April 28th, 2010

Nothing Warrants Wholesale Liquidation …… Yet

The one thing coming out of the Goldman Sachs inquisition yesterday was consensus that the most perfect trading strategy for hedging against risk in any asset class is to sell that asset. I also came to this realization while assembling the parameters for my Market Timing Indicator.

[I later compared against the more traditional 300-DMA to the MTI only to discover that both generated very similar results as market timing indicators. Ever since the beginning of the Financial Crises and ensuing Bear Market Crash in 2008, I’ve periodically recommended an all-cash position based on these indicators.]

Our anxieties grow day by day with news about the financial industry reforms winding their way through Congress, our anemic economic recovery churns on and the financial troubles in Greece, Portugal, Spain and Ireland rattle world markets. We fear a “double-dip recession and sliding back into another market crash before we realize it. We try to figure out what it all means to stocks, our economy, different industries and the competitive standing of the $US.

But when we try vainly to outsmart the multitude of economists and Wall Street pros in figuring out the effects of these complex forces, we only delude ourselves. Our knee jerk reaction is to flee from our angst by dumping stock in frustration.

Alternatively, we can let the market itself tell us if and when, based on historical precedent, the preponderance of evidence indicates that supply has overwhelmed demand forcing market momentum to turn down. That’s when we will need to move into cash. For now, we need to take a reading on these indicators to see how much leeway we actually have.

The following are statistics gathered from 40 years of daily closings of the S&P 500:

According to the MTI statistics covering nearly 40 years of trading days, the 300-DMA was the top moving average of the four (300-, 200, 100- and 50-DMA) only 20% of the times. When that happened, it would have been best to be all in cash 81% of the time; the only times it wasn’t was when the Index itself remained above the 300 and 200-day MA’s.

But what about situations like today’s market? Under what conditions was it better to be in cash than stocks when the 50-DMA is still the highest of the four moving averages. When the 50-DMA was the top moving average, as it is today, the only time an all-cash position (bear market) was indicated was when the Index itself had crashed below all the other moving averages. In today’s situation, that would required the Index to be below 1000. The following depicts the situation after today’s close:

I may be saying this as much for my benefit as for yours but even though the market has been frustrating, perhaps even frightening, and the significant correction all are awaiting may now be on the horizon about to cause some serious declines in value, nothing yet warrants a wholesale liquidation of holdings.

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