I have been asked to write commentary – perhaps regularly – that may serve to help our readers protect capital, increase returns, and, generally, better understand and more ably participate in financial markets. Having spent my life in institutional investment management since early in 1974, I have experienced first-hand every sort of market environment and investing bias that has been seen in the last 5 decades. It all started with managing large U.S. pension funds at Bankers Trust New York Corp [now Deutsche Bank], then, taking some of that money with me, managing global pensions, sovereign wealth funds, and corporate investment reserves at Alliance Capital Management [now Alliance Bernstein]. After a brief stint investing globally at banking legend Brown Brothers, Harriman & Co., I worked with one of America’s hedge fund legends for 20 years.

With this background, one might correctly surmise that I am less risk averse and/or more willing than my fellow writer and investing compatriot to make forward projections of the future course of corporate fortunes and macro-economic trends. That does not mean that I like losing money any more than he does. Ray Mullaney and I agree that losing money is a bad idea.

However, an old friend gave me some of the best investment advice I have ever heard: “The best defense against a bear market is making great money in the bull market preceding it.’’ So clearly you can tell that Ray has not invited me to communicate with you to precisely echo his views but rather to add a somewhat different perspective that can – as with Ray’s insights – help you understand how to achieve your financial goals through good investment decisions.

With that said, I wish to throw a bit of caution on the current stock market party — less caution than was warranted in late January when market structure was put in danger by certain institutional trading strategies going to extreme levels, but otherwise more caution than has been warranted since just before the Brexit vote in the Spring of 2016. This is not to say the bull market is over; I think that is not the case, though I could be wrong given all the potential macro risks looming seemingly over the horizon [more on these when appropriate]. Rather I think that in the last 9 trading days there have been unusual indications in the market’s trading behavior that point to a greatly increased probability of a much better buying opportunity in coming weeks.

This means today might be a good time to consider selling stocks for which you do not have a good reason to hold, holding off on additional stock purchases until your targeted issues have retreated [though some company prices may have already reached a good entry point], and having some buying power available so you can take advantage of any unusual downside volatility that develops in very attractive companies. Please do not sell reasonably-priced stocks of companies that have a bright future and wind up paying taxes on a big gain just to avoid this possible correction; there are probably better ways to weather what we expect.

The signs that point to a correction? First is the bloodbath that has occurred in markets outside the U.S.A. Some observers suggest that instead of becoming more cautious on U,S, stocks, now is the time to become bullish and invest overseas. They may well be correct, however, the economic trends at work suggest that risk premia in emerging markets will rise further before a reversal occurs. If that is true, then it is unlikely that the U.S. equity market will remain immune to this otherwise global downdraft in securities prices. Most likely in my mind is a short but meaningful give-up phase that suddenly brings the U.S. market along for the ride down.

This decline is not new to non-U.S. markets but the contagion seems to be spreading very quietly to the U.S. equity markets in the last 9 trading days – a time in which the S&P 500 has moved upward by 1% to an all-time high, then retreated by 0.5% to Monday’s close. This period has also seen unusually heavy and sustained call buying relative to put buying suggesting that investors are very complacent in their bullishness.

A period that rose vigorously to and hovered near all-time highs is inconsistent with unimpressive ratios of advancing-to-declining issues and the number of new 12-month lows that have often exceeded new 12-month highs. Monday’s strong all-day upward move in the 2 ‘’big’’ indices [the Dow and the S&P] gives the most shocking evidence of this yet. Declining issues easily out-numbered advancing stocks on both Nasdaq and the NYSE. New lows also easily exceeded new highs on the NYSE, while Nasdaq had a slight improvement relative to recent days. These are very bad internal stats on a great day so close to an all-time high and they suggest a sharp change in market psychology can emerge very soon. Just in case, ready your nerves and ready your portfolio accordingly.

John Stewart
Chief Investment Strategist

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