Time To Buy The Dip in Stocks? Be Wary.
Over the last 12 months the winning trade has been to buy any 3-4% dip in stocks and ride the tide higher. Every modest pullback has been met with positive reinforcement from the Federal Reserve, better than expected economic data, or upbeat corporate earnings news. When you examine a chart of the SPDR S&P 500 ETF (SPY), the 50-day moving average (smooth blue line) has clearly been an excellent line of support for nearly every pullback this year.
The major indices have continued to surge as investors rotate away from interest rate sensitive investments and throw caution to the wind by driving Tesla Motors (TSLA) and NetFlix (NFLX) to new highs. These go-go stocks have been the recipients of tremendous success over the course of 2013 as investors have been rewarded with triple digit gains. However, now may be the time to start thinking about locking in some gains on these winners and looking to get more defensive with your portfolio.
It’s easy to focus on the headline stocks and lose sight of the fact that many blue chip companies have failed to keep pace with the breakneck U.S. rally this year. As I looked over the 30 stocks that comprise the SPDR Dow Jones Industrial Average ETF (DIA), I immediately noticed six bellwether names that were trading below their 200-day moving average. These companies include: International Business Machines (IBM), Exxon Mobil (XOM), Caterpillar (CAT), Coca Cola (KO), AT&T (T), and Alcoa (AA). This list represents a broad swath of sector titans that are currently sitting below their long-term trends and leading the market lower.
In order for the rally to continue, small and mid-cap stocks will have to overshadow the drag that these mega cap names are having on the major indices and sectors. That may be a tough feat considering that the iShares Russell 2000 ETF (IWM) has already gained more than 22% so far this year. I don’t know if small caps will be able to sustain the momentum necessary to keep the broader market from falling out of bed based on their current lofty levels.
The next six weeks will be critical to determine whether stocks will start a renewed upward push or get caught up in a true correction that will reset the markets. September is a seasonally weak period of time where volatility kicks into high gear, and this year the markets will be keyed into the Fed’s strategy to taper its asset purchase program.
Based on recent history, stocks will likely react negatively to a slowdown in the accommodative monetary policy that has pumped up asset prices. Bonds have already had a severe reaction to the prospect of severely hampered demand for treasury and mortgage bonds which have sent interest rates skyrocketing. Stocks right now are in a precarious position as they sit at the crossroads of technical support and economic uncertainty.
The Final Word
The ebbs and flows of the market are a healthy system that allows for excesses to be worked off and new capital to be distributed to areas that are undervalued. I will be looking at any additional pullbacks in the market as a buying opportunity to put new money to work for a year-end rally in the fourth quarter. However, I will be sizing new positions in the context of a risk management framework that takes into account the new normal of interest rate volatility. Any new money put to work should be done so with a sell discipline to guard against the possibility a more protracted decline.