As communicated in my post last week, the stock markets were overdue for a rally. And as expected, we rallied for the fourth day in a row today. What distinguishes today’s rally from the previous three days is that the market has now switched from a downtrend to a new confirmed uptrend. The real tell was the amount of volume traded on the stock exchanges and it was much higher today than the previous three rally days. Thus, today we got what is known as a “follow-through day” in the markets.
Expectations of a Greek bailout, an upcoming great 2nd quarter corporate earnings season (beginning in July) along with lower oil prices have helped improve investor and institutional optimism. Institutions are also facing quarter-end, so they help buy up the market in the last couple of weeks to make their results look better. As you know, we closed out our hedges (profitably) in the middle of last week in anticipation of this rally.
With any follow-through day, there are risks that the rally fails and the downtrend reasserts itself. This is why a follow-through day comes on the fourth day of a rally attempt and no earlier. Unfortunately, it sometimes takes two or more failed attempts before the rally succeeds. In fact, a failed follow-through day occurred most recently on May 31 when institutions sold into the rally the day after the uptrend was confirmed. So while all signals point to a rally in the short term (my guess is that it lasts perhaps 1-3 weeks), we have to be cognizant that markets are on edge these days as we digest the news of a global economic slowdown, the prospect of more European debt woes and the prospect of a delayed extension of the national debt ceiling in Congress.
A new rally is most vulnerable in its first few days and, once those have passed, the chances of succeeding increase dramatically. In any case, volatility and low volume, as I’ve mentioned before, are characteristics of summertime stock markets. So markets are more easily pushed around in this environment.
What this means for client portfolios is that new investments of cash are safer during a confirmed uptrend, which is what I started doing today. But in the current environment, just like with hedges, new investments could turn into short-term trades if the market decides not to cooperate. So even though we are investing for the long term with the majority of the portfolios, a small percentage of each portfolio is invested on a short-term (or very short-term) basis to take advantage of market swings and volatility. This could be hours, days or weeks depending on how the markets behave. In my opinion, proper diversification of portfolios includes both long-term investments and short-term ones as well.
I hope this helps you understand a little better how I’m approaching this market and trying to help manage portfolios. As usual, please don’t rely on my prognostications as a basis for any investment or trading decisions; consult with your advisor or us if you have any questions about how to invest in these markets. My crystal ball remains in the shop, so I’m no better at predicting the future than the next fortune teller. What I do best is act as your risk manager and thereby mitigate the risk of bad things happening to portfolios while enhancing portfolio returns.
I welcome your questions and appreciate your referrals. Happy first day of summer 2011!