I feel strongly that one of the keys to longevity in the business of investment management is having a repeatable process. I start each week with a review of the state of the big-picture environment. I then review the current trend and the degree of momentum behind the move.
Next, I look at the potential for a countertrend move to develop via our Early Warning Indicator Board, which is designed to suggest when “the table might be set” for the trend to “go the other way” for a while.
My current take is the odds for a countertrend move to develop are improving but are not yet at what I’d call “table-pounding” levels. And one thing I’ve learned in this game is that the best turning points occur when the stars are aligned on the Early Warning Board.
* Source: Ned Davis Research (NDR) as of the date of publication. Historical returns are hypothetical average annual performances calculated by NDR. Past performances do not guarantee future results or profitability.
View Early Warning Indicator Board Online
I think the key to the current situation is the market appears to be in a “trending” mode, which usually doesn’t favor a mean reversion trading approach.
For example, the indicators are negative. However, one could easily argue that the VIX is in the process of retreating from extreme levels. As such, these indicators could easily stay red for some time yet.
In addition, I believe we must take the current sentiment readings with a grain of salt. The key here is that the state of the virus and the economy appear to be driving sentiment. And with so much uncertainty remaining in these areas, the positive readings could easily persist longer than normal.
Over the years, I have found that reviewing the basic stochastics is a solid way to determine when an index or security may be ripe to “go the other way” for a while. I like to keep it simple here by using a 14-day %K (with 1-day smoothing) and a 3-day %D. It’s not fancy, but it tends to be an effective tool for an oftentimes complex subject.
S&P 500 – Daily
In my humble opinion, playing countertrend or mean reversion moves is more art thanscience. The key point is to recognize that overbought conditions do not always lead to immediate selling. Yes, in time, all overbought conditions are relieved. However, it is the timing of these moves that can be difficult.
It is for this reason that I play the trading game differently during what I call “good overbought” conditions. I’ve learned over the years that when the market becomes entrenched in an uptrend, stocks tend to get overbought and stay overbought for extended periods of time. During such cycles, it generally pays to resist the urge to sell into strength and instead, give the bulls the benefit of any/all doubt.
Therefore, my takeaway from our “early warning” review is consistent with my view of the other indicator boards. My plan is to (1) stay seated on the bull train as long as investors large and small continue to discount better days ahead for both the virus and the economy, (2) stay focused on the leaders, and (3) be prepared for any changes to the virus/economic outlook.
Thought For The Day: “The way to get ahead is to overdeliver. Expand the organization’s expectations of you and exceed them.”
– Jack Welch