Doubt

stock market

At the start of the year, I was reasonably bullish on the market. In the first Crisis & Opportunity update of the year, on 4 January I made an educated guess on where the market might go:

…the market looks bullish as we head into 2017.

Yesterday, Aussie stocks hit the highest level since June 2015. The rally since the “Trump reversal” has been swift and strong. A correction shouldn’t come as a surprise in the next few weeks or so, but don’t mistake it for anything more than that.

This market looks and feels like it is heading higher. The key test will come at 6000 points. This was the resistance level from the early 2015 peak. If the market really is bullish, you could see the index head straight to 6000 before putting in a decent correction.

That’s about as much of a prediction as I’ll make for this year. That is, a rally to 6000, then a good correction, before another rally through that level a few months later.

That prediction worked out, sort of. Although the market is still struggling around the 6,000 level at the moment.

That has me wondering…is the market topping out for the time being, or is it consolidating before another move higher?

It’s an important consideration.

When thinking about your longer-term strategy, the first question you should ask is, are we in a bull or bear market?

In a bull market you should be nearly fully invested. In a bear market, you should have plenty of cash.

At the start of the year, I was pretty confident we were in an ongoing bull market.

Now I’m not so sure. My conviction is waning.

Before I explain why, I want to make the point that doubt is good. I am often in doubt. Actually, I’m nearly always in doubt.

Being this way constantly makes me think about my assumptions. It makes my thought process more robust.

I am currently reading Deviate: The Science of Seeing Differently. It explains why those who doubt are often seen as indecisive or weak:

“Not knowing” is an evolutionarily bad idea. If our ancestors paused because they weren’t sure whether the dark shape in front of them was a shadow or a predator, well, it was already too late. We evolved to predict.’

But doubt is actually a good thing:

Nothing interesting ever happens without active doubt. Yet doubt is often disparaged in our culture because it is associated with indecision, a lack of confidence, and therefore weakness. Here I will argue exactly the opposite. That in many contexts, to “doubt yet do…with humility”…is possibly the strongest thing one can do.’

With that self-justification out of the way, let’s examine the bull or bear case.

Look at the charts

The best way to try and resolve doubt, as far as I know anyway, is to look at the charts. Remember, it is not what you think that matters. Rather, it’s what the market thinks that really counts.

If you think that a bear market is about to begin, yet the market continues heading north, who loses? You do.

So let’s have a look at ‘the market’ — a chart of the ASX 200. Below is a weekly chart going back five years. The weekly chart does a good job of showing the longer-term trend.

AU:XJO Weekly 13-12-2017


Source: BigCharts
[Click to enlarge]

There are a few things to note here. The long-term trend, as shown by the moving averages, is up. That’s a positive.

But it is running into long term resistance at 6,000 points. Until it clears this area decisively, you have to be cautious about a correction unfolding.

What makes me cautious right now is the current level of bullish and optimistic global sentiment.

While I don’t think we’re at a 2006/07 level in sentiment — or a 1999 — people are getting a little excited. That’s a concern.

It makes me think that perhaps a correction isn’t too far away. And looking at a chart of the S&P 500 since the bull run started in 2009, the chances of a decent correction unfolding soon don’t look that absurd (see below).

S&P 500 Index 13-12-2017


Source: Optuma
[Click to enlarge]

But as I say, it doesn’t matter what I think.

So let’s zoom in and take a shorter-term look at the market. Here’s a chart of the ASX 200 over the past year (below).

Also, keep in mind that the ASX hasn’t enjoyed a strong run like the US market.

Right now, the picture remains bullish. After going sideways for the best part of the year, the market broke higher in October, and is now consolidating around major resistance at 6,000 points.

AU:XJO Daily 13-12-2017


Source: BigCharts
[Click to enlarge]

With both the short- and long-term charts suggesting a bullish picture, probability suggests the market will continue going higher.

However, we should also take the fundamentals and bullish investor sentiment into account. And in my view, they’re suggesting that the risk of a short-term correction is rising.

In short, I think we’re in a secular (long-term) bull market, but are at risk of experiencing a cyclical (short-term) bear market.

While ever the ASX 200 struggles to get through and stay above 6,000 points, that will be the framework I use. If the market pushes beyond 6,000 decisively, I’ll know I’m wrong and the probability of a cyclical bear unfolding will have diminished.

What this means for you

Considering the bear might raise its head in 2018, what does it mean for your investment strategy?

It means continuing to pick stocks that offer fundamental value, have specific or unique growth prospects, or are cheaper than ‘the market’.

In a cyclical bear market, the stocks that tend to suffer the most are the expensive stocks with too much optimism priced in. The out-of-favour value stocks tend to outperform.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity

Editor’s note: The above article is an edited extract from Greg’s premium investment service, Crisis & Opportunity.

Greg Canavan

Greg Canavan

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Port Phillip Publishing.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

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