The Big Picture for the Week of June 26, 2011

The US equity market appears to be deteriorating. This could be because of deteriorating macro factors or shorter term micro factors or some combo of both. That sentence is intentionally vague because in terms of sticking to a defensive strategy devised before there was any hint of trouble the reason why is of secondary importance to sticking to your strategy.

We can easily chronicle the deteriorating macro factors and shorter term micro factors but can't necessarily know with certainty which is more important right here right now. My opinion is that the macro factors are more important but I take a longer term approach.

What has been interesting to me is the dance that the S&P 500 (SPY) has done at the 200 DMA, or close to it anyway. Up to this point the 200 DMA has acted as support even as it has moved slightly higher (look at a chart and you will see it is likely to keep inching higher).

There is no way to know whether it will hold the 200 DMA or if it does breach the 200 DMA if that will be a head fake or the real deal. Knowing this ahead of time is obviously not in anyone's control but staying disciplined is within our control. I generally have something in mind should circumstance dictate taking defensive action but that is subject to change.

The big idea here is reducing net long exposure in case the market goes down a lot but not being so aggressive that you get whipsawed with the entire portfolio, this is why we start gradually. True bear markets start slowly (look at 2000 and late 2007-early 2008) giving plenty of time to get out. Ken Fisher has referred to the 2% rule where the market averages a 2% decline three months in a row as being a good tell that a bear has started. In the last two months the market is down 6.76% (per Google Finance) so we'll see what this turns out to be but riding a 7% decline all the way down and then taking defensive action in front of what turns out to be a 30%-40% decline is a pretty good outcome in the context of trying to avoid the full brunt of down a lot.

After taking initial defensive action (again, if it comes to that) the plan is, as it has been, to continue to get defensive if the market shows signs of further deterioration. In both recent instances of the market cutting in half there were many months to get out before fear, panic and market cratering occurred.