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Every
comment made below needs to be taken in the context of possible Fed action.
The Fed will most certainly do something in response to the recent weakness
in the markets and deterioration in the economic data. The Fed is due to
release their next formal statement on Tuesday, August 9.
We
believe gold and silver are well positioned given current economic
circumstances and any potential Fed action. Our gut and reading of the technicals and fundamentals tell us to favor precious
metals over stocks in the short-to-intermediate term (maybe even longer). We
recently added to our holdings in gold and silver and that turned out to be a
good move, especially relative to stock market performance (see
July 13 post).
The
markets still have a mix of good news and bad news, but the bad news pile is
now much taller than the good news pile. Tuesday's sharp drop in all risk
assets, except gold and silver, did significant damage to the market's
probabilistic outlook. Consequently, we must be willing to take increasingly
larger incremental steps away from risk (raise a higher percentage of cash
more rapidly).
Since
market tops and bottom are formed based on the human emotions of greed and
fear, they often occur via a process that takes time to play out. The bad
news in the chart below is the bottoming process from the summer of 2010
looks like a mirror image of what may be a topping process in 2011. Notice
how prices below took off in a bullish manner once the top end of the green
box was exceeded. The tiny bit of "good news" is the current
process has not yet broken below the orange box, but the odds tell us to
prepare for it. A break below the orange box, could
set off a relatively sharp drop in stock prices.
 
The
chart of the S&P 500 below shows one example of a bull/bear line that was
violated yesterday. The green arrows show that the last two times sellers
brought the S&P 500 to the 200-day moving average buyers stepped up and
prices rallied. Therefore, it was logical to be patient and see if the
200-day held again. We had sell orders queued up on Monday, but decided to
hold off on selling for two reasons: (1) the Senate was due to approve the
debt-ceiling compromise on Tuesday (which they did), and (2) buyers stepped
in and propelled stocks back above the 200-day before the close Monday (see
orange arrow). The red arrow below shows this time the 200-day did not hold,
which factored into our decisions to execute sell orders before the close on
Tuesday.
It
should be noted during the shift from a bull market to a bear market in both
2000 and 2007, the S&P 500 zig-zagged above and
below the 200-day moving average approximately ten times before we shifted
into a full-blown bear market. That tells us that the market may pop above
and below the 200-day several times over the next few weeks or months.
The
200-day example of above is one of many where bearish thresholds were crossed
on August 2. The CCM 80-20 Correction
Index is another example. On August 2, the 80-20 Index dropped to 609,
which moved it into a much less favorable historical risk-reward zone (see
orange boxes below). The higher the risk-reward ratio, the better the odds
are for risk assets, like stocks. Notice the red boxes are the next stop if
stocks cannot firm up in the next week or so.
The
CCM Bull Market Sustainability Index (BMSI)
paints a similar picture of deterioration in the market's risk-reward
profile. The BMSI closed on August 2 at 2,392, which places it just above a
very mixed zone in terms of historical risk-reward profiles for the stock
market (see orange box).
How
does all this help us? We did some selling on Friday and again on Tuesday
(SPY and IYT). If weakness persists, we will continue to raise cash, possibly
at a more rapid rate. We may also consider adding to our positions in gold
(GLD) and silver (SLV).
Chris Ciovacco
Ciovacco
Capital
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