We are five months into 2014, and from the weekly conversations I have with smart money investors, I can tell you most of them have had a difficult year so far.
While there are many “styles” investors can apply to pull money out of the markets, most of them require the markets to move directionally or show some sort of volatility.
The majority of investors are long biased. So far this year, the S&P 500 is higher by 4%, but the going has been both choppy and slow, i.e., low volatility. Small-cap stocks are underperforming, with the Russell 2000 down 3% year to date. Then there was the correction in momentum favorites such as social media and biotech stocks, among others, which blew more than a few holes in investors’ portfolios. All of this has made for one tricky market.
For a little perspective, the current cyclical bull market, which was born out of the abyss in early 2009, is currently five years old. Historically, five years is a long time for a cyclical bull market. That is why I think we are in a topping phase that, among other things, is classically marked by the relative underperformance of small caps.
The CBOE Volatility Index (VIX) currently trades near the lows of its multiyear range, yet investor sentiment is nowhere near as bullish as it should be for a cyclical bull market top.
Looking out a few weeks to a few months, we would expect to see a further rise in the S&P 500 and a slowly rising VIX to create a divergence between the two. This would be more typical for the top of a cyclical bull market.
The S&P 500′s breakout past the 1,900 mark in late May does not have the look of a fake-out breakout that will reverse any time in the near future. Rather, the index coiled up below the 1,900 area for several months, which allowed its various sectors to build up power.
Additionally, the S&P 500 is made up of plenty of defensive stocks, which can keep the index afloat while big investors move from cyclical stocks into safer names. My upside target for the index is 1,970, which I expect to be reached in the latter part of June or July.
The trick to this current market environment is to understand that it is no longer possible to make money simply because the entire market is lifting higher. The importance of selectivity among sectors, industries and single names has dramatically increased.
Most important, however, is patience. Traders and investors who can show restraint during this choppy market and focus only on the highest probability setups will most likely outperform their peers as well as the broader indices.
Case in point, this week the big event will be Thursday’s ECB interest rate policy meeting. Until the announcement, it is likely a game of sitting on our hands. Those trying to force trades ahead of Thursday will likely fall into the category of overtrading, which more often than not, has unpleasant consequences.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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Download Serge’s trading plan in the Essence of Swing Trading e-book here. As of this writing, he did not hold a position in any of the aforementioned securities.