Why I moved largely to cash in early August (XLI, EWI, CSCO)

Michael AroldAuthor: Michael Arold

Covestor model: Technical Swing

Disclosures: Short EWI

July was a mixed month for the portfolio: while I was able to capture strength during the first two weeks, my stocks acted weaker than anticipated towards the end of the month.

Going into August, I moved mostly to cash. Too many uncertainties currently strain the markets –  trading is very headline driven, and it is therefore difficult to capture and maintain an edge. The environment will improve, but staying defensive is my preferred strategy until then. In addition, I will be on vacation without Internet connection in August and one of my rules is to not have open positions when I cannot monitor them on a daily basis.

In general, my market outlook is quite pessimistic. The US debt ceiling debate is dominating the headlines at the end of July, but various developments suggest that the real action is either somewhere else or that markets could continue to fall even after both parties come to an agreement.

Development #1: Europe   

The situation in Europe has not been resolved yet. Italian bond yields are still rising and are close to record highs, according to Financial Times. The topic could replace the US debt ceiling discussion in August and dominate markets. As of July 29, I am short iShares MSCI Italy Index (NYSE: EWI) in the effort to benefit from further weakness in Europe.

Development #2: Industrial Sector Stocks

Since the beginning of July, Industrial sector stocks have dramatically underperformed: Select Sector Industrial SPDR ETF (NYSE: XLI) fell sharply during the month, while the S&P 500 declined more modestly. Weakness in Industrial stocks started at the beginning of July, before markets got concerned about the debt ceiling, which suggests that another theme is currently driving these stocks.

This theme might be anticipation of lower economic growth. In July, we saw a lot of companies announcing job cuts. Some examples: Cisco (NASDAQ: CSCO) planning 10,000 layoffs, UBS AG (NYSE: UBS) announced to fire 5,000 people, and Lockheed Martin (NYSE: LMT) has made “voluntary layoff offers” to 6,500 employees. These developments are not good. At this point of the economic recovery, companies should announce increased hiring.

Another data point came out on July 29. Estimated GDP growth for Q2 came in much weaker than expected. This may explain why Industrials underperformed for the last weeks of the month. The market is a discounting mechanism and stock prices often lead the headlines.

Development #3: Investors’ Sentiment

Investors are still too optimistic. AAII Bullish Sentiment is not at panic levels, despite recent declines, according to Bespoke. Markets are at risk to decline further when investors are complacent.

Should the US economy indeed continue to weaken, expect a “QE3” discussion to start after the summer, which could support stock prices.


“Yields rise in Italian bond auction” Guy Dinmore, Financial Times 7.29.11 http://www.ft.com/intl/cms/s/0/439241fe-b908-11e0-bd87-00144feabdc0.html#axzz1TUw55ya6

“Bullish Sentiment Drops on Debt Concerns” Bespoke Investment Group 7/28/11 http://www.bespokeinvest.com/thinkbig/2011/7/28/bullish-sentiment-drops-on-debt-concerns.html