I was having a few quiet drinks with friends before Christmas at my Club and their obsession was trying to understand what had just happened in the markets. They could talk about nothing else. I guess when collectively, between the three of them, they had lost something like $250m off the value of their investments in the space of 2 weeks, it is only natural to try to understand why.
But it is the wrong question. The question is not “Why?”. Markets always move and their aim and whole purpose is to surprise you. Your question should be: “Could I have avoided it? Were there warning signs I should or could have heeded?”. That is what I told them, slightly unsympathetically.
Inevitably, they challenged me to show them these warning signs. We went over to the Club desktop and I showed them the warning signs, which were many and definitive.
1. On 11th October 2018: the Daily Risk model gives a SELL signal. Not a big deal, per se. It has given plenty of sell signals which have turned up to be not much or whipsaws.
2. On 12th October 2018: the Weekly Risk model gives a SELL signal. Again, not a definitive sign. It has happened before and a few of those occurrences were whipsaws or only mild retracements.
3. 10th and 19th October: the Risk model scores go negative on the Daily and Weekly models for the FIRST time since 2015. My ears are now pricked. For sure.
4. 19th October-30th October: despite many market rallies, the Daily model score absolutely refuses to go positive. It stays negative even on days which are +30/50 SPX. Something is not right.
5. 31st October: monthly Risk model goes to Risk off and gives a SELL signal. Score goes negative on monthly model too. First time since 2016. All 3 time models are now aligned in Risk OFF, which is very rare and is hardly ever a simple whipsaw. It is nearly always an indicator that a powerful TREND is developing.
6. The WHOLE MONTH of November, despite the many daily rallies which are very impressive in % points, the Risk model scores absolutely refuse to go positive or even improve much. Something very bad is happening underneath the hood of this market. I am beginning to get seriously worried.
7. 3rd December: market rallies like a bitch to just above 200 day moving average and model score stays negative but rallies close to Zero. This is the watershed moment. It’s do or die. Either we now go up and shake off this risk retracement or…
8. 4th December: with only a relatively small market retracement, the Risk model score goes to the MOST NEGATIVE it has EVER been this year. New lows in Risk scores? With the market well above its lows? This is TREND ACCEPTANCE. This is what I have been waiting for. While before the narrative was: lighten up, be careful of taking more risk, go to the safety of bonds; this is: GET SHORT equities, LEVERAGED, things are VERY BAD.
While none of the points above, per se or in isolation, would be enough to make you liquidate your entire risk positions, their combination with the definitive PROOF of December 4th were enough for me to close out all equity risk positions, turning a double digit loss YTD on my investments into a decent profit, outperforming a buy and hold investment strategy by double digits. Again.
All these warning signs are documented in real time on the Member Page and narrated in the Member Blog, so no one could be in any doubt whatsoever about their significance.
Next time someone says to you: “Wow, who could have foreseen that?”, you will know the answer: the risk spreads were talking to you since October 11th. All you had to do was listen.