As we look back over the past three weeks and ahead to next week, we see risks of not taking off some equity exposure, and the upside potential of staying the course.
1. Open stop loss orders. Some funds and investors sell when a stock or ETF falls a certain amount (a stop loss order) that automatically sells a holding when it loses a certain predetermined percent from its recent high. The S&P 500 is now down 10.3% from its recent high on January 3rd.
Some of the selling we’ve experienced so far could be the result of stop loss orders. If there are large number of stop loss orders open where those percentages still haven’t been met, there could be more selling pressure if the markets continue to drop. We have analyzed this type of protective behavior many times in the past, and it always results in sub-optimal returns. Remember when you sell, you must be right twice: once when you sell, and a second time when you buy back in. This is very difficult to do consistently.
2. Unforeseen event – this risk is always present and there is no way to call it until it becomes more obvious. Right now, we don't see any impending doom scenarios that could drive the equity markets much lower.
3. Bad earnings reports in the next couple of weeks. Big technology firms like Apple, Microsoft, Samsung, and Tesla report their earnings next week along with other large firms like Visa and Johnson & Johnson. The risk here is if these firms miss earnings estimates, the market could sell off further.
1. Tech and other earnings reports come out next week and could be very positive. Big positive surprises could move stock prices higher starting next week.
2. We’re past the bank bad earnings reports. The large banks reported in the previous weeks and the markets were generally disappointed with their results. We’re past this now so hopefully other good news can move the markets higher.
3. The market volatility is picking up which is usually a sign of a bottom. Price and volume volatility are both moving higher which often indicates we’re near a bottom.
4. Open lower and close higher. If the market opens lower on Monday and/or Tuesday and closes higher it could be a sign of buying the dip instead of selling the rally. This would be a potentially good sign for early next week.
5. Stocks early to drop are not falling as rapidly. The stocks that led the market lower at the beginning of this drop are not falling as much now.
6. Technical Analysis. Both the S&P 500 and the NASDAQ100 are at “resistance” in classical technical analysis. It is thought by the technical community that these resistance levels provide a potential floor on stock or index prices.
7. Interest Rates and Inflation. The bond markets have already priced in interest rate increases by the Fed. If inflation begins to cool off as supply chain issues resolve, the Fed could rethink moving aggressively to increase interest rates.
The result of the analysis above shows us there are more positives than potential negatives ahead. This, combined with the fact our metrics are close, but not quite at high danger levels, led us to not make any changes today and instead, decide to see what happens at the beginning of next week.
We know these times can be difficult, but we are paying close attention and will continue to weigh the potential harm of acting against the potential benefits.
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