I know the price of success: dedication, hard work and an unremitting devotion to the things you want to see happen.
-Frank Lloyd Wright, architect
The market suffered back to back heavy selloffs on Thursday and Friday causing many market leaders to pull back to areas of support. Though we are now trading just 2-3% off highs, the decline in leadership ideas and rise in distribution are concerning enough to recommend a cautious approach until these areas of support prove creditable. We have seen the indices bounce back in strong fashion multiple times after declining just 2-3%, but it’s best to be patient on fresh buys until we seen an actual rebound. There are still numerous strong ideas holding up well in the face of this draw down that should continue to be held if bought correctly.
For the week, the S&P 500 dropped 2.6%, the NASDAQ was down 1.7%, and the IBD 50 was down a stunning 3.7% (a loss of 3.2% on Friday). Many leading stocks suffered serious declines last week. The combination of both of these factors is what made me more defensive in the portfolio. Leading stocks tend to lead on the way up in strong markets but also tend to suffer the largest price declines during market corrections. There are plenty of reasons “why” stocks sold off last week(i.e. weak China PMI, falling currencies in Argentina and Turkey…). Since I am a trend follower, the “what” happened last week takes precedent. Quite simply, the price and volume action of the major indices and leading stocks signaled that the trend has changed in the short term and appropriate action must be taken. On the IBD 50 last Friday, not one stock rose, and 26 losers fell in volume at least 40% above average. Bearish moves in several stocks only worsened the IBD 50′s condition. About half a dozen have slid below their 50-day moving averages, marking significant weakness, if not outright sell signals.
The S&P 500 showed technical damage last week when it broke though the 50 day moving average. The red line is the 50 day MA. Please note the pick up on volume on Friday signaling clear institutional selling.
The chart below is of the Bullish Percent for the S&P 500. This is a risk measurement tool that shows the number of stocks on a point and figure buy signal. In its most basic form, the Bullish Percent Index favors the bulls when above 50% and the bears when below 50%. The bulls have the edge when over 50% of stocks are on a P&F buy signal. BPI is also considered overbought when above 70% and oversold when below 30%. A very simple way to look at this is a higher number means higher risk and a lower number means lower risk when turning points occur. Friday, we saw this reverse down to 74 which put this chart into a “bear confirmed” status. This is one of those turning points that signals that the risk of losing money from being long stocks has increased. I have learned to heed this warning when the probability of future declines has elevated. (Sorry to be so technical on a Sunday!)
I was reading John Mauldin’s Thoughts from the Frontline this weekend. Here is a quote from him: “Thirty years ago one of my mentors gave me a rule: Mr. Market is a vicious sadist. He will do whatever it takes to create the greatest amount of pain for the largest number of investors”. Certainly words to remember.
All the best,