Before I answer this question let’s discuss why the recent selloff in world equities happened. Well, the markets advanced by December 2017 and January 2018 in a parabolic (accelerating) fashion and parabolic advances are unsustainable in the long term. The advance happened as more and more investors became bullish and even retail investors, long standing on the sidelines, rushed into the market for fear of missing out (FOMO). Then came strong US employment figures (no surprise) but for the first time since 2008 average weekly salaries and wages went up considerably. This lead the bond market fear that inflation is finally picking up and traders sold bonds off heavily leading to an increase in the risk free interest rate. Higher interest rates increase the discount rate for company earnings and as such decrease the value of the company (share price). The bond market has anticipated increasing rates but not that fast. Looking at the long term chart in US 10 year Treasury Notes (below) we see that a long term double top was completed some time ago indicating further significant rate rises.
From the long term chart above you can see a topping pattern; rates are clearly on the rise. The bond market tends to lead the share market most of the time by 9 to 12 months with a bond market topping earlier. Stocks tend to top later as in an expanding economy earnings will go up compensating for a while higher interest rates. 10 year T-Notes (the benchmark risk free rate) are just below 3 % with 3 % considered being the yield where the long term (since 1982) downtrend in yield reverses. As such the markets are not surprisingly somewhat jittery.
Now I hear the pundits saying “Buy the dip” as this has worked very well since the 2009 equity market bottom. But I am still a bit cautious. Just look at the S&P 500 below:
After a severe selloff the index found support at the lower boundary of the upward channel and at the still rising 200 Day Moving Average. But volume doesn’t convince quite yet. The range (daily high – low) on the downside is much larger than the range on the upside. Downside volume is still way above upside volume. As the market went up on Friday, Monday and Tuesday, volume goes down. That means that there is currently insufficient breadth in the rally and a ‘buy the dip’ may well be a bit premature. Also, very few stocks in the S&P 500 make new highs, so we are still in the cautious stage.
So how do I trade this market right now? Well, maybe you guessed the answer buy now. Just follow the system. At first I want to see a high volume (way above average, i.e. the volume plot at the bottom of the chart above being way above the red line, the average volume). On top of that I want to see range expansion (larger daily high – low) with the market opening near the low of the day and closing near the high of the day. This should be accompanied by a 2 % or so rise in the major indices. This would indicate that the funds are buying again in a massive scale and consequently the uptrend should continue. If and when this happens I will have a look out for breakouts in individual stocks where share prices make new highs on above average volume breaking out of a trading range. We may well see some kind of sector rotation and new leaders with the old ones slowly fading away. Stocks like Apple risk rolling over now whereas some financials look good again. Although the market has many pullback signals I am currently reluctant to take those and rather buy new highs (strength).
Australia has terribly under-performed world equities in this bull market but on the flip side has fallen much less in the recent sell off. Not many new highs are currently formed in Australian shares so I shall also wait in this market for confirmation that the uptrend resumes (high volume, high percentage, high range advance) and will then concentrate on breakout stocks.
How has our model portfolio fared in this sell off? Well, we booked a few decent profits in January and February:
Saracen Minerals – 8 %, Northern Star + 3 %, Alumina + 10 %, Afterpay Touch + 10.5 %, Wisetech Global + 76 %, Challenger – 8.2 %, Santa Barbara + 15 %, Amaysim Australia – 8 %, IMF Bentham + 64 %. Our Aussie model portfolio currently holds 8 positions mostly initiated in January with an average profit per position of + 1.5 % outperforming the ASX 200 Total Return Index (with dividends reinvested) by 3.46 % points per position. So we’re still standing.
In the US we closed out Universal Display + 29 %, Texas Instruments + 32 %, Microchip Technologies – 1.8 %, Wynn Resorts + 20 %, William Lyon Homes – 11 %, Freeport McMoRan + 11 %, Grubhub – 8 %, Monster Beverage + 15 %, Realpage + 21 %. We have 11 open positions all initiated in December and January with an open profit per position on average of 3.28 % outperforming the benchmark by 4.7 % points. Given the huge sell off in the US this is not a bad result.
All % figures above are without leverage and you could have received higher % returns (on the upside AND downside) using moderately leveraged CFDs.
So I am not in a rush to add to positions and let the market (my system) decide if and when we’ll invest more.