Things don't seem to be adding up in this market. . .
You may or may not know that the small cap index is my "canary in
the coal mine". If they aren't healthy, then the market
overall is unhealthy. This is because institutional money
managers begin lightening their load in small caps when they
become weary of the market in general. They do this
because the
small caps represent the more volatile component of their
portfolios. When small caps begin to do poorly, the chances of the
entire market doing poorly are greatly enhanced.
A study was done that showed what happened to the general
market (S&P 500 Index) when the small caps were doing well as compared to
small caps NOT doing well. During times of small cap health, the S&P
500 index had an annualized return of 20.62%. This is compared to an
annualized return of only 6.78% during week periods of the small caps.
What is even MORE compelling is what happens on the DOWN side during these
different periods. The S&P 500 index's largest decrease from it's peak
(called Maximum Draw or [MDD) was only 12.08% during good small cap markets.
During poor small cap markets it largest draw down was 19.34%. These
numbers represent a 67% DECREASE in return and 60.1% increase in risk in the
general market when the small caps aren't healthy.
This brings us to today's market. You can see by the
chart below that the small caps were lower most of the summer than they were
at the beginning of the year. It took until late September before it
broke even for the year. The last month has shown an increase from the
lows, but so far hasn't shown the kind of health we're looking for.
What's next. . .
I'm fearful of a recession. I try not to make
investment decisions on fundamental data because fundamental data can be
interpreted by the market in many different ways that don't necessarily make
sense to a human being. The technicals don't show well yet overall.
The technical tell us how the fundamental data is being interpreted by the
market.
Until the small caps begin to show strength compared to the
large caps I choose to play conservatively. We have plenty of time to
make money. Unfortunately, if you lose 50% of your portfolio, you have
to make 100% just to break even. This is why it is so difficult to
ever get back to even on a losing investment.
The small caps are not showing health. I choose to
continue to play conservatively until they decide to be more technically
solid.
I will keep you abreast of any changes as they occur. Check out my website at 401k plan facts
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