Somebody Is Going To Be Real Right...

...and somebody is going to be real wrong.

If you have not heard from your friendly technical analyst, maybe it's time to find someone else in that field.

In what can only be described as coming straight out of the Edwards and Magee technical analysis bible (“Technical Analysis of Stock Trends”), the accompanying chart is a classic example of not one but two technical analysis chart pattern icons: Head and shoulders top and a bearish pole and flag.

This plus the fact that nearly 90% of the global indices I track are flashing bearish Mega Trends (use the search function on the top left for prior blog postings explaining this tool) is about as bearish as one can get.*

The first wave of a bear market almost always looks like a correction. Bulls will argue convincingly that key metrics like earnings and interest rates support this view. However, the anchor for this argument - solid earnings - can be easily undermined should the global macro story develop into something far worse than the bulls currently envision. For a recent example of this, just look at what happened from 2006 (S&P 500 operating earnings at a record $87) to 2007 ($82) to 2008 ($49). In this regard, the MERI (use search function again) is practically screaming earnings disappointments beginning next month. That could start the chain reaction of doubt, which is a strong characteristic of the second wave of the bear (as price crashes below the previous lows).

For a market priced for an economic muddle through, the worse case scenario is yet to be realized. Moreover, with limited flexibility to provide meaningful counter cycle actions, governments will be in no position to act effectively. Then there is the self fulfilling aspect of the negative wealth effect on the global macro environment that declining equity values tend to produce, which will almost certainly accelerate the downward pressure on the global economy (and earnings). Lastly, there is the unknown. Can anyone say with absolute certainty that all is good in China?

There's more. But suffice to say, an uncertain environment is hardly the prudent time to be fully invested.

Investment Strategy Implications

The advisable strategy appears to be to move as close to the exit door as possible. In portfolio strategy terms that means

1 - Reduce the equity exposure to a safe level, which for accounts managed and advised by Blue Marble Research is 60%. This means fade (sell) the rallies to, at least, maintain a constant percent equity exposure, but to preferably reduce down to the close-to-the-exit door level.
2 - Shift assets holdings to high quality dividend paying stocks.
3 - Be prepared to reduce the equity exposure to below 50% once the second wave gets underway. This means sell into the declines. The first wave of the bear gives you ample opportunity to sell the rallies. ("Looks like a correction to me.") The second and third waves do not.

Like I said, somebody is going to be real right and somebody is going to be real wrong. Of all things so uncertain in these times, one thing I am certain of: we will find out soon enough.

*Previous blog postings describe the unusual nature as to how we entered the bear (use search function). But the past several weeks have made it all the more traditional.