Why Everything You Know About Asset Allocation Is About To Change

In this week's stock market video:  

  • The single best signal.
  • Your pie chart may disappoint in the next 20 years.
  • My bonds seem to be acting differently. 
  • The lure of past balanced portfolio performance.
  • Has diversification worked well in 2018?
  • It’s all we know (recency bias).
  • Haven’t seen anything like this in 35 years. 
  • The market has changed and we may have to adjust significantly. 
  • The real world 1926-2018 vs. perceptions.
  • Is bullish momentum waning?
  • Should we be concerned about breadth? 
  • But, we are near all-time highs.

Overthinking Singular Outcomes

BREAKOUTS CAN SUCCEED OR FAIL

We all want a clean breakout and then a push higher. Unfortunately, that is not how it always plays out in the real world.  A successful retest of a breakout attempt can (1) drop back and stay above the orange boxes, (2) drop back to the orange boxes, or (3) drop back into the orange boxes before pushing higher.  On a successful retest, the important common factors are (a) breaking out, (b) dropping back toward the box in some fashion, and (c) making a higher high above the most recent previous high. In the real world, there is no neat textbook definition about what a successful breakout looks like.

short-takes-breakout-a-17-2.png

ONE EVENT vs. WEIGHT OF EVIDENCE

Since, in the short run,  it will have little impact on the bigger (and much more important) picture, experience says overthinking breakouts tends to be a distraction.  No single event makes up the weight of the evidence, including the outcome of a breakout attempt.

short-takes-breakout-a-17.png

SO FAR, SO GOOD

Heading into Wednesday’s session, the breakouts on both versions of the S&P 500’s daily chart are holding.  All things being equal, bulls would prefer to see them hold.  However, if they fail, it will not significantly alter the bigger, and still constructive, longer-term outlook.

These comments apply to our approach and our timeframe.

“We cannot solve our problems with the same thinking we used when we created them.”
— Albert Einstein

The Bigger Picture

NOW vs. THEN

The S&P 500 peaked 185 days ago on January 26, 2018.  As shown in the chart below, the S&P 500's 200-day moving average (red) has a positive slope, the 50-day (blue) has a positive slope, and the 50-day is above the 200-day.  The 50-day moving average recently printed a new all-time high.  The facts we have in hand as of 1:25 pm ET on July 30 tell us the intermediate and long-term trends remain favorable.

short-takes-ccm-ciovacco-spx-july-2018.png

The chart below shows the S&P 500 185 days after the October 2007 peak.  The S&P 500's 200-day moving average (red) had a negative slope, the 50-day (blue) had a negative slope, and the 50-day was below the 200-day.  The 50-day moving average had recently printed a new low.  The facts we had in hand 185 days after the 2007 peak told us the intermediate and long-term trends were both unfavorable. If we compare and contrast the 2018 chart with the 2008 chart, we can see they really do not have anything in common. 

short-takes-2008-spx-185-days.png

FIVE MONTHS OF POTENTIAL SUPPORT

The expression "what once acted as resistance may now act as support" tells us the S&P 500 has numerous bands inside the orange box where buyers may decide to take action.  The green horizontal bars show volume by price, which can help identify areas of stronger potential support.  

short-takes-2008-spx-185-days-2.png

ONE CHART SUMMARIZES MANY THEMES

This week’s video uses a present-day chart to revisit and recheck several major themes, including:

  • Outlook for stocks vs. bonds in the years ahead. 
  • This will end badly.
  • Demographics.
  • How markets work in the real world.
  • How about small caps?

PROACTIVE INSTEAD OF REACTIVE

As outlined on July 20,  we want to make decisions based on the weight of the evidence from multiple timeframes, rather than reacting to red screens and negative signs.