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May the 4th Be With Us!

   You might not have known that yesterday was National Star Wars day. My kids assured me. One went to school with green tape on his chest. It read, i = (M)(A). Public recognition and kudos for anyone who know what that means, (hint - Think about your physic’s equations). May the 4th has traditionally marked the end of the best 6 months of the year and the beginning of a less productive period for investor returns. As stocks are now coming under pressure again, this is a great time to check in with our cycle work. Should we be ready to face “the dark side”?

 

Best Six Months?

 

     First let’s look backwards at the market’s performance over the last 6 months to see if indeed it was “the best” 6 months of the year. Looking back to November 4th, 2015 I see the following results through yesterday:

 

Europe – 5.11%

World Stocks – 3.13%

S&P 500 - 2.20%

Nasdaq Comp - 7.40%

Nasdaq 100 - 8.00%

Russell Small Caps - 5.86%

Commodities - 6.35%

 

 

Apple -21.59%

Netflix -16.58%

 

Hedge Fund Indices -8%-10%

 

Barclays Agg Bond +3.20%

 

     I would say, with the exception of bonds, it wasn’t a great six months and the numbers are actually broadly worse if you go back 12 months to May of 2015. The point I’d like to make is that investing is just not that easy. Mantras like “Sell in May and Go Away” are cute and convenient for summer vacation scheduling, but very blunt instruments when making actual decisions. Nor should we blindly hang our financial future on a prescribed outcome during the supposed best six months of the year obviously. Looking forward, the dark side of the year should be upon us, but then again…

 

Where Are We?

 

     Business and market cycles are not appreciated enough in my opinion. The name of our firm is All Season Financial Advisors and I chose that back in 2002 after finding clarity surrounding the seasons of investing, especially as described by the business cycle guru Martin Pring, who wrote the textbook – “The All Season Investor”. Business (Economic) and market cycles are often at odds with each other in terms of their timing and the messages they project. I’m going to offer you two cycle charts to consider and attempt to do two foolish things. First, I’m going to tell you, show you, where I think we are in these cycle charts and second, I’m going to suggest how we might position our portfolios and our expectations accordingly. Forecasting is foolish in all forms. Here’s the first one provided by Fidelity Insights in their Q2 Outlook for 2016.

 

  

 

     Regular readers know that we also believe the economy is in a mid to late cycle phase as we move through the market transition years, shifting from one based on recovery to one of expansion. The chart above shows a blue dot indicating where we are in the cycle. The chart makes it look like the economy is peaking now but in fact, what it’s saying is that the growth rate has slowed but we are still a long way from actual contraction (aka recession). During this mid to late period of the cycle, we know that credit is on the cusp of tightening – which it is. We know that the market is going to be looking for areas to invest in outside of pure growth – which it is. We know that we should expect earnings to come under pressure but companies and households still have healthy balance sheets (savings) and revenue (income). These things are also happening. It seems pretty clear where we are in the business cycle. Famous last words right?

 

     On the right side of the chart above, they conveniently show which sectors do well in this phase, between the 2nd and 3rd columns. In the last Red Sky Report, I suggested that the markets were on the cusp of a very notable shift in leadership. If you hadn’t noticed recently, Technology and Financials have been taken out to the woodshed. Consumer discretionary sectors are showing signs of technical deterioration and in the last week or two we’ve seen Industrials come under some notable pressure. GE just went negative again for the year. The market is moving away from these sectors as yesterdays’ “early/mid cycle” leaders. The market is moving toward the mid/late cycle leadership sectors like consumer staples, energy, materials, healthcare, telecom and utilities. Follow the green plus signs above and you’ll see how sector performance rolls with the business cycle. Our money should follow the same pattern as investors. Today, in several strategies we added to our telecom and utilities positions and have been selling down our technology and industrial positions at the same time.

 

Cycles and Asset Classes

 

     Let’s carry this same cycle discussion into asset classes (stocks, bonds, cash and commodities) starting with this next diagram created by the master himself, Martin Pring.

 

 

   

     If we believe we are in the mid/late stage of the business cycle then according to Martin, we should be in a Stage 3 environment angling toward Stage 4. Through Stages 1 and 2, investors have become complacent as their blended portfolios of pure stocks and bonds have performed well. We have all watched with distain and disgust as commodities (energy, metals, soft commodities, gold and silver) have lost money for nearly five consecutive years. As I mentioned last update, we are likely on the cusp of a very significant change in asset class leadership and performance. In the next Stage (3), we see a new bull market in commodities rise from the ashes while bonds become less and less productive in our portfolios. We believe there is a very good chance that February of 2016 will mark the bottom of a multi-year bear market in commodities. This is not an “all clear” to load up but we do recognize new strength in commodities and inflation hedges of all sorts. Our gold miners positions have appreciated very nicely in the last couple months. Recently we added diversified commodities mutual funds to our blended asset strategies in addition to energy services funds. These are all toe in the water positions but appropriate given the environment. If these buys hold and we are not stopped out, we are likely to add to them.

 

     Another interesting portfolio tip for Stage 3 according to Martin Pring is that cash should be held to a minimum during this phase as all three asset classes (stocks, bonds and commodities) are all generally rising in unison. When there are presumptively so many things to own, why sit in cash? If the business and market cycle moves forward, bonds will be the first things to go where we might raise some cash. Conditionally, if the current pullback is mild, we’ll be looking for places to allocate the remainder of our shrinking cash position. I know that sounds crazy and flies in the face of consensus opinion about the direction of the markets. But unless the recent developments in asset class strength really unhinge and sellers take over, we’ll take the other side of mass expectations. May the 4th be with us!

 

As we say in our Explicit Investing Creed:

 

We are seeking “Success” over a reasonable “Judgment Period” by knowing when to embrace and reject conventional wisdom regarding perceived market trends, “Risk” and “Opportunities”. Superior, above average, results over time are only achievable through unconventional decision-making, experience, and discipline.

 

Hope you had a super Star Wars Day!

 

Sincerely,

Sam “Jedi” Jones