Never Forget That Markets are Cyclical

If you’ve never seriously considered the idea of market cyclicality, you need to read Market Cycles: The Key to Maximum Returns, an article posted in Investopedia by Mary Hall back in February.  The point of this brief post is to point out that the “fundamentals” of individual companies are insufficient to predict market performance over the short term.   Macroeconomic forces and current market conditions are predictive of overall market performance, and you can’t escape shifts in beta because of them.

Beta is Street shorthand for the correlation between all stocks with all other stocks.  In a rational world, prices of stocks would be based strictly on the business prospects of individual companies.  This is not the case, and a failure to recognize this fact can lead to a massive devaluation of your portfolio for many years.  If you are of the Warren Buffett school of thought, you merely expect such shifts and ignore them. If you are an “active” portfolio manager or you are very close to retirement and will need your money in a span of time less than “forever,” you must be cognizant of market cycles.  At present, we are at the top of the current cycle, and, in my opinion, we are very near the inflection point where the momentum will shift from up to down.

Many finance experts and market watchers are saying that there is still “a lot of upside” to U.S. equity markets.  History begs to differ. The current bull market is long in the tooth, and it has lasted longer than almost any upward trend in history.  You will also hear that “this time is different.” My take on the “this time is different” argument is that it is irrational exuberance expressed by a person that doesn’t want to appear irrational.   

As I write this, technical traders are carefully watching the S&P 500 to see if it can “break through resistance” at 2,800. It is still early in the trading day, but it is starting to look like a close below 2,800.  This has a major significance to technical traders because prices have bounced off of that level several times, and that is believed to be a harbinger to a downward move. Even if you don’t trust in charts, you need to take this into account because many of your fellow traders do watch them and trade on their perceptions of where things will go.

Based on the mostly sideways movement of the market over 2018 compared to last year, I surmise that investor sentiment has shifted.  We are no longer bullish but retain a cautious optimism. Today could well be a turning point for investor attitudes. If we close below the 2,800 mark and Netflix doesn’t shoot out the lights with both earnings and guidance after the bell today, investor confidence could be shaken to the point that we see a precipitous decline.  Fear and greed are doing the tango on a highwire, and this sideways movement can’t last much longer. As famed investor Ray Dalio has observed for the last year, the current market risk is asymmetrical–there is a lot more room to move down than up.

If you have a bullish portfolio based on the synchronized global growth thesis,  I recommend moving to a defensive posture. Tech is dizzyingly high, and if there is a massive correction as many predict, then tech is not where you want to be.   If you were super bullish and bought leveraged products, I’d suggest exiting those positions immediately.  Industrials are already down a bit for the year, but nothing like what will happen if things really go south. Many traders suggest real estate because income can prop up values and the REITs tend to have a low correlation with the market in general, but to me, these seem to be in somewhat of a bubble as well.  

I like consumer staples, and energy seems like it will have some upside if political uncertainty remains. I’m currently short the S&P 500 and the Russell 2000. I like biotechnology at the moment but will exit that position if things start to decline rapidly. I will remain long consumer staples under the thesis that the sector will benefit from a flight to safety when things do take a downturn–if the downturn isn’t too rapid.  If you want to hedge your portfolio by taking on some short positions, I suggest taking a look at China real estate funds. That, to my way of thinking, is the biggest bubble of them all.

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