Why you should hold cash now
The markets have rallied nearly 50% off their lows, but the last two weeks have been decidedly slower. Are we about to correct back downwards? How severe will it be? I’ve been more focused on bottoms-up fundamental stock ideas over the last few months, but having made a few purchases these last few months and making some of my losses from 2008 back, it’s hard not to feel the temptation to count your blessings, sell in May, and go away. Maybe this year, more than ever, is the year that said mantra will protect your portfolio from all that could go wrong.
I don’t make a lot of my purchase and sale decisions based on broad market technical analysis, but I do believe that it can be somewhat helpful in trying time your asset allocation decisions.
Taking a look at the above year-to-date chart for the S&P 500, we see signs of what seems to be a profound reversal in trend. The index bounced powerfully off March lows to trade back across its 50-day moving average. At this point, the uptrend decelerated but continued in expected fashion until closing today.
Interestingly enough, today’s close and likely subsequent moves in the stock market will signal several technically significant tests of trend. The green trendline above represents the near term trend, breaching this support is less significant to long term investors, but could signal a deceleration in the pace of the stock market’s recent rebound. As there is no obvious new high, higher low which connects our last low to current interim highs, it’s difficult to say for sure where long term support ought to hold.
Without the benefit of a long term continuum, the only clear indications of support and resistance can be found using the 50-day and 200-day moving averages. In my opinion, the recent cross above the 200-day moving average is decidedly premature as the 200-day moving average has not yet inflected to form a right-side trend (upwards). Instead, true support is probably somewhere closer to the 50-day moving average, though it is fast approaching a potential bullish cross.
What does this all mean? Well, it seems we’re at a “crossroads” in market sentiment. The appreciation in the market since the brief pullback in May has been on lower volume and lower relative strength as well as an increasingly bearish looking cross in MACD. The implication here is that for the last month we’ve been the beneficiaries of residual overbuying likely to give way to selling pressure at some point.
Will the market eventually crack down? It’s hard to say, but it would seem that at least in the short term, the S&P 500 is vulnerable to shock. The real question is whether or not support will hold. A prudent investor would likely have been taking the opportunity to lock in gains and improve his cash balance so as to capitalize on opportunities when a correction eventually takes hold. Unlike the swift and relentless pullback we experienced in September and October of last year, technical indicators have provided more than adequate warning of a potential downturn in broad market action.
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