After recording one of the worst months on record this May, U.S. markets have been bouncing, writes Landon Whaley.
“We got more bounce in California than all y'all combined.” —by Soul Kid #1
Those 20-year-old lyrics were flowing through my mind last week as I evaluated the most recent countertrend rally in U.S. markets. Bounces are one of the hardest aspects of investing for investors to grasp. I’m talking here about both countertrend bounces that occur in bear markets as well as last-gasp bounces of long-standing bull markets.
Most investors struggle to decipher whether a decline in a bull market is a buyable dip or the beginning of the next bear market. Similarly, is a countertrend bounce in a bear market a shorting opportunity? Or is it signaling the beginning of a phase transition into a bull market?
Deciphering these nuances in markets is extremely difficult and can only be confirmed after the fact. Any price action, bullish or bearish, must be viewed in context to be truly understood.
Our Gravitational Framework provides this context.
We start by gaining insight into the economic and monetary policy backdrop of the market in question. We do this through our Fundamental Gravity. If a market in a bearish formation is rallying (or a bullish formation is declining), we ask ourselves: has any aspect of the FG for the underlying economy shifted? If the answer is no, then the price is diverging from the underlying Fundamental Gravity. Such divergence is a regular occurrence in markets but rarely lasts longer than six weeks.
We believe that price offers no real value on its own and often tells lies, so we then turn to our Quantitative Gravity to gain insights into what’s happening beneath the surface. The Quantitative Gravity further clarifies whether the price bounce is a façade to be taken advantage of or the beginning of a phase transition to a new directional regime that needs to be respected and monitored.
Finally, the Behavioral Gravity helps us quantify whether the bounce has shifted investors’ perception of that market, and to what degree.
When you analyze a market utilizing this three-dimensional approach, it generally gives you a very clear picture of what the price action means, and, more importantly, whether the bounce is providing you with an opportunity to position yourself in markets with a better risk-reward set-up than before the bounce occurred.
After recording one of the worst months on record this May, U.S. markets have been bouncing California-style to start June. Most investors are going to make the mistake of buying the bounce in sectors like technology, basic materials, and financials. Buying those sectors when the U.S. is in a Spring or Summer FG is just fine, but Winter is a beast of a different kind, and buying growthy equities will get your portfolio the woodshed treatment.
Nothing has changed over the last 10 trading days, the U.S. playbook remains the same, which is why we used this latest bounce to profitably short financials and to book gains in the U.S. dollar after buying it on the “Powell said there would be a rate cut” dip.
The key to successfully managing bounces is to contextualize them against a backdrop of Fundamental Gravities and intermediate-term trends. This helps you identify where risk and opportunities lurk within the price action.
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