This week, rather than showing the S&P, which again finished at new highs, I’m going to show a weekly chart of the DAX. I shared this chart several times as a talking point prior to that big break of support in October, as it looked as if Europe could lead the US to the downside. As we know, the US market has since recovered far more strongly, racing back to new highs, while the DAX and most of Europe has lagged badly. In fact, that is still one ugly chart. The DAX has failed to convincingly retake its 10-week MA, which remains below its 40-wk, as it has for a couple of months now, not to mention the sequence of lower highs and lower lows that remain in place.
Why do I mention all this?
Because as fascinating as it all is, it doesn’t matter until it does. I’m happy to share what others are seeing and talking about because it helps give you context, but if like me you are only trading US stocks, then analyzing US stocks is all you should be concentrating on when it comes to assessing your risk. I have learnt this the hard way. Once you start trying to assign causality and use it as part of your investment rationale, you are on the journalistic slippery slope of having to justify each day’s price movement within the narrative you’ve weaved for yourself.
There will always be something to worry about somewhere in the world, and some chart for someone to point to and say ‘just you wait, you’ll see’. Maybe we will. But if we waited until everything was perfect in the world we may never be invested at all, or by the time all our ducks were in a row we’d then be told we’ve already missed the opportunity, the easy money has been made.
My usual riposte to the litany of ‘yes but what if’ responses towards my approach is “It’s called risk. Manage it”.
In this regard, having a highly concentrated portfolio helps immensely. During that October pullback my number of positions was reduced from around fifteen to just eight with around 35% in cash. Note that cash isn’t a ‘weighting’, it’s just what isn’t being used because of the lack of opportunities. It didn’t get to 35% by ‘raising cash’, it got there by following what price action dictated and managing risk. As stops were hit on existing positions we got out. If new opportunities arose we took them. If they didn’t the cash would sit there, and possibly grow further, until they did.
As it turned out, those opportunities came pretty quickly and as the market traced out another ‘V’ we took the new entry signals that triggered until we were fully invested again. Clearly, this is much easier to do with a portfolio comprising of less than 20 names, than for a mutual fund manager with potentially hundreds of names. For them, taking a market view and raising cash indiscriminately may make sense. For us, we are looking at each stock on its own merits and we manage them accordingly.
The downside is the temporary gap it creates in performance. By exposure being reduced on the way down, and increased on the way up, after a 7-9% market slump and swift recovery your portfolio will likely be lagging by around 2%. That’s the price you pay for managing risk. You aim to capture most of the upside and avoid the worst of any downturn. This is where the big difference occurs vs ‘Buy and Hold’. This most recent correction wasn’t big enough to make protecting from further downside appear worthwhile, but we absolutely know it is longer-term.
With ‘Buy and Hold’ in order to capture 100% of the upside you must be prepared to endure 100% of the downside. Maximum gain = maximum pain. You want that 7% annual average return for doing nothing? You have to stand there on the ropes taking an absolute beating for as long as it lasts, and as the behavior gap shows, most can’t take it and throw in the towel. Or you can simply step aside until the market has punched itself out and then you come out fighting to claim the victory. Sometimes it’s over quickly and your prudent management can subsequently be viewed by some as unnecessary. Other times it may result in you ducking what could have been the knockout punch to your portfolio from which you would have never recovered.
What I’m talking about is the need to avoid negative compounding in order to create long-term absolute returns, rather than focusing on short-term relative returns. It’s what I explored in this post explaining my use of the term Alpha Capture. This is the business I’ve chosen. I buy stocks in uptrends and manage risk.
This week was a relatively quiet one with no new entry or exit signals, but the continued gains did allow us to trail some stops higher, and add to winning positions or reduce risk where necessary.
$DPS moved modest higher this week, consolidating recent gains in a tight range.
$HD came tantalizingly close to the hundred roll but didn’t quite make it. This still looks rock solid.
$BRK.B started the week strongly in reaction to Friday night’s earnings and digested those gains thereafter.
$NKE is another very strong looking weekly chart as it continues to stair-step higher.
$ED finished lower on reasonable volume, closing below its 20EMA as utilities along with other defensive sectors such as healthcare and consumer staples showed some weakness. There’s no shortage of opportunities out there with the market at all time highs so we won’t hesitate to exit this for a small gain if it triggers next week.
$CNSL – This is one of those charts where you could argue we’re in no-man’s land or it’s rangebound, but in actual fact it makes for a very clear assessment of risk/reward. The stop is multi-faceted; a previous breakout level, the most recent swing low and support, the 50-day MA, and if taken out it would put in place a sequence of lower highs and lower lows. It makes it more ‘obvious’, and granted there is always a danger obvious stops become the target of false breaks, but to be honest in this market with so many setups and strongly trending names I don’t need to waste time playing games and second-guessing what may or may not happen or the intentions of other players. Bottom line is the uptrend remains intact, and as soon as that changes we won’t hesitate to bail.
$SBH had a rollercoaster week, initially following through on the previous week’s decline before moving strongly higher midweek ahead of its earnings announcement. Thursday’s initial post-earnings reaction saw the stock open -4% only for it to subsequently trace out a huge 8% reversal on strong volume to finish at 9-month highs with a near 4% net gain on the day. That move was enough for our stop to move up to the previous breakout level that had triggered our initial entry, and now coincides with Thursday’s lows and the 50-day MA.
Other names include $ALXN, $COST, $QLYS, $ANAC, $CAG, $LM.
In terms of our watchlist the selloff in defensive sectors towards the end of the week made its mark with many utilities and healthcare names making way for more technology stocks, as well as what I would call the traditional growth and momentum names you might expect to see in IBD’s top 50. Here are a handful worthy of note:-