Over the last several week’s I have continued to suggest that the markets could rally back to resistance. During the time the markets have vacillated wildly between sharp declines and monster rallies.

CNBC headlines have been almost laughable as one day’s banner of “biggest rally since 2011” is followed by“biggest decline since 2007.” For the average investor, it has been nothing but nerve wracking.

I have stated many times in previous missives that it had been such a long period without a 10% correction in the market, when it occurred it would feel substantially worse. Well, it has and it did.

But what now?

As I have often written markets do not rise or fall in a straight line. During bull markets there are declines to previous support levels and during bear markets there are rallies to resistance.

Notice that at the peaks of previous bull markets, the initial correction looked much like all previous corrections during the bullish advance. The problem is that many failed to recognize the something had technically changed for the worse.

Currently, it is being argued that this correction is just a blip in an ongoing bull market. However, there are plenty of markings that suggest that the current correction could be “something different.”

A Rally To Sell Into

As shown in the two charts below, sentiment and volatility have reached levels that are normally consistent with short-term bottoms in markets. Sellers, at many levels, have been exhausted which makes any level of buying more exaggerated than normal.

While the volatility index (VIX) is still suppressed relative to historical corrections, it is at the highest level since 2012.  When combined with the most bearish sentiment reading we have seen since the summer of 2011, and a currently oversold market condition, the ingredients needed to fuel a short-term (2-4 week) rally are present. 

The chart below shows this oversold condition, and is the same “potential reflex rally” chart I have posted for the last three weeks. The dashed blue line that I drew immediately following the initial slide has been marking the exact “reflex rally” I predicted at that time.

However, given the short-term oversold, bearish and fearful condition, it is extremely likely that the markets could advance to the downtrend resistance around 2040 currently. (As time passes these levels will change slightly so DO NOT focus on exact numbers for decision making – these are neighborhoods.)

ANY RALLY TO THOSE LEVELS should be used to rebalance portfolios, raise cash and reduce equity risk. I know it is monotonous, but I cannot stress enough the importance of paying attention to your portfolio at the current time.

Portfolio Management Instructions

Repeating instructions from last week for any continuation of the rally next week: 

1) Sell “laggards” and “losers” in FULL.   These are positions that have performed very poorly relative to the markets. Positions that are out of favor on the run-up, generally tend to fall faster in declines. (Energy, Industrials, Materials, International, Emerging Markets, etc.)

2) Trim positions that are big winners in your portfolio back to their original portfolio weightings. (ie. Take profits) (Discretionary, Healthcare, Technology, etc.)

3) Positions that performed with the market should also be reduced back to original portfolio weights.

4) Move trailing stop losses up to new levels.

5) Review your portfolio allocation relative to your risk tolerance. If you are aggressively weighted in equities at this point of the market cycle, you may want to try and recall how you felt during 2008. Raise cash levels and increase fixed income accordingly to reduce relative market exposure.

How you personally manage your investments is up to you. I am only suggesting a few guidelines to rebalance portfolio risk accordingly. Therefore, use this information at your own discretion.

Have a great weekend