Investment Probabilities Say Market Has To Prove It

By: Chris Ciovacco | Mon, Jan 27, 2014
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Fundamentals and Technicals Both Waning

Deterioration in risk-on vs. risk-off charts contributed to our incremental risk-reduction moves last Thursday and Friday. Charts feed off of fundamental perceptions/economic data. The data on the housing front did nothing to change perceptions Monday. From Bloomberg:

Purchases of new homes in the U.S. fell more than forecast in December, ending the industry's best year since 2008 on a sour note. Sales decreased 7 percent to a 414,000 annualized pace, lower than any estimate of economists surveyed by Bloomberg, after a 445,000 rate in November that was weaker than previously calculated, the Commerce Department reported today in Washington. The housing rebound has cooled as bad weather slowed the market and as buyers adjust to higher borrowing costs and rising property values, which have hurt affordability.

Investing is about probabilities. It is prudent to put our capital in harm's way when the odds of success are favorable. The most favorable odds occur in quadrant 1 below, when the fundamentals and technicals are aligned in a bullish manner. Unfortunately, in the present day, the odds are shifting from quadrant 1 toward quadrant 4. Until that concerning shift subsides, it is prudent to limit our exposure to stocks.

Investing Probabilities


Market's Tolerance For Risk Is Shifting

This week's stock market video summarizes the changes in the observable evidence and provides specific examples of the rationale behind reducing risk exposure last week.


2008: This Is What Economic Fear Looks Like

As we have noted in the past, all investing involves opportunity costs. If we look at the markets from an opportunity cost, or "would I rather own this or that" perspective, we can gain valuable insight into the market's risk-reward profile. Thinking in extremes also provides insight. In the credit markets, when investors are confident, they want to chase yield (JNK). When they are (a) concerned about the economy, and (b) not expecting the Fed to raise rates anytime soon, they prefer to own longer-dated Treasury bonds (TLT). Please save your "maturity mismatch" comments; we are thinking in opportunity cost terms, not credit spread terms. The 2008 chart below shows what maximum fear looks like in the credit markets.

JNK:TLT Weekly 2008 Chart


This Is What 2014 Looks Like

During the rally off the October 9 low, demand for yield was clearly outstripping demand for conservative bonds. In early 2014, that is no longer the case (see red arrow below). As long as the chart below maintains a "risk-off" look, it will check concerning boxes for the stock market bulls.

JNK:TLT Weekly 2013-2014 Chart


Emerging Markets Contributing To Fundamental Concerns

Both Strong, Both Week

Part of the fundamental/technical push from quadrant 1 toward quadrant 4 is being fueled by increasing concerns about emerging economies. From Reuters:

The declines have been triggered by signs of weakness in the Chinese economy, including fears it may eventually face a debt crisis, and concerns about how much hot money may exit some markets as the U.S. Federal Reserve pulls back from its bond-buying program. The stimulus that program has given the world economy in the past few years is widely credited with big gains in stocks and other asset prices.


Investment Implications - Shorts Starting To Win

If the market answers the question "would you rather be long or short" with "short", it tells us something about all our long positions. Notice during the entire rally off the October 9 low, the answer was "we would rather be long" (see green arrows below); that is no longer the case, which is one of the reasons we cut back our exposure to stocks significantly last Thursday and Friday.

SPX:SH Weekly Chart

In addition to an equity scale-back call, our market model added a position in TLT last week. Our portfolios are now comprised of cash, bonds, and equities, including broad U.S. exposure (SPY) and technology (QQQ). For us to shift from incremental risk-reduction mode to redeploy-cash mode, the observable evidence needs to improve. The tweet below reminds us of an important event on this week's financial calendar that could spark a return to risk-on or an acceleration in the risk-off trade.

Chris Ciovacco Tweet

 


 

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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Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
austrian-money-supply/