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  • Writer's pictureJulie Skye

Market Correction: Buying Opportunity Or Time To Sell?

If you want a meaty discussion of this question that is at the crux of what course of action we need to follow, here are thoughts from one of the fellows I respect: Andres Cardenal CFA:

In terms of economic activity in the US, the situation looks quite favorable.

The Leading/Coincident Indicator is designed precisely to track the possibilities of a recession in advance. This remarkably complete article from Fear & Greed Trader takes a look at lots of economic indicators and their recent evolution, including the Leading/Coincident Indicator.

Source: Bespoke

The author reaches the following conclusion:

LEI/CEI ratio declines are a very good leading indicator of approaching recession, with an average lead of 26 months (median 30 months) from the ratio peak to the next recession. September data saw a new high for the index, pushing off the most likely start date of the next recession to Q4 2020 assuming things start to deteriorate immediately.

t's important to think about the different possible scenarios and how the different variables would fit into those scenarios.

Let's assume for a second that we are in the first stages of a new bear market, and the S&P 500 is going to have a drawdown of 25%-30% or more in this new bear market. In that case, credit spreads will surely be much higher than where they are now. It's hard to envision a scenario in which stocks are crushing and high yield credit spreads don't show any kinds of problems.

Also, if the stock market decline is signaling a recession in the middle term, we should see some sign of that in the Leading/Coincident Indicator, but that's not the case so far.

Anything can happen, the world is always evolving, and the different variables can have changing relationships over time. However, the probabilities are that we should see some sign of weakness in credit spreads and/or economic activity if this is going to be a long and nasty bear market as opposed to a simple correction.

The Line In The Sand

For the sake of the argument, let's say that the stock market doesn't need a fundamental reason for a decline. Maybe changing investor sentiment and relatively high valuations in the current environment are reason enough.

Or perhaps the debt problems in Italy and the economic deceleration in China are going to be reflected on U.S. economic fundamentals in the coming months and produce a nasty bear market for global stocks.

This can absolutely happen. Sometimes the stock market is the best leading indicator. Stocks can start reflecting a change in fundamentals well before that change in fundamentals is shown in the main economic indicators. If you are looking to manage your risk in the stock market, following the main trends in asset prices is one of the most effective tools you can use.

One of the most popular sayings in the market is “the trend is your friend.” Even if that is a cliché, that doesn't make it any less true. There is plenty of statistical evidence proving that investors can optimize the risk vs. return equation in their portfolio and avoid big drawdowns by following the main trends in asset prices.

The following system is remarkably simple, yet effective. The market is considered to be in an uptrend if the slope in the 200-day moving average in the SPDR S&P 500 is positive in the past 10 days. Conversely, if the slope in the 200-day moving average is negative in the index-tracking ETF over the past 10 days, then markets are considered to be in a downtrend.

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