Category: Finding Benjamin

While short term price trends sometime make us nervous with the potential for periodic losses or worse, stock investors are generally always on the lookout for long term growth opportunities.  With the current bull market in its 5^th year of existence and valuations creeping toward the upper end of historical ranges, we are all starting to work a little harder to find growth without overpaying for it.  Here’s where I see it happening over the next 3-5 years.

 

BRICs

 

The BRIC group of countries is well known as an acronym representing Brazil, Russia, India and China.  In fact there are several ETFs now with roughly equal weighting to these four countries (EEB is the most commonly used).  Since 2010 and really back to the final peak in global equities in 2007, these classic developing countries have been under selling pressure as developed markets in the US and Europe surged out to all time new highs.  Now the comparison between developed and developing nations may have reversed to favor the BRIC countries.  Russia with all of its political risk is holding the group down while the rest are working overtime to carry the group higher.  If the mess in the Ukraine subsides even a little, I think Russia will not be a drag.  We have already built a reasonable stake in the BRIC countries in our equity holdings across nearly all strategies through individual funds, ETFs or representative stock positions but I can envision us becoming even overweight in the coming months if conditions persist.  I like the BRIC countries because they represent some of the best growth opportunities in the world on a longer term basis.  Bespoke and several other research firms are now regularly reporting on percent of World Stock Market Capitalization by Country.  The US is the still the gorilla weighing in at a healthy 35% of global market share.  However, like its closest competitors in the developed world (Japan, the UK, France and Germany), that share is shrinking consistently.  Since the end of 2013, we have seen global market share in the developed world fall as follows:

 

United States              -.05%

Japan                             -.23%

United Kingdom        -.33%

France                          -.24%

Germany                      -.37%

 

Now consider the change in BRIC country’s market share:

 

Brazil                          +.07%

Russia                         -.26% (Watch for a big rebound post Ukraine)

India                           +.43%

China                          +.26%

 

Also noteworthy in the “growing country” list is Canada, Australia, Saudi Arabia, Indonesia and Thailand.  Remember, we’re talking about some long term macro shifts in contribution to global GDP.  These are slow moving trends but pronounced and consistent.  As I said, over the next 3-5 years, assuming we don’t go through another global financial market meltdown, we should remain focused on where growth potential exists.  Europe is no longer growing and it probably now in recession formally.  The US is hanging in there growing/ recovering nicely but I am becoming more concerned that the US financial ecosystem is becoming more fragile again as we face the growing threat of real inflation, tighter credit markets and a less accommodative Federal Reserve (end of QE).  Developing market investing is naturally a higher risk but higher potential reward proposition.  Don’t forget, we don’t always have to be 100% invested.  So one obvious strategy is to cut total exposure in one’s portfolio to equities but carry a heavier weight in these growth markets effectively neutralizing the impact of higher volatility positions on your portfolio risk profile.  Any of our clients with accounts in our Tactical Equity Models can simply view a current holdings report of their accounts and see that very strategy in effect now.

 

Inflation Sectors

 

Continuing on the theme of growth opportunities, I think we should also keep an eye on the commodities world.  Currently, trends in the US dollar are playing some tricks on this group and seem to be a negative but if inflation and global demand for materials, energy and metals continues higher, we SHOULD see the entire commodities complex spark up.  Again, the savvy investor will watch technical price trends and invest when they are in our favor.  Right now, I’m not seeing much of a trend but I do see a growth opportunity, which is really the point of this discussion.

 

Technology

 

Technology has been leading the developed world higher for most of the last two years.  This continues today even while our markets have been correcting since early July.  Technology, especially some of our largest companies in the world, is now one of the largest contributors to global GDP.  Plainly put, technology is responsible for most of the new hiring, wealth accumulation and demand for goods and services in the world with financial service and healthcare trailing not far behind.  While we might focus on the state of employment, monetary policy, politics and other noise, we need to respect the raw fact that a “growing” piece of our daily household spending is going toward technology, communications and internet services.   This morning, I painfully bought a MacBook Air for my son heading into 7^th grade through their education website as a mandatory part of the school supplies list.  Furthermore, the developing world is just getting started with their adoption of technology by developed world standards.  Growth in technology is real and present – buy any discounts for the foreseeable future.

 

These are the areas where I see longer term growth.  Others may exist on short term windows but they may be only good for a trade.  Stay focused and stick with the big themes and you’ll find the work of investing becomes much easier and productive.

 

Have a great last week of summer – oh my!

 

Sam Jones

What a mess.  Big headlines in a time when traders are on the beach during a natural soft spot in the year leads to the type of market we have seen over the last couple weeks.  While we’re chewing on Tums, it’s important to keep a few things in perspective.

 

US Market Correction Has Been Mild (so far)

 

Compared to the rest of the world’s stock market indices, the US is still holding up well.  Almost all of Europe is down solidly -10% off the highs of the year while the S&P 500 is down barely 3% from the highs.  The spooks are talking up the fact that the current high is 1,987 on the S&P warning that the number is subliminally forecasting a 1987 event.  Bunk.  Europe, and all that is happening there both economically and geopolitically, is really driving global stock markets lower.  Europe has slipped into recession again, the Euro is falling and it’s driving up the value of the US dollar.  Consequently, global dominos takes over with a rising US dollar driving industrials and other US based multinationals lower in price.  A rising US dollar is also tough on commodities but there more going on with that story, in a minute.  While the last couple weeks has been light on US economic reports, those that have been released are still telling the same favorable story.  Employment is healthy with new unemployment claims hitting new lows again and both ISM surveys for manufacturing and services pushed strongly higher last month suggesting business activity is healthy.  Earnings have come in healthy but as I suggested back in late June, most analyst’s had ratcheted up their expectations to a challenging level.  The bar was set a little too high and stocks are simply adjusting back to reality lightly.

 

As I said earlier, commodities are a bit under pressure with the rising US dollar.  Energy is a big piece of the commodities complex.  If you remember, energy was supposed to be one of the leading sectors in a late stage bull market.  That was the case until the end of June but since then, energy has seen more than it’s share of selling pressure forcing us out of several positions in recent weeks as stops were hit.  I think there are some structural things affecting energy that may be noteworthy and I am reconsidering my position on energy as a result.  One is that the massive production of oil and gas in the US has created an inventory bubble.  Two, energy relies on strong global demand and Europe is no longer driving the demand they were a couple years ago.  Finally, it is becoming more widely recognized at least in the US, that energy efficiency and greater deployment of renewable energy sources is now pulling away from demand for oil, gas and electricity.  In fact, for the first time in history, “miles travelled” and electricity demand have not moved up in sync with the rise in GDP or growth in the US in the last two years.  This is big!  Strangely, the end of the reign of terror of the oil and gas industry might not come from the concept of peak oil (effectively running out of cheap oil and gas) but rather the very slow move toward lower profits by lack of demand.  Lots of issues developing here and I will digest them over time.

 

Sentiment is  Approaching A Bearish Low

 

Another thing to keep in perspective is relative sentiment figures.  We know that investors have not supported this bull market with proper sentiment figures until the end of 2013 and even then, money flows into equity funds haven’t been impressive.  Now, after a couple short weeks of corrective work, sentiment figures are angling back to the low end of the spectrum where most good buying opportunities have emerged.  Remember, sentiment figures are contrarian as human nature leads us to sell low and buy high again and again.  With that said, we haven’t hit the rock bottom of bearishness even by recent standards leading me to believe that this correction is not yet done.  But we are getting closer.

 

Technical, Timing and Cycle Perspectives

 

As a last note, the technical set up still isn’t very good looking and won’t be until prices either move lower to somewhere below 1900, perhaps 1850 on the S& P 500 or until time passes with prices treading no where.  I don’t know what will happen but given the technical damage in the last month including a massive sell off in High Yield bonds, small caps and our leadership groups, I am going to say it feels too early for us to look at this pullback as a buying opportunity.  Cycle work suggests that late September is the best looking spot for a tradable low and the 4^thquarter is starting to look very attractive for a potential big upside POP!.  But between now and then, we have weak technical indicators, a market that has not corrected down to support yet, and a massive pile of headline risk in the system.  We are therefore waiting to allocate the rather large pile of new investor money received in the last several weeks.  We are also sitting on a larger than normal cash position (20-30% depending on the strategy) for our invested strategies and monitoring our stops regularly selling positions to cash as needed.  There will be another great looking set up to get aggressive again and I’m hoping it happens this year.  Between now then, we keep our powder dry and our emotional capital intact.

 

That’s it for this week – try to tune out the media, it’s pretty loud out there.

 

Cheers

Sam Jones

If you are thinking that means going into a massively destructive bear market, again, the answer is no.  If you are thinking that means the markets are doing exactly what we’ve been talking about for the last 6 months, then right you are!

 

But If You’re Such a Genius….

 

You might be thinking, well Sam if you’re so damn smart, why aren’t we up 20% YTD?  Why did my account lose money last week?  There’s an easy answer.  Success with asset management is a game of experience, behavioral economics and trend recognition.  It is about understanding real risk and seeking asymmetric returns.  In our shop, we define success as follows (part of our Explicit Investing Creed):

EXPLICIT INVESTING CREED OF ASFA:

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, conviction, and discipline.

 

Risk (defn.)

– The probability of unrecoverable or semi-permanent loss of capital, not to be confused with variable degrees of periodic volatility.

SUCCESS (DEFN.)

– Generating asymmetrical results across all investment strategies: to expose ourselves to return in a way that doesn’t expose us commensurately to risk, and to participate in gains when the market rises to a greater extent than we participate in losses when it falls.

 

JUDGMENT PERIOD (DEFN.)

– A period of time that captures a full investing cycle including both bull and bear markets – typically any rolling 5-6 year period.

Inherent to all of this talk is the reality that we cannot avoid risk altogether but rather we manage it, accepting periodic losses at different times in pursuit of steady gains over time.

 

WE TALKED ABOUT THIS

 

I’ll give you a few reminders of our discussions over the past 6 months.

 

Transition year!  Remember that?  This is a transition year in which the markets will digest gains from 2013 as well as begin orienting to a market environment that does not rely on so much influence by the Federal Reserve or monetary policy.  Can it happen without some bloodshed?  I am doubtful but neither do we need to fall back into another generational bear market.

 

Garden Variety Bear Market!  Remember That?  Yes that’s what we expect, nothing more nothing less.  These events can be scary.  10-20% is normal.  From our lofty heights having seen little more than 4% corrections in the last 24 months, it’s going to feel like a very cold shower.  We will play strong defense if and when this event occurs but plan to see your portfolio balance move down a bit as we seek “asymmetric returns”.  This process may have already begun.

 

Last Year’s Leaders Will Not Be the Same This Year!  Remember that one?  Indeed, last week’s action offered an obvious reminder.  Industrials, Small Caps and Consumer groups took the brunt of the selling.  These were last year’s winners and are now down on the year.  In fact, the entire US stock market is barely up YTD now after 7 months of “Transition”.  Treasury bonds, which performed badly in 2013, are one of the best YTD performers, the same goes for Asia and Emerging markets.

 

Adjusting to a Rising US Dollar! – Another One.  In the last 30 days, the US dollar has risen almost 2% against all foreign currencies.  This is a huge move in such a short time and certain one that is now overdone.  But the technical pattern for the US dollar is now looking decisive, showing a long term bottom and potentially the beginning of a new long term uptrend.  A rising US dollar is to be expected as the US economy hits the upper end of capacity (employment and manufacturing) and growing with stable demand and shrinking government printing and spending of US greenbacks.  A rising US dollar is hard on commodities, which are now in a downtrend, hard on gold (as a contra-dollar trade) and hard on companies that generate a lot of foreign revenue (industrials and consumer staples).  The only oddity this year is the massive underperformance of small caps, which tend to do better in periods of a rising US dollar.  I’ll be watching this relationship and doing some additional research on this so stay tuned – something strange it happening with small caps.

 

Stick With Late Cycle Leadership (last week’s “Shifty” update).  These are Energy, Technology and Healthcare predominantly as major food groups.  On the bottom of the list are materials, telecoms, and utilities.  Last week, energy took an enormous hit (-4% on the week), which challenges this theme.  Technology and healthcare did ok.  We were stopped out of a few energy positions but still holding many others.  Utilities are also bucking the trend of what “should” be happening now as one of the strong sectors YTD.  Materials and telecom gave gas as instructed.   For the second half of 2014, I’m going to expect our leaders and laggards to work extra hard to get back in line (energy up, utils down mostly).

 

Finishing on a positive note – the bull market is not over.  We haven’t yet seen much expansion in valuation measures, we haven’t yet seen sentiment shift into the bullish camp and we haven’t really seen substantial money flow into equities and out of bonds.  Technical warning flags are non-existent.  Meanwhile, the economic news is all favorable, earnings are still strong, getting stronger, interest rates are benign, inflation is barely on the scene and the Fed is still supportive for at least another 6-9 months.   Furthermore, we are working our way through one of the softest parts of the year and the presidential cycle without too much pain and suffering.  I would love a 15-20% correction but I’m doubtful we’ll get one as I am not alone in my interest to buy any discounts.

 

THAT’S IT FOR THIS WEEK – SPEND SOME TIME WITH THE FAMILY AND ENJOY THE REST OF SUMMER.

 

Cheers

Sam Jones

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

The US stock market started into a new correction pattern on the 3rd of July and that condition remains the same today despite some marginal evidence to the contrary.  This may prove to be just another brief decline before blasting out to new highs or the beginning of something more significant.  Either way, those interested in preservation of capital probably need to consider making some changes toward defense.

 

New High for the Dow, New Lows for Small Caps?

 

This subject has been kicked around the media for several months now and I’ve heard all the justifications for why small caps are under-performing.  Most notably, the primary excuse is that they did so darn well in 2013, that we should all expect then to experience some profit taking.  Maybe.  But in my years of experience, small caps under perform for one reason and that is that the market as a whole has a growing sense of concern for holdings that carry larger risks of loss or concerns over liquidity.  Small caps are to large caps as high yield bonds are to treasury bonds.  When perceived risks increase, larger investors cut out of the riskier assets first.  As the Dow made an all time new high last week (with a whopping 3% gain YTD), small caps quietly lost money again, made a new low and are now negative YTD.  Excuses aside, this is not a good thing.

 

High Yield Sell Signal (early)

 

Speaking of canaries in the coal mine, as of today, we did get our first very early sell signal for high yield corporate bonds.  Again, this is early and based only on the most volatile of our high yield corporate bond holdings but it does appear to be a solid sell signal.  The last time we made a trade for our High Yield bond allocations was solid BUY on the 16th of September last year.  Today we cut our more volatile high yield bond holdings down by 50% and sent the proceeds to cash. Several of our other high yield positions in All Season, Freeway High Income and Retirement Income are also getting close to sells but we’ll wait for the actual signal – as always.  Again, in my experience, when high yield corporate bonds sell off ahead of the broad stock market indices, the market usually follows lower in the next couple weeks.  Another warning shot for those who are paying attention.

 

Jump in Volatility

 

Last Thursday (7/17/2014) consistent with both items above, one of our short term market trend indicators based on the rate of change in the VIX index also tripped to a sell signal as the VIX jumped almost 32% in a single day.  The VIX is widely misunderstood and we do not trade on its absolute value but rather watch the change in this indicator off extremes as a sign of quickly shifting sentiment among options traders.  This is a useful indicator typically only at market tops and market bottoms but relatively useless in between.  The VIX is a market measure of volatility but more importantly, a way for us to measure the appetite for risk insurance.  A rising level means options traders want to protect themselves and visa-versa.   For weeks, the VIX has been trading at a historically low level (less than 11), like we have seen in the final months of most extended bull markets.  Low volatility is a sign that investors are fat and happy, worried about very little in terms of market risk.  In fact, these are the very times when investors begin to think that investing is rather easy.  The Do-It-Yourself investor comes out of the closet and quits his tiresome day job.   Cash is deployed in mass as it seems the coast is finally clear.  They forget that markets can be brutal because it’s been so long since anyone felt any real pain.  They often look only at the tiny expense of things and become complacent about the real costs of losing one’s capital.  Last week, without much fanfare, the VIX shot vertically higher off a multi-year low level as I hear and witness all of the above.  Someone just poked the bear.  He now has one eye open and he’s a bit hungry.  Now if we can all just sing a quiet lullaby, perhaps he’ll hit the snooze button.  Or, perhaps we should tighten up all sell stops on current positions (wink).

 

Strongest Part of the Presidential Cycle Directly Ahead

 

Finishing on a positive note, we remain very open to the possibility that the current correction could be just another great buying opportunity ahead of one of the strongest periods in the presidential cycle.  The historical averages of all presidential cycles shows general weakness for stocks into the end of the current quarter followed by 4 consecutive quarters of rather incredible gains (5-7% each quarter).  A big part of me intends to be involved in that kind of uptrend if it happens but I also want to survive the current quarter if it turns out to be a bit bloody ahead of that surge.  For the record, 2013 was not supposed to be the blow out year that it was as dictated by this same cycle.  The S&P 500 gained nearly 30%. The cycle says 2013 should have been a low single digit year.  Are all the “presidential cycle” gains behind us or still in front of us?

 

Do You Have a Risk Management System in Place?

 

Given the current weakness in the market, combined with a growing list of technical warning flags coming off a very long period of low volatility, it would seem natural for us to see some sort of significant “unexpected” decline in stock prices in the weeks ahead.  However, this same decline, like many in the past, could be one of the last great buys ahead of another very profitable market cycle.  How much of a loss can you tolerate to stick it out?  Should you wait to see what happens or act now?  What will tell you when to get back in?  Two weeks ago, I spoke of our risk management systems (“Risk Controls”). If you don’t have a system that answers these questions, then you should work to develop one quickly or pay someone who does have a system.  Not having a risk management system in place for your investments after a 190% gain in the stock market over 5 years is not an option.

 

Keep both hands on the wheel and have a safe week.

Sam Jones

“The financial system cannot absorb unlimited money forever without adverse consequences, but the current environment may last a lot longer than most of us expect — and it will likely end much more abruptly than most of us expect. In the meantime, I recommend participating in the bull market, but with tight controls on portfolio risk.”  Michael Price – On Track Report 7/03/2014

Michael Price said it well this week.  I couldn’t agree more.  This environment has rising risk but enough opportunity to warrant a fully invested portfolio.  Tight risk controls are critical so let’s review ours

What is Portfolio Risk?

In the past, we have been guilty of associating risk with portfolio volatility.  In a way, that’s not totally incorrect as every cycle of portfolio loss begins with rising portfolio volatility.  Portfolio volatility is something we should be tolerant of to a degree, as the markets will factually have up and down weeks, or months within a broader rising trend.  We can’t jerk out of every investment each time it has a small down move right?  No, but regular volatility is different from portfolio risk.  So what do we mean by portfolio risk?  Well for everyone who has any significant portion of your net worth invested in something, it means unrecoverable risk of loss.  Unrecoverable seems so absolute but it’s a term that I think is appropriate in light of the magnitude of the bear markets since the year 2000.  When an investor experiences the full brunt a bear market like any of the last two in which portfolios lost 40 or even 50%, investors have a strong history of simply washing out (selling) and sometimes never return to investing.    For example, investors sold in mass and sold massively in early 2009, at the lows and never came back, until after the markets rose a full 185% over a span of 5 years.  It wasn’t until the end of 2013 that we began to see investors slowly creep back into the stock market based on inflows into equity mutual funds. But remember, portfolio values are still sitting back at their low values with opportunities for returns getting thinner by the day.  You can start to see how a significant loss becomes unrecoverable when the pattern of human behavior leads us to make some very ill timed decisions both on the buy and the sell side.  Logically, we therefore look at that entire event as something we want to avoid.  Specifically, we want to have a system in place that tells us when to remain fully invested and tolerant of volatility but also when to move decisively out to a defensive position when normal volatility becomes “Portfolio Risk”.   Which brings me to that system.

What Are Some Risk Controls?

 

These are some high level examples of our risk control systems in place that keep our client accounts out of trouble without giving up on rising market opportunities.

 

Stops

Stops are generally a moving line in the sand at the individual security level that are monitored regularly.  When a stop is broken to the downside in the price of a security, it is sold to cash.  Stops can move up with a price of a security effectively following it higher over time giving us the best chance of owning rising securities for as long as the price is trending up.  When the price trend turns down, the stop is hit and the security is sold.  Voila!

 

Market Trend Following

 

This is a part of our daily routine in which we measure the health of the market at large including breadth, volume, new highs and new lows, Market price oscillators, moving averages and momentum.  Together, they paint of a picture of market and how it is trending.  Some markets are very strong in trending directionally as we’ve seen for the last two years.  Other market conditions are literally trend-less, moving neither up nor down with any form of sustainability.  Our indicators help us understand what type of market we are in and subsequently, how much exposure we want to have at any given time.  Today the markets are trending strongly higher but the strength of that trend is getting weaker each month for example.  We know that the odds of a market correction are rising without seeing it actually happen.  How much of a correction is anyone’s guess but it will push us into some form of defensive positioning when it happens.

 

Security Selection

 

Of course, we could just buy any S&P 500 index with 100% of client’s money and hope that our system will be robust enough to get us out at the right time.   For a portion of our equity models, we do just that.  It cuts costs and often generates some of the best returns in the portfolio.  But putting it all in an index is just too risky when we know that markets (and associated indices like the S&P 500) have experienced crashes, mini crashes and panics losing 10, 15 even 20% in a single day.  Instead we still work to maintain a mix of securities that are both non-correlated to the markets but also non-correlated to each other.  Examples would be gold or silver, bonds, international positions, low and high-grade corporate bonds, or select sector securities.  In our all stock models, like New Power, High Dividend or Worldwide, we work hard to own stocks that march to different drivers.  Some might benefit from rising inflation while others are benefiting from consumer trends or competitive advantage. Held together, we are really spreading out the risk of a sudden and dramatic loss in our portfolio (aka portfolio risk).

 

Using Rentals

 

Rentals are a term we use for securities that have no cost to trade (sell), no redemption fees and no hold periods of any kind.  Rarely do we use anything else in our strategies but liquidity is critical to the risk manager.  We must be able to sell everything when we want to without constraint.  We are still longer-term investors but we are not putting money into things we cannot get out of if conditions change.

 

We have other gears in our risk management machine but these are a few examples of key elements in our system.  As the markets marches higher, I expect these systems to begin lighting up, giving us some clues and warnings that the risk of unrecoverable loss is also rising.  None yet.

 

All of our clients are with us because they are mature investors.  They know and understand what market risk means and they pay us to run our system daily making changes as needed.  This is what we do and we do it well.

 

Thank you to everyone for another quarter of service.  We will be sending out the quarter end Change of Seasons report next week at this time.  Best of luck to all of us in the second half of 2014!

 

Cheers

 

Sam Jones

Understanding that “Jack” is a street term for money, you might appreciate the pun.  I believe we have entered a market environment where there is still upside opportunity, perhaps even significant upside, but that ultimately we are angling toward another bubbly equity market condition that doesn’t end well for the unaware investor.  Several new measures of stock market valuation and sentiment extremes have come to my attention recently giving me some greater doubt about the longevity of this bull market.  At the same time, I’m seeing the market speak of an economic slowdown ahead through sector and asset relative strength.   All things considered, my big bold statement regarding our investment stance from here on out is as follows:

 

Big Bold Statement

 

Most, if not all, gains from this point forward in the global stock markets are likely be erased in the next subsequent global bear market decline.

 

I’ll tell you why in a minute

 

Please re-read the big bold statement again and then take a deep breathe and remember this.  Investing is never easy, certainly nothing like 2013,which was clearly one of the easiest years in my 20 year career.  The markets will have bull and bear cycles until the end of time and that is why we have developed mature tools to guide our clients’ money in both up and down market conditions.  None of our investment strategies are of the buy and hold type where we assume that markets are perfectly efficient.  Markets are only as efficient as investor psychology will tolerate and we know that humans are emotional creatures.  Extremes will be hit both on the up and down side presenting a very inefficient market condition in other words.  One of our basic investing creeds is based on the assumption that few investors have the necessary tolerance to ride through any of the real bear markets of the past (40-50% declines) without selling in panic at some point – usually at the worst possible time.  Our methods and discipline will voluntarily reduce our exposure to risk, hopefully at an opportune time near the top, in order to make the investing experience tolerable as market losses become more severe for others.   There is growing evidence that we are going to be reducing our risk exposure voluntarily as we see growing evidence that the market is approaching some extremes.  Remember, we’re not there yet but simply recognizing the situation as it develops.

 

Valuation Extremes

 

I don’t want to go into too much detail on this but market valuation analysis always yields variable results depending on what you might use as your measuring stick.  The Fed (Janet Yellen) has commented several times on their view that the market is NOT overvalued based on analysts’ expectation of future revenues.  That metric is probably one of my least favorite as expectations can and often do, change over night and tend to be highly biased toward the recent past.  If that evaluation metric were used at either of the last two major market peaks in 2000 and again in 2007, they would have been useless in predicting any of the subsequent carnage in stocks or the economy.  Better methods of valuation that have had some solid predictive or coincident value, have been market capitalization for all common stock as a percent of nominal GDP (GMO, Hussman) as well as aggregate price/ 10- year inflation adjusted earning (Shiller).  In a nutshell, the vast majority of the valuation metrics that have proved to be historically accurate since the late 1940’s are suggesting that the US stock market is now between 65 and 75% overvalued (see below)

 

(CHART HERE)

 

Now before you drop your toast, consider that overvalued markets at extremes have moved as high as 150% overvalued in the year 2000 and were almost 100% overvalued in the year 2007.  So you see, there is room for the market to run higher but I am now coming to understand that we are nearing the very high end of the range for all credible metrics.  GMO (Jeremy Grantham), curmudgeon that he is, even suggests we’ll see the S&P 500 hit 2250 in the next 24 months before our market hits a 2-sigma extreme from which heavy bear markets unfold.  2250 is a clean 20% higher than where we are today and worth a considerable allocation to stocks if it’s really available.

 

Other Extremes

Other extremes are coming from the less statistical side of things, more sentiment, and moral hazard type stuff.  For instance in the last year, we have seen a near frenzy in IPO offering especially among fad companies with zero revenue.  Bitcoin and several other things that I would never invest in, ran up 5,500% in 2013 only to crash and fail dramatically in a tornado of fraud.  Cyber currency IPO with a 5,500% gain! Come and get it!  What?  Internet stocks did another parabolic rise in 2013 gaining 50, 100, 200% in a single year.  We played some of these in our New Power model but cut and ran early in the year.  It’s not wrong to be a momentum, investor as long as you’re ready to cut and run when you need to.  I believe most momentum drive internet and biotech stocks are roughly ½ way down to their ultimate bottoms this year.  These types of instant riches are definitely one of the calling cards of market tops.  Real estate is again approaching that crazy cycle of bidding wars for junk on spec by people using other people’s money.  Still, despite the fact the Fed is pulling back on their QE measures methodically, there seems to be a well entrenched assumption that if things go south, we can always rely on the Bailout Nation to make our pain go away.  Moral hazard is with us.  While we at All Season Financial had a reasonably good year, I think I will also expect to hear the growing din of demand for ever great returns based on the perception that the gettins’ are good!   Balancing these demands and our business risk with the growing list of extremes that I see in the market will be my cross to bear for the next year or so.

 

Sector and Asset Strength

 

I often speak to this subject as it helps us identify where we are in the business cycle.  Take a look at this first chart of the business and sector cycle below courtesy of the cool relative strength tool on www.stockcharts.com .

 

(CHART HERE)

 

You’ll notice that when Energy, Consumer staples and Healthcare lead the market, we are often looking at a “market top” of some sort.  The economy, shown in the green curve, doesn’t actually top out until later when it reaches “full recovery”.  By then stocks of all types are on their way down (aka a bear market).  Now look at the sector strength since the beginning of 2014

(CHART HERE)

 

Can you see the curve in the market’s preference for energy, consumer staples and healthcare?  Utilities are up big this year and we’re not sure why but they represent such a small part of the US stock market, that no one really cares J   Sector preference is pretty clearly pointing to a pending market top.  Of course this can change and we’ll be watchful for strength in cyclicals, tech and industrials as a group to indicate another potential surge higher  – perhaps up to GMO’s 2250 mark?

 

Asset class rotation is painting the same picture of a pending market top as long term Treasury bonds are just crushing everything this year, up nearly 11% while stocks and most commodities are still flat.  I don’t get it but it is what it is.  Bonds are forecasting recession, sectors are forecasting recession and yet the economic reports are almost universally gaining strength each month.  It would make sense that the market is beginning to forecast events in the economy that are not yet apparent with the very typical lead time of 6-9 months.  We’ll see.

 

In summary, it seems that no matter what happens in the next year we have now entered the land of the overvalued market.  While not yet at historical extremes, we need to move into a shorter-term frame of action where we might give the market and our holdings a shorter leash.  Losers and weak positions should be sold quickly without much puzzling, while any buys should be slow with a heavy burden of proof to qualify.  Raising cash is not wrong but let’s not be in a hurry either.  Finally, let’s keep our “Jack” nimble and assume that profit taking is in our future.  When the real decline comes and hits hard, we’ll hope to have our physical and emotional capital intact for what could be one last great buys of this decade.

 

Cheers to that

 

Have a great week

 

Sam Jones

As the first quarter of 2014 comes to a close, I can’t help but feel like the financial markets are behaving as if freshly awaking after a night of too much drink.  The hangover is not a pleasant thing and the price we pay for too much self-indulgence.  It can hurt and is often a driver behind the need for relief from other things.    2013 was the party, 2014 is pretty clearly going to be a hangover year.

Stock Headaches

I  see lots of sector rotation and lots of noise while the market averages move between +1% and -5%.  Smart money folks said this was going to be a year where sector rotation and stock picking could trump the averages.  That’s true but thus far we have really seen much persistence in our leadership groups.  For instance, technology, biotech, and internet sectors were all dominating the markets leading us higher with low volatility and lots of fanfare… until two weeks when all went into near death spirals.  Technology funds have faired the best as they are down ONLY 7% from the highs.  Biotech and Internet are -16% and -12% respectively with individual stocks off 20-30% in just two short weeks.  Energy and financials have been laggards thus far in 2014.  But now they are bubbling to the top of the rankings for the last two weeks.  While it’s nice to have something to buy with our internet proceeds, I don’t like being forced to make sector rotations every 2-3 weeks anymore than your tax prepared does.  The big rotations like those out of bonds and into stocks or commodities are the ones we want to act on – aggressively.  Sector rotation among industries can happen much more frequently and are somewhat of a pain to chase around if they don’t persist beyond a few weeks or months.

Looking at the big picture, I think the market is recently orienting to accommodate expectations for the next earnings season.  If the rotation out of internet/ biotech and into energy and finance is correct, we might expect to see some disappointments in earnings from internet and biotech in the coming weeks while energy and financials might surprise to the upside.

Also in the high-level perspectives camp, we know that fast moving sector rotations indicate and market environment in which investors and money managers are getting a little jumpy and anxious to find returns.  They are not willing to even sit with an underperformer and certainly not something that is losing money.  More hangover action in an effort to get comfortable.  After a big year like 2013, the possibility of losing money seems all the more painful.  Where’s the party?!!

Bond and Commodity Relief

So, Janet Yellen says that the Fed is no longer bound to a policy of low rates tied to anything.  She says they are likely to begin raising rates in mid 2015 and what does the Treasury bond market do?  It breaks out to a new high for the year.  I will never understand the bond market.  Regardless, 30 year Treasury bonds are now up nearly 7.5% YTD as yields fall on the long end.  Short-term bonds where all the money lies are barely up 2.5% (basis 10 year Treasury bond).  The yield curve is flattening if you understand the math indicating a greater likelihood of recession in the future.  The curve is not at all inverted and is a long way from it but this is the first time we have really seen the SHAPE of the yield curve change in many month.  Yellen and the Fed are no longer supporting a policy of zero interest rates and the markets are responding to that new reality.  In the meantime, we have some nice Alka-Seltzer type relief coming from our bonds in our blended asset portfolios.

Commodities are also providing some relief to the throbbing headache coming from the stock market.    Soft commodities like the grains and other foods have been on a tear this year – up almost 15%.  Shortages coming from drought are expected given the winter status and short water supply in our agricultural belt.   Metals and other hard commodities are recently lagging a bit but still up stronger than the stock market by a long shot.  And now energy and energy funds have recently broken out to a new high for the year.  I think this is a supply side thing as well as a value-based trend.

Alternatives Ready

Alternative sectors and investment vehicles are also waking up fresh and ready to go after a terribly long sleep over the last 3 years.  Real Estate funds, REITS, Master limited partnerships, and pure alternative funds (managed futures, macro opportunities, long/ short, absolute return), appear to be bottoming selectively.  These funds are a nice new tool for the every day investor offering a new asset class with little or no correlation to the stock market.

We have not invested in “alternative” funds for quite some time but I’m making a list and frankly surprised at how many great options I’m finding.  I would anticipate taking several positions in these funds in our Blended Asset strategies over the next 30-60 days if conditions persist.

All things considered, we may have a hangover type Stock market but we don’t have to look far to find relief for our aches and pains.  This is going to be a great year to manage your asset allocation on a somewhat dynamic basis using representatives from many non-common stock types of securities.  Get it done now; it’s not too late.

That’s it for this week and next as I will be writing the Change of Seasons quarterly update.

Happy Spring – 10” of snow last night up here in Steamboat Springs – ugggg

Sincerely,

Sam Jones

After 3 days and a mild 3% correction, investors are now remembering what it feels like to lose money in the stock market.  It’s been a while since we’ve seen any real selling pressure so no doubt, this seems new and awful.  By Friday of last week, the selective selling of the previous month turned into a round of “get me out” and more indiscriminate selling.  These panic moments can lead to more selling but often mark at least a short term low in stocks.  Is this the end of the correction?  Read on.

 

Fear

            When I’m feeling afraid for my investments (yes I get afraid too), I find it helpful to tear apart the fear.  How much is based on solid evidence versus getting caught up in the moment?  What am I really afraid of?  In doing so, I am almost always relieved to find that the situation is not as bad as my initial perceptions and better yet, I begin to see opportunity.  Let me first digest the fear side, and then let’s talk about short term and longer-term opportunities developing now.

 

What is fear for investors?  Fear is not about losing money.  That is in the past and it shows up as anger, resentment and regret.  These are part of investing and we try to keep these emotions contained by way of containing losses.  No, fear is really about the future, specifically not knowing the future and wondering if the future is going to be bad or worse than previously expected.  Effectively, for investors, we are talking about fear of the unknown.  Obviously current events have a way of projecting forward in our expectations.  Last week, I noted the titles of all 2014 forecasts being nothing but happy, bullish and optimistic.  After last week’s declines, I wonder what we might expect to see and hear now?  I bet no so much Bull.  Also embedded in our fear is a sense of being helpless.  If you are in a position where you have no sell side criteria and your investment strategy is one of hoping for positive outcomes, then no doubt you are feeling more fearful.  What if the market unwinds?  When will I sell?  Who will decide?  What day?  Which stocks?  These are fearful thoughts going through your mind right now in the absence of a strategy.

 

In our shop, all positions have sell side criteria.  Some are tied to the markets via indices so we can use market technical indicators to suggest when we should adjust (cut) our market exposure.  Others are more specific to the individual holdings like our bond and individual stock positions.  Last week, several of our positions broke down through our “stops” and were sold to cash.  That is called risk management and it follows a predefined strategy.   I don’t know the future but I do know when my investments are moving against me.  Having a system that creates an action item helps one manage fear because we know that we are in the driver’s seat and not simply a victim or what may or may not happen in the future.

 

As I continue tearing into my fear, I do find real concerns based on real evidence unfolding now.  These are things I can focus on, measuring them and addressing them with respect.  One is the unintended consequence of the Fed’s recent activity on foreign currencies.  Globally, foreign currencies have been crushed in the last week on the basis that the US Federal Reserve is not going to be flooding the global markets with as much cash as we have seen in the last several years.  A currency crisis is not fun, I’ve been through a few and they can have a significant negative impact on stocks, both domestic and foreign.  Selling is driven by foreign investors looking to repatriate their wealth to their own domestic currencies, which involves the sale of all things – good and bad.  I have little doubt we are seeing that type of selling now.  US investors sort of get sideswiped as they really don’t have the same currency concerns and yet all stockholders pay the price.  Currency driven stock declines can be nasty.  However, they are also quickly recovered as currency exchanges whip rates back to historic norms after the selling.  In 1998 the Russian and Asian currency crisis caused a 26% decline in the S&P 500 and complete recovery of the same in less than 60 days.   Tums anyone?

 

I am also concerned about the impact of congressional bickering regarding our own spending (debt) limit in early February and the general stage of the investment cycle where investors are looking for reasons to take profits after such a bountiful 2013.  I am not currently concerned about any other aspect of the financial markets.  With that said, let’s look at the situation from an opportunistic perspective.

 

Opportunity

 

            In the short term, I do not see an immediate opportunity in stocks.  That is nice of way of saying; this market is likely to go lower before we see a sustained new uptrend.  Based on cycle work alone, which is a blunt instrument for trading, we are looking all the way out to the late summer or early fall as the most likely point for stocks to resume the strong bull market uptrend of the last four years.   Remember, we have been calling for a “Garden variety” bear market this year during the first two to three quarters.  This is not the type of bear market we have see in more recent years with losses of 40-50%.  I am talking about a more cyclical, technical, profit taking type decline, perhaps using a currency crisis as the catalyst that simply erases much of the bullishness in the system and resets prices back to a more attractive entry point.  It could be 10%, 15% or even 20% but I would guess at the lower end of the loss spectrum.  The opportunity to buy stocks aggressively will happen again in 2014, but later.  Stay focused on risk management and capital preservation for now.

 

Right now, I think there is a real opportunity in the income world, not Treasury bonds but higher income bearing securities, like those found in our Retirement Income and Freeway High Income strategies.  2013 was an unproductive year for these strategies, which gained less than 2% in the year.  In the process, the opportunity was reset.  Investors sitting on giant piles of cash in bank accounts earning nearly zero interest could entertain adding money to either of these two accounts which are back on a track of generating 8-10% annualized returns since becoming fully reinvested just 30 days ago.  Remember, our “income” strategies have very little to do with Treasury bonds or any perceived risks here.  In fact, one of our core holdings are floating rate funds, which actually move higher in price as interest rates go up (if that’s is your concern).   If I had cash in the bank that is earmarked for investing, I would add SOME to income models now and wait until July or August to allocate the rest to my favorite stock strategy.  Personally, I do not carry much cash in the bank and never have, as I don’t like lending money for nothing.  In 10-15 years when banks are again paying 5-6% interest on deposits, I might reconsider.

 

I’ll finish by saying this opportunistic statement; the bull market in stocks that began in 2009 is not over by any means.  Longer-term technical guides that warn of a bull market peak 6-9 months in advance are nearly absent.  In the short term, we are long overdue for a corrective cycle but ultimately it should be just another great buying opportunity.  Earnings this quarter are coming in ahead of expectations by the widest margin in over six quarters.  Earnings season is not over yet however.  Revenue numbers are also strong.  If prices decline into the fall and corporate profitability continues as is, we could be staging for quite the launching pad for another very strong move higher in stocks well into 2016.

 

Cheers to that!  Have a great week

 

Sam Jones

January is the most interesting month of the year for investors, at least it should be.  It’s like a “call” in any card game when the betting stops and everyone still in play shows what they have.  Winners and losers are established, those who have been bluffing are shamed and those with the goods, take all the chips.  With the month only half way over, it’s certainly too early to have confidence in which will be the winners and losers for the year, but we’re getting a clearer picture every day.  You might be surprised at those who have tipped their hands so far.

Not Quite What You Were Expecting?

Once again, the market has a crafty way of upsetting forecasts.  Today, via email, I received several more 2014 year investor forecasts. Calamos – “2014, The Year of the Fundamental Investor”.  John Hancock – “ Global Growth Prospects Brighten for 2014”.  Etc, Etc.  Not one suggested the results for 2014 could be anything other than bright, profitable, and yes even better than 2013.  Well so far, the pervasive overly bullish consensus opinion about stock market performance in 2014 is living up to its traditional role as a contrarian indicator.  Companies with strong fundamental performance reporting earnings and revenue that beat estimates are being sold off (Synnex, CSX, Barracuda, Alcoa, Capital One, Intel, JNJ, Verizon, GE).  UPS is down over 5% YTD because they simply have too much business to handle?   Others, like American Express, with complete misses on both earnings and revenue are up over 4% YTD. So far, I certainly wouldn’t call this the year of the fundamental investor but it’s still early.

You might also remember my comments about last year’s winners rarely extending to becoming this year’s winners.  Netflix is now down -13% and falling like a stone among others.  While losers from 2013 like IBM and Caterpillar are up both up!  Momentum investors beware.  Same goes for asset class rotations.  Stocks are down so far while the most hated asset classes in the world like long term treasury bonds and gold are up 3-5% YTD.

Also in the upset camp so far is the theory that the US stock market will dominate all global markets again in 2014.  Out of 76 country specific stock indices, the USA ranks 55th.  Leading the charge in 2014 are our old debt laden friends, the PIGS (Portugal, Ireland or Italy, Greece and Spain).  I suspect the theme of investors looking for growth a reasonable price (GARP) , presented in the last Red Sky Report, is at play here.  I’m not excited to invest in the PIGS now or later.

There is one “call” that seems to be playing out as expected and that is the market’s preference for cyclical sectors over defensive.  Again, please re-read the last Red Sky Report on GARP or GULP.  Growth sectors that benefit from a rising economic cycle seem to be the right place for investor money while defensive sectors like utilities, consumer staples and Energy and Telecom are not.  No recession in sight, low inflation and easy money are still the dominant themes driving performance differences.  A quick look at the sectors above and below their 50 day moving averages for 2014 tells the story clearly –  via Bespoke Investment Group.

The message is pretty clear to me.  Wall Street is littered with investors who refuse to see things for what they are and ride their assumptions all the way into insolvency. Selling is happening in stocks but more importantly, we are seeing selling into an environment where fundamental reports are perceptibly strong.  The “Call” is diverging from what is being reported.   This is a situation we often see closer to significant bull market peaks or at least significant market corrections.  With that said, it is too early to sell stocks, buy bonds and/or gold as our market “call” has not moved all the way around the table yet.  But so far, we should respect and be cognizant of what the cards say so far.

In our shop, we are actively setting stops on all positions and selling them as they are hit.  In special cases we are using proceeds of those sales to buy new positions selling at better values but still in the growth sector or rotate into non-correlated asset classes.  By and large, we are focusing more on capital preservation now and following relative strength trends as they unfold.  From a timing perspective, this week should see a short term low in stocks with a strong seasonal period showing up during the last week of January.  If we don’t get a good thrust higher in late January, I’ll take that as another serious clue.

Stay tuned and have a great week

Sam Jones

Your money manager with both hands on the wheel

Well I can’t say that I’m that surprised with the start of the year beginning negative for stocks – now down a bit over 1% in the first three trading days.  The end of 2013 was just a bit too good and we should expect some profit taking early in the new year, right.  Still, we don’t know where this mild correction will end and none are very interested in giving up what was made last year.  How much pain should we tolerate before becoming more defensive?  How much should we be willing to lose just to stick with the primary uptrend?  GULP!

Market Support – GULP

Of course, the market is just an observable creature by which we can assess overall conditions.  It does not have to represent our investments.  For those of us who are not indexers, we only measure support and resistance on “the market” to determine risk and thereby our total exposure to stocks.  For others, the market IS their investment and thus support lines might have a more salient meaning.   From my seat, we should all be willing to tolerate any profit taking in “the market” for at least another 3% loss which would bring us down to the shortest of the most meaningful moving averages (the 50 day SMA).  On the S&P 500, we’re talking about 1789.  However, a basic look at the S&P 500 chart of the last 7 months shows the S&P 500 index has violated the 50 day moving average three times before quickly rebounding higher back into the primary uptrend.  So, with that knowledge, I’m going to extend the GULP factor by another 1% marking support on the S&P 500 at the lows of December (1772).  A strong move below this level on rising selling pressure would change the technical picture rather dramatically and put us on target for a deeper correction down to the next level of support around 1684 on the S&P 500.  That’s a 10% correction from the high set on 12/31 and regular readers know I expect more than one of these in 2014.

Preference for GARP

It’s really hard to identify leadership with only three market sessions in the new year but I’m going to tell you what I think is happening in terms of investors’ preferences based solely on winners and losers so far.  GARP stands for Growth At a Reasonable Price and this seems to be the sweet spot for new purchases thus far.  The market is still hunting for growth but given the whopper year in 2013, investors are rightly a little critical of paying any price for it.  The talking heads are saying that the valuation for “the Market” is below the average of the last 15 years.  Now that does not provide a lot of comfort for me.  Think about all the averages inherent to that statement.  We have “the market” average, which is made up of VERY overbought things and some very oversold things.  Then we have the 15-year average and it has been a wild 15 years for stocks with extreme highs (year 2000) and extreme lows (2008) in valuations.  Averages aren’t worth much when the range of statistical significance is this wide.  What we can recognize is that 2014 is going to be a stock pickers’ year, meaning one can do very well if one has the tools and systems to invest in stocks selling at real discounts to growth.  We have been busy in the last couple weeks making upgrades to current positions along those lines.

Specifically, we are selling positions that have falling or declining earnings per share growth rates (3 year trends) with unsupportive price to earnings (PE) ratios.  In many cases, this means selling a position that no longer carries double digit earnings growth.  Now that sounds like an unreasonably high bar but there are plenty of options out there with solid double digit earnings growth selling at a P/E of 15 or less.  These are GARP stocks and we are picking them up now.

Beyond individual names, there are growth-oriented sectors, which are generally cyclical in nature, also getting some investor attention early this year.  Some did OK last year, but many reallyunderperformed the broad US stock market making them potentially good candidates for 2014 investments.  Highlights are banks, financials, real estate and select technology.   Oddly, many of these are obviously interest sensitive sectors.  While the Fed is now openly discussing the end of QE and bond buying programs, the market seems to think that low interest rates are here to stay.  Or put another way, it seems that the bond market may have fully discounted the mild reduction in Federal stimulus that investors expect.

Gold and Silver are raging higher after the 2013 massacre but the conditions are just not right for Gold or Silver so I’m not really considering either.

Income Models Back in Gear

Our Freeway High Income and Retirement Income (previously called “High Income”) programs hardly made a return in 2013.  Both are bond strategies and bonds did poorly across the board.  Most of the year we were playing defense or sitting in cash as dictated by our discipline.  Well now, of course, both models are leading the charge in 2014 as our best performers at least for last week.  I am not surprised in the least.  Often our worst performing strategies leap to the top of the leadership board on the next cycle.  Both strategies are almost fully invested in high yield bond funds and hybrid securities including floating rate funds, high yield muni bond funds, preferred securities,REITs and corporate bonds.

I’ll certainly have a better feel for leadership in the next couple weeks so I’ll keep this short for now.  There will be no Red Sky Report next week as I will be busy compiling the year end Change of Seasons report with detailed insights into our various strategies.

Have a great week and Happy New Year to everyone!

Cheers,

Sam Jones

Being Wrong and Staying Wrong

Before I get into this year’s forecast for the market, let me say a quick comment about humility as an investor.  Being wrong about your assumptions, beliefs about the future, is part of the game. Humility is an investor’s best friend as the earlier you accept your “wrongness”; the quicker you can get your money where it really needs to be.   Investors will be wrong often, all investors, and not just bad investors.  I learned this lesson many years ago – in my twenties, and I’m thankful for the early education.  The lesson is not about being less wrong but avoiding the situation of staying wrong and really paying the price in lost opportunity or lost capital.

For instance, at the end of 2012, in the heat of election and talks of Fiscal Cliffs, the evidence in front of us overwhelmingly suggested 2013 was going to be a tough year on all fronts.  The case for a garden-variety bear market unfolding in the neighborhood of 15-20% by May was very real to the vast majority of professional investors including ourselves.  Subsequently, institutional investors, pension plans, endowments and the most savvy of investors, added defensive positions to their portfolios including Gold, Silver and yes Treasury bonds.  Flows of investment capital confirm these moves were made in mass.  By February, it became obvious to us that the chance of a large decline was shrinking.  Bonds and Gold were in near free falls in price and stocks were breaking out to all time new highs with gusto!  This was not supposed to happen.  We were wrong and knew we had to make some serious changes.  Many were not willing to admit such error suggesting instead that the markets were wrong.  Many stuck with their bonds and gold and silver, suggesting the whole market was a dancing puppet of the Fed.  Many still do.  But they were wrong and are now angry that their portfolios haven’t made much in the way of gains for 2013 – if at all.

We began adding to our stock allocation in February and continued doing so until May when we reached our maximum equity allocations by strategy designs.  Our All Season and annuity strategies went from 50% stock to 80% stock, High Dividend moved to a 95% invested position, the highest in over 3 years.  New Power and Worldwide were also fully invested.  But all of this took some time and we were not fully and aggressively allocated until the late spring.  Of course, we have lagged most of the fully invested stock indices in this yearlong process but we’re still pleased with our year-end results.  Those who “stayed wrong” are now in a tough spot.  They hate their gold and silver (-40%); despise the government for deceiving them and manipulating the markets.  They hate bonds (-14%), all bonds and can’t stand watching piles of cash in the bank earn nothing.  The Stay Wrong investors are angry not at the world but ultimately at themselves for not having the humility to admit error early and move on.  Tough lessons.

Forecast for 2014

I’m a probability-oriented investor.  2013 was a year that broke the probability mold as the market rose dramatically without as much as a 5% correction all year.  This is rare, extremely rare.  So as a probability guy, I’m going to say with strong confidence that we are going to see an increase in volatility with at least two stock market corrections of 10% or more in 2014.  One early in the year and one in the fall.

I think the economy and the stock market is going to go through a transition year but avoid a formal recession or a dramatic collapse in the financial markets.  Think of it this way; there is truth to the notion that the Federal Reserve has supported by the economy and the financial markets with their bond-buying program.  $85Billion/ month of purchasing power has kept us safe and happy for several years now.  This support is coming to end and will be gone by June of 2014 – so says the Fed as of last meeting.  Now imagine that first day when we remove the training wheels for our young bicycle rider.  There is some weaving, some scary swerves, near misses and maybe even a small tip over.  But soon there is that moment, when the smile comes, the arms shoot to the sky and we say, go, go, GO!  And our young rider never looks back, never needs the training wheels again and feels the confidence of their own independence.  That day is coming, perhaps in 2015.  2014 will be a bit wobbly.

I’m also going to assume that this year’s winners are not also going to be next year’s winners.  Now is the time to start buying those things, sectors, countries and asset classes that present greater value or for whatever reason have failed to participate in this year’s frenzy.  Sales should happen in securities that are obviously no longer good values and there are many that fit this description.  Generally for taxable accounts, we are waiting until the new year to do these sales so as to push capital gains tax liability into 2015.  But for tax-deferred accounts, anytime around here is a good time.

In terms of sectors themes, it seems that 2014 will still be good year for cyclical sectors but specifically those that are late cycle leaders.  These are more hard asset type companies found in the industrial, technology hardware (and software), energy, basic materials, andhomebuilders.  Outside of those sectors that make stuff for our growing economy, I still like the banks and financials, which still represent some of the best values and are poised to benefit from a rising interest rate environment.  On the unattractive side, I would avoid things that have run too far too fast or those that represent recession trades.  The chance of a recession now is very slim.  To you that means cut back on healthcare, consumer sectors (discretionary and staples), utilities and of course bonds and gold if you haven’t already done so.  Interest rates and the US dollar will be rising gradually and erratically now and for the next 3-5 years.  Bond and precious metals prices will also be falling.   In terms of country preference, I’m hopeful but not expecting a rebound in emerging markets while US rates are rising.  China and Asia are not as dependent on low US interest rates so if you’re going to go international stick with Asia and Europe for 2014.    Right now, internationals are a better deal than US stocks on valuation alone.  The smart investors will look for companies that derive revenue from many different countries as their international exposure.  Picking one country or another is a bit ofcrapshoot for 2014.

Subjectively, I see the next 3 years being tough on the current president.  Wealth is on the rise, incomes on the rise and tax rates are on the rise.  This is not a function of president Obama but the price we all pay for nearly two decades of government financial support of a faltering US economy.  I have no doubt that by 2016, the next president will be a Republican as the system will feel it doesn’t need the help of a democrat in office anymore.    I think the Affordable Care Act will be completely retooled or removed in 2014 because it is a genuine disaster as is.

If I had to forecast anything about investor behavior, it would be this; 2014 will be another year where an investor needs to stay flexible, both in their allocations and their assumptions about the future.  I see much money flowing into things that have already run past the point of reasonable.  Netflix, Facebook, Pandora and Tesla need a long break after this year and yet I watch the share volume and see many millions on the buy side.  In our speculative New Power model, we have sold our big winners and are looking down, not up, for new opportunities.

With that, I’ll wrap up my 2014 forecast and hope that if I’m wrong I have the mental strength and humility to avoid staying wrong for longer than necessary.

529 Investors – Make Your 2013 Contributions (to cash)

As I said earlier, 2013 was not a year that offered ANY reasonable low risk entry points for new cash.  We did not have a 5% correction during the entire year!  Our strategy within the 529 investor space is to encourage adding money on market discounts as we have only one “investment allocation” change per year (Ridiculous!).  The best we can do to manage risk is to buy low right?  But now we’re against the fence and have to get our contributions done before the end of the year in order to get the state income tax benefit.  I am recommending that contributions be made now in full, but direct the contribution to cash, without changing the allocation of funds currently invested.  In 2014 when we get our first discount or correction, we’ll get that money to work at a better level.

The current limits on contributions are $14,000 per parent, per child for calendar year 2013 – so $28,000 for joint filers if you have the cash flow and want to do it.

And with that, I’ll wish everyone a fantastic holiday and a happy new year.  There will be no weekly update next week.

Cheers

Sam Jones

December is typically a good month for stocks and I don’t expect any real upsets this year.  Some are beginning to wonder as the start of this month hasn’t been as healthy as one might want.  The patient investor will like to hear that the weight of evidence still points to higher prices starting…. Later. Also in this update, a possible new asset class may be joining the party and a sad look at a country literally choking on unregulated growth.  Enjoy.

The Situation Now

Last Friday was a relief to investors who had greatly suffered through a decline of less than 1% in the first 4 days of December.  I’m joking of course.  The only notable thing about last week was the near panic that came from a market showing some very mild signs of profit taking.  Good grief people.  Don’t forget, investing is not a fixed income giving tree with positive results every day.  A 10% correction is POSSIBLE ANYTIME IN ANY STOCK MARKET.  Such a move would correlate to 1,600 point loss in the Dow from current levels.  When it really happens, it will feel like the world is coming to an end, as we have seen virtually no downside volatility in stocks in over a year.  If you are a DIY investor, plan on this event and know what you will do in response.  Maybe something?  Maybe nothing?  I am doubtful that the next real correction will be limited to only 1,600 Dow points.

Economic reports in the last couple weeks have been largely benign, extending trends in place since the middle of 2012.  ISM manufacturing and services reports combined to show a growing economy, the jobs report on Friday was genuinely healthy pushing the unemployment rate back to 7% flat.  Consumer sentiment rocketed higher breaking a 5 month downtrend and GM broke out to a new rally high on strong truck sales.

Technically, the market is overbought as it has been for many months.  Breadth and volume are weak in the last couple weeks but not by enough to generate any signals to reduce market exposure (yet).  Leadership is changing daily so no reason to really change any holdings.  The only thing that I find a bit bothersome is the fact that investor sentiment is now again at an extreme with over 66% bulls in the “dumb money” and less than 33% bulls in the “smart money”.  Rarely does the market run higher once the spread between these two groups approaches these extremes.

Finally Gold, Silver and Bonds are all still in the toilet driving investor money to find new homes in stocks.  From a timing perspective, it might give a little confidence to know that widely expected December gains do no typically materialize until after the 15th.  Historically, the first two weeks have been flat.

So all things considered, I’m not terribly worried but also not expecting much between now and year-end.  The situation is not the type that generates real selling although we need to be prepared to get defensive every day right?  Best bet is to sell nothing, but avoid new purchases until we see a real resurgence in broad market buying.  The Ho Ho Ho rally may be more of a ho–hum rally this year.

Commodities Bottoming?

The short answer is maybe.  In the last two weeks, I’ve certainly noticed a bit of outperformance in commodities over most other asset classes including stocks, bonds and foreign investments.  The US dollar has been a little weak but not enough to justify the move in commodities by itself.  Also, commodities are now trading at their 3 year lows.  Often, institutional investors will begin accumulating positions they want to carry in the next year during December so I’m going with that assumption for causality.  In terms of the business cycle, we would also expect commodities to begin showing some signs of strength about now.  The economy is now in full recovery with demand for natural resources rising.  Stock and commodities often trend higher together in this Stage (III) of the cycle, while bonds continue to suffer.  Seems like that’s quite possible.  Finally, I think investors are looking around for deals as stocks are no longer cheap.  The energy complex looks especially attractive now considering their double digit, 1 and 3 yrEarnings per share growth rates and P/E ratios in the low teens.  With that said, I am not a buying of gold or silver within commodities.  In fact, they look worse now than anytime in the last 4 years during which both have lost 40% or more of their value.  Commodities investments should be limited to useful commodities – I have called them utilitarian type commodities.  Unless you live in India, Gold and Silver have very little real utility.  We have chosen to own Basic materials as our pseudo commodities position across almost all strategies.

Choking in China

What if you lived in Shanghai, China?  It’s unbelievable to me that the city still has inhabitants.  Take a look at these photos courtesy of 361 Capital.  That is not fog.  And the air filter on the right is only 3 days old!  If you have ever questioned the value of the EPA or our regulations on emissions from power plants and autos, think about what life could look like in a city near you.  Wow.  One more reason to embrace New Power.

{Image missing}

{Image Missing}

Our New Power Fund is now approaching +60% for those who have been there since the beginning of 2013 net of all fees.  Much of the gain has come from incredible returns in the renewable energy and energy efficiency holdings.   I have little doubt that clean tech and clean energy investments will continue to be the real drivers of tangible company based global growth for the next decade, maybe longer.  New Power is all about owning companies in this space as well as innovators and game changers in other industries.  When I look at the global problems of air quality, energy demand and resource scarcity in places like China, I know that the solutions will be wildly profitable.  We were early to the scene when we started this program in 2004 and paid the price for being out on that speculative frontier.  Today, I was surprised to see that New Power is now gaining ground quickly on the total returns generated by the stock market over the last 3 and 5 years.  Next year will mark the 10thyear anniversary for New Power and I would like to see it mark that moment by outperforming the S&P 500 ( on a 10 year basis ).  I think it’s both possible and likely.  Cheers to that!

Happy holiday shopping and have a great week

Sincerely,

 

Sam Jones