Some comments from Bob Swanson, our portfolio manager who provides guidance to the team on asset allocation and macroeconomic trends:
We are trying to gauge the potential magnitude of the correction that may now be under way. First, I hope this is the last move we have to endure relating to political shenanigans. We overcame the November sell-off relating to the election, the December drop due to the fiscal cliff, and now the February dip due to the sequestration. I believe this should be a "garden variety" correction of 4 to 7%, not 10% or more, because there has been no indication of financial stress as highlighted below in the Global Financial Stress Indicator. The last correction of 9 to 10% was in May 2012, where the index hit 0.75 and moved above the 200-day moving average. Readings above the 200-day moving average and above the 0.5 level have in the last five years been accompanied by more dramatic sell-offs. While the current reading may be indicative of too much complacency, it does not suggest anything more severe than overbought conditions:
For the last four years, Bollinger bands have done well at providing the upper and lower trading limits of the S&P, being correct 10 out of 10 times on long positions and six out of 10 times on sell recommendations. The last buy signal occurred at 1410 on the S&P, with a more recent sell signal at 1460. Using other technicals, I would put support at the prior high in September at 1460, and if that gets breached, then lower in the 1435 range. This suggests a correction of 5 to 6% to the 1460 level or 6 to 7% to 1430. We have corrected 3% as at the time of writing.
- Bob Swanson
Author's note: As I discussed recently, we had increased our cash positions as the market became extended. We are seeing a number of our preferred names come back into buy territory. In these types of sell-offs, everything tends to fall at similar rates, so we typically use them as opportunities to upgrade our portfolios to emphasize our best ideas – which I believe is a good practice for all investors.