Sometimes the smartest money is on the sidelines, waiting for just the right time to get back to work. Remember... when our money is invested in the stock market, it is at an elevated risk of loss. You and I are not afraid to have our money at risk in the stock market. That is why we buy and sell stocks. But, neither of us want to take on more risk than we believe to be appropriate. Right now... the risk is high and frankly, too high to have more than about 20%-30% exposed to this market.

Next week, the situation can certainly change. Patterns and trends can emerge. The data can become far more specific about where to put our money to work in the stock market.



Symbol Last Price Change % Change