Holy Smokes! To say that the last few trading days since the beginning of February have been rough would be an understatement. Although… the market hasn’t hit a point of “Devastation” yet either. We’re FINALLY seeing a bit of volatility in the market that we haven’t seen in well over 2 years. I think many of us have forgotten what this feels like.
Here’s a few talking points you can use with your friends to help you sound smart and sophisticated about the market;
- The market averages three to four “five percent pullbacks” per year. The last 5% pullback was July 2016, so we’re way overdue.
- The market averages one “ten percent pullback” per year going back to 1928. The last 10% pullback was January-February 2016.
- We went the entire calendar year 2017 without even a 3% pullback. That is NOT normal.
With that being said, I’d like to tell you right now that this is NOT the time to panic. Not Yet anyway. What we’ve seen over the last few days is likely to shape up as one of our more traditional average 10% pull backs that we haven’t seen in a while but usually see about once per year.
Remember that one of the most important tools we have in our investment toolbox – and one of the primary reasons many of our Baby Boomer clients have ended up working with us – is the Traffic Light Portfolio Management System.
The Traffic Light System gives us two (2) very important tools to help us make informed and non-emotional investment decisions. 1) Knowing when to Sell and 2) knowing when to Buy.
Every investment strategy you could possibly consider simply must include these two factors at a minimum.
There’s no such thing as a “Perfect Investment Strategy”. Heck, even buying and holding index funds has it’s weaknesses and drawbacks.
So, for those of our clients who would like a quick refresher course on how the Traffic Light System works and how we’re using it to help us manage the risk in your portfolios, I’ll review it quickly here with some helpful pictures. If, you just want to hear what our professional opinion is on the market and what you should do about it, feel free to jump to the last two sections of this article and I’ll be happy to share it with you.
The Traffic Light Portfolio Management System – The 4 Minute Version
Our Traffic Light System relies on 3 basic principles;
- WHEN You Invest Is Just As Important As WHAT You Invest In (Diversification and Allocation)
- Only invest in Statistically Healthy Markets – or Positive Trending Markets (Technical Indicators)
- Moving To Cash Is The Right Thing If All Markets Look Unhealthy (Risk Management)
With those 3 rules as our foundation, I’ll share with you the two Indicators we use to help us put these principles in action;
Indicator 1: Simple Moving Average
Our first technical indicator we look at is a simple monthly moving average.
As long as that blue line is above the red line, we’re going to give this signal a “Thumbs UP” and say that we’ve got a reasonable “indication” that the market is in an “Up Trend”. However, when you see the blue line cross BELOW the Red line and stay there for the duration of the end of that month, THEN we give that indicator a “Thumbs Down” and call that our first warning sign.
Example Chart of S&P 500 Monthly Simply Moving Average
Indicator 2: The Moving Average Divergence Convergence (or MACD)
While this indicator uses different formula to generate it’s signal, it does follow a similar pattern to the simple moving average. You can see below where we give either market environment a positive or negative rating.
Example Chart of S&P 500 Monthly MACD
How To Apply The Signals
When these two indicators are put together, they’ll tell you how much of your portfolio should be invested. When both indicators are negative, we would say that’s an “Unhealthy Market” and you should not be invested there. That’s a “Red Light.” When one indicator turns negative but the other remains positive, you should pull half your money off the table. That’s a “Yellow Light.” And as long as both indicators are positive, then we’re in a statistically “Healthy Market” and you can be confident investing in that market until the signals change. That’s a “Green Light.”
Applying a disciplined investment approach – whether it’s the Traffic Light, buy-and-hold, or any other – still requires intestinal fortitude. There will be days, like we’ve experienced this week, where the market goes crazy. This isn’t a time to panic though. In fact, there’s never really a time to panic if you have a strategy to follow to help you know when it’s officially time to “get out” of the market and protect your portfolio.
Following a system like this doesn’t mean you’ll always be right. It does mean however that you’re not going to lose your shirt when the next major market crash hits us. It’s coming eventually. I can’t predict the future to tell you when that next crash will hit us. But we’re ready for it when it gets here and that’s why you should have the Traffic Light System working for you. Otherwise, you’ll just have to trust that gut instinct and that doesn’t always work out well for most people.
Current State of Affairs
The market is reacting to almost nothing right now. Wait. What did I just say??? Yep, you read that right. There’s really nothing major going on in the market or economy right now that should be affecting the market this much.
No one is going to war. No big companies are going bankrupt. The GDP growth trajectory is solid. There’s not even a sniffle of corporate scandal making the headlines. So what is it?
Well, there’s a potential that we could see some inflation… So there’s a threat that interest rates could go up. Considering the fact that inflation has been relatively flat for the last nine years and interest rates are still at rock bottom, leads me to believe that even a slight adjustment in either category is a healthy sign.
Here’s the kicker though that makes this argument a pretty short conversation; 30 year interest rates CAN’T go up more than a couple percent TOTAL. Seriously. If they did, the government couldn’t support its own debt. So while there is a chance that interest rates will rise, you’ll likely not pay more than 6 or 7 percent on a 30 year mortgage for the rest of your life. Our country simply couldn’t afford that kind of interest payment.
If you’d like more information on the economic outlook for 2018 and beyond, go check out this 6 minute video from Economist Tom Hegna’s Blog. https://tomhegna.com/blog/2018-economy-what-to-expect-when-ringing-in-the-new-year
The Traffic Lights Today
So where are we today Jeff? What are the Traffic Lights telling us right now?
That’s a great question. Here’s a chart I pulled this morning on the S&P 500 to show you what we’re seeing right now. As of 2/6/2018 we opened the day with the market at least 1.5% away from giving us our first true warning sign. According to the quick refresher lesson above, this is one of two indicators that can help us make informed decisions – but remember that it doesn’t actually trigger a negative signal until the END of the month.
You’ll also see on this chart the “Support and Resistance” lines (in green) are still far above and below where current market conditions are. This means the market is within its normal range and there’s not much to worry about. The bottom resistance line is really that last line of defense. If you see the S&P drop below 2450 and stay there through the end of the month, that’s a pretty sure sign that we’ve experienced a change in the trend. Those changes don’t happen over one or two months though. Certainly not over one or two weeks either.
We need to take a deep breath, go for a walk, and let the market air out a little. If you look at that chart, there’s a lot of profit in that run up we’ve just experienced over the last 2 years. We’re not going to see that go away all in one month.
But rest assured, if this pattern persists and we do experience a full fledged “Red Light” then we’ll be taking action to do something about it. But that day is not yet here. It could be soon, but not yet.