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Shifty

          This is a confusing market to many investors, and with good reason.  For as many times as I hear analysts suggest that the markets are on solid footing, I see growing evidence that the ground is quickly shifting beneath us.  While it’s important to maintain a sense of rising or falling risk based on analysis of high level variables to help guide our exposure to the markets, it is equally important to be willing and able to act on shifts in leadership.  Many things are suddenly in motion; your money should be too.

 

Ground Shifting

 

            Last week’s update had a decidedly bearish tone.  I was simply identifying some of the first signs of technical deterioration we have seen in several months.  Of course the market decided to mock me by pushing out to another all time high on Thursday.  But by Friday, that wondrous event, gave way to selling that brought the weekly gain for the S&P 500 to +0.01%.  Meanwhile the Dow lost .82% and small caps gave up another .62%.  The headlines will read “Another week of all time new highs”.  I take notes to myself which read, “the correction that began on July 3rd is still in force”.  Confusion.  Several things tell me the ground is still shifty and the markets are not on solid footing in the short term.  Our sell signals for High yield corporate bonds appear to have been a good and we continue to sell down our stake in this asset class to a minimal level as of the close today.   Tomorrow will also be a very important day for the markets.  Tomorrow (7/29) we’ll find out if small caps are able to hold the July lows.  If not, it will be a quick trip down to the May lows setting up a relatively nasty looking long term chart with a triple top.  A triple top is series of short term peaks, 3 of them to be exact, which fail to push beyond the previous peak implying that the strength behind buying enthusiasm is waning.  We see this type of price behavior before more broad based selling materializes. 

 

            I’m also aware that one by one, we seem to be losing sector strength in this rally.  Last week was tough on the consumer sector, both discretionary and staples.  I have no doubt that consumers are reacting a bit to higher prices in all things and beginning to make incremental cutbacks.  I hesitate to even mention the realities of inflation, as the veil of deception is so thick and accepted these days.  The private sector says inflation is running between 6-7% annually.  Government reports continue to say the number is barely 2%.  You choose which one is more accurate based on your own observations.  Anyway, the number of downside revisions in earnings from the 1st quarter was very high for the consumer sector and so far Q2 earnings haven’t been very impressive for this group.  Transportation is also showing some new signs of selling pressure but so far, I would call this light profit taking.  Nevertheless, the fact that our cyclical giants like consumer and transports are underperforming should be noteworthy.  Treasury bonds also made a new high last week.  Flight to safety seems logical right?  Gold and gold miners are also getting a strong bid even as the US dollar is stable and rising.  The market is clearly speaking to us as the ground quietly shifts under our feet.  Stocks are under selling pressure while safety assets are in favor at least at the moment.  But it still seems early for stocks to put in a meaningful long term peak.  The current environment is still favorable and the Fed has not yet even completed its QE measures, let alone become an adversary.  Current earnings are still strong, rates are rock bottom, employment is solid and cash flowing into the markets is plentiful. Investors are warming up to stocks with new cash investments but there is also a very consistent thread of bearish sentiment that simply won’t go away.  It has been there for nearly 5 years.  I take no comfort knowing that I am angling into that camp after being bullish since late 2009.  With history as my teacher, I won’t be surprised to see some form of blow out move to the upside that finally shifts mass sentiment into the bullish camp.  Then, I’ll be ready to really cut and run. 

 

Shifting Leadership

 

            I mentioned several sectors showing selling pressure but there are other new areas of interest for investors.  China, emerging Asia (S. Korea), India, Brazil and Canada are all showing excellent strength to the US stock market on a 12 month basis.  China in particular is coming off of a 3 year low; Brazil has just barely started a new uptrend.  India is also leading the charge in foreign equities.  It is no secret that growth rates in the developing world are far stronger than the US and now offered at a much more attractive price!  Investors in international securities need to understand the impact of currencies on returns.  Those countries mentioned above have solid relative returns to the US stock market net of currency exchange rates and are thus the most attractive in my opinion. 

 

          If we are to assume that the current bull market is in its last 12 months (in existence), they we should also watch our domestic sectors for more clearly defined leadership.  Jim Stack of Investech does an excellent job modeling cyclical leadership and he showed this week that we should be overweight energy, healthcare, technology and industrials as our best bets for this late stage bull.  I would argue that industrials are not going to be winners as the rising US dollar will have negative current influence.  Industrials tend to be more on the multinational side generating larger portions of their revenue from overseas.  Since the US Dollar made its most recent low on May 7th, industrials have lagged badly (including the Dow Jones “industrial” average” which is up barely 2% YTD).  On the under-performance side of the table, we see utilities, financials, telecom and consumer (what do you know?).  Shifting money into China, developing markets and Canada with proceeds from those US sectors likely to under-perform, seems like a natural and logical trade.  We have already done so in our strategies over the course of the last month.  Side note -  Some have a hard time with trading at all citing unnecessary activity, transaction costs, etc.   I look at costs a little differently.   What is the cost of leaving your money in an investment that becomes stagnant, or loses ground?  What is the cost in terms of time in making up for those losses?  What is the cost of missing a low risk entry point for new bull market in Asia? I will always say.. move it or lose it.  The upcoming Solution Series called “The Real Costs of Investing” will cover many of these topics.  If you have issues with trading, you’d be wise to attend.

 

Have a great week – stay cool in the hot, hot, hot

 

Sam Jones