Stocks: Be Prepared, But Not Time To Overreact

Slowing Momentum Fundamentally & Technically

The stock market is trying to figure out if the Fed can pass the baton to the economy. Recent hesitation in stocks speaks to the market’s still tentative outlook for earnings and economic growth. Monday delivered a mixed message in terms of economic data. From Reuters:

Two measures of activity in the U.S. services sector showed slower growth in December, pointing to an economy that continues to expand at a modest pace, while factory orders rose in November. The pace of growth in the U.S. services sector slowed for a second straight month in December with business activity expanding at a lower rate and new orders contracting, according to the Institute for Supply Management. Separately, financial data firm Markit said its services sector Purchasing Managers Index eased slightly from the prior month, slipping by 0.2 point to 55.7 in the month.

An Ounce Of Prevention

On January 3, we showed how many years of stock market gains can be wiped out when the big bad bear finally arrives. We also noted the market’s current bullish tolerance for risk says a correction appears to be more likely than shifting into a full blown bear market. Consequently, it is prudent to work on our correction plans while the skies are still blue. This week’s video covers the 2010 Flash Crash in a “how can it help us in 2014?” context.

After you click play, use the button in the lower-right corner of the video player to view in full-screen mode. Hit Esc to exit full-screen mode.

Video

Video

Earnings on Deck

Markets always look for the next possible cause of a bull derailment. With the Fed meeting behind us and New Year’s confetti cleaned up, earnings are on deck. From The Wall Street Journal:

Alcoa unofficially kicks off earnings reporting season later this week, when the former Dow component posts fourth-quarter results after Thursday’s close. Sam Stovall, chief equity strategist at S&P Capital IQ, said expectations for earnings growth is about the same as at the end of the third quarter, which he believes is a positive for the market. “It’s nice to know that the starting number, that is usually improved upon, is equal to the third quarter,” Mr. Stovall said. “If history holds true, reality will end up being better than expectations.”

Having A Reference Point

One of the most difficult things for investors is pulling the trigger to make allocation changes when market conditions begin to deteriorate. Drawing lines in the sand can help. For example, using the daily chart of the S&P 500 below, one might say, “I will cut my stock exposure by 5% if the S&P 500 closes below 1827.” One takeaway from the chart below is that numerous forms of possible support come in between 1775 and 1827.

Investment Implications

Last week, our market model detected relatively minor, but noticeable deterioration in the market’s risk-reward profile. Consequently, we reduced our exposure to stocks in many client accounts. If the S&P 500 fails to hold at the support levels shown in the chart above, the model will call for further incremental reductions in equity exposure. For now, we continue to maintain positions in U.S. stocks (VTI), financials (XLF), energy (XLE), small caps (IJR), Europe (FEZ), and global stocks (VT). We will let the market be our guide, given the somewhat vulnerable state of stocks and the economy in the short-run.


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