FREDAlert!
Volume 3, Issue 6
September 21, 2011
We have had a number of questions related specifically to our forecast of an 80% chance the SPY will make a new closing low for this move. The question is: has the market bottomed already, and should advisors become fully invested at these levels?
Since many of the advisors we have spoken with have above average cash levels, and by this we mean higher levels of cash than normally high risk levels, we thought we a note to answer this question would be appropriate.
First:
We believe the chance of a new closing low has likely DECREASED to a 60 – 40 chance. Our reasons for this are:
(1) daily moving averages are, once again, positive.
(2) sentiment indicators have moved into buy areas, and
(3) most everyone in the press is looking for new lows, and the market does not often accommodate the majority.
Second:
We still think risk management is key – as the risks out of Europe are very large. If European and Emerging Market banks get into trouble, there seem to be few easy ways to inject liquidity into the foreign banking system easily. Advisors should check with their firm’s strategists on this issue, as it could mean that, should problems erupt, risk is much greater than currently anticipated.
Third:
What would we do now? We have mentioned in calls, and in some prior reports, that we would start to add back some money to the market. For example: We spoke too an advisor who normally holds a maximum of 30% cash in a high risk situation, but is now holding in excess of 40% cash. We advised adding 10% or so to stocks to get down to a normal risk profile – but with a tighter stop-loss strategy in place to acknowledge (a) the 60% chance of lower lows, and (b) the elevated European risk profile.
Fourth:
Call premiums are quite high so we would be implementing buy/write strategies here.
Our last point is that it is hard to tell if the market is properly discounting European risk. Certainly we are not the only people aware of these risks, and prices are holding up. We still see a 60% chance of more correction ahead. But we see some strong stocks in strong sectors, particularly tech and energy, which may not fall even if the market corrects from here. This is a very difficult juncture – most difficult one all year, but we feel, on balance, that it is worth adding some stocks here to bring portfolios to a more normal risk profile.