Investment Strategy: “The 7% Solution”

The Seven-Per-Cent Solution: Being a Reprint from the Reminiscences of John H. Watson, M.D. is a 1974 novel by American writer Nicholas Meyer. It is written as a pastiche of Sherlock Holmes, and was made into a film of the same name in 1976. Published as a "lost manuscript" [about] the late Dr. John H. Watson, the book recounts Holmes' recovery from cocaine addiction (with the help of Sigmund Freud) and his subsequent prevention of a European war through the unravelling of a sinister kidnapping plot.

... Wikipedia

We have long been big fans of the books about Sherlock Holmes ever since our misbegotten youth. Strangely enough, being a strategist/analyst is much like being a detective. One has to gather the evidence, pour through it, decipher it, eliminate the “noise,” and come to a conclusion that tips the odds of making money in our favor. We have been doing that professionally for 47 years and investing with our father for over 54 years. We have made a number of bad “calls,” yet in this business when you take a stand and make a “call,” you are going to make mistakes. As often stated, “When you are wrong you say you are wrong and you say it quickly for a de minimis loss of capital,” a trait not many have in this business. That said, our correct “calls” have vastly outweighed our bad “calls.” Most recently, we noted that our short/intermediate proprietary models, after being constructive for a REALLY long time, were targeting early to mid-February as a point of downside vulnerability (bear in mind that our models have a plus/minus three-session variability). Accordingly, the Dow Dive began last Monday (1-29-18) exactly three sessions before the beginning of February. Subsequently, the senior index has surrendered over 3% from the recent all-time highs. Yet as one of our financial advisors emailed me last Friday, “You didn’t tell us it was going to be this bad!” “Really,” 3.9% off of the highs and we get bombarded with comments like that.

Another question was, “How far can this decline go?” Such questions caused us to pull up a chart of the S&P 500 (SPX/2762.13) to look for what would seem to be a reasonable support level for the SPX. Before we forget, remember, our models do not tell us how far a decline, or rally, will go. All they tell us is the equity markets are nearing either a point of vulnerability, or a point for a decent rally. Nevertheless, studying the chart reveals there are a number of support levels. There is a gap in the SPX chart at 2767, 2750, 2736, 2723, and 2714, which could represent support. However, 2672 would be a 7% pullback from the peak that should find major support at the mid-December 2017 lows, aka “The 7% Solution.” To be sure, that would be enough to spook the majority of participants and represent a decent point of entry. That said, there could be some kind of throwback attempt this week since the McClellan Oscillator is extremely oversold (Chart 1), but we would not trust it.