Editor’s note: Beat the Bell editor Serge Berger will be filling in for Sam Collins until May 26.
Before I get started with today’s morning missive, allow me to thank Sam Collins for the opportunity to fill in for him while on his well-deserved respite. I am looking forward to sharing my daily take on the markets and will do my best to fill his big shoes.
It has been a while since I shared my vibes with Sam’s loyal audience, so let me start with the bigger picture and then narrow in on the here and now.
Trading in U.S. equities thus far in 2015 has been choppy, and while there have been pockets of strength, without meaningful participation from important groups like financials and transportation stocks, the low-momentum sideways shuffle will likely continue.
I always iterate to my clients and readers that choppiness in markets, however ultimately, leads to better directionality. So, during these times, it is best to take a step back, do less, and, more importantly, raise cash.
One of my mentors at JPMorgan Chase & Co. (NYSE:JPM) used to remind me daily that going to cash is as important a decision as any other from a portfolio management perspective. In other words, cash is also an asset class, and while not a high-yielding one, sitting in cash does allow traders and investors to stay out of trouble and to look at markets in a less biased way.
Throughout 2015, I have been operating with an average of 50% in cash, which hasn’t kept me safe from the chop entirely, but it has been a solid hedge.
Over the past 17 years as a market participant, I have noted that equity volatility usually follows volatility in other asset classes. Looking at the past 10 months or so, here is what we saw:
— Commodity volatility began to pick up in the summer of 2014.
— Currency volatility also picked up in summer 2014 as the U.S. dollar embarked on its major rally.
— Interest rate volatility picked up in a major way in early 2015.
Equity volatility will almost certainly start rising more meaningfully, which is another way of saying that stocks are likely to come under pressure.
To that point, on the chart below, I plotted the S&P 500 in blue versus the CBOE Volatility Index (VIX) in red.
The obvious takeaway is that the spread between the two has been very wide, on a historic basis, for some time. This gravity-defying move will likely see at least some degree of mean-reversion in the not too distant future.
The VIX has already begun making a series of higher lows since the summer of 2014. While that’s not a reason to head for the hills yet, I would be remiss not to point it out.
In the latter part of a cyclical bull market, which I believe we are currently in, small-capitalization stocks, as represented by the Russell 2000, can be used as a leading indicator for when the broader stock market may be ready to roll over.
I often discuss the importance of understanding both the absolute and relative picture or risk missing out on an important part of the equation. To wit, on the ratio chart below, I divided the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) by SPDR S&P 500 ETF Trust (NYSEARCA:SPY). It shows the relative weakness of small caps and a first important line of support broken.
This also isn’t a reason to sell everything and hide under the covers, but take it for what it’s worth — another piece of the puzzle that points to a tiring U.S. equity market that could ultimately see a 10% to 20% correction.
Moving on to the here and now, Wednesday’s trading action in the S&P 500 was once again lackluster as the index gave us another failed rally attempt.
The choppiness in recent months makes it almost pointless to watch it on a day-to-day basis, unless you are a day trader. I have been and continue keeping it simple in the S&P 500.
A break above 2,120 on a daily closing basis would give the index a better chance of stringing together a final rally toward 2,150-2,200. A break below 2,065 on a daily closing basis may signal the S&P 500 has topped out and risks falling to the next downside target closer to 1,990-2,000.
Until either of those scenarios develops, traders and active investors are likely best off nursing a healthy cash position in their portfolios.
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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