There were important developments in the market that have prompted an additional step to the most defensive allocation in our Model Fund Portfolio since the 2000 Tech Bubble, observes Jim Stack, money manager, market strategist and editor of InvesTech Research.

Most notably, our Housing Bubble Bellwether Barometer decisively broke through its critical support level. In addition, the latest data from the National Association of Homebuilders (NAHB) revealed an ominous drop in Homebuilder Confidence AND Traffic of Prospective Buyers.

Topping this deteriorating outlook for housing, the 30-year mortgage rate shot up from 5.23% to 5.78% this week, the largest jump since 1987 and the highest rate since 2008!

Adding to our concerns, our Canary (in the coal mine) Index and Gorilla Index of the market's most popular stocks have both broken their support levels and are now hitting new lows.

We developed the InvesTech Canary (in the coal mine) Index early last year to provide advance warning of a major breakdown in speculative fervor, just as in the old mining days when canaries were used for early detection of methane gas.

This important signal came on January 4, 2022. The canary’s demise confirmed that our avoidance of such speculative issues and early defensive positioning were well warranted. The high-risk stocks contained within our Canary Index have collectively lost over three-quarters of their value so far (see graph at left), and history suggests it’s likely even more pain lies ahead.

The InvesTech Gorilla Index, which is comprised of just 10 stocks representing almost 25% of the S&P Index, has fallen more than -40% from its high last November. The index Index continues to display technical weakness by breaking through major support levels, which means that it could drag the S&P 500 down further before this bear market is all said and done.

On the macroeconomic front, the Federal Reserve’s 0.75% rate hike was the largest since the 1994 economic “soft landing.”  The problem is that evidence continues to mount that we are not heading for a soft landing! Both consumer sentiment and small business outlook have plunged to historical levels that invariably end in recession.

History has shown that one of the extreme challenges with today’s overheated economy is that a tight labor market and inflated home prices only cool down with a recession. And while it is not in the Federal Reserve’s stated objectives, we see increasing evidence that a recessionary outcome for the U.S. economy may be inevitable.

Our latest trades have bolstered the already significant defenses of our Model Fund Portfolio as we continue to navigate this period of extreme and growing risk. 

Bear market bottoms are often V-shaped events, with a sharp sell-off followed by a strong rebound. Nonetheless, there are identifiable characteristics — none of which are present at this time. For now, it is most important to remain patient and disciplined.

Our net invested allocation of only 44% is now the most defensive in over 20 years (our most defensive allocation during the Great Recession was just slightly higher), and our portfolio is well positioned to weather the potential storm ahead. The “good news” is that this will ultimately lead to one of the best buying opportunities in decades; but for now, patience is paramount.

Subscribe to Investech Research here…