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OBJECTIVELY MANAGING RISKS

The stock market inched its way to new all-time highs this past week, as investors continue to exhibit an absolute conviction that good economic times are here to stay. Complacency, extreme bullish sentiment readings, and fear of missing out on the rally remain the order of the day. This situation reminds me of the old stock market cliché that says: “The stock market can remain irrational longer than you can remain liquid”. The status quo may continue, but in this business of managing financial risks to client wealth bullish extremes often appear toward the end of bull legs, and bearish extremes tend to appear near the end of bear legs.

Alexander and I are in the risk management business, and we do not attempt to forecast future movements of the price in the stock market. We will leave stock market predictions to those, which believe they have the requisite skill, talent and expertise, to be successful at that most difficult of arts. However, objectively measuring the ever changing balance of supply and demand in the equity market, and then setting those measurements into a historical reference is something we do routinely with proprietary indicators designed specifically to account for the ever changing balance of supply and demand created by countless transactions on the NYSE, and in the global derivative markets.

Human nature tends to repeat in the crucible of the stock market, and this makes comparison of objective measurements of human nature in action over time in the markets a worthwhile, and potentially profitable exercise. So today, very likely well in advance of a major stock market top, I’m going to briefly describe how the next major top will likely form vis-à-vis the tools we share with clients every week. I will bring you up to date on the current status of these supply and demand tools in the two sections to follow, and at the end of each section I’ll describe how these tools will likely configure their readings during a routine correction to re-invigorate demand, and/or how these tools will likely configure themselves as the next major top builds out. At this point, history suggests there will be at least one (or more) corrections prior to the formation of the next major top.

TATY   —   A REPRESENATIVE OF A FAMILY OF STRATEGIC SUPPLY AND DEMAND INDICATORS

TATY is shown above in yellow with the S&P-500 cash index overlaid in red and blue candle chart format. TATY finished the week up a bit at a strong 154. However, TATY continues to paint out a negative divergence with the price, which is touching new all-time highs. Negative divergences almost always result in the price entering a correction, but not always. Demand can gather strength during negative divergences, which can erase the divergence, but these events tend to be rare. Once buyers fatigue sets in, which appears as the negative divergence, that fatigue tends to go to completion in the form of a correction to set up lower prices, which in turn stimulates investors to act on their latent desire to buy at what appears, in the light of recent history, to be bargain prices.

In environments of bullish extremes like currently, corrections may appear to come out of the blue, and may be quite uncomfortable and nasty, but fleeting. History suggests investors may encounter just such a price decline during the first quarter, or as the positive seasonal bias begins to wane around Easter. As long as the next significant price decline results in a corresponding bottom in the TATY indicator in, or close to, the red zone surrounding the 140 level, then we shall treat such a decline as a potential opportunity to put excess cash to work. A price decline with a corresponding configuration in the TATY indicator would strongly suggest a continuation of the bull trend, and possibly renewed assaults on new all-time highs.

However, a price decline strong enough to drive TATY readings into the caution zone surrounding the 115 level would be a warning to Alexander and I that the dynamics of the supply and demand balance may be changing enough to compel us to consider, or even take defensive action in client portfolios to protect accumulated profits, and/or protect client wealth from risks rising to levels, which may not be prudent for conservative investors. The chart gymnastics required for the supply and demand indicators to complete the requisite patterns would likely take weeks, so in the near term we shall investigate declines as opportunities to put excess to work with lower risk entries.

 

SAMMY   —   A REPRESENATIVE OF A FAMILY OF TACTICAL SUPPLY AND DEMAND INDICATORS

SAMMY is shown above in the second chart alone, and below with the SPXL 3X S&P-500 ETF overlaid. The SPXL three times leveraged S&P-500 ETF is for reference only, certain quirks related to its derivative construction can result in tracking errors with its S&P-500 benchmark over time.

SAMMY has one purpose in life, which is to identify re-surging demand after sellers have exhausted their propensity to sell. Exhausted sellers are a necessary condition for a significant stock market bottom, but not a sufficient condition. To complete a bottoming process there has to be evidence of exhausted sellers, which is followed in a reasonable amount of time by evidence of re-surging demand. When both conditions are met, the probability of a new bull leg developing is extremely high. SAMMY is virtually worthless once it has signaled re-surging demand. So for now with a rally underway for weeks, SAMMY is shown for information only, and is of little value. However, as the next significant bottom forms, SAMMY will likely become critically important to us as a risk management tool for getting clients significantly more invested in stocks. At that next significant bottom I expect SAMMY to leap higher while painting out a bar on its chart completely above the previous bar. SAMMY looks like it has been shot out of a cannon when investors return in size, even as the price often is making new lows.

THE BOTTOM LINE

Timing the market is not part of anything we do at Optimist Capital, as we are strictly risk managers. However, in this update days, weeks, or possibly months before the next significant event in the stock market, we have described to our clients what we will do to manage the risks to your wealth, and how we will do it using objective market generated information from the NYSE, and the derivative markets. Opinions are subjective, and rife in this business, and tend to cause confusion, so all our actions are the result of taking into account what the markets are telling us about themselves through the objective information they generate. That information is then put into a strategic plan, which is implemented with the application of a tactical plan. This approach has been shown over time to allow us to grow wealth while minimizing risks. So now our clients know likely well in advance of us taking any actions what we will do, and how we will do it, in order to grow your wealth with the least risks possible.

 

DISCLAIMER : Optimist Capital LLC, does not guarantee the accuracy and completeness of this report, nor is any liability assumed for any loss that may result from reliance by any person upon such information. The information and opinions contained herein are subject to change without notice and are for general information only. The data used for this report is from sources deemed to be reliable, but is not guaranteed for accuracy. Past performance is not a guide or guarantee of future performance. Optimist Capital LLC, and any third-party data providers, shall not have any liability for any loss sustained by anyone who relied on this publication’s contents, which is provided “as is.” Optimist Capital LLC disclaim any and all express or implied warranties, including, but not limited to, any warranties of merchantability, suitability or fitness for a particular purpose or use. Our data and opinions may not be updated as views or information change. Using any graph, chart, formula or other device to assist in deciding which securities to trade or when to trade them presents many difficulties and their effectiveness has significant limitations, including that prior patterns may not repeat themselves continuously or on any particular occasion. In addition, market participants using such devices can impact the market in a way that changes the effectiveness of such device. The information contained in this report may not be published, broadcast, re-written, or otherwise distributed without prior written consent from Optimist Capital LLC.

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