US markets have sold off since Tuesday’s election. At this point I’ll take a politically neutral stance and repeat what I said before the election. The market wanted to see a “mandate” win. And while the electoral college spread was fairly wide, the popular vote was very close. It is now a wait and see game on whether the Republicans feel as if they had enough support to threaten blockage of any tax increase proposals to deal with the fiscal cliff. Or if they feel the better strategy is to acquiesce to the victor. Until this issue is resolved the markets will probably stay unhappy.
In addition, with 24/7 election coverage over, there once again has been a realization that we are not alone in the world. Europe is back to the forefront as well as the Middle East and China.
Last week the S&P 500 breached its 200 DMA and closed just below that level. As a function of our strategy and remaining disciplined to that strategy we expect to start the process of taking defensive action in accounts if it looks like the market will close below the 200 DMA consistently this week.
As a side note, I have said repeatedly that the specific strategy that one uses to trigger defensive action isn’t crucial because no single strategy can be the best for all occasions but they can be reasonably effective in protecting against large declines. For example the RBS Trendpilot funds take action after five days below the 200 DMA, Jack Ablin from BMO waits until the SPX goes 5% below the 200 DMA. Our actual sell signal uses the SPX Total Return Index which adjusts for dividends reinvested in the index. This too gives us a delayed signal.
In terms of thinking about what sort of defensive action to take, a reason to give the market the benefit of the doubt and not get too aggressive is that the 200 DMA is still sloping upward and likely to do so for quite a while yet. One reason to not give the market the benefit of the doubt is that in terms of normal cycle duration (both for the economy and the stock market) we are late in the cycle. There is no way to know with certainty if we are at the end of the cycle but by definition if it is late in the cycle then it is close to the end of the cycle.
Right here right now there is no way to know if the market is on the verge of going down a lot. We may all have an opinion, or not, and some will be right and some will be wrong. Being right is far more difficult than the simple action of sticking to whatever strategy was laid out before the market started going down. The idea there is that a strategy laid out before the market started going down was done so with no emotion involved. Anyone may or may not have an emotional reaction but the important thing is not succumbing to the emotion, all that needs to be done is to remain disciplined and we all have more control over that than being correct right now about whether this is or is not going to be a large decline.
Hopefully the market will take back its 200 DMA this week and we won’t have to deal with this now but the important thing is the no matter what we might want we will take action consistent with being disciplined to our stated strategy. I will disclose any defensive action we take on the blog.