Broker Check

Market Commentary: Risk On or Risk Off?

Written December 20, 2018

Okay readers, time to get down in the trenches with me.  We’re going to be wading through some weeds. Stick with me; it’ll be worth it in the end. And you’ll feel so much smarter. 

First of all, the Fed increased rates by 0.25% yesterday and alluded to two more hikes in 2019.  Of course, Mr. Market didn’t like that much, so we’ve seen major indices break their support levels (the blue line on the graph below).  But the market is also oversold at this point (meaning that the price has fallen to a level at which there is a high probability of a short-term rally):

Looking at support/resistance lines and overbought/oversold indicators is something called technical analysis.  It’s looking at the price movement of the markets to drive decisions about how offensive or defensive to be and when.  It’s not perfect (nothing is) and it’s not a good idea to use in a vacuum. 

That’s why we also use fundamental analysis, which is the art of interpreting economic data and figures to determine what the market prices “should” be.  It’s good for the long-term view because history has shown that markets gravitate toward their fair values over time.  The caveat is that it might take a few years.  There aren’t any hard and fast rules on how long a stock (or a market) can deviate from its fair value.

I’ve written a lot in past commentaries about the fundamental side of the coin.  Economically, we’re in good shape.  GDP is above 3%; earnings growth hit record highs last quarter; unemployment is extremely low; and despite the rate hikes, interest rates are still historically low.  But a particular trend has emerged in the last two months that is concerning and adds to the market’s volatility.

Margin debt is how much investors leverage current stocks they own to buy more stocks.  It hit a record high several months ago, which wasn’t concerning in and of itself, but now it has started to decline.  As stocks fall, investors have margin calls and are forced sellers of their stocks in a down market.  It puts additional downside pressure on an already weak market.

Below is a graph from Investech that shows margin debt levels compared to the S&P 500.  I’ve added additional lines to show that not every downturn in margin debt equates to a major market top.  Margin debt declined in 2011 and 2015 – and the market didn’t collapse.

On the technical front, rallies have been met with selling as investors are entering panic mode.  In my opinion, what is causing the panic are many what-ifs.  I’ve written about those in past commentaries already.  But as of December 17th, technical indicators are showing a short-term bottom but a change in overall trend to “down.”

Here’s what we’ve already done and our game plan moving forward for the accounts we manage:

In all but our most aggressive models, we purchased 10-20% of a defensive position that will help reduce downside risk.  After our indicators show that the next rally is exhausted, we’ll get more defensive.  The amount depends upon a client’s particular risk tolerance.  We don’t advocate for moving 100% to cash or making drastic moves all at once.  We can point to 2011 and 2015 as examples of how that would have been a bad idea; the market can quickly change direction and never look back.

If the market makes an about-face and the technical indicators change the market trend to “up,” then we’ll gradually remove the defensive guardrails.  But considering the change in risk on the technical side and the decline in margin debt, we’re taking steps to mitigate more potential downside risk.

If you have any questions or want to know even more of the nitty-gritty details, feel free to email us.  Rest assured that we’re paying attention, reading the road signs, and taking action.

- Victoria Bogner, CFP®, CFA, AIF®

Disclaimers and Notes

Registered Representatives offering securities and advisory services through Cetera Advisor Networks LLC, member FINRA/SIPC, a broker/dealer and a Registered Investment Advisor. Advisory services also offered through McDaniel Knutson Financial Partners. Cetera is under separate ownership for any other named entity.

The views are those of Victoria Bogner and should not be construed as investment advice. All information is believed to be from reliable sources, however, we make no representation as to its completeness or accuracy and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for informational purposes only and does not constitute a recommendation. Economic and performance information is historical and not indicative of future results.

Investors cannot invest directly in indexes. The performance of any index is not indicative of the performance of any investment and does not take in accounts the effects of inflation and the fees and expenses associated with investing.

Because dollar cost averaging involves continuous investment in securities regardless of fluctuating prices, the investor should consider his or her financial ability to continue purchases through periods of falling prices, when the value of their investments may be declining. Dollar cost averaging does not ensure a profit.

Exchange-traded funds are sold only by prospectus. Please consider the investment objectives, risks, charges and expenses carefully before investing. The prospectus contains purchases through periods of falling prices, when the value of their investments may be declining. Dollar cost averaging does not ensure a profit.

The S&P 500 Index is a capitalization-weighted index made up of 500 widely held large-cap U.S. stocks in the Industrials, Transportation, Utilities and Financials sectors.

A diversified portfolio does not assure a profit or protect against loss in a declining market.