01 Jul

Is the party over? Many investors may be wondering if the stock market's advance in 2023 is for real and if it's a good time to stay invested or even add to an existing position. In other words, does the market have more to go or has it run out of gas?

In order to answer that question we think it's a good idea to take a step back and look at the bigger picture. The S&P-500 spent all of 2022 fighting strong selling pressure to finish the year down about 20%. In fact 2022 was the worst yearly performance for the index since the financial crisis of 2008. 

After an ugly year like that it is very reasonable to expect the market to experience a bear market rally that retraces somewhere between 60% to 80% of the first leg of the bear market. And so far in 2023 the stock market is doing just that. Inspite of this strong performance and what most investors might perceive as a "new bull market" we believe this bounce is only just part of a larger and longer lasting correction that should continue into 2024.

Basically put, this advance so far in 2023, is more likely to be near it’s completion point or will be in the very short-term and then we believe the path of least resistance will be down with strong selling pressure for the next 9-12 months. If this outlook is correct then the S&P-500 is likely to experience a drop of 20-30% or more from current levels that would take it below 2022's lows.

The weekly chart of the S&P-500 below gives a good visual of the volatile nature of the drop the market experienced in 2022 and the bear market rally in 2023 recently reaching the first significant reversal zone (red rectangle/down arrow) that could very well take it all the way down to the support zone shown on the chart (green rectangle/up arrow) in the coming 3-4 quarters.

Bottom line based on how the stock market got here our analysis suggest that this is more likely to end up being a major "bull trap" than the start of a long-term advance. Nobody knows what will happen but this may be a good time as any to flip to the conservative side.

The good news is that currently increasing cash holding actually pays really well. At current market levels we believe the best way to handle the current situation, even if premature, is to take the following actions:

  • Increase cash holding: Earn 4-5% in T-bills, CD's or savings accounts and aggressively reduce passive investments.
  • Increase allocations to alternative managers: Look for managers that have demonstrated positive returns or those that have significantly outperformed in bear market conditions.

One caveat with all this is the current AI boom cycle. Should the tech sector continue to rise dragging with it the other sectors the actions above will likely still produce favorable results even if it underperforms the general stock market returns in the short-term. 

On the other hand, if the market does fall 20-30% from current levels or if the market decides to test all-time highs before doing so the above actions will make a significant difference and cash will be available to jump back in when the time is right at discounted prices.

It's all about managing risk and not getting emotional in the process. The quote below seems to fit quite well in this current situation. 

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