We all remember the Twilight Zone, Rod Sterling’s classic American T.V. franchise back in 1959 in which Sterling invited viewers into a “5th dimension middle ground that lies between the pit of man’s fears and the summit of his knowledge.”

The series hosted all manner of episodic genres, ranging from fantasy to science fiction, suspense to horror, and often concluded with a macabre or unexpected twist, followed immediately by a moral.

The Twilight Zone analogy is therefore eerily fitting to the markets we face this December.

But we’ve got a “map” here that will get us safely through – and allow us to make some money during these strange times…

This Is History’s Weirdest, Most Distorted Market

From the fantasy of Modern Monetary Theory and endless money printing to the science fiction that rock-bottom interest rates, record global debt, and record-high deficits are a good thing, to the suspense that always accompanies market tops or the horrific potential for another ’08 moment, we too have to prepare for the unexpected as we head into 2020.

As for the moral to the story, we already know that every significant market collapse is preceded by a debt bubble followed by a melt-up and complacency phase similar to the one in which we now find ourselves but which the financial media continues to ignore or down-play.

In the quartet of charts below, we are indeed watching this Twilight Zone play out:

Viewing these charts clockwise from the upper left…

Graph 1 Record Debt – A decade of easy money has burdened the world with a record $250 trillion of government, corporate and household debt, totaling nearly three times global economic output, all to keep the global economy afloat in the wake of the ’08 financial crisis.

Graph 2 Contracting Manufacturing – Despite record corporate debt, U.S. manufacturing is contracting.

Graph 3 Consumers Plateauing – That all important consumer is getting tired.

Graph 4 Stocks Topping – Stocks are topping as GDP tanks.

What to Do: Investing vs. Trading

What to do is conditioned upon outcomes, informed understanding and timing.

For starters, as we’ve recently said here, Storm Tracker is blowing at 35 knots as we enter December. This means that 35% or so of your portfolio should therefore be in cash, or near cash as in money market funds, treasuring bills and the like.

For the rest of your portfolio, we’re at a crossroads in this Twilight Zone, with three potential outcomes in the year ahead: (a) we continue to melt-up as the tab for all this money printing and binge borrowing is can-kicked and ignored; (b) we muddle along in a nervous, sideways market; or (c) we begin that dreaded melt-down.

Trade or Invest? Go Long or Go Short? Think Near-Term or Long Term?

Which brings us to three sets of choices. You can “invest in” or alternatively “trade” these markets; you can do so “short-term” or “long-term”; and you can either bet against the market on the “short-side” or bullishly ride the market to the “long-side.”

As always, the answers to which direction YOU should take will come from (a) what the markets are telling you and (b) what type of profile you fill-the investor or the trader.

There are important differences between investing and trading. If your sitting on a portfolio of primarily stocks and bonds, relying upon a financial advisor to manage your portfolio, you are investing, probably for the long haul, probably to the long side.

This would be fun during a melt-up but the riskiest approach we could imagine in a Twilight Zone environment, especially if you lack a cash-buffer to manage risk.

At the other extreme, if you are trading on your own then you are focused shorter term, probably both to the long and short side as markets rise and fall.

Finally, if you are trading correctly, you should be able make money whether we melt-up or melt-down from here.

And that’s the key, folks. It’s risky out there. All this crushed volatility and artificially repressed rates tells us so.

So…stay liquid; invest a portion of your portfolio for the long term; but in light of the risks, carve out a meaningful short-term allocation to trading strategies (both to the long and the short side), diversified across stocks, bonds, currencies and commodities, with rules!

Rules-Based Trading Is the Key

Rules based trading will save your behind when markets leave you behind, especially in a Twilight Zone fraught with DC chaos, random bouts of volatility, bigger players than you and just plain endless indicators of risk.

In the CSR’s to come, we’ll be teaching you even more how to navigate this Twilight Zone.

Already in Here Are the “Buy” Signals in a Market Gone Crazy, we introduced the concept of developing a Sector Heat Map so you will know what sectors are hot and which are not when it comes to identifying leading sector ETF’s.

In our following piece, How to Quickly Spot a Sector’s Best-Performing Stock Buys, we took you under the hood so you could see how to target the leading stocks in those leading sectors – our favored “trading” strategy.

These CSR’s gave you an introductory look at how to use rules and guidelines to identify trading opportunities that have an edge when it comes to being profitable.

This is what rules-based systems do: They define the trade set-up, pull the trigger and exit the trade when the time is right, on a profit target or a stop-loss threshold; or for options, when the trade expires of not earlier sold.

That’s the easy part. Here’s the harder part when it comes to rules…

  • Minimize your emotional involvement.
  • Be comfortable with the securities you are trading.
  • Be patient, but don’t marry the trade.
  • Define your risk and reward thresholds (risk-management is key).
  • Use prudent money management (set a fixed $ amount for each trade).
  • When market conditions change, act and adapt.
  • Let your profits run (stay in the trade as long as it is working).
  • Cut your losses short (exit when your losing money or your stop-loss is hit).

Next Up: Volatility, Trend & Flows

Soon, we’ll be describing a few other integral parts to our trading strategy that you may want to adopt at home, even if your profile leans more toward longer-term portfolio management than short-term trading, namely concepts that relate to volatility (hint: there are two flavors, good and bad); to trend (the trend is your friend); and to money flows (you want the money flows to be with you, not against you).

All in, our aim here at Critical Signals Report is to keep you abreast of the macro environment, but also to help you when it comes to allocating between cash, long-term investing and shorter-term trading. Think of it as a pyramidal approach to wealth management:

Stick with the Critical Signals Report. We’ll keep you informed, safe and help reduce that Twilight Zone stress.

Sincerely,

Matt & Tom


Comments

3 responses to “How to Trade These Twilight Zone Markets”

  1. A while back you did a piece on gold, which you totally omit from the above discussion. From the response to that piece, a lot of your readers are believers in gold as a hedge to the hubris of the so-called elites in charge of our country’s finances. Personally I have about a third of my portfolio in selected gold stocks (primarily), and this seems to work effectively on the market’s big down days. On its worst days I generally have close to my best days. This comes at the expense of tempered overall gains relative to market averages, but it gives me comfort that it is a good defensive approach. Of course, when gold tanks, I can see some pretty ugly days, but who cares? It’s a hedge, and I’m a believer in gold’s long-term trajectory, and losses are only paper unless you sell. I hold a smaller percentage of cash than you recommend, but I feel the gold stocks essentially serve the same insulation purpose. I toss this out there because I know there are a lot of readers interested in gold who might be curious how it has performed.

  2. I am new at all this .Are you suggesting on the (spy & XLK) to buy a call option ? Can you explain more clearly on this matter on this on what to do ?

  3. Hi Byron–you are correct to note the gold discussion is an important one, yet not mentioned above. We actually re-visited the gold discussion just last week on December 2. You can do a key word search in the search bar above or simply scroll through the archive tab above and search for articles that interest you by monthly archives.

    Adam, we are not giving specific option signals in the weekly articles. As for going long the S&P or other sectors discussed in various articles, we have been openly bullish on equities since our October 15th post (as well as earlier in the spring), but correctly backed off a bit in the summer and fall–becoming bullish only after the Fed began printing money again. Despite any bullish stances we take throughout the year, we always temper the same with cash recommendations, given how inherently distorted Fed-driven markets have become. Check out storm tracker posts for more on this.

Leave a Reply

Your email address will not be published. Required fields are marked *