Searching for value, and coming up “short”
After the giant move higher in most sectors of the stock market, it is hard to find something that screams, “buy me!” Our analyst team tracks hundreds of stocks and ETFs every day, and applies our proprietary rating system to all of them.
That system is primarily based on technical (chart) analysis. And lately, that’s particularly helpful. After all, in this Covid-infested world, can you rely on earnings estimates? Can you assume that companies that have reliably paid dividends will do so in the past? Consider us skeptical.
Why technical analysis?
With technical analysis, we simply listen to what prices tell us. And, if you look across enough sectors, industries, asset classes and stocks, and do so consistently, the market tells you a “story.” Interpreting that ongoing story, particularly at major market turning points, is part of our Hedged Investor process.
When we look at the 11 sectors of the S&P 500, one thing was clear: after 6 months of dramatic recovery from the March lows, all sectors look stretched. Does this mean that the market is likely to fall? No. But it does signify that any reward we seek is accompanied by a higher level of risk than normal.
What we found
There are 11 S&P 500 sectors. We tried to divide them into 4 categories: lower risk, moderate risk, high risk and very high risk. These are intermediate-term ratings, and in a market like the current one, they are pretty fluid.
As it turns out, we didn’t need the first 2 categories. None of the sectors are what we’d call lower risk and moderate risk situations currently. 5 sectors (Basic Materials, Financials, Industrials, Utilities and REITs) appear to be rolling over. But they look better than the other 6 sectors (Communications, Energy, Technology, Consumer Staples, Consumer Discretionary and Healthcare). If the market continues to fade, they are good candidates to be the downside leaders.
Dealing with weakening stock markets, the Hedged Investor way
What are we supposed to do with all of this negativity in the S&P 500 sectors? First, recognize that any analysis can turn on a dime if facts and emotions surrounding the stock market suddenly brighten. Still, our job is to make decisions based on the evidence, not to engage in outright speculation. We’ll leave that to mainstream Wall Street.
There are plenty of other corners of the stock market to explore. And there are the bond, currency and commodities markets. However, as was the case in February, it is very difficult to find the type of strong reward/risk tradeoff we like to see.
And that is exactly why we are hedged investors! Market dips are one thing. Bigger losses that don’t recover immediately are another. The latter is what we are always on the lookout for. And when 11 of 11 sectors don’t inspire us at the moment, that is a sign that more portfolio defense is in order. As a result, our “net long exposure” to the stock market is lower than it has been in a while.
Finding needles in those haystacks
Finally, when good buying situations are difficult to find, look carefully to identify market sectors or segments may present strong, sustainable buying opportunities in the near future. That is the other thing our proprietary scoring system for stocks and ETFs is designed to do.
No investor can predict the future with certainty. And any investment can produce profits at any time. But if you have a consistent, diligent process of separating high-risk situations from low risk, you will always have a fighting chance. Avoid big losses, keep emotions at bay, and stick to the process. That’s what we plan to do, as always.