Associated Press
Investors are flailing in this stock market environment, and there’s a clear reason why.
The Dow Jones Industrial Average today fell 1.7%, and the S&P 500 Index declined 1.3%. Industrial, materials and technology shares led the market lower as the 10-year Treasury yield briefly rose to 3% level for the first time in four years.
The combined efforts of global central banks to support asset prices for years on end have been turned on their head. As recently as September, central banks were buying $60 billion of global assets every month. Today, they’re effectively selling $30 billion a month. That’s a $90 billion differential in seven short months.
The big buyer at the other end of the table is no longer supporting global asset prices with fabricated demand. Instead, central banks are now removing liquidity from the global financial system and, in doing so, wreaking havoc on complacent buy-and-hold investors.
No safe havens
What’s worse, this is happening on the heels of a global asset bubble in stocks, bonds and real estate. There are no safe havens in any of those asset classes, and everything that benefited from central bank stimulus efforts is subject to a correction.
In every respect, buy-and-hold strategies are dead for the foreseeable future.
Investors should not act like a deer in the headlights. The driving force behind the market today is exactly the same as what it was for years. Liquidity matters most to asset prices — it still does — the only difference is that the amount of liquidity has changed dramatically. This will cause asset prices to correct themselves. The market is absolutely set up for a crash.
Trading, not investing
Where is the opportunity?
Although investors are feeling the pain, this volatility presents exceptional trading opportunities for proactive investors. The markets are moving aggressively in both directions, and when that happens, trading opportunities are ample.
In this type of environment, rules-based strategies are best. However, using a subjective approach is not a good idea because it could cause emotions to run high and mistakes to be made. Investors will need strategies that have been proven to work in volatile conditions.
One such strategy is our Sentiment Table Strategy. (Click here and scroll to the bottom right to see an example.) It is designed to embrace volatility, but it is not without its nuances. The lack of volatility in 2017 was a problem for this strategy. It did not fire a single trading alert during the entire calendar year because there was not enough volatility to cause an overbought or oversold condition to surface.
This year, however, that has changed. Where there were no trading signals last year, there have been eight so far this year. The strategy has identified overbought and oversold market conditions, and the rules associated with the strategy have resulted in a gain of about 15% on those eight trades. It trades only ETFs based on the Nasdaq 100 Index Those are ProShares UltraShort QQQ and ProShares Ultra QQQ The rules are fact-based and free of emotion.
Upcoming crash
Investors need to protect their portfolios from what is likely to be a market crash. The crash may not happen today or tomorrow, but without global central bank support, asset prices that have been buoyed by fabricated demand will reprice themselves based on natural supply and demand.
Natural demand levels are defined by The Investment Rate, and in addition to the material shifts we are seeing in global central bank liquidity, The Investment Rate also tells us that we are in the third major down period in U.S. history, just like the Great Depression in the 1930s and stagflation in the 1970s. (Click here for a full definition.) This is based on natural demand, demographics and ingrained societal norms, not on recent economic data. Therefore, not only are we faced with shifts in central bank liquidity, but natural demand levels are far lower.
Either way, the conclusion is the same. Rules-based strategies are best, and investors who cannot be proactive should protect everything they own.
Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily.