With Market Risks Rising, We're Staying Cautious

The markets are finding another base after months of climbing to multi-year highs. The risk to the long side seems higher as we look at some sectors such as the rails, air freight companies and some interest sensitive stocks such as Exelon Corp. (NYSE:EXC).

Stocks including Norfolk Southern (NYSE:NSC), CSX Corp. (NYSE:CSX), Union Pacific (NYSE:UNP) and Canadian National have seen some heavy institutional selling lately.

The airline stocks and air freight companies such as FedEx (NYSE:FDX) and United Parcel Service (NYSE:UPS) have also been on a downtrend for the last few weeks.

Governments around the world are borrowing trillions and central banks have launched quantitative easing programs and the excuse for the poor showing of rail company stocks is lack of coal demand due to the increased use of natural gas. We think that just maybe the stock prices got ahead of themselves or maybe conditions have changed.

Whatever the reason for these moves, the trend is the trend. When large companies such as these turn down with heavy volume while so much easing is going on, The Trend Following model follows along with what is happening and not what everyone thinks or predicts will happen.

In this model we cannot short specific stocks and we will look to potentially trade or invest in some inverse ETFs if the opportunity presents itself. The quantitative easing by the Fed makes going short difficult as the markets move wildly at the mention of another government program to stop a market downturn.

We may also just stay on the sidelines in cash. Any breakouts that occur will be scrutinized and must have powerful reasons such as evidence of institutional volume increases as the investment rises for us to trade and or invest at this juncture.

What we would really like to see is a specific group of stocks in the same sector to lead the way to the upside and not just a general market move due to government intervention. A sector providing innovative products and services leading the market would let us know that the market is entering a potentially powerful bull phase due to capitalism and free enterprise.

Innovation makes for powerful stock moves and profitable investments. This general government push makes us very careful as the bad companies rise along with the good due to the government QE push.

We do not predict future moves and there lies the problem with giving many investors and traders what they want. They want a sure bet or prediction. This refusal to predict may frustrate investors however it gives us the ability to change direction of our ship as the ocean of investments demands us to do. If we see evidence of some major sectors turning to the upside with institutional volume out of this current base, we will at that point consider pressing our trades and investment to the long side at an increased percentage of the models assets.

A few drug stocks such as Gilead Sciences (NASDAQ:GILD) and Amgen (NASDAQ:AMGN) have been rising as the above mentioned industrial stocks have fallen. Time will tell if this is rotation or the last gasp before a broad sell off in the markets.

We also have been looking at some special situations and we currently have a trade and potential investment in a small drug stock Synta Pharmaceuticals (NASDAQ:SNTA). The company is an example of a stock that has risen to multi-week highs on high volume and potentially has a drug that will help people who suffer with lung cancer. The markets are making us cautious when it comes to holding investments longer term.

Gold, silver and a few other commodities have made some recent gains however the trend following models industrial stocks indicator as mentioned above makes us a bit suspicious of this move. We missed the move so far and we will evaluate the price and volume action here in the next few weeks to see if another opportunity presents itself.

If industrials fall, we feel that deflation may take hold bringing value investors to these sectors and away from inflation hedges. It is hard to believe that with all of this printing of currency that gold and silver are not higher here and now.

There are other cross currents and we will find out in time where the real value lies. The precious metals are on our radar and we are ready to act accordingly.

This action in leading transportation stocks as well as some other evidence give us reason to believe there may be some selling in stocks in the next few months. The Trend Following model will attempt to capitalize on these moves. How will we do this? How will we know when to act?

We will follow our proprietary indicators and ride along with what is happening while at the same time attempting to mitigate risk by admitting when we have invested and traded wrong. Even as we admit when we are wrong there can be circumstances where the market moves out of loss taking parameters due to the amount of the high risk betting in this model. We will as well continue to attempt to make outsized gains when the opportunity presents itself.

Disclosure: Performance discussed is net of advisory fees. The index comparisons herein are provided for informational purposes only and should not be used as the basis for making an investment decision. There are significant differences between client accounts and the indices referenced including, but not limited to, risk profile, liquidity, volatility and asset composition. The S&P 500 is an index of 500 stocks chosen for market size, liquidity and industry, among other factors.

The investments discussed are held in client accounts as of September 30, 2012. These investments may or may not be currently held in client accounts.The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or that investment decisions we make in the future will be profitable.

Certain of the information contained in this presentation is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Covestor believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.

Covestor model: Trend Following

Covestor Ltd. is a registered investment advisor. Covestor licenses investment strategies from its Model Managers to establish investment models. The commentary here is provided as general and impersonal information and should not be construed as recommendations or advice. Information from Model Managers and third-party sources deemed to be reliable but not guaranteed. Past performance is no guarantee of future results. Transaction histories for Covestor models available upon request. Additional important disclosures available at http://site.covestor.com/help/disclosures.