Topping or Consolidation?

I have a jam-packed day today — Yahoo Finance, Jeff Gundlach’s Doubleline presentation, and the MSNBC’s Dylan Ratigan — but I wanted to  jot a few thoughts down before heading out the door.

The recent sturm und drang about the market pullback has taken me aback. I do not recall ever hearing so much noise about a less than 5% pullback coming after an 18% rally (see chart below).

The noise is rather perplexing. Part of the blame goes to under-invested managers who missed the Q1 rally. I have been there, and know how painful it can be. Indeed, one of the reasons short term trends tend can be self fulfilling prophecies is due to exactly that: Managers with cash to put to work responding to clients questions. There are not many things more powerful than a big client asking their advisor/fund manager “Why are we carrying so much cash with the market ripping higher?

Not ironically, the opposite does not seem to be true. The penalty for being long as the market collapses seems to be less immediate, and more modest than sitting out a monster rally. The behavioral economists note this as “Career Risk.” As markets go higher, most managers eventually get dragged in, kicking and screaming.

I continue to get the sense that many pros are still under-invested. I got a taste of that this week when an ETF holding of ours — a subject of a future post — jacked up their internal fees to what we determined was an unacceptable level. We jettisoned a 10% position across all accounts and found ourselves sitting with an equity exposure of about 50-60% (plus or minus) and a decent amount of cash and bonds. Since then, the market was down 1% and then up 1%. Our balanced portfolios should really be about 70% equity exposure, according to the model portfolio I run.

I am looking at a handful of options to redeploy the capital. I do not feel any compulsion to put the money to work immediately, and if the market comes in further it will be more appealing. Given the FOMC backdrop, the near term downside (90 days) is probably limited to 15% pullback. That number has been precisely determined by me through a highly technical and sophisticated technique known as “guessing.”

Which brings me to the headline of this post: Topping or Consolidation? Using the same insightful technique as above, I place the odds that we are consolidating at 65% and that we are topping at 35%.  My working assumption is that we will produce some more clarity from numerous factors, including market internals, over the next few weeks. I reserve the right to change my mind as new data comes in, as that will impact an even more sophisticated technique of “Quantitative Guessing” — which has worked out so well for the Fed.

Back shortly . . .


Market Swings, July 2011 – Present

Source: The Chart Store


Consolidation versus Crash (April 10th, 2012)

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