Prepare For A Volatile Summer Market.

By Nicholas Marriot

Market Letter May 19, 2012
Macro Outlook

This has been a crap week for the market with the S&P down 5 days in a row. The macro outlook continues to deteriorate with the never ending crisis in Europe intensifying with no solution in sight. The only permanent solution is for Greece, Portugal, Spain and probably Italy to leave the Euro and until that happens expect more riots, strikes, bank runs, bond defaults and bailouts. Europe is facing a situation not unlike the US in 2008 when AIG, Merrill, Bear, Lehman etc all went under. Needless to say this prospect is not good for the market.

In the US the modest recovery seems to have slowed somewhat. The weekly jobs report showed no improvement in job losses and the monthly Philly Fed report was terrible… provoking Goldman to recommend shorting the consumer discretionary stocks ( Auto manufacturers, HD). I think we have seen the high in the S&P for the next few months.

In China the hard landing prospects are becoming increasingly dire and this is hitting material stocks. Since the beginning of May RIO has fallen from $56 to $43. and BHP has fallen from $76 to $62. Canadian material stocks have followed suit. Oil is also down with the easing of the Iran crisis, increased supplies from Canada and the US and reduced consumption in developed countries. If the economy in the industrialized countries continues to weaken oil prices will fall further.

If it were not for the situation in Europe I would be mildly bullish on the US market. S&P 500 profits are good and the forward P/E is attractive. The Toronto market has not participated in the first quarter rally but has dropped with last weeks correction and now represents reasonable value. The sectors I would stay away from are oil and metal stocks as these are likely to be volatile to the downside

My primary indicator, the 10 year monthly S&P chart will likely give a sell signal at the end of this month. The indicator line, the 10 interval EMA was almost at the crossover point at the end of April. Also my other two indicators, the CRB index (CRBQ) and crude prices (OIL) are also declining. However is likely that there will be a bounce at S&P 1278, the 200 day MA.

Investment Strategy

Over the next week I plan to re-orientate my holdings to prepare for a volatile summer market. The first principal of investment in this climate must be preservation of capital. This means giving priority to return of capital not return on capital. Reaching for yield by purchasing riskier securities is a very bad idea since capital losses can far exceed the additional yield of one or two percent per annum. One should be long only the strongest blue chip stocks.

Proposed Portfolio

The principals followed in developing this portfolio are:

1. Blue chip dividend paying stocks only

2. Sufficient daily volume to get out quickly and easily in case of a market crash (except for the two preferred recommended. These could be replaced by CPD if desired).

3. Inclusion of short protection (HXD) and gold (ABX) to limit downside and reduce volatility. However the portfolio will be net long to reflect my mildly bullish outlook. If my primary indicator gives a sell signal at the end of the month I will increase the short position.

The following is a macroeconomic view of the current market from fellow Canadian investor Nicholas Marriot, who primarily invests based on fundamentals when leading stocks incur a significant pullback.  Nicholas can be found on twitter as @shlick if you'd like to follow him.