I wrote last week that while there continues to be a great many inputs to consider in this market (earnings, the economy, rate liftoff, Europe, the ECB, global QE, valuations etc.) I keep coming back to the question of whether or not the character of the market has changed. The proliferation of trading in ETFs and the growing popularity of high speed trend-following seems to be causing a significant increase in the level of “noise” in the market on a daily/intraday basis.
The end result is a market that has been range-bound for the better part of the last six months. As the chart below indicates, there have basically been two trading ranges that have defined the market since the end of November.
The bulls will argue that Friday’s “Goldilocks” Jobs Report may represent the catalyst needed for stocks to finally “break on through to the other side.” And the spirited advance that ensued after the Nonfarm Payrolls data would appear to be exhibit A in this argument.
Lest we forget though, it was just last week that Janet Yellen called market valuations into question by suggesting that stocks were overvalued by historic measures. Couple this with the punk economic data, the slowdown in earnings growth, and the propensity for the fast-money to sell into each and every new high and well, one has to wonder whether the bulls have the fire-power to make a meaningful break here.
So, what are investors to do at this point in time? This maddening back-and-forth, up-one-day-and-down-the-next, environment has made a mockery of anyone trying to manage the short-term trends of the market (which only seem to last a day or two before traders spy a different bright, shiny object to focus on) and/or manage risk.
Five Ways to Play
Unless the consolidation phase suddenly comes to an end or one has the discipline to just ride out the current environment, it is probably a good idea to have alternative ways to play this bucking bronco market.
So, here are five ways to play the current game:
- Ride the Range
- Do Nothing, Absolutely Nothing Until There is Something To Do
- Play Longer-Term
- Go Alternative
- Utilize MPD – Modern Portfolio Diversification™
Ride the Range: While implementing such an approach at this stage runs the risk of violating the old Wall Street cliche , “Something that everybody knows isn’t worth knowing,” one way to play the game here is to buy the low end of the trading range and sell the high end. One caveat to this approach is to make darn sure you have a plan to deal with the breakout that will inevitably occur – well, in theory anyway!
Do Nothing, Absolutely Nothing Until There is Something To Do: The key to this approach is the exact opposite of the range riding strategy. Instead of trying to buy low and sell high with the rest of the fast-money traders, the idea here is to hold your current position and “do nothing, absolutely nothing” until the trading range breaks. And given that the dreaded “breakout fake out” has become prevalent of late, anyone using this approach will probably want to either (a) scale into positions as prices break or (b) wait for a 1% – 2% “confirmation” move and/or a successful “retest” of the breakout zone before committing capital.
Play Longer-Term: In light of the fact that the S&P 500, Dow, and the NASDAQ Composite have been working slowly and steadily higher during this consolidation phase, another way to play is to utilize a longer-term approach. Instead of trying to manage the market on a short- or intermediate-term basis (with the latter being exceptionally difficult these days), employing longer-term strategies has historically worked pretty well in this type of environment. The key is that the short-term “noise” is simply ignored as longer-term strategies focus only on the big-picture.
Below is a chart showing the historical buy and sell signals of just such an approach. I’ve highlighted this system several times in the past and have mentioned that if I were stranded on a desert island with only one indicator, it would be this one. The idea is to look at the technical health of the 104 sub-industry groups in the S&P 500 (the S&P 500 can be broken into 10 sectors, 20 industries, and 104 sub-industries). When the majority of the sub-industries are “healthy,” history shows that the stock market has performed well. And then when less than 45% of the sub-industries are “healthy,” history shows that risk levels have been elevated and it has been a good time to head to the sidelines. (Note that we use this indicator in our long-term risk manager strategy for clients at both Heritage and Sowell Management – so we are definitely putting our money where our mouths are here.)
Go Alternative: Another way to play this back-and-forth market is to avoid the stock market altogether and utilize “Liquid Alts.” The idea is to focus on non-correlated assets in your portfolio – especially during times of market uncertainty. We like managed futures funds as well as a handful of other ideas in this space. Granted, you won’t get the big return when the stock market finally breaks one way or the other, but the ride during these bumpy times can be a bit smoother.
Utilize MPD™: And finally, perhaps the easiest way to play difficult markets is to utilize a properly diversified, modern approach to portfolio design. If investors have learned anything since 2000, it is that traditional asset allocation failed them when it counted. As such, I’m a believer in the idea that modern markets require modern thinking and modern solutions. MPD™ is the idea of diversifying your portfolio not only by asset class, but also by strategy, manager, methodology, and time frame.
So there you have it; five different ways to play the current, difficult, non-trending market environment. It is my sincere hope that you find at least a small tidbit of this report helpful.