Broker Check


September 09, 2020

ALMOST LIKE CLOCKWORK…but it can’t be that easy…

In our blog posted August 10th we talked about a contradiction of sorts between fundamental data and technical data.  The technical look to the markets was hinting at more gains for the next couple of weeks or at least days, and that’s precisely what happened.

The price action on the S & P 500 since early August felt like a classic ‘blow-off top’.  A blow-off top is when stocks break through a technical level and become extremely over priced in a matter of days, and upward momentum seemingly cannot turn around.  The blow-off portion comes from the fact that these tops are generally followed by sharp declines across the board, especially in the stocks that just days earlier would not stop going higher. 

Like clockwork, this blow off top coincided with a weekly RSI (relative strength index) overbought condition of approximately 70 and a daily RSI overbought condition of approximately 80.  The last time we saw similar signals was right after the New Year before the beginning of the pandemic market correction first began.  Because we were watching these technical signals, we were cautious when others were elated!  

We’re not saying we have a crystal ball, but we’re saying that it pays to manage risk differently at certain market signals ie. taking on more risk when others are fearful, and reducing risk when others are greedy (to quote Mr. Buffett).  Now our eyes turn to the questions:  how far can this correction go downward? How long?  and what types of investments do we like at cheaper prices than they were trading at just a few days ago?  In other words, it is always smart to have a short shopping list put together before you actually walk into the store. 

In terms of what we think would be healthy, probably an additional 3-5% (considering that as of the close on Sept. 8th the S & P 500 has already sold off 7%).  In this pocket, we’d begin to find individual securities that were attractive; however, if the previous market corrections are any indication of the type of volatility we can expect for this pullback…we would not be shocked to see larger declines.  We’d view a more disorderly/emotional pullback in the neighborhood of an additional 10% to really reset the markets sentiment. In layman’s terms, we feel the market went down too much during Covid19 (Feb.-Mar.) and has now gone up too much post Covid (April - Aug.).  Somewhere in the middle would set up a better foundation to actually access what types of prices and multiples stocks should warrant given their potential for growth in the new economy.  

For a Refresher on RSI :