I wish they’d ring a bell at the top . . .
Really . . . it would only be considerate if the oligopoly of institutional traders and investors who move the markets would be kind enough to ring a bell, wave a flag, or even post a quick message on Facebook: “Hey market players . . . listen up! For the time being, we market movers plan to hold some, fold some, and keep lots of cash in our pockets. Expect a market drawdown soon.”
But alas, the Powers-That-Be on Wall Street are not known for sharing their strategies up front, and so it’s left to us—individual traders and investors—to prepare for the next market move.
Now, it’s no secret. The market is looking toppy, at least in the short-term. This year alone, the S&P 500 Index has run up 8.9%. If we look back further, we see that since January of 2012, the benchmark has gained 67.2-percent. And if we check back to the S&P’s March 2009 low of 666.79, we can see that from that market trough until our recent closing high of 2007 (Sept. 5), it has gained more than 200-percent.
Indeed, these have been sweet times for U.S. traders and investors. Our market has soared in a textbook-perfect uptrend, giddily sailing past geopolitical scrabbles. Bulls have been energized by low interest rates, rising corporate earnings, and evidence of an economic recovery.
Still, the capital markets of industrialized nations move in cycles. And the U.S. markets are stretched pretty tight. If you check out the monthly chart of the S&P 500 below, you’ll see what I mean.
S&P 500 Index — Monthly Chart
Chart courtesy RealTick
As you can see on this price chart, the S&P is soaring high above its 12-month moving average. The 12-month Relative Strength Index (RSI) is at all-time highs, signaling an overbought market—and perhaps a time to be cautious.
We don’t run outside and shutter our homes in the middle of a hurricane. We hang the shutters and make other preparations before the storm hits. Just so, experience has taught me that the time to prepare for an upcoming market retracement is before it emerges—while the “gettin’ is good.” And I do so by 1) managing risk in my current portfolio, and 2) investiging new opportunities so I’ll be ready for the market’s next upswing.
For me, that means taking steps to:
- Pinpoint current trades where I plan to grab profits if the market rolls over.
- Establish firm protective stops with my broker on any over-valued growth stocks. (In a market downturn, growth stocks tend to fall from 1 ½ to 2 ½ times faster than value stocks.)
- Take a little time to investigate for unloved, undervalued companies that have suffered from sector underperformance or poor fundamentals, but that have the potential to fly “Phoenix-like” out of their ashes and regain profitability when the market once again moves higher. Make a “wish list” of the most promising candidates.
We are wise to remember that at all times—in both bull and bear markets—that our primary responsibility is to preserve our capital.
And while I do not believe that the next market downturn will evolve into a bear market (drawdown from recent highs of 20% or more), I do think that this market is due for a breather in the upcoming weeks.
So, let’s be smart. Absent ringing bells, raised flags, and warning posts that a market downturn may loom ahead, let’s take a few moments now to manage risk in our current positions and for future opportunities.
Until next time, keep green on your screen!