The S&P 500 Index lost -5.5% from July 27 th to August 18 th and the Nasdaq 100 Index lost -7.25% from July 19 th to August 18 th. The 10-year Treasury yield increased during the same period, and the US Dollar (USD) regained strength alongside the energy sector (XLE). Should these trends continue meaningfully during the next few weeks, the stock market should feel the pressure.

Technical Perspective of the S&P 500 Index:

The big uncertainty of the stock market sell-off was when the S&P500 and the Nasdaq pierced their 50-day Simple Moving Average (SMA). A violation of the 50-day SMA and a recovery above the SMA usually means that the uptrend will resume, and the test of the 50-day SMA was an opportunity to add risk to your portfolio. The pierced of the 50-day SMA and lack of recovery above the SMA usually means that a corrective or distribution period has begun. This is when risk management becomes intense, and calculations must be made. How much will my portfolio lose if the stock market drops to this or that level? Do I have to adjust or hedge my positions to prevent undesired losses? What kind of adjustments can I make to protect capital?

Think of the stock market in three phases: (i) accumulation – market moving up. (ii) Consolidation – market moving sideways within a defined range and (iii) distribution – market moving down.

After the piercing of the 50-day SMA, both indexes recovered and moved back above their respective SMA. Thus, some investors saw this as an opportunity to add risk to their portfolios. But some see it in a different way after the August unemployment report was released earlier today. Hiring cooled down this summer as employers added 187,000 jobs last month, and the unemployment rate rose to 3.8% from 3.5%.

The futures market traded up on the unemployment news, indicating a positive stock market opening. In fact, the opening was positive, but at the time of this writing, the S&P 500 is slightly up, and the Nasdaq is slightly down. Those investors who added risk to their portfolios certainly believe that the accumulation phase is in progress. After all, the S&P 500 and Nasdaq are back above their 50-day SMA. I see it in a different way. I believe a short-term distribution phase may be evolving. The stock market remains in a secular upward trend (bull market), but it needs to deal with a well-announced economic recession in the short term.

The 10-year Treasury yield decreased during the last few days, cooling down the strength of the USD and favoring the above-mentioned stock market regained of the 50-day SMA. As long as the trend in Treasury yields remains down, the stock market should continue to regain strength. The problem with this assumption is that Treasury yields continue to be up, not down. From a macroeconomic perspective, the trend of commodities (USCI), USD (UUP), and Oil (WTIC) are up. Commodities and oil are contributors to inflationary pressure. The bearish trend on copper is interesting because it may signify a worldwide cooling economy.

The bottom line is that unemployment may start rising from here; the yield curve, which remains inverted where short-term rates are higher than mid and long-term rates, should start flattening, and stock market valuations should adjust to the reality of an economic recession. This should be the final adjustment of the economic cycle, providing a clean slate to start a new healthy cycle. And this should be the right time to start adding risk to portfolios.

Having said all of the above, one must focus on evidence. Financial markets give us signals every day. Those signals arise from the interaction between the different asset classes, sectors, and industries. The result of the analysis of these signals will allow me to understand whether or not my assumption above is correct. If it isn’t, I must adjust to the evidence provided by financial markets and position my portfolios accordingly.

Check the Main Trend of stock indices, volatility, yield, currencies, and much more here.

Consider not being fully invested, taking on smaller position sizes, and holding a higher allocation of cash.

(*) The Greenwich Creek Capital “Index Trend Table” is not meant to be used in isolation, it is part of a more complex set of variables and it is not designed to provide trade entry and exit points.

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Saul A. Padilla

Saul A. Padilla

Registered Investment Adviser and founder of Greenwich Creek Capital Management LLC, bringing over 34 years of experience in managing discretionary and non-discretionary investment portfolios for wealthy families and institutions. His main focus is to protect invested capital by re-balancing the allocation of cash, equities, fixed income and alternative investments, while closely monitoring macro-economic indicators and market trends to determine the transition phase between the completion of a Bull Market and the beginning of a Bear Market. He started his career in early 1987 mainly managing family financial investments.