By Pete Biebel, Senior Vice PresidentPrint This Post
Back in the olden days, Monty Hall was the long-time host of a TV game show called “Let’s Make a Deal.” The show was famous for having contestants select one of three doors for their prize. Hidden behind one of the doors would be a great prize, like a boat or a car, and behind the other two would be much lesser prizes, like a rocking chair or a goat. He, (Monty, not the goat) knew where the big prize was.
That schtick inspired an infamous logic/probability problem: Suppose that after the contestant chose door number one, Monty reveals the goat behind door number three and then offers the contestant an opportunity to change their selection. Should the contestant opt for door number two?
For the past eight weeks, investors have cheered as the market indices shot higher. Last week they blew through their 200-day moving average (the indices, not the investors). Investors are now faced with a predicament similar to the Monty Hall problem. With stock prices having appreciated so steeply in just two months, should an investor switch to a more defensive posture or remain bullish expecting a run to new highs?
For investors who are well diversified and who didn’t lose much sleep as stock prices fell in December, it’s just a rhetorical question. What happened last week or last month or last quarter has little impact on their long-term plans. Investors who are less well diversified and/or who were deeply upset by the declines in their portfolio values in December, might want to use this eight-week rally as an opportunity to develop some sort of risk reduction plan.
Perhaps those investors who are most torn by this paradox are those who are holding too much cash. Maybe they sold stocks as positions were stopped-out when prices fell in December. Maybe they rode through the December sell-off but sold stocks when prices began to rebound in early-January. If the indices are headed for new highs, I need to put that cash to work now. If the rebound has run its course and the indices are likely to revisit their December lows, then clearly, I should do no buying now.
The reality is that, unlike the Monty Hall problem, it’s not a one-time decision. Investing is an ongoing process that depending on one’s age, income and risk appetite, might require anything from just occasional tweaking to frequent tactical adjustments. In December we got the goat, but in January we got the new car.
To anyone who feels that they’re holding too much cash and who feels tempted to chase the current rally, I’d suggest holding off for a week or two at least. On a short-term basis, the market is overdue for a little settling back. The market has steamrolled further and more persistently higher than most expected. The early weeks of the rally brought a snap back rebound from an extremely oversold condition through the overhead vacuum created by the whoosh down in December. No big surprise, but in subsequent weeks, stocks continued higher powered largely by better than expected earnings. The rally has pushed the indices beyond typical percentage retracement levels and beyond their 50-day and 200-day moving averages. That greatly reduces but doesn’t eliminate the potential for a retest of the December lows.
The key takeaways over the next few weeks might be…
- Can the indices see sustained trading above their 200-day moving averages? Following the October decline, the S&P 500 Index (SPX) rallied twice to poke above its 200-day average only to fall back below it in a day or two. SPX closed Friday just below 2776; its 200-day moving average is currently just below 2745.
- If/when the market does sell-off some, does it break below any key technical levels? On SPX, the first such level is the early-February low near 2682. The next, more critical level is the 2600 – 2620 area.
- After whatever timeout phase unfolds, can the indices rally beyond their February highs? Doing so would be a very bullish development.
The statistically correct answer to the Monty Hall problem is that the contestant should opt for the other door. While that answer seems illogical, it has been proven to be correct in formal mathematical proofs and in computer simulations. One source describes this as a “veridical” type of paradox, “because the correct choice is so counterintuitive it can seem absurd but is nevertheless demonstrably true.”
Just by coincidence, I ran across another reference to “intuitive” over the weekend. I’m including this solely for entertainment purposes. This should not be inferred to be any kind of editorial on the rules involved; I’m in complete agreement with the outcome. The managers of a mutual fund, which holds a significant percentage of its assets in an illiquid investment, initially placed a much higher value on that asset than the fund’s auditors would sign-off on. Upon further reflection, the managers grudgingly came up with a new lower valuation (and a new auditor!). In their quarterly public filing, the fund’s managers acknowledged the forced change, but seemed to still be pouting about the situation when they wrote, “…we must respect the non-intuitive nature of accounting rules applicable in this situation.” That struck me as a very grown-up way to say, “Yeah, but it’s a stupid rule.”
With the flow of quarterly earnings reports diminishing to a relative trickle, and with a very light economic report calendar, the greatest scheduled catalyst for market movement this week is likely to come from the Fed. The minutes of the Fed’s most recent meeting will be released Wednesday afternoon. That will be followed by speeches on Friday from several regional Fed presidents, a regional Fed chairman and a Fed vice-chairman who will all likely provide some color on the Fed’s bias with respect to its balance sheet wind-down. Random headlines on tariff/trade negotiations with the Chinese will probably continue to roil the markets occasionally. They (the headlines, not the Chinese) have so far provoked predictable responses in the markets. The real news will be when good news is followed by lower prices or vice versa.
|Tuesday 2/19/2019||Housing Market Index||58||59|
|Wednesday 2/20/2019||FOMC Meeting Minutes|
|Thursday 2/21/2019||Durable Goods Orders, M/M||+0.8%||+1.2%|
|Durable Goods Orders, ex-Transportation, M/M||-0.3%||+0.3%|
|Initial Unemployment Claims||239K||225K|
|Philadelphia Fed Business Outlook Survey||17.0||14.0|
|PMI Composite Flash||54.5||54.1|
|Existing Home Sales, SAAR||4.990mm||5.050mm|
|Leading Indicators, M/M||-0.1%||+0.2%|
Links to previously published commentaries can be found at benjaminfedwards.com/Company News/Blog/Market.