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Headline writers seemed to have settled on attributing the latest market volatility to a "taper tantrum." They are referring to sellers seizing on comments from Federal Reserve Chairman Ben Bernanke that the Fed will eventually stop adding liquidity to the markets.
While "taper tantrum" makes a great headline, it does little to tell us whether or not the selling is the start of a significant decline. In fact, stock markets already seem to be recovering, creating even more confusion for investors.
Rather than relying on headlines to determine when I should join in the selling, I base decisions on my 26-week rate of change (ROC) system.
The 26-week ROC system is designed to buy the strongest ETFs when the market is rising and avoid positions in markets that are weak. Right now, the system is confirming that international stocks have turned bearish.
This confirms the pattern seen on long-term charts of the BRIC markets. The BRICs (Brazil, Russia, India and China) are considered bellwethers because they are fast growing and important to the global economy. Right now, all four markets are on sell signals with prices below the 10-month moving average.
Each of these markets gave a sell signal like this in 2008 as the bear market began accelerating. In this case, the BRICs are bearish while developed markets like Japan, the U.S. and most European stock markets are still above their 10-month MAs. The BRIC sell signals could be an early warning sign that stock markets in larger economies are about to drop.
The 10-month moving average is one way to define a bull market. In the 26-week ROC system, I use the performance of the system itself as a signal. This signal is now saying that international stocks have a high level of risk.
In the past, these signals have helped us avoid large losses. This type of signal led us to sell bonds, avoiding the large drop in fixed-income markets that started even before the taper tantrum.
WisdomTree Japan Hedged Equity (NYSE: DXJ) is currently in the system portfolio and is now a sell. DXJ suffered a sharp drop along with other Japanese stocks in May. It is about 11% above its recent lows after the price made a small recovery in the past three weeks. This sell signal is being driven by the performance of international stocks in general.
After selling DXJ, the 26-week ROC system will only be holding two positions and cash. If the downtrend continues in the metals market, I expect to see a sell signal in ETFS Physical Palladium Shares (NYSE: PALL) within the next few weeks, but currently that ETF is still a hold.
iShares Dow Jones US Broker-Dealers (NYSE: IAI) remains a strong buy despite the recent market turmoil. The chart below shows the strength of this ETF.
On the daily chart of IAI, the uptrend can easily be seen.
This group of stocks (large U.S. brokers) would be expected to show weakness before a severe market crash. Instead, IAI is showing that U.S. stocks could continue rebounding for at least a short time.
And if you're worried about another market crash, I've devised another simple system that tells investors exactly when to sell stocks before they tumble. Even better, the system has generated an average annual gain of 21.5% during the past decade -- trouncing the S&P's measly 7.3% gain. To learn more, go here...
Action to take: Sell DXJ and increase cash in the 26-week ROC system portfolio
After selling DXJ, we will only be holding:
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