Global Risks Looming

In The Highstreet Group by John Bartoletta

The world remains awash in economic and geopolitical risks. The two biggest geopolitical risks revolve around Russia and Greece. Other substantial – though lesser – risks relate to the geopolitical risks that arise from lower oil prices and the European political environment. Finally – at least among the above-the-fold risks – ISIS remains concerning, but seems incapable of achieving global economic significance. On the economic front, we have the impending FOMC rate hike with its timing and resulting impact as big question marks. We also have the ECB wading into the quantitative easing pool with dubious expectations on its effect on the Euro and the reversal if EU economic growth.

Despite all of these risks hanging over the markets, the Dow Industrials and the S&P appear to be headed back up to their highs again, which are about 1% above current levels. But not much else has changed in the market, as other indexes and stock groups remain very mixed and generally not as bullish as some of the larger-cap stocks that have been holding the Dow and S&P at higher levels. We would not be surprised to see new highs set by the large stock indexes, but still have that same-old problem with much of the rest of the market that is not confirming the strength in the larger stocks.

It really is a continuing overall mixed trend that we believe may not amount to much in either direction for another month or two. It is interesting, however, that with each rally or pullback, how the sentiment can shift from hopeful to disappointment, but even the sentiment readings are stuck mostly in neutral and are not reaching the kinds of extremes that are normally associated with a major top or bottom. So try as investors do, to be bullish or bearish, the market trends remain more flat than trending, and could remain this way for some time yet, with the main message to investors seeming to be that “you’ll get nothing, and you’ll like it.”

Over the last month we have been writing about the volume levels and the probability of a directional change in the markets. Following are a series of three graphs of the S&P Index with different time frames that we feel support our theory that the markets could have some downside pressure soon.

Volume remains relatively low (despite a few days of increased market weakness) without the participation of a larger part of the rest of the market. A market move to new highs would prove to be suspect. This has caused an overall attitude of complacency in a market that has been mostly rewarding to those who are willing to own the highest volatility and most risky of the large-cap growth stocks, while most of the rest of the stocks in the market struggle to find a bull trend.

We also wrote about the low level of the VIX index and probability of a directional change to the upside if the markets retreat and sell off. Following are a series of three graphs of the VIX Index with different time frames that we feel support our theory that the markets could have some downside pressure soon.

This was supported by the extremely low reading in the volatility Index (VIX), however over the last month when the market showed weakness it caused a slight lift to volatility. We think that the situation is not likely to clear up over the next few months with most of the indexes signaling that we are close to a mini- corrective move. At this time, we are leaning more towards the possibility of a short-term corrective move of 3% to 5% rather than a meaningful move to the upside from here. If it gains downside momentum we would not be surprised to see 7% to 10% reached.

TRADING UPDATE: Diminished or lack of global growth could derail generally bullish (mixed) US fundamentals. This may contribute to increased headline volatility that is difficult (if not impossible) to anticipate as to when it may occur with either fundamental or technical analysis. We have stopped buying equities at this time with no compelling reason to be fully invested. This market was being forced higher and we were moving in unison with the rally. However, we are becoming increasingly cautious in the short-term (days to weeks) and will look for anything that could derail the current trend. We have continued to increase our counter-trend downside hedge in the portfolios and will stand ready to increase the exposure if we see the markets weaken quickly. This would give us a more favorable area to enter the markets. After we get through this short-term phase we anticipate getting fully invested. Intermediate term (weeks to months) and long-term (months to years) we remain bullish as we are in a long-term secular bull phase. Until then, we continue to remain diligent in our research and will continually monitor the markets and report back as data becomes available.