Battening down the hatches

Three weeks ago, on 27 November, the markets suffered a nasty 1-day decline. I argued then, in my post, Whoa!, that the market's backdrop was worsening; however, even assuming that analysis as correct, the market yet had some (upside) life remaining...

"However, this go-round, things could be different; yesterday's decline could include trend-changing dynamics. For one, the US$ trends down, and nears a breakdown from a crucial long term level of support. $ moves almost always presage something big in the equity and credit markets; recall 1987 as only one example. Which leads to another cliche: Tighten your stops... [And]even if the high for this move is 'in', some testing (of the recent high) is in order so that a top could form."

Well, yesterday's market action, examined apart from other factors, concerned me enough that I began to hedge -- and even to sell some -- of my portfolio's positions. There are several items of alarm to note; I list only two:
• The VIX index (measures volatility) traded at a new multi-year, if not all time, low before reversing. Does this low and reversal presage a bout of extended downside volatility?
• The market's leaders (the grouping from which I like to own) now, and suddenly, lead to the downside.

Consider the many stocks listed in the Entelechy post; many turn tail from recent new highs. For example, NuCor/NUE broke down from a nice base and burgeoning up trend. (Previously warned.) Or Google/GOOG's ugly price and volume action (yesterday); not only breaking down beneath various levels of price support and its 50 day simple moving average (sma) but doing so with explosive and unrelenting volume. (GOOG likely will retrace to ~$475.) To those two, you could add Under Armour/UA...

[click on chart to enlarge] © Daily Graphs

When examined in a vacuum, yesterday's price reversal (see highlighted price area) -- from a new all time high to a negative change on the day and very close to its intra-day low -- is not especial cause for concern. Such a reversal typically would set up the chart action for several weeks of meandering as it builds a short term base. This time, due to the market's possible future action, it instead could be a short term top. From such a pattern, I would expect it to decline to ~$48, and breaking beneath that level, then accelerate toward $42-38. This possible decline does not end my bullish thesis for the company and its shares, it merely would interrupt it.

How and when might this market decline transpire, if [I am] correct? I would expect the ferocious portion of the decline to begin sometime within the next 5 days to 5 weeks. An arguably good single data point would be Tuesday, 2 January (2 weeks from today) -- when a typical up opening could be followed by an intra-day reversal and hugely negative close. This represents typical price action and is to be expected. Whether it occurs has yet to be determined.

Knowing only what I know now, I doubt the decline would be more than a trader's break, albeit one with an intermediate term periodicity (1 to 6 months). During such a decline, I would expect many stocks to breach their 50-day sma and then decline to their 200 day simple moving average; some would exceed that measure, others would hold there, and a few would decline not even that deep.

This post serves not as a prediction, but as a recognition of increased and increasing risk; money management, pure and simple. I do not intend this post to institute a breathless, mindless, panicked rush to sell out your portfolios. As always, examine well the merits of each portfolio holding; you might sell all shares, sell only some, hedge positions, sell short, or even ignore this 'warning' due to your long term investing time frame. Or you consider your ability to dodge possible bullets mandates you remain long and unhedged. Or you consider my analysis and perceptions to be incorrect, and thus invalid for your purposes.

But after a lengthy period of fattening your wallets, now might be a good time to consider battening down the hatches. I used to think I could buy or sell at the optimal moment; I no longer think or even try for that. The big declines of yesterday could pale in significance to what is coming. In such an event, I would rather have cash or be hedged. As always, new winners will emerge during such a decline (should it occur) -- it is always thus. Nonetheless...

Caveat emptor.
David M Gordon / The Deipnosophist