Add Iraq To List Of Concerns
U.S. investors have been unsettled by Russian troops, economic concerns in
Europe, and a possible shift in the Fed's interest rate time table. If that
was not enough, the term airstrikes is being used to describe possible
scenarios in Iraq. From The
Wall Street Journal:
The Obama administration is considering airstrikes against Islamic militants
in northern Iraq in a move to protect American personnel in the city of
Erbil as Islamic militants pose a growing threat to the country's Kurdish
heartland, U.S. officials said. U.S. officials described the likelihood
President Barack Obama will authorize airstrikes as increasing. Airstrikes
could come even before those humanitarian airdrops, or shortly afterward,
officials said, emphasizing that as of Thursday afternoon, the White House
had not made any decisions to strike.
Support Can Help With Countless Inputs
Given the potentially bullish implications of a strengthening U.S. economy
and the long list of counterbalancing concerns, it can be difficult to make
investment allocation decisions. Sometimes the simple concepts of support and
resistance can help. The chart of the S&P 500 below shows the market is
nearing a trendline that has provided support in the past (see green arrows).
The red arrows highlight previous areas of resistance, between 1897 and 1902,
that may now attract buyers near the blue arrow.
How can the chart above help us? If support holds, it will increase the odds
of a potential bounce-back rally in U.S. stocks, meaning we can exercise some
patience with our equity ETFs (VTI). If support does not hold, the odds of
further weakness will have increased, and it becomes easier to consider additional
defensive chess moves. We learn something either way.
ECB Leaves QE Door Open
The stock market loves quantitative easing (QE) since it injects money into
the financial system. Europe is sending somewhat conflicting signals to U.S.
investors. The bad news is the European economy is showing some signs of ongoing
strain. For example, Italy released negative GDP figures this week. The good
news is the European Central Bank (ECB) could launch a QE program in an attempt
to spur economic activity and combat persistently low inflation. From Bloomberg:
European Central Bank President Mario Draghi said the risks to the recovery
from conflicts including that in Ukraine are increasing. Headwinds facing
the 18-nation euro area's recovery are intensifying after Italy slipped
back into recession and the standoff between Russia and the U.S. and its
allies escalated into the worst such conflict since the Cold War. Draghi
has said large-scale asset purchases are an option for dealing with a severe
economic shock, leaving investors seeking clarification on what the trigger
could be.
Bulls Typically Stagger Before They Fall
There is another reason to monitor key support on the S&P 500 - a snap
back rally remains possible. Prior to the recent bout of weakness in U.S. stocks,
the technical picture has been favorable. If we also consider relatively strong
economic data, it tells us to keep an open mind about the next move in equities.
Even if the bears get their hoped-for significant correction or bear market,
tops can form over time. For example, it took the Dow nearly three months to
peak in 2011 (see chart below). A sign of weakness emerged when the slope of
the 50-day rolled over in early June 2011 (see orange arrow on left). After
a scare, the Dow staged a significant bounce-back rally all the way to point
A; a similar rally remains a possibility in 2014.
Odds Of A Recession?
How does the bigger picture look today? It is a mixed bag. From a negative
perspective, the 50-day is starting to roll over (see orange arrow below).
From a positive perspective, the Dow is still holding above its 200-day moving
average, telling us many blue-chips remain relatively healthy from a longer-term
perspective. Another positive is the health of the U.S. economy. Bear markets
are typically associated with recessions. The U.S. economy does not appear
to be at high risk of an imminent recession (based on the data we have in hand).
Investment Implications - The Weight Of The Evidence
On August
6, we listed 1911 on the S&P 500 as a bull/bear guidepost. On August
7, the S&P 500 closed at 1910 and change. How does that help us? We used
it as a reference point and trigger to see if our current allocation was
in line with the market's current profile. In our case, the answer was "our
cash and bond positions remain sufficient to offset the risk of further downside
in our equity holdings (SPY)". Therefore, by rule, we made no changes Thursday.
However, market weakness on August 7 did nothing in terms of making the market "prove
it to us". If stocks cannot post gains Friday, the odds are good we will
reduce equity exposure for the fifth time since July 24. If stocks can rally
Friday and hold key support shown above, we will be more apt to maintain
our current exposure to stocks. It should be noted that making no moves on
August 7 does not mean everything is rosy for stocks. To the contrary, the
market's profile is currently so concerning that we have already cut risk
significantly, with the first defensive step coming back on July 25. We will
enter Friday's session respecting both the "highly vulnerable to even a plunge
scenario" and "potential support is in the neighborhood" scenario.
