The weekend concluded after a series of blows on a global scale. A failed coup in Turkey left thousands of military and security forces who favor secular democracy in custody; European Union leaders have reportedly discussed denying Britain voting rights to hasten its exit; and another attack on law enforcement officers in the U.S. dominates headlines domestically just as the political conventions begin. For investors, one question to ponder as the week begins is whether security and geopolitical threats to stability will undermine the impact of aggressive easing actions of the world’s central banks. A recovery in the Turkish lira and global equity indices and a retreat in gold prices, seemingly fueled by the coup’s failure, suggests that at least some parts of the market believe central bank policymakers still trump security threats when it comes to financial asset valuation. Meanwhile, the dollar’s continued strength has been fed by derivatives markets that have seen rising bets that the Federal Reserve will hike rates before the end of the year, indicating that some traders are betting that still strengthening underlying fundamentals will offset any external risk factors.
Pace of Chinese home price expansion cools. China’s National Bureau of Statistics released data on Monday indicating that the pace of rising property prices in China cooled somewhat in June, with average prices for new homes declining in ten out of the 70 cities surveyed versus four in the prior month. The slowdown follows a push by several regional governments to curb potential price excesses in recent months.
Massive chip maker takeout. Japan’s SoftBank Group Corp. on Monday announced the acquisition of ARM Holdings for more than $30 billion. The move by the Japanese firm to buy out the British tech giant, which works closely with mobile-device makers such as Apple and Samsung, comes as a positive signal for U.K. valuations post-Brexit.
Republican convention to begin today. Cleveland, Ohio will welcome the first day of the GOP convention today as splinter groups continue to work to thwart the nomination of real estate mogul Donald Trump. The presumptive candidate is scheduled to address the crowd on Thursday evening.
BofA earnings better than forecast. Bank of America Corp. on Monday announced second quarter results that, at $0.36 per share, was stronger than consensus analysts’ estimates. As will rivals JPMorgan Chase & Co. and Citigroup, the bank’s earnings were padded by an improvement in fixed-income trading earnings. Trading revenue at the Charlotte-based BofA rose by 12 percent versus the same quarter last year.
Portfolio Perspective: Tighten Your Helmet Straps
Our bullish call on stocks has been proven correct. However, we are now reminded of the Japanese proverb attributed to Tokugawa Ieyasu (1543-1616): “After victory, tighten your helmet straps.” We maintain a strong, longer-term bullish bias on the market, and this is a good time to take a rational, objective view of the factors that could challenge that bias or prove it wrong. Simply put, we need to spend some time thinking about “what should not happen” if our bullish bias is correct.
In recent years, many writers have worked to help investors understand the cognitive biases that lead to errors in the marketplace. Chief among these errors is confirmation bias, which is the tendency to pay attention to facts that support our position while ignoring facts that would contradict it. In extreme cases, someone suffering from a case of confirmation bias might not even see contradictory data points. We cannot truly overcome these cognitive biases, as they appear to be a deep part of the machinery that makes us human. However, we can take steps to protect ourselves and one of the key tasks of trading, investing and market analysis is to actively seek information that would contradict our biases or make our positions incorrect.
To that end, we spend a lot of time thinking about what we should not see if our bullish bias on stocks is correct. Overextension (or, in the more common parlance of technical analysis, overbought/oversold) is a fact of life in financial markets, which move back and forth between periods of strength and weakness, with average prices somewhere in between.
We expect that markets may retreat from overextended levels, as a natural function of the flow of buying and selling pressures. Put this together with the statistics we shared last week (that markets tend to reverse from significant highs), and we have a situation in which a pullback should be taken as normal and fully expected.
However, there are a few things we should not see within a bigger picture bull market. Mainly, selling pressure should not lead to more selling. If this happens — for example, multiple large sigma down days, extensions below the lower channel that are not quickly recovered, general assessment that the character of the market (such as “every dip is bought”) changes — then we will have cause to reevaluate our bullish stance on stocks.
We do not think this is likely, but it is always possible, and there are cases where trends end with a minor test of new highs (such as we’ve recently had in the Standard & Poor’s 500.) Normal, moderate weakness is to be expect. Extreme, enduring and unrelenting weakness are not to be expected and would be cause for concern. To reiterate: We see no evidence of this and see a high probability that the bull market is beginning a new leg up. However, effective risk management means being a step or two ahead of the market, considering all the possible ways that prices could unfold.
Adam Grimes is chief investment officer for Waverly Advisors in Pittsford, New York.
