Short Term Reflex Rally Approaching Heavy Resistance
The Dow Jones Industrials have moved up some 1100 points over just the past five trading days, an unusually strong winning streak. As such, we believe that the risk of a near-term pullback has also increased, but by an amount that may be about one-half of the previous rally period. The volatility fallen off considerably (see chart below) and sometimes a drop in volatility can lead to a snapback that is even quicker than the way up. We would look at any dip like that to be a potential opportunity, in general. In the meantime, the DJIA and the S&P are working into areas of heavy resistance that were created by nearly a year of trading within those high ranges. We think this will also take quite a bit of time to get through, and so we view the market as being mostly neutral but also volatile for the next few months, and then leading to a more-bullish trend next year.
VOLATILITY: With the recent abnormally strong reflex rally in the equity markets and the fact that the market is approaching heavy technical resistance, we feel it is time to buy the VIX to capture a spike in volatility. Below is a graph that we feel is supporting our theory that the markets could see another wave of downside pressure if the recent bounce fails. Until the VIX stabilizes we feel that there is still downside pressure in the markets.
TRADING UPDATE: We are looking to hold what we have and put at least some cash back to work into stocks as conditions warrant. At this time we are not seeing clear indications of what areas of the market may lead in a recovery, so a more general approach is best at this time.
We continue to hold cash levels of 30-34% that are limiting the portfolios to about 60% of the market volatility. The cash can be put to work quickly should we see opportunities present themselves and the hedge positions will remain a trading tool to improve risk exposure in the portfolios.