I always thought BEARS were hibernating this time of the year. This has to be global warming that everyone is talking about. The BEARS have been prowling around Wall Street since the first week in January. There hasn't been much in the way of places to hide when they have been on the scene.
Coming into this week's action, the Nasdaq is off to its worst start to a year ever. And for just the third time in its history, the Russell 2000 went from a 52-week high to a 52-week low in the span of fewer than three months.
With relentless intraday selling so far this year, the S&P 500 is down 7.6% and closed below its 200-day moving average for the first time since June 2020. Regarding that constant intraday selling, the S&P 500's performance in the last hour of trading this month is on pace to be the weakest of any month since October 1987 and helped make the recent holiday-shortened trading week the worst for the S&P 500 since March 2020.
So if you are looking at your portfolio and wondering what happened, you have your answers. That won't make an investor feel good but unless they possessed the uncanny ability to KNOW the last high in the S&P 19 days ago was THE high, there was no way to "prepare". That is a word we hear a lot of in the investment game. For the most part, it is all 20/20 hindsight talking. According to the consensus view, investors were supposed to be getting "prepared" in April of 2020, and that would have been a disastrous strategy.
The evidence was mounting that things will be a lot different this year and it was presented here week after week. Fed's policy shift is still the big headwind for risk sentiment, particularly with some shift in focus to quantitative tightening. Pickup in concerns about a growth slowdown is also in focus and increasingly playing into the policy mistake narrative. Q4 earnings beats have been solid but have underwhelmed yawning investors. That is plenty of food for the BEARS and could be the reason they have stayed around.
In some ways, astute investors have prepared. Recognizing the time to get into 'some' value specifically energy was the right way to proceed last year. Diversity was another theme that was pounded home week after week. With the damage done to most portfolios much greater than the indices, I don't lament, I look at what's been done right and on that score there is plenty. When investors concentrate on the "what ifs" and get wrapped up in "I should have done this or that" commentary it feeds the negatives, it serves no purpose.
That is what gets investors into deeper trouble. We have the change I've been talking about that has given us a new environment. With that comes a new set of rules. If we avoid emotion and follow the new rules it will be a lot easier to navigate this year and get portfolios back on track. This is the time to keep the situation in perspective and remain in control.
Indices, sectors, ETFs, and individual sectors have all taken on a waterfall look. So far, any bounces have been very short-lived and the selling has seemed relentless. Usually, this only happens when the big money is trapped and willing (or forced) to get out at any price. Forget about the headlines trying to explain the price action. What I just described is what is transpiring now.
We all knew certain areas of the market (meme stocks, HIGH PE, clean energy, crypto-related, SPACS, etc.) had built up the "excesses". It appears it was a lot more than we thought and we also may find out that many hedge fund managers were leveraged up in the speculative momentum names. When the excesses get wrung out it can take down the good names with them. The "gainers" become the cash machines, they are liquid and they are sold to help with margin calls, etc.
This isn't the time for panic but we are slowly exposing the crowd that has played the game without a strategy. I warned about that crowd lately. Some seem to never get it right as the stock market is the ultimate teacher.
The Week On Wall Street
The S&P entered the week on a 4-day losing streak while the DJIA opened trading with 6 straight days of losses. The NASDAQ started the opening session on track to post the worst January performance since 2008.
The fearful mindset continued sending indices to gap-down openings. It didn't take long (about 2 hours) before all short-term support was breached and the S&P traded down to levels seen last July. It wasn't until later in the day when the oversold extremes were met with a buying stampede that wiped out major losses on all of the indices. The S&P experienced a 190+ point swing and for the first time in history the Dow reversed a 1,100+ point drop to close higher on the day." The small caps were the first to signal the "turn" and they led all indices with a 2.2% gain.
Investors are now wondering whether Monday was a "capitulation day" with near-record volume in terms of value traded. Based on the closing price, roughly $111 billion was traded in SPY. The only day where a higher value was traded was back in late February 2020 when the daily dollar volume topped $114 billion.
Tuesday opened with another weak start with the S&P dropping 100+ points before staging a mild intraday rally to finish the day at 4356 down 1.2%. The DJIA started 800+ points lower and while it couldn't match Monday's feat, the index did manage to rally 700+ points making the action feel like a ho-hum day at the office.
All of the indices were lower and every chart had the same look to it by posting a higher low than Monday. On a positive note Energy (+3.8%) and Financials (+0.52%), our "leaders" came back nicely.
On Fed day (Wednesday) the roller coaster ride continued. The S&P moved higher at the start, reached an intraday high just above resistance then fell back below that level as volatility continued with wild swings in direction. When the Fed released their statement the index took another run at the resistance level, briefly poked above, but was once again met with selling that intensified into the close. The intraday move was a 149 point swing for the S&P 500, and at the close was down 6 points. A lot of price movement with little change.
The amusement park rides continued on Thursday and continued until the closing bell on Friday. Rallies were sold, dips were bought as the back and forth action was constant. The S&P 500 and the DJIA rallied enough to post gains for the week after setting lows on Monday, which hasn't been seen since last July.
Advance Q4 GDP posted a 6.9% growth rate, 3 times the 2.3% pace in Q3, and respective rates of 6.7% and 6.3% in Q2 and Q1. Personal consumption growth increased at a 3.3% clip, up from 2.0% last quarter. Business fixed investment posted a 2.9% rate from 1.7%. The GDP chain price index rose to a 6.9% rate from 6.0%, with the core rate edging up to 4.9% from 4.6%.
U.S. private sector firms signaled a marked slowdown in growth at the start of 2022 amid softer demand conditions, worsening supply chain disruptions, and labor shortages linked to the Omicron wave.
Adjusted for seasonal factors, the IHS Markit Flash US Composite PMI Output Index posted 50.8 in January, down notably from 57.0 in December. The resulting upturn inactivity was only marginal, and the slowest since July 2020.
Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) fell to -0.15 in December from +0.44 in November. Two of the four broad categories of indicators used to construct the index made negative contributions in December, and all four categories deteriorated from November. The index's three-month moving average, CFNAI-MA3, moved down to +0.33 in December from +0.40 in November.
Richmond Fed's manufacturing index slumped to 8 in January, half of the 16 in December. The components were mixed. Much of the weakness was in the order backlog gauge which dropped to 2 from 26 and the employment metric which slid to 4 from 19. Also, the new order volume declined to 6 from 17. Price trends were mixed with prices paid slowing to 5.8% from 7.0%, while prices received rising to 6% versus 5.7%. The report is much weaker than expected and reflects the various pandemic-related issues of supply chain disruptions, labor shortages, and price pressures.
The first three of five regional Fed manufacturing activity indices show a sharp drop in manufacturing activity. It's too early to be overly concerned about the backdrop for the economy, the slowdown in manufacturing activity does suggest a lower pressure economy.
In addition, it is yet to be determined what if any impact did Omicron have on activity.
Personal income increased 0.3% and spending declined 0.6% in December after respective gains of 0.5% and 0.4% in November. Compensation rose 0.6%, the same as in November. Wage and salary income climbed 0.7% from 0.6% previously. Disposable income edged up 0.2% from November's 0.4%.
The savings rate increased to 7.9% from 7.2%. The PCE deflator, the FOMC's preferred measure, increased 0.4% on the month after the 0.6% gain previously, with the core rate rising 0.5%, as it did in November. On a 12-month basis, the headline rate climbed to a 5.8% y/y pace from 5.7% y/y.
That was the hottest since 1982 (and compares to the all-time peak of 11.6% from March 1980). The core rate jumped to 4.9% y/y in December from 4.7% y/y previously and is the strongest since September 1983.
Consumer confidence fell 1.4 points to 113.8 in January, not as bad as projected. This erases the less than half of the 3.3 point increase to 115.2 in December, which ties highest since August and compares to July's 125.1 print. The index was at 87.1 a year ago. All of the weakness was in the expectations component which declined to 90.8. The current conditions index improved to 148.2, extending slightly the December gain to 144.8.
January consumer sentiment slumped 1.6 points to 67.2 in the final print from the University of Michigan, worse than expected, after rising 3.2 ticks to 70.6 in December. This now marks the lowest going back to late 2011 after the index ranged from 88.3 to 67.4 in 2021. The gauge was at 79 a year ago. Most of the weakness was in the expectations component which dropped to 64.1 from 68.3 previously. The current conditions index slid to 72.0 from 74.2 in December.
The 1-year inflation gauge was picked up to 4.9% versus December's 4.8% and is the hottest since 2008. The 5-10 year price measure rose to 3.1% versus 2.9% previously and is the highest since 2011. This report is a horrible combination for the economy with slumping confidence and surging inflation.
New home sales climbed another 11.9% to an 811k pace in December, much stronger than projected. It is the best since March. But it follows small downward revisions to the prior two months. Regionally, sales were higher in the Midwest (56.4%), South (14.0%), and West (0.4%), but slid in the Northeast (-15.6%). The number of homes on the market increased to 403k from 397k, while the months' supply dipped to 6.0 from 6.6. The median sales price declined -9.2% to $377,700 after falling -1.3% to $416,100 in November. The drop in prices and the increase in inventory likely supported the further gain in sales.
Pending home sales slumped 3.8% to 117.7 in December after slipping 2.3% to 122.3 in November. This is the lowest since 116.5 in September and compares to the all-time high of 130.3 in August 2020. A lack of inventory was a major culprit, along with rising mortgage rates and affordability issues. Sales declined in all 4 regions, led by the West (-10.0%), followed by the Midwest (-3.7%), South (-1.8%), and the Northeast (-1.2%). On a 12-month basis, the index posted a 6.6% contraction rate versus 0.2% y/y previously.
The Global Scene
With only four ETFs up in a meaningful way year to date, heavy selling has not just been isolated to the US. Brazil (EWZ) has bucked the trend, though, rallying 10+%. Despite the strong start to the year, EWZ is still one of the ETFs down the most from its 52-week high. The huge rally this month leaves EWZ deeply overbought alongside South Africa (EZA).
While there are only two overbought countries, nearly half of the list is oversold. South Korea is the most oversold of these, but it has not experienced the largest decline this year. Russia (RSX) takes that crown as RSX has fallen 16.65% YTD as geopolitical tensions with Ukraine arise and the threat of sanctions weighs on that market.
IMF downgraded its 2022 global growth outlook amid expected weakness out of the U.S. and China along with persistent inflation. The Fund projects world growth at a 4.4% clip, slipping from the 4.9% estimate from October. The IMF estimated 2021 growth bouncing 5.9%, the best in 4 decades, but after the -3.1% contraction in 2020. However, 2023 growth was bumped up to a 3.8% clip.
The U.S. saw the largest downgrade with the economy now expected to grow at a 4% pace, versus 5.2% previously, in part as the IMF removed its outlook for more fiscal stimulus as Build Back Better has stalled, and as the FOMC prepares to reduce accommodation.
Chinese growth was lowered to 4.8% from 5.6% previously amid ongoing Covid disruptions and a zero-tolerance policy, as well as the bearish regulatory developments in the housing sector.
Eurozone activity was trimmed by 0.4% to 3.9%. The negative impacts from Omicron are expected to diminish, but supply chain disruptions are seen to be more long-lasting.
Inflation is expected to average 3.9% in advanced economies this year, well up from the prior 2.3% projection, while emerging nations should see their prices at a 5.9% rate.
In my view, some of the recent weak market action can be attributed to what some anticipate will be slower global growth. Despite revised forecasts, I'm also somewhat skeptical of the 4% growth projected for the U.S. I believe we have to take any GDP forecast quarter by quarter. Lack of action on the supply chain issues, combined with the absence of pro-growth policies leaves me questioning the optimistic forecasts.
In general, manufacturing data was stronger than expected compared to services.
Eurozone business activity growth slowed for a second successive month in January as the spread of the Omicron variant took an increasing toll on the region's economy. Although an alleviation of supply chain delays provided a welcome boost to manufacturing production, renewed COVID-19 restrictions led to a marked slowing in service sector growth.
The headline IHS Markit Eurozone Composite PMI dropped for a second month running at the start of 2022, down from 53.3 in December to 52.4 in January, according to the 'flash' estimate*. The latest reading indicates the slowest rate of output growth since the recovery from lockdowns in early 2021 began last March. On a positive note, German manufacturing was especially strong. German services also rose to a two-month high.
Another slowdown in the service sector held back the UK economy at the start of 2022, according to the latest PMI data compiled by IHS Markit and CIPS. With hospitality, leisure, and travel all struggling due to Omicron restrictions, this offset resilient growth in business and financial services.
At 53.4 in January, the headline seasonally adjusted IHS Markit / CIPS Flash UK Composite Output Index remained above the 50.0 no-change thresholds for the eleventh consecutive month (since March 2021). However, the index was down slightly from 53.6 in December and signaled the slowest rate of output expansion since the recovery from lockdown began last spring.
Profits of China's major industrial firms surged 34.3 percent year on year in 2021 as industrial production recovered and profit margin improved. The full-year industrial profits were 39.8 percent higher than the 2019 level, putting the average annual growth for 2020 and 2021 at 18.2 percent.
In 2021, the combined revenues of those firms went up 19.4 percent from a year ago to 127.92 trillion yuan, and 32 out of 41 industries saw growth in profits.
Flash PMI data indicated that activity at Japanese private sector businesses dipped into contraction territory for the first time in four months at the start of 2022. The pace of decline was modest and led by the sharpest fall in services activity since August, while manufacturers commented on a slight quickening in output growth.
The Federal Open Market Committee, at its annual organization meeting this week, unanimously reaffirmed its "Statement on Longer-Run Goals and Monetary Policy Strategy". The statement reads in part:
The FOMC signaled liftoff is likely at the next meeting in March, noting it will "soon be appropriate" to raise rates. That was as expected, as was the unchanged policy stance. It was also indicated asset purchases will end in early March. But there were no real details as to the exact timing or pace of actions.
Indeed, the statement was rather vague by intention, allowing maximum flexibility. There was no indication in the statement regarding the balance sheet. The Fed indicated indicators of the economy continued to improve, while supply-demand imbalances continued to contribute to elevated levels of inflation. And it repeated the path of the economy continues to depend on the course of the virus and that risks to the economic outlook remain. The vote was a unanimous 11-0.
The key highlights
Bottom Line: Not much has changed with the official stance of the Fed. They remain data-dependent.
However, that is not how some see the situation as they are already making forecasts without data. JPMorgan calls for six or seven rate hikes in 2022. BofA seems to agree with their announcement of seven increases.
President Biden's recent press conference signaled growing desire among Democratic lawmakers to focus a revised spending bill on energy policy, healthcare, and education (paired with revenue raises), in what appears to be a "start from scratch" effort. The "push" to get something done remains but the path forward remains unclear.
Looking ahead - As Washington seeks to reset domestic policy, foreign policy issues tied to a comprehensive China policy bill and debates on a U.S. response to potential Russian aggression will be the near-term priority for lawmakers.
Russia-Ukraine: The US is considering deployments of troops to Eastern European countries near Ukraine and has withdrawn embassy staff and dependents from Ukraine as expectations for a Russian invasion mount. Financial markets are pricing a high likelihood of conflict as Russian asset prices collapse under the expectations of aggressive sanctions in response to any invasion; those are likely to include cutting Russia off from USD assets and blockades of key imports like semiconductors
China-Taiwan: - China Flies 39 Warplanes Near Taiwan violating Taiwan airspace. China vows to one day "reunify" Taiwan with the mainland, using force if necessary.
Investors can expect knee-jerk market reactions from time to time as these tensions play out. While I may be altering strategy due to other concerns these situations are not part of my investment planning.
History tells us S&P 500 earnings expectations have risen most rapidly when the Fed's hiking but still accommodative, and when hiring, lending, spending, and nominal GDP growth are stable. That sounds a lot like the situation now.
In my base-case scenario, (with any new taxes off the table) I have an above-consensus 2022 earnings estimate for the S&P 500. If the S&P does track to that assumption, there is plenty of room for stocks to stabilize at or near these levels. It will then be incumbent to start seeing inflation peak and move sideways before melting away. That is the BULLISH scenario.
The BEARISH view has the administration adding to the existing ball and chain on growth while offering no solutions to the supply chain and labor shortage issues. That stuns growth, keeps inflation high, meaning the Fed stays in the game much longer.
As we have already learned far too many things can occur to change that outlook, so I continue to view the situation in shorter periods.
73% of S&P 500 companies have beaten estimates so far by an aggregate of 6% (just above the 15-year averages of 70% and 5.3% respectively). Additionally, forward estimates continue to trend higher. Guidance so far has been relatively good versus history but weaker relative to recent quarters (expected) as 12% of companies have raised forecasts and just 3% have guided lower.
Every DJIA component that has reported beat EPS estimates and the majority raised guidance. For the most part, investors have yawned.
The Daily chart of the S&P 500 (SPY)
For those that thrive on volatility, this was their week. The S&P recorded the low for the week at 4,222 marking the depth of the pullback at 12%. From there it was a headline-driven market with emotion, algo trading, and volatility hitting highs.
By many measures, the S&P is extremely oversold, but I'll remind everyone markets can stay oversold and overbought for a while. They also tend to overshoot to the UPSIDE and the DOWNSIDE. The short-term view is completely broken, and longer-term trends in many of the indices and individual stocks are being tested. The late-day rally on Friday moved the S&P right back to resistance.
It sure appears the tug of war will continue to be waged in the coming days/weeks, with plenty of volatility as an added attraction. This remains a difficult market to navigate.
It's hard to believe the S&P 500 began the month at Overbought levels and during the week hit an extreme Oversold condition. Such extreme moves do happen, but it's not common. Investors are pondering whether this is a buying opportunity or the start of a larger corrective move.
Despite the poor technical picture and the consistent negativity regarding interest rates, I turned my attention to the earnings season. I'm tracking those companies that have produced, continue to produce, and announce they will be producing down the road. It may be surprising to some BUT there are plenty of names that fit that category. While investor sentiment is in the dumps now, when it turns it will be those companies producing results that will come back first. If they offer a dividend so much the better.
The deleveraging continues despite extreme oversold conditions being met, and one wonders if, in the short term, investor morale will ever improve. Now is the winter of our discontent, with Omicron impacting the economy, Fed hawkishness taking its predictable toll, and inflation still roaring. At the lows, the S&P tipped into official correction territory before rebounding. Smaller cap indexes are now in BEAR market mode (-20%), while value outperformed growth again and essentially all sectors outperformed tech, which is taking the brunt of market deleveraging.
It doesn't take a long memory to recall a ~10% pullback in equities in January 2016 and again in January 2018 in similarly ugly starts to the year. Some believe this economic cycle is happening so fast, we are already entering a "late-cycle", similar to early 2018, and thus maybe this isn't the end, but it's the beginning of the end as the Fed hikes aggressively.
While it may be early to form a definitive conclusion, this 2022 event is much more similar to 2016 when the market pulled back on the expectation of the Fed finally beginning a rate hiking cycle and a vigorous debate whether this would cause a recession or if the economy could handle it. In addition, equity valuation concerns, China's economic weakness, and corporate earnings risk were the stew that was served at the 2016 pullback, and that sounds eerily similar to today.
All of those concerns caused an ~11% pullback in the S&P 500 in January/early February of early 2016 (~-16% from 52-week high), and far worse for mid and small-cap indexes which are similar to today. Back then it was an easier call as many indicators told us the economy could handle it, and the market rallied with a cyclical bias for the next two years.
At that time the 10-year yield increased from ~1.2% to ~3% as the Fed was raising rates. In 2018, the 10-year stopped rising, and that yield curve flattening was ultimately the driver of the market believing the Fed made a mistake. That triggered a 10% correction in the S&P in January 2018. The market did right itself and the S&P rallied to new highs in 2020 just before the COVID event struck.
While investors find themselves in a similar position with rising rates, this time around interest rates will rise to quell inflation. Now there will be concerns about whether this economy can withstand the rise in rates, especially with no pro-growth initiatives being offered in what I expect to be a slowing economy. The issue is how slow. We are witnessing more muted economic data recently BUT that could easily be the Omicron issue, and that phase is over. Investors also have to struggle with the idea that the fight with inflation could last a lot longer than many believe.
There is a solid positive; the huge Tax and Spend package is dead. All of that leads me to believe this economy can probably handle higher rates for a while assuming we don't see any roadblocks. Further proposals on increased taxes or regulations change the entire discussion.
There is plenty to worry about, there always is, and this year adds the uncertainty and challenges that come with the midterm election cycle. It is sure to promote more emotional reactions from investors keeping volatility escalated.
2022 Is Here And The Playbook Is Open For Business
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After last week's breakdown, the Russell dropped into official BEAR market territory this week. One has to wonder if the small caps are warning investors that this economy won't be as robust as many believe it will be. If we don't get a rebound very quickly from these levels and the Russell 2000 falls deeper into the BEAR market that message may be one of no growth. Critical levels will have to hold. The index has already breached the lows posted on Monday, while the other indices have held support. We will need to see a very quick change in the form of a decent rebound for that story to change.
This group (XLP) continues to have some of the better technical patterns these days as investors search for more defensive plays. For those so inclined that is fine but be aware that you are buying these low-growth stocks at premium prices.
Without question, this sector is where the BULL market continues. The Energy ETF (XLE) set another 52-week high during a week that saw other sectors fall apart. WTI traded above resistance at the $83-$85 level, and it was the catalyst. Energy represents "value", so the sector is in demand. I repeat the same message:
The financial ETF (XLF) continues to trade in a sideways fashion that is tied to interest rates and the yield curve. It will be important for this group to remain resilient for the overall market to stabilize. Goldman Sachs (GS) is a standout "value" proposition. I also find that opportunities are abundant in the regional banks that will benefit from a rising rate environment.
The NASDAQ composite has led this BULL market until recently. Now, only the small caps have lost more ground, as the index sits 14+% off its former high. All short-term support has been broken and the Composite is now testing longer-term support levels. It is a critical time for Technology.
If investors look at EPS results from Apple (AAPL), realize the world isn't going to end, and don't turn this technology market around, I'm not sure what will. A fed funds rate going to 1%-1.25% isn't going to impact the results of growth companies as much as many investors believe. Yet sentiment and price action are telling a different story now.
DANGER. Semiconductors have been the leaders of this market for quite some time and it appears we have lost this sector as leadership for at least the short term. The "reversion to the mean" I referred to is here. The Philadelphia Semi ETF (SOXX) broke a critical support level this week and may have more to go on the downside.
While I wouldn't contemplate a "short" here, I wouldn't be rushing in to pick up what might appear to be a bargain. Instead, I sold more calls against my positions and await stabilization before making any moves in the sector. We could be for a long sideways pattern now, being selective is more critical than ever.
It's been a rough year for the crypto space, which has continued a trend that has been in place since the fourth quarter of last year. While the space held up relatively well for a while, crypto finally broke down, and now Bitcoin is down ~ 48% from its Q4 peak while Ether is down ~45%.
The aggregate crypto market cap is now down 38% from the November 9th record high, and while there have been much, much larger percentage draw-downs for bitcoin or aggregate crypto prices, this is the second-largest ever draw-down in dollar terms for both bitcoin market cap and aggregate crypto market cap.
While it may not be a hedge against anything nor a store of value, it's apparent crypto is a great measure of "risk appetite". When stocks staged their big rallies after the selloff this week, crypto was leading the way. However, these may continue to be short-lived events as 'risk' is not part of investors' playbooks now. That makes the short term very tricky now.
For the most part, the long-term and intermediate-term trends have been and remain constructive. However, it should come as no surprise, the short term has completely broken down, and it will take a long time to repair this damage. The first step has occurred with many of the investors (weak/forced hands) that could no longer take the pain are gone. If you aren't sure of that, go take a look at the latest Robinhood EPS report. This boutique trading platform that was the gem of the newbies who were going to teach investors how trading was done has cratered. The stock reflects its financial performance and it is down 85% from the highs.
Nothing has changed. This time isn't different. Savvy investors realize if you live by the speculative sword, (meme stock, crypto, SPACS, et al), you perish by the speculative sword. If you refuse to diversify you pay the price.
Whether we have to remove another wave of weaker hands remains to be seen. On the fundamental side, the biggest risk to the market remains policy error. Lack of action on the key "issues" is a worrisome problem. The stock market is looking down the road and is wondering if the latest Atlanta GDPNow model estimate for real GDP growth in the first quarter of 2022 at 0.1% is the new trend.
While I'm not sure the economy sinks to that level, I have maintained since the last quarter of '21, the analyst forecasts for '22 GDP are way too high. It is time to step back and ask the question I have asked since last year:
The stock market is also contemplating that same question.
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In different circumstances, I can determine each client's situation/requirements and discuss issues with them when needed. That is impossible with readers of these articles. Therefore I will attempt to help form an opinion without crossing the line into specific advice. Please keep that in mind when forming your investment strategy.
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