An Important Update on the Markets

Jan 21, 2022

If you’re feeling a little anxious about the markets, you’re certainly not alone.

Despite the holiday-shortened week here in the U.S., stocks are on track for their worst weekly performance in more than a year. And as of Thursday’s close, the benchmark S&P 500 Index (SPX) was down more than 7% from its recent all-time high.

In the grand scheme of things, a 7% decline isn’t all that concerning. It doesn’t even qualify as an official market “correction” (a drop of 10% or more from a peak).

However, it is the biggest pullback we’ve seen since the market fell nearly 9% ahead of the 2020 U.S. presidential election. And, more importantly, some of the most popular and widely owned areas of the market have performed far worse than the S&P 500 would suggest.

For example, the Nasdaq 100 Index (NDX) — which has a greater concentration in high-growth technology stocks — has fallen more than 11%.

The small-cap Russell 2000 Index has lost more than 17% to date.

And many individual stocks — ranging from market-leading blue-chip tech stocks like Amazon (AMZN), Netflix (NFLX), and Tesla (TSLA) to more speculative growth and “meme” stocks — have fallen 20% to 40% or more.

So this week, I’d like to take a few minutes to share what our TradeSmith market health tools are saying about this pullback so far. We’ll also review a few of the most important ways to protect yourself from whatever the market does next.

Let’s start with the good news.

As you can see in the snapshots below, our market health tools show that the overall markets are still generally healthy today. (If you’d like a refresher on how these tools work, click here.)

Our Market Outlook tool shows that most major indexes — and most of the stocks within them — are still in the TradeSmith Health Indicator Green Zone.

It’s also worth noting that even the two weakest U.S. indexes above — the Nasdaq 100 and Russell 2000, which I mentioned earlier — only just dipped into the Yellow Zone this week. Neither is in imminent danger of falling into the Red Zone today.

Our S&P Sectors tool is sending a similar message about the individual sectors here in the U.S.

Again, most sectors and most of the stocks within them remain healthy. Just one of the Yellow Zone sectors — Communication Services — is at serious risk of falling into the Red Zone today.

In other words, despite the intense selling in some areas, our tools are saying this is just a normal bull market correction so far. They’re not detecting any of the usual signals that precede a crash or severe bear market.

For now, it would be foolish for us to panic and sell otherwise healthy stocks prematurely.

However, it’s essential to understand that this could potentially change in the future.

That’s because our market health tools operate more like a powerful X-ray than a crystal ball.

They allow us to look “under the hood” of the markets, which can provide valuable clues to their next moves. But no tool can perfectly predict the future.

If we see continued selling pressure in the days or weeks ahead, our proprietary Bearseye Signal could trigger in one or more indexes.

In that case, I personally will be selling all stocks (even healthy ones) in those indexes and moving to cash. And I would generally recommend most investors do the same.

Last summer, I explained how this bear-market warning signal works. If you missed it, you can catch up here.

And don’t worry if you’re not currently a TradeSmith subscriber. As I mentioned back then, I will alert all Money Talks readers if a Bearseye Signal appears in any of the major market indexes we follow.

In the meantime, if you aren’t already following our basic TradeSmith risk-management advice, I urge you to correct that immediately.

First and foremost, I recommend you set and follow a trailing stop loss on every position in your portfolio.

If you’re a TradeSmith subscriber, that means selling when any stock or asset falls into the Red Zone or hits its VQ (Volatility Quotient) Trailing Stop, no questions asked.

If you’re not yet a TradeSmith subscriber, you’ll sell when a stock falls by 25% or whatever fixed percentage you’ve chosen.

(If you’re new to Money Talks, you can learn more about trailing stop losses here and here.)

Second, you want to make sure you’re not risking too much in any single position.

If you’re a TradeSmith subscriber, our Position Size and Risk Rebalancer tools can do this for you automatically with a few clicks of your mouse. But you can also do this manually with some simple calculations, as I explained right here.

And finally, be sure your portfolio is reasonably diversified.

This includes making sure your money isn’t concentrated in any single asset class, like stocks. But it also means making sure you’re not taking too much risk in any asset class.

For example, you might have only a portion of your overall portfolio allocated to stocks. But if all of those stocks are speculative, high-VQ stocks, you could still be taking more risk than you can comfortably handle.

I explained the basics of proper diversification here.

Again, if you aren’t yet following these simple guidelines, I hope you’ll do so today. They could make a huge difference in your investment results this year — and help you sleep better at night — no matter what the market does next.