Recent Data and Breakdowns Call For Defensive Bias

By: Chris Ciovacco | Wed, Aug 3, 2011
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Every comment made below needs to be taken in the context of possible Fed action. The Fed will most certainly do something in response to the recent weakness in the markets and deterioration in the economic data. The Fed is due to release their next formal statement on Tuesday, August 9.

We believe gold and silver are well positioned given current economic circumstances and any potential Fed action. Our gut and reading of the technicals and fundamentals tell us to favor precious metals over stocks in the short-to-intermediate term (maybe even longer). We recently added to our holdings in gold and silver and that turned out to be a good move, especially relative to stock market performance (see July 13 post).

The markets still have a mix of good news and bad news, but the bad news pile is now much taller than the good news pile. Tuesday's sharp drop in all risk assets, except gold and silver, did significant damage to the market's probabilistic outlook. Consequently, we must be willing to take increasingly larger incremental steps away from risk (raise a higher percentage of cash more rapidly).

Since market tops and bottom are formed based on the human emotions of greed and fear, they often occur via a process that takes time to play out. The bad news in the chart below is the bottoming process from the summer of 2010 looks like a mirror image of what may be a topping process in 2011. Notice how prices below took off in a bullish manner once the top end of the green box was exceeded. The tiny bit of "good news" is the current process has not yet broken below the orange box, but the odds tell us to prepare for it. A break below the orange box, could set off a relatively sharp drop in stock prices.

Bears Gain Momentum - Short Takes Ciovacco

The chart of the S&P 500 below shows one example of a bull/bear line that was violated yesterday. The green arrows show that the last two times sellers brought the S&P 500 to the 200-day moving average buyers stepped up and prices rallied. Therefore, it was logical to be patient and see if the 200-day held again. We had sell orders queued up on Monday, but decided to hold off on selling for two reasons: (1) the Senate was due to approve the debt-ceiling compromise on Tuesday (which they did), and (2) buyers stepped in and propelled stocks back above the 200-day before the close Monday (see orange arrow). The red arrow below shows this time the 200-day did not hold, which factored into our decisions to execute sell orders before the close on Tuesday.

Bears Gain Momentum - Short Takes Ciovacco

It should be noted during the shift from a bull market to a bear market in both 2000 and 2007, the S&P 500 zig-zagged above and below the 200-day moving average approximately ten times before we shifted into a full-blown bear market. That tells us that the market may pop above and below the 200-day several times over the next few weeks or months.

The 200-day example of above is one of many where bearish thresholds were crossed on August 2. The CCM 80-20 Correction Index is another example. On August 2, the 80-20 Index dropped to 609, which moved it into a much less favorable historical risk-reward zone (see orange boxes below). The higher the risk-reward ratio, the better the odds are for risk assets, like stocks. Notice the red boxes are the next stop if stocks cannot firm up in the next week or so.

Bears Gain Momentum - Short Takes Ciovacco

The CCM Bull Market Sustainability Index (BMSI) paints a similar picture of deterioration in the market's risk-reward profile. The BMSI closed on August 2 at 2,392, which places it just above a very mixed zone in terms of historical risk-reward profiles for the stock market (see orange box).

Bears Gain Momentum - Short Takes Ciovacco

How does all this help us? We did some selling on Friday and again on Tuesday (SPY and IYT). If weakness persists, we will continue to raise cash, possibly at a more rapid rate. We may also consider adding to our positions in gold (GLD) and silver (SLV).

 


 

Chris Ciovacco

Author: Chris Ciovacco

Chris Ciovacco
Ciovacco Capital Management

Chris Ciovacco

Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors and tax advisors before making any investment decisions. Opinions expressed in these reports may change without prior notice. This memorandum is based on information available to the public. No representation is made that it is accurate or complete. This memorandum is not an offer to buy or sell or a solicitation of an offer to buy or sell the securities mentioned. The investments discussed or recommended in this report may be unsuitable for investors depending on their specific investment objectives and financial position. Past performance is not necessarily a guide to future performance. The price or value of the investments to which this report relates, either directly or indirectly, may fall or rise against the interest of investors. All prices and yields contained in this report are subject to change without notice. This information is based on hypothetical assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money management firm based in Atlanta, Georgia. CCM helps individual investors and businesses, large & small; achieve improved investment results via research and globally diversified investment portfolios. Since we are a fee-based firm, our only objective is to help you protect and grow your assets. Our long-term, theme-oriented, buy-and-hold approach allows for portfolio rebalancing from time to time to adjust to new opportunities or changing market conditions.

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