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Tuesdays are Tough!

11/16/2010

Thankfully, the bell has rung and ended a rather difficult session for Tuesday, November 16.  A 1.62% selloff in the S&P 500 Index has many questioning whether it is time for the long anticipated major portfolio reallocation out of risky assets into…well, tough to figure that one out isn't it? 

First, let's go back one week to another difficult Tuesday, the 9th of November. The price action on that day certainly raised concern for me about the market's ability to appreciate further without a near term correction.  A fear that I have expressed is a scenario in which the prices for equities, gold, oil, and government bonds all declined at the same time. That is a rather unique occurrence that unnerves markets. It happened on Tuesday November 9th.  Generally, as one asset class declines, capital flows support other asset classes. But on the 9th an obvious warning signal to the capital markets was on display as investors and money managers challenged all price valuations as if in need of a correction. 

The market has done little in the days following the 9th to reverse the initiation of a correction.  In fact, a four day pattern of lower intraday highs weighed on the markets entering the 16th. What we are left with after Tuesday the 16th is confirmation that a correction is underway.

S&P 500 Index Tuesday November 9 to Tuesday November 16

Source: Bloomberg

The obvious question is do you believe the above mentioned "long anticipated major portfolio reallocation out of risky assets" is unfolding? A reallocation which, six months from now, investors will look back upon and say "thank goodness I shed those risky assets." Let me provide my perspective. I believe the current trading environment demands that investors and money managers be more tactical in order to create alpha. So, I identify the current correction as a "tactical correction" within the context of a market that appreciated over 17% from September 1st to November 9th. This is active money management at work.

S&P 500 Index September 1 to November 16

Source: Bloomberg

I am confident this is just a "tactical correction." 3 points to consider:

  1. Hedge funds are the dominant seller over the past five days. The hedge fund VIP list, including copper, Freeport McMoran (FCX), gold, industrials, and technology Cloud Computing equities are being sold the hardest. This is a classic hedge fund liquidation, just like in February of 2010. My conversations with hedge fund managers over the past few days are about locking in this year's gains and turning their attention toward next year.
     
  2. The market still awaits the outcome of the Bush tax cuts. Yes, a temporary extension for all is probably priced in and limits the upside potential. But, that works both ways. On the downside I believe a much deeper correction will not unfold, as the market expects Congress to temporarily extend the cuts for all.
  3. Technicals provide insight toward the structure of a market. Currently, on a cyclical term, the market is in a bull phase. Long term support for that phase rests below the market at 1110 to 1130. Expect major support there and active buying interest from those who missed the September to early November rally.

Strategy - I believe the market will move sideways to higher for the remainder of 2010. Those "Hedgies" who exited the market in the past few days probably will wait to return until January. Less risk will be assumed as we head toward December 31.

SIMPLY STATED - The Overweight risk trade from September 1 to November 9 just transitioned to a Marketweight risk trade.

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.