Blackwell Boyd is headquartered in the Hilton Head Island area. Living on an Atlantic Coast island, we locals know that late summer is the time to start watching the Weather Channel, checking for those little radar blips forming off the coast of West Africa. Eventually, one of those blips will find warm water as it approaches the U.S. mainland and develop into the next Katrina, Hugo, or Sandy. The time between “blip” and landfall is often a little more than a week. Wise Islanders know this is the time to do your storm-proofing, find the spare batteries, and plan the evacuation route. It’s a pretty good analogy to storm-proofing our portfolios.
We began that process for our clients earlier this year. Our February blog began with “It’s Time to Take Profits” and our July 3rd blog concluded, “It would certainly not surprise us to see the market finish in the red for the year”. Correspondingly, we began to raise our target cash levels. Our storm-proofing process continues with additional protective positions, and an increased focus on selling securities that carry suspect market multiples. These are the ones that will be hit hardest in a correction.
The Advance / Decline Line is one of those “blips” on our radar. Pop quiz for you: You may know that the S&P 500 contains 500 stocks (duh), but how many does the Dow contain? Answer: 30. Point is, the indices can be a relatively narrow barometer of the market’s health. Further, price changes of large stocks can have a disproportionate effect on capitalization weighted stock market indices such as the S&P 500. For example, Apple Computer currently makes up the highest weight of the S&P 500. So, if Apple Computer is doing well the market must be doing well, right? Maybe, but not necessarily.
So how do we get a better view of what’s happening behind the indices? One method is to turn to the Advance / Decline Line (A/D Line). Simply stated, the A/D Line is a reflection of how many individual stocks are moving up or down. We use it to measure the participation of individual stocks versus the market indices. It’s gives us deeper insight than does the popular, but too narrow, market-weighted indices. What is the A/D Line telling us now? Well, it’s been falling since April. That’s an indication that the market may have underpinnings that are significantly weaker than what is reflected by the popular major market indices. If you care to look deeper, there’s a chart on the A/D Line and a good article from Forbes listed in the notes at the bottom of this blog (2).
Dow Theory is another blip that makes our radar. The theory is over 100 years old and focuses on two key components: 1) the Dow Jones Industrial Average and 2) the Dow Jones Transportation Index. Much-simplified, Dow theory says that weakness in transportation stocks is a warning for the broader markets. Recently, the Dow Industrials have confirmed the bearish trend in the Transports, indicating that the technical outlook for the stock market (according to Dow Theory) is now bearish. So, the key question is does Dow Theory work? Despite more than 100 years of data and studies arguing for and against the Dow Theory principle, the answer is maddeningly yes… and no. At some critical junctures in the market’s history Dow Theory provided an early warning of a major shift in the market. At other times it was a distracting false alarm. Our summary: We would not advise acting on Dow theory alone. For us it’s another blip, worthy of our attention but not to be taken in a vacuum.
Heraclitus of Ephesus said, “The only constant is change”. But this year, not much has changed in the U.S equity markets. For all the talk of volatility and the furrowed brows on CNBC, there has been very little actual manifest volatility. As I type, the S&P 500 is essentially flat (-0.4%) from its starting point for the year. Question for you: When was the last time there was a correction of 10%. Answer: Nearly four years ago in October, 2011. Perhaps this sideways market action is a consolidation phase prior to the next leg up. Perhaps. But, the cracks forming in the market’s fundamentals indicate an increased probability of a long-overdue correction.
We see blips off the Coast of Africa. Perhaps the storms will pass us by and head out to sea. Then again, Heraclitus may be proven correct (again). Storm-proofing our clients’ accounts through this cycle of the market continues to be the prudent move.
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Blackwell Boyd is a Hilton Head Island based wealth management boutique serving clients across the U.S. The firm is 13 years old, renamed to Blackwell Boyd in 2011. Blackwell Boyd specializes in providing superior attention and results to a relatively small group of approximately 250 clients through a dedicated custodian agreement with Charles Schwab (1) which gives our clients full service access to all Schwab branches and 24/7 customer service. The deep level of attention provided, coupled with Charles Schwab’s global resources, is an attractive combination that serves our clients well.
(1) These materials have been independently produced by Blackwell Boyd. Blackwell Boyd is independent of, and has no affiliation with, Charles Schwab & Co., Inc. or any of its affiliates (“Schwab”). Schwab is a registered broker-dealer and member SIPC. Schwab has not created, supplied, licensed, endorsed, or otherwise sanctioned these materials nor has Schwab independently verified any of the information in them. Blackwell Boyd provides you with investment advice, while Schwab maintains custody of your assets in a brokerage account and will effect transactions for your account on our instruction.
(2) For additional reading: