How Long Can S&P500, PMs and Bonds Rally?
Source: J.W. Jones, Options Trading Signals (1/5/11)
"Stocks are overbought currently on nearly every timeframe."
In the second half of 2009 all the way through 2010, a variety of asset classes performed quite well.
Investors who purchased stocks, gold or silver and bonds anytime in 2009 were handsomely rewarded in 2010 if they held their positions. How long will these assets continue to perform well? How long can gold pump out double-digit returns before suffering a bad year? How high can stocks climb when uncertainty seemingly surrounds the marketplace? Price action is never wrong, but history reminds us that a particular asset class does not outperform all other asset classes consistently over long periods. Trees do not grow to the sky.
Since 2009, stocks, precious metals and bonds have all had tremendous performance records. Most economists point to actions by the Federal Reserve as the primary reason because these interventions lowered interest rates to extremely low levels that caused investors to take more risk for better returns. High levels of liquidity paired with low interest rates moved nearly every asset class higher, with stocks and precious metals earning outstanding year over year returns.
With 2011 just starting, will stocks, bonds and precious metals continue rallying? When looking at probabilities and statistics the odds are not favorable that all three asset classes will remain outstanding investments. In fact, it is possible and arguably likely that at least one of the asset classes, if not more than one, will face headwinds in 2011 and beyond. While Tuesday was only the second day of 2011, precious metals are under significant pressure and the fundamental picture for bonds and stocks is uncertain.
Stocks are overbought currently on nearly every timeframe. Some pundits are calling for another outstanding year while others believe a correction is likely to unfold. I for one am totally unsure about the future, but what I am certain of is that I would be cautious at this current juncture in time. I would not be afraid to take profits and adjust stops to protect my trading and investment capital at these levels. Risk seems excruciatingly high and when we look at a longer-term chart of the S&P500 it is rather easy to surmise that a pullback may take place.
S&P500 Index (SPX)
If price action yesterday is any indication of what may be in store for gold and silver investors a nasty correction or pullback may be likely. I have been warning about the possibility of such an event and as usual have received countless emails and even some veiled threats. Gold may go up for years, but most assets do not trade straight up. Price ebbs and flows with the marketplace and buyers and sellers come together in the process of price discovery.
If this is the start of a correction in gold, a potentially outstanding purchasing opportunity is possible for patient traders and investors. While the gold bugs fill up my email inbox with hate mail, I wait patiently to enter at lower prices while they remain in denial. The daily charts of gold and silver futures below illustrate key support levels that would likely offer solid risk / reward entries.
Gold Futures Daily Chart
Silver Futures Daily Chart
For most traders and investors that started their careers in the 1980s, they have witnessed a bull market in bonds as yields went from double digits to the lowest interest rates in history over the past 20–30 years. New all time records could be set in the future, but strong fundamental headwinds exist. Overexposure to bonds could prove dangerous and diversification regarding duration, currency exposure and geography remains paramount.
Many pundits and economists are showing considerable concern with regards to municipal and treasury bonds. Defaults are being discussed openly in the municipal space and there is additional concern that interest rates could continue to rise on U.S. Treasury obligations against the Federal Reserve's wishes. Neither scenario is pleasant and certainly would impact bond pricing. Municipals have been under pressure, which is evident from the daily chart of MUB shown below. Additionally I have displayed a weekly TLT chart with additional technical analysis.
MUB Daily Chart
TLT Weekly Chart
I have no idea what is going to happen over the next 12 months in financial markets. What I do know is that equities, precious metals and bonds have been providing outstanding returns for over a year. While I realize that there are fundamental and technical drivers impacting the price action, I would be remiss if I did not remind traders and investors that taking profits is never a bad strategy. While all three asset classes may power higher by the end of the year, at some point in 2011 it is possible that all three asset classes may potentially go through a pullback. By taking profits, traders allow themselves the opportunity to put fresh capital to work at potentially lower prices sometime in the future.
A patient trader who uses fresh capital to buy assets at lower prices compounds his/her returns while selling when prices are relatively high and buying when prices move lower. By no means am I saying to sell everything and move to cash, but when bullish sentiment is so pronounced and the price action looks extremely overbought, taking profits is something worth considering. At some point, we know at least one of these asset classes will lag going forward simply because it has been working well for such a long time.
Statistical probability dictates that every month that passes with higher prices brings us closer to a correction or pullback. Those who are prudent and take profits while raising cash levels along the way will have capital to take advantage of lower prices. In addition to taking profits, investors should also consider moving stops and limiting their risk profile. There will always be new opportunities, but replenishing capital is seemingly harder by the day.
The great thing about options is that if you know all the strategies available then you can make money in virtually any market condition. Our recent trades in Dec. and Jan. thus far using options have been: AMZN 8%, USO 15%, TBT 58%, SPY breakeven, IBM trade is currently open.
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