The two most important points about this decline are that we know from the sentiment breakout of December 28 that a pullback will not be the end of the bull market, and we knew from the momentum reversal of 2CS and some other indicators on January 12 that a pullback was fairly likely within a few weeks. This is the beauty of sentiment: it allows us to follow a trend without calling for tops every week and it tells us when a trend change is likely.
I'm going not going to pretend to predict at what price or which date the pullback will end. We can all do the Fibonacci calculations or other projection methods. One of my favorite chart probabilities is the CSI Data seasonal or annual pattern for the Dow 30. This is based on daily action in the Dow beginning in 1928.
The normal pattern is for a high in early January and a low in March, like last year. Nothing is guaranteed, but 82 years of market action is pretty convincing for a rough guide to the next two months.
If indeed is still a bull market and the pullback is severe (10-20%) I would expect a bottom when 2CS reaches about 110. It's 74 tonight after making a low of 60 on January 11. Being a five day measure it takes a while to get moving but once it gets to 80 it can quickly jump up.
There is no way to know if this will be a 10-20% move. It may be over again in a few days as it has done since last March, but sentiment and other measures are set up for a larger decline if the market obliges.
Very little has changed this year to date. This week's special US Senate election in Massachusetts will set the tone for major Obamist legislation up to the mid-term elections in November. The Executive branch and the Federal Reserve remain the major surprise factors, whether we like it or not.
As for investing, I have done nothing so far in January except to add back LSBDX into the IRAs for yield and gain potential. LSBDX's principals won the Bond Fund of the Year award from Morningstar for their long term returns and excellent bounce back. They became more conservative as last year progressed, and are holding a lot of Canadian T Notes and fewer junk bonds. Since I have several high yield junk closed end funds (HIO, PKO), LSBDX is a diversification along with steady Pimco Bond Fund PTTRX, my largest position in the IRAs. I am keeping Vanguard Ginnie Mae fund VFIJX, even though its yield has fallen greatly, because I need to have a certain minimum of Vanguard Funds to get the low commissions ($8) and other Vanguard benefits. So VFIJX is basically my "money market fund" in the non-taxable area
In the taxable accounts I have done nothing and still have a large amount in the tax-free money market fund. The limited partnerships (LP) I bought in December amounted to about 15% of total taxable assets. They have done very well in just a month, up 6.3% not including dividends. Much of their dividends are tax-deferred until they are sold, and I may just keep them forever. These are EPD, ETP, ETE, NS, NSH, and DMLP. DMLP is a oil and gas property and royalty owner which benefits from rising prices and from new drilling paid for by others. The rest of the LPs are pipelines, storers, and processors of gas and crude oil and products. ETP also distributes (sells) propane gas. Much of their income is fee-based rather than being tied to commodity prices.
The basic idea behind buying these LPs is that they throw off 8-9% of largely un-taxed income like high yield junk municipals did a year ago, but they don't have the same risk of default. I'll admit that I misjudged the muni market in that it has done far better than I expected. The direct Federal support for states and counties and cities has kept them solvent so far, and the new direct placement "federal" municipal bonds have allowed issuers to avoid the regular new issue market, just as with the mortgage market. With reduced issuance and increased worries about higher taxes coming, longer term municipals have flourished. After their rise back to pre-crash levels they are probably overdue for a "rest", so I am using the LPs to augment the muni money market yield.
For other taxable account choices, I have thought a lot about buying Wellesley Income fund VWINX/VWIAX, Vanguard Health Care VGHCX, or Vanguard Energy Fund VGENX. Even though the "health care" bill will hurt Medicare beneficiaries, the demographic reality is that the population is aging and will have more medical problems as they age. There are so many truly exciting therapeutic possibilities under development that more than a casual investment in health care seems warranted. VGHCX was a huge winner in the 1990's but just average in the last decade. I am waiting for a pullback to buy it.
Right now I have ~20% in gold and gold stocks, and ~30% in money market funds. The rest is largely in fairly high yield vehicles of various sorts as I have previously detailed. Thus I have plenty of cash to take advantage of opportunities that might arise. I may be adding to cash this week by unloading the Merk currency funds MERKX and MEAFX. They are unleveraged and have been OK but not great. Gold and gold stocks are a much more efficient and profitable way to hedge the dollar. To stay in my portfolios a stock or fund has to pay me a very good yield or provide excellent hedging capability and prove it.
Although I don't have many "generic" stocks, many closed end funds and open end corporate bond funds trade like stocks, so I am of course interested in the outlook for conventional or generic stocks. I think we are in a bull market, as I outlined previously, due to the sentiment breakout in late December. Also market breadth remains solid. However the relaxation and happiness (I hope it was for you!) of the holidays is over, and this is normally a time of year for a larger pullback. That's not a prediction, and we may not get one.
Pierre Bernier has kindly sent me a year end update for VIXEE which was featured here last August. VIXEE is essentially 2CS with Bernier using the current VIX (I use VXO for continuity in my manual spreadsheet from 1996) and ISEE's new or opening put/call ratio while I use CBOE combined put/call (all position volume). They are quite similar in signal output.
If you look at the chart from the 2007 top you will see again that both 2CS and VIXEE have re-visited levels which have resisted further price action during this decline to March 2009 and up to last week. For 2CS that is the 70 level and for VIXEE 14% on the scaled chart: During the bull market up to June 2007 sentiment was quite bullishly brisk. 2CS readings were often under 70, 60 or even rarely under 50, and as August's chart from Pierre Bernier showed, VIXEE was often under 10% (scaled) from 2005-07. In fact, as I wrote recently under the gold post, sentiment was generally very brisk all the way from mid 2003 to mid 2007. What's more, this tendency for 2CS to fall into and below 70's was true of the entire bullish period from 1996 to mid 200o! So 40's, 50's, and 60's are typical 2CS readings at bull market rally tops, and mid 70's are typical at bear market rally tops. 2CS was 72 at the May 2008 rally top.
Surprisingly, however, 2CS touched 64 on December 24's New York close, so we are facing a potentially tantalizing test of sentiment versus market price. Are we really just in a bear market rally since November 2008 or March 2009? Or is this a new bull market like from October 2002 or March 2003 to 2007? (I do not wish to debate Elliott wave or other interpretations of bull and bear markets at this point, but over four years of a rise with a new all-time high in some markets into 2007 or even 2008 would traditionally be judged a bull market.) SPX has re-traced 50% of its loss from 2007 to 2009. Current sentiment levels, as measured by VIXEE and 2CS, are historically associated with bear market rally tops, and we have a seasonal tendency for US stocks to decline in early January. On those grounds alone the markets "should" go down from here.
Does reaching 64 for 2CS this past week indicate that we are in a bull market and that even a 10% decline now in INDU or SPX would not be the end? Of course one cannot build an entire "guaranteed" market scenario based upon just one indicator. However, 2CS and Bernier's VIXEE have performed very well over many different market environments. Also, do take a look at Carl Futia's year end sentiment analysis and evaluation.