How I Can Best Protect My Investments as the Markets Tank

The following is an article I wrote for Crains Wealth last week.

Investors don’t plan to fail. They fail to plan.

Markets typically pullback every month. Most pullbacks are nothing more than innocuous 3% to 5% dips – short bouts of weakness followed by new highs. Every quarter or so, the shallow pullback deepens to a 6% to 9% drop. Occasionally, full-fledged corrections of 10% or more take hold. Every four to five years, a bear market hits that lops at least 20% off of the major stock-market indices.

When investors think about protecting their investments, they usually don’t worry about the small pullback, and many don’t really care about the deeper one. It’s the steep declines of 10% or more that tend to test the mettle of the average investor. I know from my own client base that I rarely hear from anyone who is concerned until they see a stock-market decline, usually one that exceeds 10%, make headline news.

Before the stock market begins to decline, investors need to have a set of plans designed to remove emotion from the decision-making process. Whatever that process is, it absolutely cannot be a subjective decision, since countless studies have shown that emotion-based investing fails in all market environments. Don’t wait until the stock market is in full decline before establishing the plan!

In my firm, we use time-tested, sophisticated, quantitative and technical models to determine risk/reward ratios, allocations, position sizing and our overall exposure to various markets. However, it doesn’t have to be that complex.

Simple systems include selling a certain percentage of a position when it declines by a predetermined amount from a peak. Others use the 50-day, 100-day or 200-day moving average to generate buy and sell signals. Momentum investing 101 has guidelines for buying or selling securities after the return over a certain period becomes positive or negative, in essence betting on the continuance of an established market trend. Dow Theory involves watching the industrials and transports make new highs or breach secondary low points to determine how to navigate the investing environment.

After the investing plan is created there are a several methods to protect investments once the situation has been triggered.

The first is the easiest and simplest; securities are sold to raise cash. The small downside is that it becomes a taxable event, but in my business, tax considerations are secondary to opportunistic capital preservation.

Another way to preserve your investments is to hedge. That means once your plan triggers to take defensive action you buy a mutual fund or exchange traded fund (ETF) that goes up when a given market index or sector goes down.

A more complex and sophisticated method to protect a portfolio from decline is to buy put options or sell call options against the position. In this advanced case, the purchase of put options is preferred if volatility is low or if he anticipated decline is substantial. Selling call options may be a better choice if volatility is high or if the forecast weakness is on the more mild side.

Finally, good old fashioned, non-correlated asset diversification may be helpful.

In a modern-day equity portfolio, a Treasury bond mutual fund or ETF will often rise when stocks decline. Additionally, the Japanese Yen typically behaves in a similarly contrarian way and can be purchased through the CurrencyShares Japanese Yen ETF (FXY). During other periods over the past 40 years, commodities and real estate investment trusts (REITs) have sometimes been non-correlated to equities, but that hasn’t been the case during this bull market.

The most important takeaway is to create a comprehensive plan in advance and stick to it, no matter how stressful market conditions become.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Post Crash Behavior Leading to Dow 20,000

The day before Flash Crash II last week, I opined that the bottoming process could begin as early as last week. From my seat, it did. One week removed from the mini crash or crashette and stocks took it hard on the chin again. China was blamed, but that’s only a cover story and coincidence. However, unlike August 24, we did not see another Flash Crash. There was no panic. The selling was fairly orderly, which can be viewed as a good thing and a not so good thing. Volume was on the light side. Market internals were abhorrent.

In short, stocks are shaking out from mini crash type action according to history. Of all the declines since the bull market launched in 2009, including the 20% one in 2011, the current correction gives the bears the most ammunition to claim that a new bear market has started. But before you jump to conclusions, read on…

I remain steadfast that while the bull market may continue to be old, wrinkly and not exactly the pillar of health, it is nonetheless alive. That’s the same conclusion I have drawn during each and every decline since 2010. The final peak lies ahead of us and that’s very likely to be north of 20,000 on the Dow.

I know. I know. I am crazy.

Who in their right mind would forecast fresh all-time highs ahead, let alone Dow 20,000 with China imploding and global recession supposedly all but a certainty. And there is always a risk I am wrong, but I do love being in a camp by myself!

So getting back to the action since August 24, you can see a few different ways in light green arrows on the chart below on how this bottoming action may play out. I chose those paths by looking at other similar action. There weren’t many over the past 30 years where a bull market peak was so close. That was criteria number one. The bull market peak was within two months of the crash.

Defining the actual crash isn’t as easy. It’s easy to spot in hindsight and you can certainly feel it when it’s happening. It’s rapid downside acceleration without any intervening rallies that usually leads to a 3%+ down day at the end.

I am going to take you through each occurrence to compare and contrast starting with the most recent. The years will be listed on each chart along with the “crash”, one of the most overused words in investing lexicon, and then where the final bottom was before stocks took off again to the upside.

On the surface, 2011 and 2015 look very similar although the decline in 2011 was more damaging and deeper. It took roughly six weeks to bottom.

2010 is next. That’s where we saw the first Flash Crash which doesn’t seem all that bad on the surface. This week’s action looks very similar to the three day rally immediately after the Flash Crash. The final bottom was eight weeks later and at prices significantly below the crash, something very unusual.

1998 is next and that looks exactly like what we saw in 2011. In fact, I wrote an article after the crash in 2011 forecasting that the final bottom would be a mirror image of the 1998 decline. In both instances, the decline was more than 20% and the final bottom was six weeks after the crash.

1997 is below and that crash behavior doesn’t really behave like the rest. Stocks pulled back a little, but the crash was essentially a one day decline that was sharply reversed the very next day.

1994 is next and while the decline was not even 10%, the post crash action was very similar to most other periods. I marked the final bottom 11 weeks later because that was low from which stocks finally rallied, but you can certainly argue that it was right at the day of the crash.

1989 has some similarities to 1997 in that it was essentially a one day outlier decline based on the leveraged buyout craze imploding with takeovers in United and American Airlines falling apart with Donald Trump involved. The bottoming process was fairly quick and not very painful with the final bottom occurring roughly four weeks later.

Finally, the greatest crash of the modern investing era was seen in 1987. Similar to 9/11, most people remember where they were and what they thought as the day unfolded. I recall my father launching a new discount brokerage business that very day. While I thought the timing could not have been worse, he often said that it was perfect since none of his clients lost any money on that day as there were no clients yet!

As with most of the other crash periods, the final bottom was seen some weeks later, six in this case.

Crashes, mini crashes, crashettes are all very emotional events. The most panic is typically seen during the crash when the market makes its internal or momentum low. There is usually a rally and subsequent final bottom some weeks later. The only caveat I will add is that the more pervasive the sentiment towards this behavior, the more the market will morph and confound the masses.

As always, please do not hesitate to contact me directly by hitting reply to this email or by calling the office at 203.389.3553.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Down 43% and Up 80% All in 12 Minutes. HFT is to Blame.

I am scheduled to be on Fox Business’ Risk & Reward TODAY, Friday, at 5:25 PM. The topic will be a follow up from the two pieces below on my rant after Monday’s embarrassing open as the Dow crashed 1100 points and the financial system was broken.

Flash Crash II – HFT and Computers Run Amok… AGAIN

This was a Flash Crash

Although it was fruitless, I did some more digging to uncover even more inexcusable and unfair trading.

My view remains firm that high frequency trading (HFT) exacerbated the decline, but also led to price dislocations not only in ETFs, but in some very liquid, blue chips stocks. I listed a few the other day, but here is the most egregious ETF one I have seen so far.

I have heard the HFT guys in the media denying any responsibility. What else are they going to say? “Yeah, we raped Mom and Pop Main Street?” What do we hear from Goldman and Credit Suisse and the Wall Street firms? Crickets!

I am far from an expert on HFT, but did enjoy reading Flash Boys by Michael Lewis. I am, however, a guy in the trenches who continues to see our markets unable to handle the speed and systems that have been developed to take advantage of the system’s inadequacies.

What happened on Monday to SPLV, XLV, VHT, JPM, GE, VZ, MCK and probably hundreds more securities was a travesty. It was sad and pathetic and something you would expect from a frontier exchange in Africa or Asia, not from the capital of capitalism!

Markets have calmed down substantially from the panic pace early this week. I wrote about the bottoming process starting as early as this week and that comment was spot on and remains the case. Next week, I will show a few other time periods that look similar to this one. Markets are in the healing process which will eventually lead to appreciation phase again.

I remain steadfast (we’ll see rightly or wrongly so) that the final bull market peak has not been seen. That means I see fresh all-time highs ahead! And I think you will be surprised and probably skeptical at my upside target…

Have a safe and enjoyable weekend!

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Flash Crash II – HFT and Computers Run Amok… AGAIN

Well that was certainly fun on Monday! Stocks crashed 1100 points at the open, rallied 800 points and the fell almost 300 points to close down 588 points. Given yesterday’s full Street$marts edition and the two blog posts I did here, I am sure most people were expecting a market update. After all, I did offer 3 Scenarios for Monday’s Trading and the market did end up following scenario number one the most. I will get to the market in a subsequent post. Of note, almost every single interview I saw and comment I read called for “staying the course” or not selling. I guess those were the same folks who told investors that all was well over the previous few months as the major indices peaked. Hmmm…

It’s not a topic I often mention, but from my seat, the system was clearly broken in the first half hour and the computers ran amock. It was beyond embarrassing and ridiculous, AGAIN. Just like we saw in May 2010, this was a second Flash Crash. NYSE and NASDAQ? Goldman Sachs, Citadel, Merrill Lynch and Virtu? You can hear crickets from the cats who ate the canary.

As someone who had forecast and was positioned for the correction, I was chomping at the bit to deploy some cash. Without any widespread firsthand knowledge, I believe that High Frequency Trading or HFT was responsible, not for the whole stock market decline, but for the quick acceleration and pricing dislocations or anomalies. Remember, HFT thrives when markets are volatile and liquid. Not so much in quiet and less volatile markets.

What I did see firsthand was enough small orders of less than 100 shares early in the day to make me believe that the computers were out of control as one of the footprints of HFT is odd lot trading or orders less than 100 shares. Let’s add in the outrageous pricing in the opening few minutes that went away quickly enough that I couldn’t even finish getting my orders in the que to execute. A little sour grapes perhaps? Absolutely, but there was also something very wrong with our markets.

As the day began and I was glued to my screen, I noticed that XLV, a healthcare ETF was in free fall, showing an opening loss of 6% which almost immediately became 20%. These are not high flying micro cap technology stocks that don’t trade volume. These are the most liquid stocks in the healthcare field. Johnson & Johnson and Pfizer account for almost 18% of the ETF. Memories of May 2010 and the Flash Crash immediately came to mind. I quickly checked IBB, a biotech ETF, and saw similar but not as dramatic weakness. That was clue number two as biotech is almost always more volatile than XLV and should have been down more.


You can see what I am talking about in the chart above. XLV opened down 6% and quickly collapsed to down 26% at the bottom of the green candle right after the tall red one. Minutes later, XLV was trading at $69 or 20% higher. That’s not only abnormal, but shows a system not functioning like it was supposed to. And during this brief period as you can see above, volume was enormous, another hallmark of HFT.

I started looking at random large cap individual stocks both in and outside the healthcare sector and saw some truly astounding pricing dislocations in my opinion. Again, these stocks should not have fallen 20% in a matter of a few minutes. None had company specific bad news. GE, JP Morgan, CVS, McKesson and Verizon to name a few. I have not done a lot more research since then because I don’t think it’s worth the effort at this point, but I know from speaking with colleagues and peers that it was widespread in the ETF space. Just look at VHT, also in the healthcare space, below.


I am not big crier of injustice and “demander” of government intervention to fix our problems, so you won’t find me flooding the SEC with calls and emails or creating a grassroots campaign to do so. I won’t be surprised, however, if the SEC does open a formal inquiry into Monday’s opening of trading as another Flash Crash did occur. While my clients may have lost an opportunity, there were thousands of investors who were likely stopped out of their positions when they should not have been, costing them untold amounts of money.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Three Scenarios for Monday’s Trading

There are three scenarios I see for Monday and the short-term.

1 – Stocks open sharply lower and then spend the morning stabilizing and closing at least okay. From there, a sharp, snapback rally develops for 1-2 weeks before rolling over again to the downside. The final low is seen next month at lower levels.

2 – Stocks open sharply lower and see one or two feeble and failing rallies during the morning before a full-fledged crash in the afternoon. The Dow closes down at least 1000 points. Stocks remain volatile the rest of the week, but establish a low, just not the ultimate one.

3 – Stocks open higher and rally all the way to the close. The advance continues for a few days before rolling over again to the downside with another leg lower to come.

The bottoming process begins this week. The length of the process will be determined by how stocks act during the week.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Don the Crash Helmets! It’s Bloody and Ugly Out There!!

By now, everyone knows that the Dow Jones Industrials fell by 1000 points last week, including a 531 point down day to close the week. More selling lies ahead in the short-term. It’s getting ugly. There’s blood in the streets. Sell what you can not what you want. Margin calls are coming. Maximum pain thresholds are being hit for the individual investor. Panic is here!

Before I opine on what it means, let’s put it all in perspective. 531 points is a 3% decline and 1000 points is just under 6%. Since the Dow peaked on May 19, the popular index has corrected 10% so far. In a worst case scenario, it could grow to 15-20% if China unravels beginning Sunday night.

For several months I have written many times about my concerns with the market. The most timely blog post was right at the most recent top on July 20.

Trouble Brewing Beneath the Surface

There were plenty of opportunities to take action, hedge, play some defense, sell, just do something proactive! I am sure that the vast majority of investors did absolutely nothing. In our portfolios, I am happy to report that we definitely took action several times by selling to raise cash as well as buying bonds which typically act as a flight to quality or “safe haven”.

I am not arrogant enough or naive enough to believe that during a full-fledged stock market correction that we won’t lose some money, but I am definitely pleased with our high levels of cash. This is a market time that separates the wheat from the chaff. The “pretenders” in the business get exposed. Investors don’t plan to fail. They fail to plan.

I often speak about the investing risk/reward ratio, referencing 18,500 on the upside and 16,900 on the downside. That negative skew caused us to take various defensive measures in many of our 12 strategies over the past few months. With the Dow finally closing below 17,000 with more downside to follow, the risk/reward is in the process of swinging firmly back to the positive side. It’s time to build a shopping list and prepare to deploy some of the beautiful cash that has built up.

Before I dive into the details of the stock market, I am going to start with my conclusion. While the evidence is certainly not as strong as it was a few months ago, I do not believe that the 6+ year bull market has ended; read, all-time highs lay ahead. The weakness looks like the first full-fledged correction since October 2011. The behavior we are currently seeing looks similar to what we actually saw in 2011, as you can see from the two charts below.

dia16 dia11

As I write this over the weekend and have not seen any stimulative action yet around the world, the preponderance of the evidence suggests that stocks are about to the enter the bottoming process, as soon as this week. While that doesn’t mean an immediate return to Dow 18,300, it does suggest that the repair process starts sooner than later, although high volatility won’t end soon.

From time to time as my great friend and colleague, Sam Jones, likes to say; Calling All Cars. It’s time add cash to your accounts. Blood is in the streets. Panic is setting in. It’s time to take on a little more risk or open a new strategy that’s more aggressive. That will likely be my theme for the next few weeks. On a personal level, I will be making my entire 2015 retirement plan contribution over the next few weeks so you truly know I how view the current situation.

If you have any questions about the market’s correction or your portfolio, please don’t hesitate to contact me directly by replying to this email or calling the office.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

My Oh My… The Music Has Stopped

If you listen to the media or have an active Twitter feed about the markets, you would think stocks have literally collapsed into the depths of a bear market. We MUST be down at least 10-15%! Yet as I type this, the S&P 500 has pulled back all of 6%. It’s a little more than half way to the 10% correction level.The Dow hit my initial downside target of sub 17,000 and the S&P 500 is on its way to 1970 – 2000.

Sentiment has swung dramatically from ebullient in June and July to pessimistic now on its way to possibly despondency shortly. Options traders are positioning for Armageddon. Volume in popular stock market ETFs SPY and QQQ is exploding higher as investors seek the refuge of liquid broad indices over individual stocks.

Technicians are talking about a new bear market and things like Dow Theory Sell Signals and the “dreaded death cross”. (I have written several blogs about Dow Theory and it’s probably time for another.) Market leaders in biotech, healthcare, consumer discretionary are finally getting hit. Market generals, Amazon, Regeneron, Google, Netflix, Facebook, Disney, etc. are being bludgeoned as the music “suddenly” stopped in the game of market musical chairs.

Markets typically don’t bottom on Fridays. I have to find my notes, but I recall Friday being the least likely day for a low although I do remember the post 9-11 bottom being on a Friday. Stocks are currently in the middle of the recognition wave where investors no longer believe it is a mild pullback to stay the course. The masses now believe there is further downside to go. Very light panic has set in. “Sell what you can, no what you want” is often heard. We should be seeing the bears on the popular financial channels any day doing the “I told you so” tour. Cue perennially wrong perma-bears Marc Faber, Jim Chanos, Peter Schiff, Porter Stansberry, etc. They are waiting in the wings!

From my seat as someone who has not been bullish for a while and raised significant cash over the summer, this looks like the beginning of the bottoming process. Unlike the routine and regular bull market pullbacks that just bottom out of nowhere 3-5% off the highs, this one has some more depth and teeth. While the zone to find a low has begun, it may be days or longer. Tops take a long time to develop, sometimes months or quarters, but bottoms are usually not a single day in time. They are quicker yet still require the necessary pieces to be complete.

The markets are a lot closer to a low than they were yesterday and last week and last month. It’s just going to take some more time and patience.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

Semis & NASDAQ 100 at Odds

On Tuesday, the Semiconductor Index as well as its ETF counterparts hit new lows for 2015. This is important for two main reasons. First, historically, as go the semis, so goes the NASDAQ. And as goes the NASDAQ, so goes the broad stock market. It is an intermediate to long-term concern that the semis are more than just struggling. Bull moves typically do not continue without support from the semis.


Below you can see the NASDAQ 100 which is anything but struggling right now. While it has pulled back to the top of the previous trading range from April through June, the index hasn’t done anything wrong technically to warrant specific concern. As you know, however, I have been concerned about the stock market in general for several months.


This divergence between the semis and the NASDAQ 100 is not likely to continue. The odds favor the NASDAQ 100 losing its grip, at least in the short-term, and following the semis lower.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

U.S. Recession Part II – Off the Beaten Path

Continuing the theme of recession, two of my favorite off the beaten path economic indicators are below. The first is the Restaurant Performance Index, which essentially measures the health of the average consumer rather than the Wall Street executive spending $1000+ per couple at Masa or Per Se in New York City.

You can see on the left side of the chart that this index steadily weakened well before the crisis hit and was solidly below the 100 level which is viewed at neutral. Over the past few years, the index has risen and is a long way from falling below 100.

The next chart is the Architecture Billings Index which measures non-residential “work-on-the-boards” and usually a leading economic indicator by 11 months. 50 is the neutral level. Not surprising given the banks’ general unwillingness to lend as in the past, this indicator has been oscillating around neutral but generally above for several years. Commercial real estate is still trying to recover from the bust and remains hampered.

Between the consumer discretionary sector, RPI and ABI, I absolutely do not believe the U.S. is on the verge of recession. Our economy strengthens and weakens periodically in the context of an ongoing recovery. This expansion may be aging, but it’s not dead. Keep an eye on the indicators and not the pundits.

If you would like to be notified by email when a new post is made here, please sign up, HERE.

U.S. Possible Recession Part I – The Consumer

There has been renewed chatter lately about the U.S. economy being on the verge of recession. It’s not as loud as we (wrongly) heard in 2011, but it’s definitely growing. I vividly remember the Economic Cycle Research Institute doing interviews on CNBC, Fox Business, Bloomberg and just about every major financial website, pounding the table that there was almost 100% chance of recession in 2011 and their indicators were “never” wrong. “Never” is one of those words I don’t typically use when it comes to the markets, economy or politics. How many times did we heard that word as 2008 approached and then during the year?
For the past six years, I have used the same description of our economy. That is, we are seeing the typical post financial crisis recovery. It’s uneven. Sometimes it teases and tantalizes on the upside yet frustrates on the downside. It’s anything but the “normal” recovery from recession which is usually very powerful. Deleveraging, a period of unwinding debt, usually takes 1/3 of the time it took to build up the debt. In this case, it took roughly 30 years to build so 10 years from 2008 puts us at 2018. That should also coincide with a mild recession just before or during.
Returning to normalcy after a financial crisis typically takes two recessions. We already survived a doozy from 2007 – 2009 and the mild recession I already mentioned should be coming this decade. I say “mild” because corporations are sitting on more than $3 trillion in cash and relatively low inventories. Of that, banks have more than $2 trillion in cash. It’s really hard to have a serious economic collapse with banks in such good shape with capital and corporations flush.
Another conventional way to look for recession is to watch the activity of the consumer with their discretionary income. In good times and in bad, we all need to buy groceries, pharmaceuticals and other staples. That’s why they are referred to as defensive. However, in good times, we spend more money on cruises, Disney, resorts, jewelry, clothing, furniture, cars, dining out, etc. For the most part, those are discretionary items.

Consumer discretionary is a major stock market sector and you can usually glean good information about the consumer. It’s really difficult to believe that a recession is close at hand if this sector is at or close to new highs. In 2011, when recession calls were abound, I looked at the chart below and saw a new high for the consumer in June. When the stock market collapsed under the weight of Greece, threat of U.S. default and the S&P downgrade of our debt, the sector went down as expected.

One reason I did not see a recession coming was that it’s very unlikely that the consumer stocks peak and then recession hits within the next few months. Usually, there is much more lead time, like 6+ months, for the consumer to weaken.

In 2001 as you can see below, the consumer sector saw its high a full year before recession hit. That recession, spurred on by the Dot Com bubble bursting and accelerated by 9-11 was brief and generally mild although the multi-year bear market in stocks was severe.

Below you can see the action before the Great Recession hit. The consumer sector peaked in the middle of 2007 and then weakened dramatically to year-end when the recession officially began. I remember living this in real time and I did not believe that recession was hitting late in 2007. I saw weakening, but my original thought was that the dramatic cut in interest rates would stave off recession at that point. I was wrong.

So where is the consumer today?

As you can see below, consumer discretionary saw an all-time high just a few short weeks ago. That makes it very difficult to believe that a recession in the U.S. is in the cards this year. I am not going to use the word “never”, but after you read the next blog, it’s really hard to argue that case.

If you would like to be notified by email when a new post is made here, please sign up, HERE.