Covestor model: Technical Swing
Though stock prices gained slightly in the month of March, the markets recently have been sending out warning signs – for example, small cap stocks have been underperforming their larger peers. Also, copper prices turned sideways and a declining number of stocks participated in the rally.
In the past four years, copper has been a great leading indicator for stocks. So has been market breadth: indices often turned lower after stock participation dropped.
On the other hand, there are also positives. Technically, the S&P 500 established a stable uptrend and short-term declines have been limited so far; buyers have been stepping in on every minor dip. Most important: leading stocks continue to lead. Even a high flyer like Apple (AAPL), which has gained over 60% since last December, acted well in March. As long as these market leaders continue their strong price action, the bull market is fundamentally intact.
On a sector level, prices kept diverging, which is not necessarily a bad sign: financials, technology and consumer discretionary stocks acted very strong, while energy and basic materials demonstrated relative weakness as a result of a stronger dollar and declining demand from China.
The markets are all about expectations. Most participants, including me, expect a moderate pullback, which hasn’t materialized so far. Stocks tend to surprise the majority of investors, which is a thought I discussed in earlier reviews. From this standpoint, we should not see lower prices in the near term.
The fundamental environment for stocks is still positive: Fed Chairman Ben Bernanke confirmed the outlook for low interest rates for months or even years ahead. Speculation about China cutting interest rates will be starting soon or has even been started. Europe is a mess, but is also keeping a loose monetary policy. With the US in economic slow recovery mode, there is almost no alternative to investing in American stocks.
From a trading perspective, I was playing it safe in March by actively hedging with various short positions. These trades didn’t really gain in value and I was quick to close these shorts when they went against me. Since small caps underperformed, the inverse leveraged Direxion Daily Small Cap Bear 3X Shares (TZA) was my favorite hedging vehicle.
Risk management, hedging operations and significant market rotation of leading stocks resulted in a relatively high number of trades in the model portfolio. My goal is to trade less, but trading activity is higher at potential market turning points and past model performance has demonstrated the validity of the approach. So I’m not overly concerned.
One has to stay unbiased and follow the moves or the market, which is why I’m reluctant to formulate outlooks. Statements like “stocks will trade higher in April” are academic exercises. What I can do, however, is to watch out for signs in the market that certain themes might start to play out.
One issue which could gain traction in the upcoming quarter is China: should the government indicate it will start cutting interest rates, basic material and energy could be the leading sectors in coming months. As usual, I need to see technical conditions improving before starting to trade stocks of these sectors. A good indicator to watch in this context will be copper prices.