Monday, January 4, 2016

New Year and the Stock Market

Happy New Year. Although today is the first trading day of the year, markets opened at negative 300. From a such a negative opening its very hard to make a come back and close in the positive territory. And market declines on the first day of the year, odds of a losing year are at 50% based on historical data (link).  

At Understand, Survive and Thrive, we suggested that the market has undergone a trend change back in September (link).  However, we suggested that shorting opportunity is not here, and we should wait for a market rally. Experience shows that markets rally after a sharp decline for two reasons:

  1. To entice weak hands into the market as buying opportunity
  2. To shake shorts who were early to the game
Once the mood changes, markets start their decline phase, which is persistent. At this point, the possibility of a prolonged decline has increased sharply. In fact, several of the high fliers like MSFT, NetFlix and others are down big today, which shows that the leadership is now leaving the market.

This is also evident from the structural integrity of the market. Stock market patterns can provide very valuable insights into the performance of a particular stock or the over all market. We discussed in December (link) that the market is tracing out a Head and Shoulders pattern, which symbolizes potential trend changes. That pattern is still in plan. But now another Head and Shoulders pattern is visible in Nasdaq (shown below).

Once this pattern is completed, which is almost complete, we can see a sharp sell-off to the downside. This could take the prices down to prior base level i.e. potential 6%+ decline from current levels.

One might ask what can cause such a decline. Although there are many reasons that we will read in the news for today's decline, earnings will be the primary driver, which start in 2 weeks. As economy weakens, earnings will dwindle and stock market will follow. So in the situation what an investor must do?

Following are some of the strategies that we are applying to navigate through this situations:
  1. Invest in assets that are in bull markets (Bonds)
  2. Exit longs from stocks
  3. Short indexed ETFs with predefined mix of diversified assets and risk mitigation startegies
  4. Keep powder dry for upcoming bull markets in other asset classes

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