If it looks like a bear, if it walks like a bear and if it growls like a bear – what is it?
Answer: A bull market
It all boils down to investor perception of the current reality and the disconnection with the behaviour of stock prices.
Many research analysts and portfolio managers will include some form of technical studies in their work because they know stock prices are forward looking. In many cases economic news, earnings surprises or company guidance is already "baked" into the price.
The current global stock market advance from the March lows is a good example of stock market behaviour disconnecting from the current reality.
The current reality is the vaporization of three Dow components with Citigroup Inc., General Motors Corp. and American International Group Inc. trading down to penny stock status and then getting the boot from the "select" group of what are supposedly America's best corporations.
The current reality is poor numbers on employment, retail sales and auto sales.
Market participants can only assume that if stock prices are forward looking, the current powerful advance is forecasting a short recession.
The bears who are sitting on cash tell us this is a bear market rally and we may yet see the broader world indexes revisit the March lows.
Now there are a few conditions that must first be satisfied to be classed as an "official" bear market rally.
The advance, or bull skew, must be powerful and of short duration and the subsequent decline, or bear skew, must be longer and retrace all or more of the market's advance.
There have been 10 modern bear market rallies since 1960 that have satisfied these conditions. The average gain or bull skew was about 18 per cent and the average duration of the advance was 5.8 weeks.
The current advance is now into week 13 and the 30 per cent plus return has so far exceeded our bear market conditions in terms of time and price magnitude.
And now for the "just in case we're wrong" strategy.
Bullish investors who have enjoyed the great advance should have some basic constraints on their equity portfolio that could mute any damage if the markets get nasty once again.
Limit your single stock exposure: Never allow a single stock to exceed 15 per cent of the total assets
Limit your sector exposure: This begins with the understanding of natural sector rotation. Rotation occurs when the 10 distinct sectors such as financial, consumer, energy and industrials do not generally advance and decline at the same time.
This reduces the volatility of the overall portfolio and for that reason we need to limit our exposure to any one stock group or sector to a maximum of 30 per cent of the total assets.
Own at Least five Sectors: Remember those 10 distinct sectors? Make sure to own at least five of them in order to have some degree of diversification, and yet take advantage of sector rotation. This will allow us to adjust our sector weights according to risk.
One of the easiest ways to identify the order of rotation in the stock groups is to monitor any weekly price momentum oscillator.
I use a 10 week rate-of-change (ROC) that generates a series of positive and negative weekly numbers.
I have produced a sector (or risk) table, above, sorted by the number of positive ROC numbers this year.
The S&P/TSX Global Gold sector has printed 19 weeks of positive ROC numbers so far this year and the S&P/TSX and the TSX Telecommunications sector has printed only 3 weeks of positive ROC numbers this year.
We could now anticipate the outcome of the TSX sectors if we were to encounter nasty markets with the highest-ranked sectors taking the greatest hit.
Bill Carrigan, CIM is an independent stock-market analyst.
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