Does It Make Sense To Short U.S. Stocks?

JC Parets
September 10, 2018

For us, the big question going into the weekend was whether or not the most recent leg higher in U.S. Stocks is the beginning of something bigger, a breakout of epic proportions, or just a major whipsaw that will lead to further selling into September and October, two of the most historically volatile months of the year.

We see various crowds. On one hand, you have the bearish cult who for many reasons have fought this uptrend the whole time. Whether they just missed the last couple of years in stocks or, worse in some cases, missed the entire decade, they've been very wrong. There's even a group who wishes harm on the United States and elsewhere around the world, just because they disagree with decisions being made in D.C. They certainly don't want stocks to rise. And then you have another group, who is indifferent and is just looking for a favorable risk vs reward shorting opportunity and they think this is finally it.

We have been in the camp, consistently, that stocks are in an uptrend and we've wanted to be buying them. As we gather new data every day and every week, we reevaluate that stance to see if there is enough evidence that would suggest that a sellers approach favors the aggressive buying strategies that we've been incorporating. The buying has specifically been in individual stocks because how I learned it, "If you trade the averages, you get average returns". However, the fact that we've wanted to err on the bullish side is in part because we've believed that the major indexes would rise as well.

Is it true that the S&P500 is flirting with failing to hold above the January highs? Yes. Is the Dow Jones Composite Average, which combines the DJ Industrial Avg, DJ Transportation Avg & DJ Utility Avg, running into the same dilemma? Yes. One thing I think is worth pointing out, however, is that this is a market of stocks. I've ripped through thousands of charts this weekend, in between football games, and my conclusion is simply this: there are more stocks that I want to be buying than stocks I want to be selling. And this is by an overwhelming amount. It's not even close.

So when it comes to having to decide in which direction we would rather err, the evidence continues to point to an environment where stocks are being accumulated, breadth is expanding and sector rotation rules.

Here is the S&P500 attempting to hold above this breakout from an 8-month base. If we are above 2870, then we want to be buying stocks very aggressively. From a risk management standpoint, more neutral approach in the short-term is certainly warranted if we're below it:

Here is the Dow Jones Composite Average. Our big level has been 8600, which represents the 261.8% extension of the 2014-2016 decline. If we are below that level, then like the S&P500, a more neutral approach makes sense. But if we're above those January highs, then very aggressively buying stocks is the best strategy by our work:

Finally, the Small-caps and Mid-caps have been the leaders. As bulls, we want to see that remain the case. So if we're below 170 in the Russell2000 Index $IWM, a more neutral approach is best. But above that and we want to remain aggressive from the long side:

Technology represents about 25% of the entire S&P500. I would argue that this makes it an important sector for the overall market. Underneath the surface, there are a few key levels I want to make sure we identify. From an upside confirmation perspective, the Dow Jones Internet Index Fund $FDN holding above 148 would be incredibly constructive for the Sector, as this has been one of the leaders along the way:

From a risk management standpoint, the Software Index Fund $IGV holding above 188 is a key level. If we're below that, the in all likelihood something is wrong and a more neutral approach towards equities short-term is probably best:

We can make the same argument about the Cloud Computing Index Fund $SKYY and 55. Holding above that level is key. We want to be aggressively buying stocks if $FDN $IGV and SKYY are above their respective lines in the sand:

On another positive note, Berkshire Hathaway went up in price every single day last week. This is the largest component of the S&P Financials Sector Index, with an even higher weighting than JP Morgan Chase $JPM. In our work, we treat $BRKB as another index, like the S&P500 or Nasdaq Composite.

If we're above 200 in $BRKB this is further evidence to me that we need to be aggressive from the long side. More specifically, not just buying $BRKB, but Financials in general, and therefore the rest of the US Stock Market as a whole.

One thing that has worked for us is to own the leadership. Getting cute and bottom fishing underperforming stocks and sectors has proven to be foolish. While sector rotation is certainly evident (e.g. Healthcare now making all-time highs after struggling for a while), buying the stocks that are already going up continues to make the most sense.

I went through thousands and thousands of charts this weekend. I'm not seeing enough evidence to suggest that turning bearish and shorting stocks aggressively here makes much sense.

We're long.

JC

 

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