2023 turned out to be a great year for investors. It was really hard not to make a lot of money last year. And while the trends for stocks and many other risk assets are certainly up, we want to be identifying what the market will have to do for us to position ourselves much more defensively into the new year, states JC Parets of AllStarCharts.com.
The first warning of a non-so-great market environment would be a breakdown in the Nasdaq100 and Small-cap Russell 2000. Look at those former highs in QQQ from late 2021. If the Nasdaq100 ETF is below 400, that would put it back below those former highs, increasing the vulnerability for further downside, or even a grind sideways.
It's a similar setup in the Russell 2000. A recent breakout attempt out of this 18-month range could fail if the IWM gets back below those former highs. Like the QQQ above, a breakdown here would increase the vulnerability for further downside, or even a grind sideways:
As money went into stocks and other risk assets throughout 2023, a lot of money flowed out of the more defensive areas. Consumer Staples were front and center, as they usually are during bull markets. Historically, consumer staples underperform during healthy market environments. It's when they outperform that stocks in general are usually under pressure.
If Consumer Staples relative to S&Ps starts to break back above those former lows from late 2021, that would indicate defensive rotation and an environment where being much less aggressive from the long side is probably best. Short positions would likely be doing better in this scenario. Larger cash positions will also make sense if XLP/SPY is back above those 2021 lows:
And finally, the most defensive asset of them all, the US Dollar, needs to be included in the list of items that it would take to get much more defensive than we've been. Think about it, not only have we not been defensive the past few months, but we've gone out of our way to be aggressive.
Our strategies were based on a bullish environment, loaded with sector rotation and a weaker Dollar. If we start to see a stronger US Dollar, that is most likely happening in an environment where stocks are under a lot more pressure than what we've grown accustomed to over the past quarter.
Notice how the Dollar has completely fallen apart since peaking on October third. October third was the day that the new lows list peaked on the NYSE. Also, notice how the Dollar rallied off those mid-July lows. The Dollar bottomed the same day that the new highs list peaked on the NYSE. None of this is a coincidence, in my opinion. If the US Dollar is back above 102, that's likely happening in an environment where stocks are under pressure and a more defensive position is best tactically.
I think it all comes down to time horizons. What are your objectives as a trader an investor, or both as in my case? What about your risk tolerance? How much money are you willing to spend on any one theme or idea? It's important to make sure you nail down these answers before moving forward. This goes for all of us. And remember, these answers will likely change over time, depending on your own personal situation, or in many cases, your clients' situations. Think about it. But these are a few key items that I believe will be a good tell that we should be much more defensive than we have been.
To learn more about JC Parets, please visit AllStarCharts.com.