The stock market suffered another day of steep losses yesterday, with the S&P 500 falling -3.2%. Small stocks were hit even harder, with the Russell 2000 down -4.4%. It was the fifth day so far in 2018 that the S&P 500 has fallen at least 3% (and the second-worst December daily decline in the past 25 years). But it was the worst single-day decline for the Russell 2000 in more than seven years.

Despite the painful losses, yesterday doesn't really add any clarity to the current status of the stock market. Consider the following chart, which shows the market's path over the past three months:

There are no changes to the DAA lineup for December. Read on for the full details.

DAA is a core portfolio strategy that is designed to help SMI readers share in some of a bull market’s gains, while minimizing (or even preventing) losses during bear markets. The strategy involves using exchange-traded funds to rotate among six asset classes, holding three at any one time. DAA is a defensive, low-volatility strategy that nonetheless has generated impressive back-tested results when evaluated over full market cycles, demonstrating the power of "winning by not losing."

The recommended categories/ETFs for December are (in order of current momentum):

There is no change being made to the official SR recommendation for December. Read on for the details.

Sector Rotation is a high-risk/high-volatility strategy. While its peaks and valleys have been more extreme than SMI's other strategies, it has generated especially impressive long-term returns, as discussed in Sector Rotation is Risky, But Highly Rewarding.

It’s not unusual for new readers to become concerned when one of our recommended funds suffers what appears to be a severe one-day decline! We assure them there’s no cause for alarm: the drop was caused by a fund distribution.

Why Upgrade?

SMI offers two primary investing strategies for “basic” members. They are different in philosophy, the amount of attention they require, and the rate of return expected from each. Our preferred investing strategy is called Fund Upgrading, and is based on the idea that if you are willing to regularly monitor your mutual-fund holdings and replace laggards periodically, you can improve your returns. While Upgrading is relatively low-maintenance, it does require you to check your fund holdings each month and replace funds occasionally. If you don’t wish to do this yourself, a professionally managed version of Upgrading is available.

SMI also offers an investing strategy based on index funds called Just-the-Basics (JtB). JtB requires attention only once per year. The returns expected from JtB are lower over time than what we expect (and have received) from Upgrading. JtB makes the most sense for those in 401(k) plans that lack a sufficient number of quality fund options to make successful Upgrading within the plan possible. Here are the funds and percentage allocations we recommend for our Just-the-Basics indexing strategy.

After bouncing back in early November, the stock market retested the October lows again this week. Here's your pre-Thanksgiving run-down of where things stand.

Valuation

As this chart from Ritholtz Wealth shows, stocks are extremely expensive on a historical basis. Prices have been higher (relative to earnings) only at the peak of the late-90s Tech Bubble.

Liquidity

However, valuations have been high for at least a few years. The big change this year has been the amount of liquidity provided by the world's central banks. Led by the U.S. Fed, these banks are removing the excess liquidity of the past decade and trying to "normalize" interest rates while also trying to pare back their enormous balance sheets. The problem is, as economist David Rosenberg tweeted this morning, this liquidity has been the fuel for risk assets throughout this whole nine-year bull market. He went on to point out that the global monetary base has been contracting since March and is now falling at a -7% year-over-year rate.

Financial asset prices rose for years on a flood of central-bank issued liquidity, and now we're seeing prices decline as that liquidity is being taken away. This is no surprise — we've been talking about this being the eventual key to the end of this bull market for at least 5-6 years. The only surprise is that it's taken this long to arrive at this point.

Analysis

The valuation problem isn't going away. This is the backdrop for the remainder of this bull market — as it has been for the past few years already. It likely will be resolved only by the next bear market taking a bite out of stock prices, making them appear more reasonable when compared to company earnings.

The liquidity issue is a bit of a different story though. That could actually change dramatically in the short-term — or at least the perception of it could — with a simple statement from a Fed bigwig saying they're planning to slow the pace of future interest rate hikes. Or absent that, the failure of an expected rate hike in December could accomplish the same thing. If either of those were to happen, equities likely would celebrate with a big move higher. It wouldn't get rid of the problem, as interest rates eventually would have to resume climbing and the assets on these central bank balance sheets removed. But it would kick the can out at least a few more months.

And that's why patience — that most valuable of all investor qualities — remains required at this point in the market cycle. The market's losses over the past seven weeks or so have been jarring, but not outside the scope of a "routine" market correction at this point: at their worst, the S&P 500 index (large stocks) down a little less than 10%, while the Russell 2000 index (small stocks) has been down about 15%. Remember, this would be the fourth such market correction in just over three years, and as with the prior three, the market could rebound from here and keeping chugging higher.

Long-term, the combination of these factors — high valuations and the worsening liquidity picture as interest rates rise — seem almost assured to combine and bring this long-running bull to a halt. But short-term? That process could already be underway — it's entirely possible we'll end up dating the end of the bull market (and the beginning of the bear) as this past September 20. Or stocks could certainly rally once more and push that off another several months or more. There's just no way to know at this point. Which is where that patience comes in!

Thankfully, we don't have to guess which way things will go, or exacty when. We can rely on the defensive measures built into our normal strategy processes to let us know when it's time to shift more money to safety. (I say "more" because our Dynamic Asset Allocation strategy began that process some months ago.) That process of our strategies getting more defensive could accelerate soon, or could delay a while longer.

I'm very thankful that we have such systems to help us navigate these tricky market trends! I'm also thankful for all of you — we so appreciate the opportunity to serve the SMI community doing what we do. Praying all of you have a wonderful Thanksgiving!

October's market slide created some pretty significant investor anxiety. While that has faded as the market has rebounded, Monday's nearly 2% drop served as a reminder that we're not necessarily out of the woods yet.

This post has the potential to be confusing, especially for newer readers. So let me begin by saying that if you don't know what the term "annual seasonality" means, you can safely ignore everything written here.

For those of you who do know about annual seasonality, the fall signal to buy has (surprisingly) been triggered.

I’m going to repeat some background about annual seasonality, then turn to the specifics of this particular signal. (If annual seasonality and MACD are old-hat to you, skip down to the “Recent Developments” heading below.)

There are no changes to the DAA lineup for November. Read on for the full details.

DAA is a core portfolio strategy that is designed to help SMI readers share in some of a bull market’s gains, while minimizing (or even preventing) losses during bear markets. The strategy involves using exchange-traded funds to rotate among six asset classes, holding three at any one time. DAA is a defensive, low-volatility strategy that nonetheless has generated impressive back-tested results when evaluated over full market cycles, demonstrating the power of "winning by not losing."

The recommended categories/ETFs for November are (in order of current momentum):