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Not My Favorite

As I said last week, the markets were “On the Edge” where buyers would either step up to support the market or we would have to start taking defensive steps.  Thankfully, it looks like buyers stepped up giving us a little breathing room to sit with our current (high) market exposure.  Still, when I look at the guts of the recent buying pressure and the larger context of the current market, I would have say, this isn’t my favorite set up.  It still feels like we’re going to see a better real buying opportunity later in the summer.  With that in mind, there is some opportunity for actionable steps now and until we see a more significant downside correction in stocks.

 

Options

This is one of those markets that offer investors a lot of options.  We can simply buy cheap to own, index ETFs that match “the market” hoping that this six year old bull market will beat the historical odds of producing a seventh year of gains.  That is certainly a popular option but one that should come with a warning label about staying too long or playing too much golf this summer and not closely monitoring your holdings. 


Another option is to diversify across the globe, building in some international exposure in Europe, Asia Pacific, Emerging markets and Japan.  Currently, we’re holding about 12% in internationals now. YTD, most foreign markets are outperforming the US by 4-5% despite the strength in the US Dollar.  That leadership seems to be resuming again after a healthy correction in the last 30 days so this could be a reasonable entry point.  Some of the more attractive new ETFs offer international exposure that hedges out currency risk, like HEDJ or DXJ.


There are also a number alternative investments that are still trending higher but doing so with almost no correlation to any of the major US benchmark indices.  These are probably my favorite options right now.  Investors need to really understand what they are getting into with alternatives and few really do.  They come in many different types but generally involve an active trading strategy under the hood that tries to capitalize on some inefficiency or extremes in the markets like Long/Short strategies or managed futures. 


My advice is to remain invested in here but pay special attention to owning a more diversified portfolio of investments that are trending higher but move in a non-correlated fashion to any of the US stock market indices.   Our tendency now is to gravitate all holdings toward one thing or another that looks just like the Nasdaq Composite or the S&P 500 because that’s where the gains seem to be.  Spend some time looking elsewhere and you find you can scrub out a lot of the portfolio volatility.


Bulls are Few, But Not Enough Bears Yet

From the investor sentiment perspective, there is something that still gives me an uneasy feeling.  Again, I respect the new market strength and select new highs we’re seeing but this set up just isn’t one of my favorites.  Bullish sentiment is sitting at one of the lowest levels we have seen in several years (roughly 25% according to AAII sentiment polls).  Sentiment figures are of course contrarian so we might read that very low bullish number and think the market has substantial upside from here.  I like to watch Bearish sentiment myself when looking for good meaningful lows.  Looking at the bearish sentiment numbers (below from Bespoke), I see a market that still needs to scare a lot more people before I’m going to get excited about a good new buy.

 

If Bearish Sentiment could push up to 50% level or higher, I could get really excited but it would certainly take something other than all time new highs for that to happen right?  More evidence to me that we still have more “corrective” work ahead probably surrounding the Federal Reserve and their choices about the timing of the first interest rate hike.  Remember the average market loss before the first rate hike is around 8.5% (down).  Haven’t seen anything close to that yet and earnings season is right around the corner.

 

Sectors, Styles and Special Situations

If you are like us and have a full plate of investments, we should all make sure our money remains in the right place.  Sector strength is still fairly consistent this year with Healthcare, Biotech, and Pharma leading the way to bold new highs again last week.  We have owned Healthcare and Pharma for several years now.  Technology, Internet and Semiconductors are also still in the drivers’ seat and should be core positions for all.  Financials are also leading again thankfully especially insurance and banks.  We especially like the valuations now among the financials relative to healthcare and technology, which remain fully valued by historical standards.

 

On the Style side, the market still likes growth – small, mid cap or large caps.  This is typical of this stage of the economic and market cycle where value can just become deeper values while investors bid up for growth and are willing to chase it higher.  Speaking of growth, our New Power model (www.newpowerfund.com) is once again leading the charge among our investment strategies as an almost pure stock only growth strategy, investing in disruptive game changers with very high growth rates and yes real earnings.  New Power is angling toward +10% gains YTD, making another new high last week and continues to outperform the S&P 500 since the end of 2011 net of all fees.   New Power is not risk managed like our primary core strategies but relies on price momentum and selection to make returns.  I continue to actively encourage participation in this strategy but to do so with a light portion of total portfolio assets given the exposure and inherent volatility.

 

Special situations are also available.  As I mentioned last week, I continue to like the homebuilders even though they have had tremendous gains off the 2009 lows.  Take a look at this chart and ask yourself if homebuilders are in a good position now.  I think so – so does the market. 

What we have seen from real estate in the last six years has been a complete depletion in the inventory of homes.  Existing homes for sale are nearly gone if one is measuring available inventory.  Furthermore, in the Northeast, bad weather created some very high pent up demand for homes with almost no building.  Last month we saw a near explosion of new permits issued for building in the Northeast.  These will sell because buyers have nothing else to buy.  Here in CO, 10 and 20 “bids” for home for sale are now common.  I don’t see this as the same situation as 2006 when such an event marked a top.  In this case, we’re talking about real homeowners that simply have no supply rather than “investors” chasing real estate prices higher.  With that said, I wouldn’t be a buyer of REITs or mortgage agencies as both are now highly prone to interest rate risk.  But Homebuilders have surprisingly low interest rate risk and are now in full swing helping meet the new demand. 

 

What They Don’t Want You to Know  - Issue 1, Part 1

Starting with this Red Sky Report, I’m going to try to include a weekly segment that attempts to educate anyone who cares about investing realities.  I will do so until we recognize the next bear market is in place at which point, you will either be in good shape or not.   Frankly, I still see and hear too much misinformation out there for me to remain quiet.  Investors are poised to get burned badly again and they need a better understanding of how to manage their money so they can survive as an investors over the long term.  This is especially timely as we approach the End Game of nearly 30 years of falling interest rates.  The future will not be like the past on this basis alone.   You can put this knowledge into the camp of what the industry doesn’t want you to know.  You will not hear this from your Edward Jones guy who wants you to buy and hold commission based American funds forever.  You will not here this from any of the Robo advisor options out there because algorithms that rebalance index funds don’t write newsletters J  You will not hear this from any custodian like TD Ameritrade that suggests you “fire your broker and hire yourself” because you are the only one that really cares about your investment future?  Caring about your future does not mean that you are going to be successful in the least.  Knowledge, experience and discipline are what deliver consistent returns in all markets, so let’s get to it.  Today I’m going to throw out some bear market facts.  The intent is not to scare you or suggest that a bear is imminent but rather to understand the raw, quantifiable facts about their magnitude, impact and frequency.  This is about being prepared for known risks, as they will come as surely as an afternoon rain shower in Colorado.

 

Consider This – with special thanks to recently retired investment magician, comedian and historian, Greg Morris.

The Dow since 1955 to 2015 has drawdowns (loss periods) that look like this graphically.   60 years of data.

Statistically speaking, here are the stats:

Average Decline from the Peak                   -41%

Return Required to Recover                       +71.78%

Average Days in Decline                               557

Average Months in Decline                           32

Average Days to Recover                             1174 (gulp)

Average Months to Recover                         70.81

Average bear market duration in Months     103

Frequency of Bear Markets                          34% of the time

Now ask yourself if you, your broker or your Robo digital money machine is ready for this.  Do you plan to ride this out knowing these statistics?  If not, when will you act? Do you have a system that cuts exposure early in the decline or like most will you sell only after you “can’t afford to lose any more”.  Now look at the right side of the chart in the Red area.  Do you see a pattern that shows nearly zero drawdowns?  I do. 

 

What can we expect next?  I’ll leave it at that.

 

Have a great week and know that we have the knowledge, experience and discipline to manage your investments appropriately in all market conditions.

Sam Jones