“Good investors gather information, put that information into current and historical context, then make sound decisions.”
June gave us a short-term bottom, August gave us a short-term top, and September took us back to the short-term bottom. Now we have a trading range, and a trading range that is indeed trade-able. The tops and the bottoms of the trading range are flexible and that is alright. The range is trade-able in part because the distance between the top and the bottom is large enough to accommodate and negotiate a successful trade. In this case, the top of the trading range for the S&P 500 Index (SPX) at 4325 is 19% above the bottom at 3625. Yes, both levels are below the high of 4818 on January 4, 2022. We will get back there in time. But first this market needs to find a bottom and build a base. And that’s what trading ranges can do.
Time for a quick reality check of 2022. Equity markets are most certainly still down for the year. The decline has impacted every equity sector, some first and some lately. For the most part, the declines have been steady and organized as we saw from January to May. Mid-June there was a series of selling algo-trades followed by a very nice rally through July and August. Mid-September there was another series of selling algo-trades that took markets back down to the June bottom. Rising inflation, interest rates, and oil prices are the usual suspects. Factor in mid-term elections and the war in Europe and there are ample reasons for institutional selling.
Another reality check is that to one degree or another, all of these things have happened before, alone or together. And equity markets have not only recovered, but moved even higher. That’s how it works in the good old USA. That’s why we invest in equity markets. They will eventually stop going down, but we don’t know exactly when. Then they will build a base for a period of time, we don’t know exactly how long. Then they will start the process of climbing higher, we don’t know exactly how high. This reality is based on over a century of closely examined market data.
Rarely, once actually, equity markets dropped and recovered in what is known as a “V recovery”. This occurred in 2020 when our government decided to turn off the ignition while going 80 MPH on the interstate. Equity markets dropped -35% in one month, recovered most of it in one month, then rallied another +60% over the next two and a half years. The U.S. economy is still recovering, but strong enough to regurgitate high inflation in response to the trillions of dollars the Federal Reserve pushed into its system.
Bond markets remain in a long-term downtrend and are deeply oversold after breaking a support level last Thursday. The strategy with bonds is different than with equities. Bond markets may present opportunities for counter-trend rallies. Bond Indexes are 12% under their trendline, which is a downtrend. They haven’t yet been successful at establishing a trading range that may develop into a base. This has been problematic for portfolio allocations because bonds are traditionally utilized as defensive weapons when equity markets are declining. This year bond markets were down double digits before equity markets were down double digits.
Trading ranges present a range of opportunities. This includes portfolio rebalancing, tax loss harvesting, dollar cost averaging, and the trusty old ‘buy low, sell high’ approach. ‘Buy low, sell high’ works inside a trading range that provides enough room to maneuver. The application inside a trading range is to ‘buy the dips, sell the rallies.’ It requires patience and experience to be effective. The alternative is to just sit and wait for the markets to get better. The good news about that strategy is that it will always work, eventually. It also requires patience and can make an investor mighty grumpy. We prefer to take advantage of opportunities and be happy.
Edward D. Foy, Manager, SELECTOR® Money Management, Chief Investment Officer, Foy Financial Services, Inc.
Sources: Bloomberg.com, Marketwatch.com, StockCharts.com, Morningstar