WASHINGTON. Opining on the future direction of the stock market in Q4 2018 is about as rewarding as being a fervent Trump supporter in New York City. Whether you’re right or wrong or simply middling, you’ll still never get any credit for what might go right and all the blame if anything heads South. Upside-down, right-side up or sideways, stocks in nearly all sectors take off in unpredictable directions during every single trading day. It’s roller-coaster investing at its worst.
We’re in a roller-coaster investing environment
Making matters even more depressing, every exciting rally since roughly Labor Day habitually gets erased and then some by successive vicious bouts of selling. There’s still a lot of good news coming on the economy, and a majority of stocks have continued to outperform as evidenced by Q3 earnings season reports. But what the heck, sell anyway, right?
Stocks today trade almost purely on headlines – mostly and purposefully negative these days. And the daily chaos of rotten headlines, which, only occasionally are backed up by actual facts, tends to drip, drip, drip on delicate emotions. Investors get more and more frightened. Ultimately, they’re terrorized beyond their ability to retain a rational investing approach.
This, in turn, results in wave after wave of panic selling. In other words, roller-coaster investing. Investors have, at least for now, moved on from the twin BTD (“Buy the dip”) or BTFD (“Buy the effing dip”) mantras. In turn, their replacement mantra – STR (“Sell the rally”) now finds itself in the driver’s seat. In real life, I avoid roller-coaster rides at all costs. But when I’m trying to make money in stocks and encounter a roller-coaster investing environment like this one, it’s just a sickening to me as a real roller-coaster ride.
Picture the madness in the charts
Note the craziness of the regular-way McClellan Oscillator chart as of COB 11/12/2018. Extreme peak or valley moves generally provide accurate buy or sell signals, at least short term.
As you can plainly see, these inflection points have been quite extreme since Labor Day and they continue in that vein, indicating a treacherous trading and investing environment.
Meanwhile, the VIX, a volatility measure, seems to be trending down, although it remains at elevated levels. That’s easy to see in the following chart.
The VIX measurement would indicate that traders have gotten much of the panic (and tax-loss) selling out of their collective systems. But they’re not yet calm enough to give us a more placid, and less volatile VIX.
Conclusion: We’re not quite in a correction yet (except maybe for tech), but we’re going to get there if things don’t settle down soon. (And arguably, techs, particularly Amazon [AMZN] and Apple [AAPL] are already in correction territory.)
Losing your grip? Read this:
As investors and institutions lose their collective grip, we’re seeing the dismal results, which David Keller notes in his short article entitled “When Emotions Take Over.” I offer an excerpt below, which, I believe, is a free, linkable sample from the fine technical investment site Stockcharts.com. So this link should work.
“When a market is selling off and things rotate from more positive to more negative, it’s so easy to get caught up in the emotions when faced with a potential loss of capital.
“Daniel Kahneman won a Nobel Prize for his work developing Prospect Theory, which essentially says that we hate to lose much more than we love to win.
“This loss aversion is what causes us to make all sorts of mental errors, from holding on to our losing trades to selling way too early.
“The best way to combat the emotions of the markets is to look at the evidence, derive the conclusion, and make the necessary changes.
“When I look at the evidence, I see the S&P 500 selling off from resistance, defensive sectors outperforming offensive sectors, and growth underperforming value.”
How negative divergence looks when the bears take over
Keller offers the following chart as an example of this phenomenon, which pits a pair of representative ETFs – the Consumer Discretionary (XLY) SPDRS and The Consumer Staples SPDRS (XLP) – against one another, illustrating the divergence of this pair via a performance ratio that skews increasingly negative in the final third of the chart. (I’ve truncated it here, so it would fit.) This effectively illustrates his final point. It also provides us with a clue about what active individual investors might consider doing at this point late in 2018.
Currently, the only sectors that are only two of them reliably holding up the waning cyclical bull market. The widely-followed S&P / Wall Street Journal index system defines them as Consumer Staples and Utilities. The former are stable in the sense that if a key household appliance (or equivalent) gives up the ghost, you have to buy another one, like it or not. Ditto your utility bill. Ignore it and see what happens. Both tend to function like death and taxes.
Defensive maneuvers in a market that looks scared to death
I continue to pare back on some minor disasters in my portfolios. But I see no point in dumping perfectly good stocks given reasonably promising quarterly estimates. Same thing for large sector ETFs, since they’re less volatile and, of course, my stable of generally okay preferred stocks.
These stocks – senior to a company’s common stock pay a regular, pre-determined dividend. That’s generally true even if the common shares’ dividend gets cut. They tend to behave in a stable way. But these stocks, like bonds with their fixed coupons, can suffer some price erosion when the Fed is getting aggressive with interest rates.
But in the main, the preferreds in my portfolios haven’t eroded much.
In the past, I purchased mostly “term preferreds.”
Term preferred stocks offer fixed redemption dates that often occur in the relatively near future. This limits the interest rate risk, making them less sensitive to interest rate hikes.
The problem here is that it’s increasingly tough to find these preferreds. If you can find them, you’ll usually find them overpriced.
Different preferred stocks act in different ways
More common today are “perpetual” preferreds or perpetual “floating rate” preferreds. These preferred stocks expire, well, whenever (like 2099, seriously). Those with fixed interest rates are hostage to the Fed. If rates keep rising, they could lose considerable principal value over time.
The floating rate preferreds are what they say they are. They start out with a generally attractive, high, fixed interest rate for roughly their first 5 years. Then rates float in a formula linked to a widely-followed interest rate measure like the London LIBOR fix. That should provide some interest rate protection and it makes these issues more popular these days.
We’re mostly sitting tight, occasionally adding tiny increments to our index-based ETFs. We also look with interest at decent preferred stock offerings. We’re not panicking out of stocks, at least not now. But we’re not doing anything to add to our risk profile either.
Our current Wall Street roller-coaster investing environment is a ride that’s just too scary for us right now.
— Headline image: In this 2001 photo, note the crazy corkscrew turn in the Raptor. This famous coaster attracts roller-coaster fans at Ohio’s Cedar Point amusement park. Such paying customers love this kind of thrill ride. But not so much traders and investors enduring similar action on Wall Street. (Image via Wikipedia entry CC 3.0 license)