Category: Finding Benjamin

Yes, this is the notice you’ve been waiting for.This is that all-important time zone when we should add some new money to our investment accounts if you have the means or need to do so before year end.  This Calling All Cars is a tentative suggestion with considerations for different types of investors and larger cycle implications.  Please read this update thoroughly and feel free to call us with questions or clarifications about your specific situations.

For Investors Approaching or In Retirement

Honestly, adding a lot of new sideline cash to investment accounts is probably not realistic or recommended at this stage of your life.  This is especially true if you’re already making monthly withdrawals against your investment balance.  If you happen to have significant cash and want to get that money to work, you should consider an investment strategy focused on income (like our Retirement or Freeway High Income) strategies.  There are still opportunities in Income if one knows where to look and what to avoid more importantly.  Gains from here will still be muted in income strategies but the next big move in 2019 will very profitable, especially if high yield corporate bonds continue to re- price at the current pace.

All Other Investors with a Time Horizon Longer than 5 years

This is a time zone when you should consider making your 2018 annual contributions.  Today, our firm made all 2018 employee profit sharing contributions for instance because we need to get it done before year end.  These contributions went into the money market account and will wait for clear entry points to buy into specific investments.   The same would hold true for education accounts (like 529s) where funding must happen before the end of the calendar year.  Now is a reasonable time to put new money to work, however we have had almost no signs that a “durable” low is in place, even in the short term.  So, if we had to really fine tune the advice, it would be this; Get your money into your accounts, put it in cash or money markets, and wait for more signs that sellers are exhausted.  Today was the first sign of actual buying we have seen in the month of October, which was historically one of the worst months for stocks in the last two decades.  That is a fact.  But rarely is it a good idea to buy the first up day.  We would love to see more back and forth action at these levels to make sure prices aren’t going to waterfall lower.  Elections are looming and that event might be the catalyst for a relief rally that is just days away.  The market hates uncertainly so it probably doesn’t really matter which camp takes or retakes control of Congress, just that the event is over.

Bear Market

This is important for everyone to understand.  In November of 2007, we issued a similar Calling All Cars after a very rough October, just like today.  That particular low was a good one… for about 30 days.  2008 ushered in a continuation of the bear market that had begun in the fall of 2007 and prices fell much further.  We view this “buy” as nothing more than a short term low within a longer term downtrend.Long term moving averages are now sloping down which defines the market trend.  The trend is down!  The environment has changed and it is not investor friendly.    So any advice to add new money must come with a strong caveat that this level is not likely to be the lowest you will see in the next 24-36 months.  If you believe in adding money at market lows and buying discounts all the way down into a deeper bear market cycle, that’s not a bad strategy but you have to stick with it.  If that’s not tolerable for you, then wait.    Many of us have annual tax issues and education funding mandates making this a reasonably good opportunity to deploy new cash for this calendar year.  Take it with a large grain of salt.

Call if you need help – The Lighthouse is on!

Regards,

Sam Jones

Taking losses is painful, especially in the short term. Emotions run high. Sometimes there is even a physical reaction as we extrapolate the worst. While we don’t like losses any more than you do, market moves, like we have seen the last couple weeks, do create some tremendous opportunities for us. Our portfolio approach tends to have us lose right along with the market for the first 5-10% decline as we raise cash. We raise the cash for a couple of reasons: 1.) to soften the blow should things get worse from here; and 2.) to allow us to take advantage of opportunities should volatility subside. As always, we will adhere to our process, scope out the opportunity, and react further as needed.

Here are several things on our radar after a tough couple of weeks:

1. There are a host of indicators that are signaling that stock markets are now oversold. Markets rarely move in a straight line. There is an ebb and a flow to them (sometimes more ebb than flow). We think there will be an opportunity to pick up some broad stock exposure over the next several months.  In some cases, non-US markets are down 20-30% over the last year. US small caps are down almost 20% off their highs.  Valuations and expectations have been reset to where we think it makes sense to add some of this exposure.
2. Sector rotations have been occurring the last two weeks. Technology, industrials, and energy—the sectors that had been leading the last year—have given way to utilities, consumer staples (household goods, etc.), and some precious metals miners. The market is no longer strictly rewarding growth. The companies that we generally gravitate towards—the ones with more stable balance sheets, cheaper valuations, dividend yields, and cash flow– should start to outperform again. The hope is that these companies should perform well, no matter what the overall market is doing.
3. We use international stocks in our asset allocations, including emerging markets, which offer up the possibility of excess returns over time. That said, until a couple weeks ago, US stocks were really the only game in town. But, that appears to be changing. On average, US stock markets are still one of the more fully valued markets out there, and in certain stocks and sectors, valuations are at outright extremes (think FANG—Facebook, Amazon, Netflix, Google).That really is not the case in emerging markets right now. Most are trading very cheaply based on their growth prospects, and once the dust settles, emerging markets are certainly a place that looks attractive. China, Brazil, India, and some other Asian markets look good given the valuation, demographics, and shifting focus of their economies. We plan on using country and regional ETF’s to establish these positions.
4. Bonds have offered little to no help despite the volatility in the stock market. In fact, broad bond market indexes are down for the year. We think that may be changing. There looks to be an upcoming opportunity to own high quality bonds, namely US Treasuries and parts of the municipal bond market. There may even be an opportunity to own investment grade corporate credit once this selling cycle ends.
5. Commodities still offer some value. Those markets tend to move independently of the stock market and offer up protection against unexpected inflation. We will continue to maintain an allocation to broad commodity indexes in our Blended Asset strategies and may even add a position in precious metals.

During these bouts of volatility, we really lean on our process. We monitor a blend of fundamentals, sentiment, and technical indicators to assess how much risk to take. Part of that process is trying to judiciously buy discounts in markets or securities that fit our criteria. It is a bit scary, but a necessary part of trying to deliver returns. Every cycle is a bit different, so short-term results can certainly vary. Our goal is to position portfolios in the geographies, sectors, and companies that can offer outsized returns over the long run with a lower draw down profile. When we can’t find much, we stay in cash. We won’t avoid losses in all market declines, especially from all-time highs, but if we can side step the deeper losses, we will be able to compound wealth at a much higher rate.

Sincerely,

Sean Powers, Chief Investment Officer

Well, here it is.  The market environment has changed as our Net Exposure model indicated earlier this month.  The “change” is really making it more difficult for investors on a lot of fronts, which we’ll discuss today.  Also, the change requires that we adjust our approach and decision making criteria. Lots to take in.

The New Environment – The Best Days are Behind Us?

We said in the last update that this correction in the global stock markets, which now includes the US market, is different than the corrections we have seen in the last several years.  We discussed the condition of the Valueline index which is now trading below it’s long term trend line and pointed to the deep dive in the “Summation Index” beyond anything we have seen since 2015.Leadership from the widely held FAANG names is also gone now.  Meanwhile, the recession trades are on full blast including new strength in a few notable defensive groups (telecom, utilities, and consumer staples).Treasury bonds are starting to find support and everything cyclical like industrials, energy, materials, home builders, etc are just getting smashed every day.  So all things considered, equity markets are forecasting recession ahead, or at least a dramatic slow down in global growth.  Today, earnings are coming in just fine, very healthy in fact, but institutional money is hyper sensitive to “guidance” coming through those reports, many of which are focused on the negative impacts of the trade and tariff wars imposed by Trump.  Revenues are also a bit soft indicating that sales are not as robust as they have been in the past.  Furthermore, there are indications that rising costs from borrowing (Thank you Federal Reserve) and rising wages (employment at full capacity) are adding to expenses.So we have that tough economic MOMENT in time when earnings looking backwards are still good but critical eyes are worried that the best days are behind us.  They are probably right but time will tell.  Stock prices always reflect future expectations so we shouldn’t be surprised to see some rather aggressive selling if investors think the best is in fact behind us.  Remember, stocks typically peak 6-9 months before the economy.

I saw this chart below from Bespoke and found it interesting.

What we’re looking at is two types of Federal receipts.  The top chart is Corporate Income tax, which is now in a free fall following Trump’s Corporate tax cut.   By the eye, we’re looking at a drop of nearly $200 Billion in lost tax revenue so far. The bottom chart shows the much smaller revenue coming from customs duties (aka tariffs).  Again, by the eye, this is a gain of about $10 Billion since the tariff war began.What can we learn from these charts about the future?

Well we know that our deficit (Federal Debt) is exploding higher now, which is inherently inflationary and possibly one of the reasons why long terms bonds are no longer a benefit to any investor.  Bonds have traditionally acted as a safety net for investors during times like these, but bonds are down dramatically and have been trending down for almost three years.    We have warned many many times that investors need to wake up to the reality that long term bonds are not going to serve their primary function of mitigating losses this time.   So far, those warnings are playing out.  We can own short-term bonds and things like floating rate funds, or bank loans which do provide some income and ballast but that’s about it.

We also know that the additional $10 Billion in revenues coming from tariffs is being passed 100{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to the consumer in the form of higher prices and higher costs of goods sold.This too is inflationary.

So from these two simple charts, we begin to understand why the Federal Reserve is going to continue raising rates, why inflation is not going away and why corporate earnings could potentially get pinched here.

Asset Allocation Getting Tough For Investors

As indicated above, this is a tough environment for investors who have become quite complacent about potential market risk, their exposure to aggressive growth type stocks and passive stock index strategies.  Most investors are not diversified at all after years of concentrating assets in things like the S&P 500 index or FAANG stocks.  They don’t own much in the way of bonds, commodities or other non-correlated asset classes so they are no doubt beginning to worry here.

From our view, this is exactly the time for diversification to select commodities, playing defense by owning recessionary sectors, carrying high cash and owning short-term bonds of several varieties.  More on how we are allocated specifically in a minute.  The point is that long bull markets in stocks have the tendency to blind us a bit.  We have been conditioned to buy dips like we saw in February.  Never sell, never sit with cash, never own gold or bonds, and never own boring stuff like utilities and consumer staples.  You might have heard the acronym TINA which stands for There Is No Alternative (to stocks).

TINA…. R.I.P.

Making Changes to Holdings – and our approach

These are the days when mature investors know they must adjust their holdings and methods.  The trend for US stocks is now mostly negative if one simply looks at any number of broad market indices, especially outside the US and outside of large cap growth.  When the trend is not our friend, we cannot simply sit by holding and hoping that the bull market will resume.  We must respect the reality of what is, not what we hope will happen.We have been on the sell side of our portfolios since late September and accelerating our selling into October pushing our current cash and short-term bond positions to these levels.

Cash (including short term bonds like T-Bills and Floating Rate bonds)

Tactical Equity Strategies     35-45{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Blended Asset Strategies    40-45{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

Income Strategies                  70{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}+

We also made significant changes to our remaining holdings to orient toward those recession proof sectors like consumer staples, utilities and telecom after selling out of our cyclical groups almost entirely (industrials, energy, technology, etc).You can find these defensive positions in your accounts easily by name (like Rydex Telecom, consumer staples or utilities).

This is also a time to consider closing out positions that are held at a loss for tax purposes.  We have a few that fit this criteria so we plan to capture the loss at these levels, helping to lower our tax liability for the year and potentially reallocate to more productive holdings when we see reasonable set ups.

Finally, we are moving to short term trading systems where we buy oversold conditions, like now, and plan to sell those positions on a rebound knowing that the trade is likely to be short term.  The goal is to offer our accounts and strategies some buoyancy even in a more protracted period of stock price declines.  We are buying weakness (now) and selling strength (on a rebound).    This is a zone where we should see a significant bounce as most of our short-term indicators are now deeply oversold.  With that said, we have a tight stop on these short-term trades and will quickly sell if this level does not hold.

Downside Price Risk is Still Significant

Take a quick look at this last chart, which I doctored up drawing a few trend lines on the S&P 500 ETF (SPY).  The long-term bull market trend is marked by the Green line dating back to the lows in 2009.I have also drawn a trend line across the recent lows since Trump was elected in dark blue.

If these lows don’t hold, the US market is likely to set course down toward the longer-term trend which is about -17{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} below prices today.  From the highs, that would be a 30{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} decline and something worth avoiding.These are important days for investors to consider their tolerance for downside risk in the context of your age, proximity to retirement, need for regular cash and ability to recover from a loss of that magnitude.  Given our high cash, orientation to defensives, and diversification away from stocks, our clients will obviously experience a different outcome as we have already seen in October.

Please stay tuned as conditions are changing rapidly.

Rest easy, you’re in good hands with risk controls firmly in place.

Sam Jones

Bull market tops are messy. They can last a long time spanning 6 months to almost 2 years. We’re in that period of time now and in my experience, they can be very frustrating. Let us provide a quick update acknowledging how you might feel right now and finish with a reality check. Our intention to set expectations to better sync with current market conditions.

Special Client Update Regarding October Market Declines

This is an update for our clients who want to know how we’re positioned now that the markets are in a steep decline. To offer a quick summary, our Net Exposure model moved to a strong negative reading on Thursday of last week (from +6 to a -15). That type of movement in our net exposure system is not at all normal and indicates much more underlying weakness in the market than most are aware of. All equity models raised cash to 25% by last Friday and we have now hit our second level of defense early this week taking our cash position for equity models even higher (nearly 40%). Blended Asset models (All Season, Foundations and Gain Keeper Annuity) were already very defensively positioned last week with less than 40% stock exposure plus short term bonds and commodities which continue to plow higher. Income models are largely in cash, floating rate funds and T-Bills – super safe. So, rest easy, we’re in very good shape in terms of our net exposure and have been playing defense since late September. Now the markets are entering the oversold territory and we’re expecting some form of bounce from these levels. Much will be learned from the nature of that rebound. Rest assured we have both hands on the wheel and are making daily adjustments as needed.

Expectation vs. Reality

When investors feel, or expect, one thing and find that their assumptions are not playing out, we get frustrated. I’ve been there, and it stinks. We want to be right, we want to do good homework and be rewarded for our effort, knowledge and time. We want to see our wealth continue to move higher as it has done for the last 9 years. Seasoned investors know that the equity financial markets can be very rewarding, better than any other asset class as a matter of fact. But they also know that there are periods of time when returns simply stop coming, volatility rises, and our objectives need to change. Specifically, as conditions become less friendly and opportunities give way to risk of permanent loss of capital, we must become more focused on preserving wealth, rather than accumulating wealth. Thankfully, these periods tend to last about 24 – 36 months on average which is actually a relatively short period of time. But they can be devastating to your net worth if not managed appropriately. Remember, there’s nothing wrong with bear markets, It’s just the natural order of things, like the seasons of the year (All Season!) In fact, as prices move lower and reset to more attractive levels, that is when real opportunity and real value begin to emerge. We genuinely look forward to deep market corrections because we know that out of those lows, we’re going to make a ton of money. But let’s get back to where we are today. We’re carving out a long-term top in stocks with little doubt and it’s time to match up your expectations with reality.

You might be expecting returns to continue as they have for the last 9 years. You hear that prices are at an all-time high but it seems like your investments are not moving much. You’re in good company, everyone is having the same experience including our own clients to some degree. We told all of our clients at the end of 2017, in print, on-line, in person, etc that 2018 is going to be a year of higher volatility and much less productive in terms of total returns. Remember the commentary about picking up nickels in front of a steamroller?  There is growing evidence that the last major market peak in January of this year marked the beginning of the “topping period” for the US stock market. And with the price action in October thus far, we may be carving out a more meaningful top now from a very slightly higher level.

This is standard market action for this stage of the cycle. We are lured into believing that the bull market will continue with recent marginal new highs in various indices. And on the surface, YTD numbers are still okay for the stock market. But if we shift our gaze to the January peak and do our comparison again, you see another reality. You see very few gains, if not outright losses (since the January peak). For instance, at the end of last week, the Dow Jones Industrial Average squeaked out a marginally all-time new high. On the same day, more than 50% of the stocks in the index were trading down below their long term 200 day moving averages. This is reality. We have a thin market, represented by a couple indices, hovering at all-time highs, while the majority of their components are already trending down in price. Remember that bonds are now down between 4-11% as of last week as well. Commodities are starting to perform well but no one owns commodities (except us – wink). All said, we might begin to understand why a diversified portfolio might not generate the types of returns you have seen in the past few years.

If we were to offer advice to everyone, right now, it would be this; Temper your expectations and adjust for a market environment that will be less rewarding for a while. Limit your efforts to make big returns, change your focus to capital preservation (as we have) and get excited about the developing opportunities to make some real returns from much more attractive levels. We are forever grateful for opportunity and truly loathe these late cycle environments when gains are a bit fictitious and hard to keep. Keep the faith, investing is the best way to increase your wealth over time. Never give up but stay diligent with your systems. “Creating wealth and defending it (like it says in our logo), requires that you look both ways when crossing the street and that process begins with a mental adjustment.

That’s it for now, just some timely mental health if you need it.

Cheers

Sam Jones

Every day, I find something that just blows my mind. Today I found four things.  Two are just illustrations that support some of our recent commentary.  This will be short and sweet.

Adventures in Parenting- Supporting Your Adult Children

I don’t have adult children yet but they are close. And honestly, I can’t say what I would do if one or both of my boys came to me desperate for financial help.  I’d probably help them.  But take a look at this chart and tell me where you find the desperation.  Is it the financial support for vacations?  Is it paying for their entire cell phone bill or their car payment?   What?

60{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of parents surveyed cover some or all of their adult children’s food and groceries.  Let’s be real for a second and nod in acceptance at the fact that most young people don’t shop for groceries or make food.They eat out – always, every meal.Ok maybe that’s a little extreme but honestly, let’s call this subsidy Bar and Restaurant, not Food and Groceries.  I hope this is just a generational extreme in bad behavior.

As I mentioned in my last update on this subject, we need to teach our kids how to survive on their own, invest their own money, value saving and differ consumption if resources aren’t there.  Easier said than done but looking at this chart, we can all see what happens later if we make it easy for them now.  I’m sure my kids will hate me, but they will be independent.  “It’s not my job to be their friend”.

Emerging Markets Diverging

What do you see in this chart comparing the S&P 500 and Emerging Markets?  I see two sides of the globe that have been tracking together very closely for a long time until May of this year.  Let’s be clear that something external is forcing these two worlds to diverge and that something will eventually go away bringing these two return streams back together.  This is extreme behavior and we’re expecting a reversion to the mean of recent performance.Get ready to buy emerging markets.

Brazil and Turkey may have just bottomed.   Stay tuned.

Passive Investing in the S&P 500 Will Underperform

Here’s another chart showing extremes in behavior.This time, it’s the fact that the S&P 500 index has outperformed practically everything to a historic extent.And by historic, I mean that extreme level where this behavior tends to reverse course.  Note that most “active funds” outperform only because they have the capacity to follow trends and cut exposure when market conditions in general get tough.  As discussed last week, that’s us.

If history repeats, funds (or managers) will outperform the S&P 500 for the next 4-5 years by mitigating market risk and putting assets into defensive securities.  When this starts is anyone’s guess but I’m going to say soonish.

Last one.

US Households Own a Lot of Treasuries

In fact, US households have purchased more than $800 Billion in Treasury bonds in just the second quarter of 2018 and that number is larger than the purchase totals for the rest of the world combined.  Note – some people are still worried that China owns our bond market.  Not true.

For the sake of the US buyers, I hope they are buying ONLY short term bonds or bond funds.  Long term bonds are down almost 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} YTD in price.10 year bonds are down over 5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} YTD and the Barclay’s Aggregate index is now down over 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} YTD.  Those are bad numbers but they could get a lot worse by the time the bond market really washes out.  After today’s bloodbath in bonds, we’re standing right on the edge of the cliff and I actually hope prices hold here.  I don’t think anyone is ready for an interest rate spike and price collapse in their very healthy allocation to Treasuries.  I suspect we’re seeing some real fear play out with this increased demand for Treasuries.  And ultimately, owning a bunch of bonds is going to be the right trade.  But folks, we are clearly in a Stage IV environment and have been for almost three years.  This is the stage when you own stocks, a heavy allocation to commodities and go very light on bonds.  Clients can look at their blended asset strategies with us and see those allocations exactly.  But to have been buying bonds with this much money anytime in the last year is some extreme behavior.

That’s it for now,

Stay tuned, lots of jaw dropping action these days.

Sam Jones

Unconventional Wisdom – Part 1 Billion

Regular readers know this is one of my favorite subjects.  I’m hearing way too much consensus thinking now to sit by without saying something.  As our Explicit Investing Creed states; We are seeking Success over a reasonable Judgment Period by knowing when to embrace and reject conventional wisdom… We are approaching another one of those times.  I’ll offer up just a couple items now and how you might accommodate when conditions change.

The Unintended Consequences of Protectionism

Much of what we understand to be US public policy coming from the current administration stems from the fear of becoming a non-competitive nation in a fast changing global ecosystem.  Like most developed countries, the US has been losing global market share of commerce for almost two decades. It’s a legitimate fear and not one that will reverse easily for many reasons.  It doesn’t take much thinking to see how trade wars, tariffs and highly restrictive immigration policies fall under the banner of protectionism in an effort to Make America Great Again.  The effort seems sincere as we rework trade agreements to be more US friendly, or add tariffs to imported goods (making our home grown goods relatively less expensive).  And, we might even understand how tougher immigration might support the US labor force keeping wages high for legal work.  But let’s look under the hood at a few unconventional realities, or unintended consequences.

We are a global system now and have been for several decades.By removing ourselves from trade, renegotiating terms of trade, adding tariffs to imported goods, etc, we are making the false assumption that we don’t need to be part of the global system.We are pushing our little raft away from the busy port of global commerce and assuming that we’ll have everything we need on board.  That is lunacy.  The US is a very dependent country.  We need cheap labor and cheap stuff to support our purely consumption based economy.And it all comes from outside of the country.  Pick up any item at Wal-Mart and you’ll find it is Made in China.  That’s how they keep prices so low… until now.    When we push off and disconnect from our global partners, we also cut off foreign consumers for our own goods and we cut off our supply of lower cost labor. We must understand and know that all of this protectionism will “trickle down” in the form of higher costs of living for everyone here in the US.  We do have the history books with plenty of examples to show that protectionism leads to inflation.   The most obvious example today can be found among homebuilders where higher costs of materials (after tariffs) are making it tough to build affordable homes – among other things.    Take a look at the Home Builders ETF below.  Other industries will follow as tariffs simply add costs to the end consumer.

The first round of tariffs went after raw materials.  Now the latest round is targeting finished goods.  The end user will always pay the bill as the supply side of the equation just shrugs and passes on the cost.  As long we are willing to pay more and more for the same thing, that trend will continue.

How should you accommodate?

Well, the obvious answers are found in your purchasing decisions.  We should be working now to accommodate for a higher cost of living.

• If you’re buying a home, lean on existing inventory before building something new.  Building costs are going to be much higher than you think and the finished price per square foot is likely already higher than current inventory.
• Lock in what you need now, rather than wait until later when prices will be higher.  This especially applies to durable goods or things that you only purchase once every 7- 10 years (like a refrigerator, car, etc).
• Look for ways to reduce your monthly cost of living.  That might mean eliminating any sort of consumer debt that carries high interest, getting on a bit of a budget for eating out, review your monthly credit card bill to discover all things that are dinging you on recurring charges.  I’ll bet you find some stuff you don’t even use anymore.  Call you wireless provider and ask if you’re paying the absolute minimum necessary based on your usage.
• If higher costs and inflation really take hold, we should also expect a somewhat abrupt change in the economic conditions in the US.Needless to say, our current environment doesn’t have much capacity for actual inflation.

This leads me to my next point.

Passive index investing is just another trend and all trends end.

Ben Carlson is the great author of “A Wealth of Common Sense” blog and worth following if you’re looking for some good insights into lots of good personal finance stuff.  I can’t remember how I found him but I like him.  He’s got a sense of humility that I find refreshing in a world of know it all bloggers. He has generally been in the buy and hold camp stating that you can’t beat passive indexing, etc.  Well in June, Ben Carlson changed his tune on investing theory.  In this piece

https://awealthofcommonsense.com/2018/06/my-evolution-on-asset-allocation-2/

Ben works in his own admission that behavioral economics tends to weigh in heavily at market extremes, both highs and lows.  He says that asset allocation using passive indexes would be great if not for the realities of the human factor which drives us to sell at the lows and buy more and more at the top.  Fear and greed, greed and fear.  We are our own worst enemy when it comes to investing and that will probably be the only true constant in this business over time.

The unconventional wisdom here is the understanding that passive index investing is just another temporal investing method that comes and goes, like many others.  Today, we happen to be the very pinnacle of consensus opinion regarding indexing.  It has become widely accepted as the only method that works.  When the next bear market in stocks comes rolling through, that opinion will change quickly as it always does.  In a more recent post Ben reminded everyone of the carnage in 2008 and 2009.Actually prices peaked in October of 2007 for the record.

You might notice the very high correlation among index returns.  All down hard.  Only bonds put up positive numbers (+8{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}) but that wasn’t enough.

How Should You Accommodate?

Trend following systems like ours keep you out of these situations by actively moving out of indexes when the trend turns lower.  Trend following systems are necessary to your financial survival.  Conversely, passive systems rely on diversification across asset classes to preserve capital.  It doesn’t work over a full cycle of bull and bear markets.  Looking at the table above, I’m going to say that diversification would not have saved you in the last bear market beyond a little help from the bond market (not shown).   I’m glad at least Ben has seen the light.   So keep it real in here and recognize that passive indexing is just the trend of the day.

If you don’t already have a system in place that monitors trends and makes changes accordingly, you need to do so right away.  This applies to your 401k at work, your little sandbox account of stocks at E-Trade and any other pot of investment capital that is exposed to stocks.

Note – 2018 is thus far an inversion year for stock price patterns.  That means that it began weak (January – March) and has had an unusually strong middle (March – Sept).  Again, conventional wisdom justifies all of this with strong earnings in the last couple of quarters.  But you must know that inversion years are very rare and usually show up in the final year of long bull runs.  If the 4^th quarter proves to be down, we should take note.  2000 and 2007 were both inversion years and both saw the markets down over 6{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} into the end of the year.

Investech pointed this out recently showing how the markets are inverted with the normal mid-term election cycle pattern at this point in the year.

Just a few things to chew on for this update.  I have several more, but I’ve exhausted your attention span.  Have a great week and know that we’re sticking with unconventional wisdom at this stage of the cycle.

Cheers

Sam Jones

 

Adventures in Parenting – Lessons I Learned Helping My Teens Invest

You might skip this update if you don’t have teens in the house or are not interested in teaching your children about investing (at any age).  But, under the hood, you might also find some insights related to more signs of extremes in current market conditions.

Cooper’s First Investment Account

My son’s name is Cooper, he will be 17 in a few weeks.He’s a smart kid and has shown an interest in investments.  In fact, almost by dumb luck, he won his high school investing contest by purchasing S&P 500 futures at the very lows in 2015.  He doesn’t know what a futures contract is but liked the idea of buying “the market” with just some of his pretend money and using leverage.  He has a colorful certificate in his room now.Cooper got a job this summer making sandwiches for a sub shop.  He made a few thousand dollars and I made him a deal to encourage saving and good financial behavior.  I said that he could put whatever amount he wanted into an investment account from his summer earnings and I would match that amount dollar for dollar.  I am a good dad!  He chose $500 and we opened an UTMA (custodial) account at Fidelity for $1000 with my match with very little trouble.

Tip – You can’t open any other type of account than UGMA or UTMA accounts for anyone under 18.  In effect, the parent is setting up the account but the money becomes the property of the minor at age 18.

Another Tip – No one under 18 can be set up to access their account on-line.  You, the parent must own and be responsible for the whole thing (trading, reports, etc).

So now, we have an UTMA with $1000 sitting in something called a Fidelity Government Money Market fund earning 1.87%/ year.  Not bad.We talked about that.  Cooper asked why he should put “his” money at risk when he could get almost 2% doing nothing with no risk.  You know the answer.  I told him that he could make more than that and he should shoot for something closer to 8%-10% on all of his investments over time at his age.

“But dad, everything I hear and see makes it sound like things are going to get bad soon, I don’t want to lose my money”.  Smart kid.Welcome to investing as that fear is valid and forever present.

So we start to put together a no-cost (free to trade ETFS at Fidelity Retail) portfolio of low cost ETFs using our own percentage based formula for stocks, bonds, commodities, etc.Now remember, we only have $1000 to work with.

Very quickly, we realized that even the most basic of indexed ETFs are by price alone almost unaffordable.  I’ll give you a few examples.

IVW – Ishares S&P Growth ETF                   $178/share

IVV – Ishares Core S&P 500 ETF                 $292/share

IJS – Ishares Small Cap Value ETF               $170/share

IJK – Ishares Mid Cap Growth ETF              $237/share

Wait a second…. What about bonds?

AGG – Barclays Aggregate bond ETF          $105/share

Hmmmm……..

As it turns out, if one is a first time investors like anyone who is just starting out with a small balance, you can’t really put together a diversified portfolio with anything less than say $5000.

A few of Cooper’s friends are talking at lunch about stocks as well. Cooper said they don’t have $1000 to invest but they are talking about stocks like Amazon ($1989/share), Netflix ($368/share),  Spotify ($181/share) and things they know as modern consumers.  They should be looking at things like Snapchat now that it’s down to $9/share but they all hate Snapchat now.  Clearly,  they haven’t done the math yet based purely on price/share and affordability.

Tip – Investors really should not invest in individual stocks until they have at least $50,000 to work with.  New investors, stick with low cost ETFs until then.

What we did find affordable, purely on a price basis, were a few sector oriented things and a bunch of internationals, especially emerging markets.   You know we are focused on this area for our managed portfolios as the best growth opportunities globally trading at significant discounts.

In the end, we finally put together a portfolio of 14 ETFs to create a diversified, global but growthy blend of securities that he wouldn’t have to think much about.  In some cases, he will in fact only buy 1-2 shares.  It wasn’t easy as price/share became a bit determinant of what we could own.   Our plan is to pick off pieces of this portfolio as they present opportunities to buy which is why his account is still sitting 100% in money markets.  We might buy some internationals next week.

 High price Implications of today’s market

No one should really factor in the actual price/share of a security when making an investment decision – unless you’re 17 and only have $1000 we discovered!

Price/share means very little as some highly priced companies are actually cheap relative to their earnings.  In the academic world, the price we are willing to pay for shares of a company, should be justifiable as a discounted measure of future free cash flow.  But, the fact that the entry fee (aka price) to buy practically anything in the financial markets after nine full years of rising prices should nag at your sense of the future

This market ain’t cheap on many measures, just ask a 17 year old first time investor.

Teach What Matters

There are may different models for how parents try to teach their kids about money.  Strangely, there seems to be a strong focus on building credit, presumably so they can go out and accumulate great gobs of personal, school and home debt.  Oops, I tipped my hand.  Teaching our kids should not start with credit or how to live under the burden of borrowed money.  Somewhere, somehow, the lending world twisted our realities into believing that we cannot exist without debt.  We can, it just requires a different set of standards.  Let’s dive into that.

Delayed gratification

I can see you nodding.  We need to teach this first but how?  Children and adults want everything now whether they can afford it or not.  And offering credit to an uncreditworthy person as a means of buying something NOW is just greasing the skids toward insolvency.  Sadly, in that Puritanical way, the best lesson we can teach is about delaying the purchase until you can afford it.  As parents, it’s hard.  We want our kids to be happy.  We want to give them what they want now and it’s hard to say no.  So how do we teach delayed gratification gracefully.  I think there is a lot of good lessons in providing a financial budget for a young person.  That means giving them some money on a monthly basis if you can.

*Note some kids are great at earning real incomes during the school year and paying for everything themselves.  That is awesome!  But lots of teens don’t make enough in the summer to pay for much.

The monthly budget does a number of things.  They learn to live within a monthly budget.  Keep it real.  We put $100/ month into a teen checking account for our 17 year old and he has a debit card.  With a debit card, he can’t spend more than he has.  He has to use that budget to pay for everything himself.    He spends $65 of it on gas, which means he has to be careful not to drive too much.   If he goes out to lunch everyday at school, he’ll burn it all.   If he wants to go to a concert with his friends, he’d better save for a month or two.  If he wants things that cost more than $100/month, he’ll start looking for a paying job during the school year.  After about 6 months of this, Cooper now checks his account balance every week.He knows what he has available.He has to wait until his next $100 infusion to get “stuff”.  We are teaching delayed gratification.  Along those lines, I would strongly recommend against providing your teen with an open ended credit card.  That teaches dependence and a life built on debt.  Don’t do it.

 Turn Savings Into Investing

Circle back to the original offer.  You’ll need to provide them with an incentive to save.Try the matching thing for any money they save from summer jobs.  Turn “savings” into “investing” by putting the money in an account that is difficult or impossible to access (like a Custodial account at Fidelity).  They are smart enough to recognize that a savings account at the bank is ready cash so you really need to make savings more of a long term commitment.   Get them involved in security selection and building a portfolio.  Have them experience joy and pain with the outcome. The critical point here is not about handing them money, it’s about teaching them what to do with money and how it can grow over time if they pay attention.

Self-Reliance

Along those lines, I see many parents who try to hold the line on not giving their kids any money until after college or something like that.  The thinking goes that a teen is not responsible enough to do such a thing.Well, I’m going a different route.I think our country is financially illiterate and that is the root cause of our great bust cycles in the last decade.The next generation must break this destructive mold and we need to teach our kids about money at a much earlier age than past generations.  I would rather have my kid make mistakes with $1000, than with $100,000, right.Teaching them about money is really a daily and weekly grind.  We need to talk them through decisions they are making, spend time with them weekly going over their investments.  We need to give them enough money that they take it seriously early in life.  How young?  I would say around 15 or 16 is the right age.

If we as parents spend the time teaching our kids, there will be two benefits. The first is that they will have a lifetime skill that they can leverage as they begin their working years.  I tell my kids, your money should be working as hard as you do.  The second is that they will accumulate a reasonable nest egg to launch themselves post college.  They will have the satisfaction of having saved, earned and accumulated something that they can use to pay rent, buy a car, even a house.  There is pride in that for them in being independent and doing it themselves.  I would suggest you get started while they are young and teach them to be financially self-reliant.

That’s all I’ve figured out as a parent so far and I’m sure there are plenty of other ideas or plans that work.  Feel free to shoot them over and I’ll post them the next time we get into this subject. Best of luck to all with your own adventures in parenting.

Cheers!

Sam Jones

Finding Value

I’ve been thinking a lot about this topic.  We’ve moved forward in this economic phase to a place where value is being ignored and forgotten.  In my years of experience, forgetting to focus our purchasing behavior on what is “valuable” is truly a mistake and one that can be devastating to your financial well being.

What is Value?

Value doesn’t have to mean a value stock like a traditional utility or consumer staple company.  We are simply looking to buy things (stocks, stuff for our homes, food, cars, healthcare, etc) that are presented to us as “Valuable” offerings.  These are opportunities to pay less for something that provides real benefit to us, so why wouldn’t we always and forever remain focused on value?  Well the answer is that we tend to lose our minds, especially when it comes to investing and trend following.  Today, everyone knows that the only place to make money in the financial markets is to load up on Facebook, Apple, Amazon, Netflix and Google (FAANG) right?  No doubt, these are great companies but they are currently priced/share as if they are going to be the greatest of all companies for the next two decades.  I don’t see value in today’s prices in these names.  They can go higher but they won’t become any more valuable to us in the process.  As a matter of fact, we think most of the FAANG trade is done at this point and downside loss potential is considerable.  And guess what has been driving the US stock market to these levels?  It is these same very few FAANG names inside the technology and consumer discretionary sectors, which account for a combined 77.5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} of the gains in the S&P 500 this year.  Take a look.

You have to remember that value comes in many forms.  We can find growth companies that are now trading at a discount.  That’s a value right?  There are lots and lots and lots of these available in the market today outside of FAANG.  Most of these are among materials, industrials, energy, consumer staples and select healthcare.  We own some and are buying more now.  We can also look for countries like emerging markets or China that are GROWING FASTER THAN THE UNITED STATES OF AMERICA (sorry for the big letters), but are now priced at less than ½ of the US stock market in aggregate.  Here’s a snapshot from Bespoke last week comparing country valuations using next 12 month P/E mulitples.

If you’re looking for something of value to buy in the way of country specific index exposure, lean on the right side of the chart where you’ll find all things developing and Asian.  The least attractive indices in the world are found in the US markets.

Our Worldwide Sectors strategy, as the name implies, has a high allocation to internationals but thus far international indices are all negative YTD, yes all.  Consequently, Worldwide Sectors has understandably underperformed the US stock market.  We have reduced our international exposure and carried more cash this year but will quickly reengage with full international exposure once these countries stop falling.  Not to fear, the strategy is still producing double-digit numbers on an average annual basis since we retooled the strategy in 2016.  (Please review our composite performance disclosure links).  It’s just lagged a bit so far in 2018.

If I were a bettin’ man, I would add to our Worldwide Sectors strategy right now as the strategy is becoming more “valuable” relative to the US market with each passing day.  

             I’ll give you a few other examples of value as I see it today, more on the consumer (non investing) side of the story.  Plugin Hybrid Electric Vehicles are now presenting some very attractive values compared to their gasoline powered brothers.  I have a 2018 EV comparison Chart of all models of electric powered vehicles. if you would like a copy, please send me an email.   There are a few takeaways from the chart.

• There are now 43 models of electric or plug in hybrid electric vehicles to choose from.  More are coming each week.
• The battery range on all is pushing higher – reaching for 100 miles on a charge – way more than most of us drive daily.
• 16 of the 43 models are now less expensive than their gasoline equivalents and still offer State and Federal tax credits.
• The new Electric Jaguar (I-Pace) is a better value than a Tesla Model X.
• PHEV vehicles with All Wheel Drive are coming fast – awesome!
• The best teen car in the world is a Subaru Cross Trex Plug In – $20,500 after tax credits and your teen never has to pay for gas.

Or you could buy a giant new suburban or luxury SUV that gets 16 miles to the gallon and costs much more than anything on the list – no value.

Here’s another one

I just bought a pair of prescription glasses from an on-line company called Warby Parker.

https://www.warbyparker.com/

They have an on-line tool that measures your face, suggests frames, sends you 5 frames at a time to try on at home for free.  When you’ve decided what you like, you order on-line, send in your prescription and they arrive in your mail 10 days later custom made for you!  Total cost $95.  Normal cost for a cheap pair of prescription glasses and frames (maybe $300-$500?).  They even have 15 locations now where you can get a “valuable” eye exam.  Love the Stanford grads challenging the status quo.

Finally, I’ll finish with real estate.

If you’re buying real estate now or anytime in 2018, you’re really not making a decision based on value in most cases.  It’s an emotional decision.  Anyone who knows anything about real estate will tell you there are only three things that matter; Location, Location and Location.  I agree because no one wants to live next to the dump or under power lines or a highway.  However, if you actually want to make money in real estate, there is only one way to do it.  You make your money in real estate on the buy side.  That means, find things that are a good value in real estate, buy them, upgrade them and sit for 20 years or more.  You should be able to beat inflation over time as a rate of return.  I can hear you laughing.  Consider this, with the exception of Seattle, Dallas and Denver, real estate purchased in 2006 (Bubble highs)  has not kept up with the rate of inflation.   Of course this doesn’t account for your annual carrying costs like a mortgage, insurance, taxes and upkeep either.

But there is no value in today’s real estate market.  Prices have pushed up to nosebleed levels in most of the country and the environment is becoming hostile in terms of carrying costs (rising taxes, interest is no longer deductible, rates on the rise, etc).  Again, you make money in real estate on the buy side and this is not the time to be locking into expensive digs in my opinion.

So this is one of those keep it real updates in an age where value has been forgotten.   Things will always revert back to real value, which is why guys like Buffett have had such long and impressive investing careers.  Be very careful about what you own or are considering buying here.  We believe we’re on the cusp of a significant change.

Happy fall!

Sam Jones

If Not Now, Then When?

I’ve been managing money for a long time, 24 years to be exact.  When you do anything for that long, you start to develop a few extra senses that are hard to describe.  These senses nag at you as your brain absorbs information from research, observations, behavior, patterns, and other things that contribute to your perceptions about the future.  It’s like a De Ja Vu experience where you know what’s going to happen but you can’t explain why (or even justify it with current evidence).  For this update, I’m not going to provide a lot of evidence as much as simply describe what I’m feeling and sensing right now regarding a bunch of financial stuff.  Take it for what it’s worth, which could be nothing beyond experiential guesswork.

Stock Markets

My overall sense here is that making money and keeping it, is going to be tough for the next 2-3 years.  This is a relative statement because for far too long now, investors have been rewarded for doing nothing, knowing nothing and simply owning any index.  As they say, don’t confuse brains with a bull market.  It’s a bull market and a long, tired one at that.  But the stock market landscape is stretched to the point of breaking with enormous performance differences recognized over the last 2-3 years.  Just in 2018, we’re seeing gains of 25% in select domestic indices/sectors while entire countries like China and Emerging Markets are approaching true bear market losses of -20%.    You’ve heard us talk about the historically wide spread between value and growth styles as another example.  I would add that gains coming from passive indexing relative to active managers have also never been wider.  When markets get this stretched in terms of winners and losers, my senses start tingling in an uncomfortable way.

Honestly, 2018 is going to be a crap shoot in terms of the final gains for the year and we really have no idea how things will shake out.   But my sense is that this will be one of the last years of this bull market one way or another. Returns looking forward will not come easily but they are available outside of passive indexing, outside of the US, perhaps outside of stocks.  We’re in that business of allocating client money in areas where real returns are both available and probable so I like our particular seat at this table and expect our relative performance to shine.

Inflation, Interest Rates, Real Estate and Taxes

I loved reading Trump’s finger waggling at Fed Chair Jay Powell this week.  Trump is apparently “not thrilled” to see the Fed raising rates and threatening the US economy.  I have news for Mr. Trump.  His policies are protectionist to the extreme and…. you know the rest of the sentence….. protectionism is….. INFLATIONARY.  His policies are directly driving inflation higher in our country and it’s just getting going now.  My sense is that most people are beginning to feel it and point to it.  The mouth is slightly open, eyebrows are angled in and down and we find ourselves saying things like “that’s ridiculous!”  Yes inflation is here and grossly understated in our country.  Consumers are buying things because they feel a bit more flush but it’s just now happening as prices are pushing beyond reach for everything including healthcare, housing, eating out, etc.  As anyone in my office knows, I’m really cheap.  I don’t buy expensive things.  But for years, it hasn’t been a problem as I could always find cheap stuff.

Guess what, it’s now hard to find anything cheap outside of outlet malls selling last year’s clothing at heavily discounted prices in a race to see who can go bankrupt first.  Price inflation is everywhere and we all know and feel that.  Trump’s trade war is going to hurt our economy badly in the form of even higher prices and that comes home in 2019.  So Jay Powell has a tough choice.  He can raise rates in September, as he should to keep pricing in check and track with our fully employed economy with rising wages and inflation.   But in doing so, he’ll be parting ways with Trump and possibly his job.

Real Estate pricing and activity is probably going to come to a screeching halt as well.   It already has in the truly overblown markets along the coasts and highflying cities like Vancouver. Pricing will become more attractive (read lower) as borrowing costs continue to go up especially for the segments of the market that rely on financing.  That might actually be a rosy assessment in the end.    But the window to shop for real estate is closed now as far as my senses suggest.  Today, we have high prices, rising borrowing costs (that are no longer deductible), sharply higher property taxes (also not deductible anymore) and a sellers market where buyers are still in bidding wars.  Does that sound or feel like a good time to buy?  I’d be a seller if anything.  I am now resetting the return bar for real estate.  I expect zero returns for real estate holdings in terms of price appreciation for the next 4-5 years.  The last time I said anything so unacceptable and unsavory was October of 2006 when I declared:

Real Estate will be DEAD MONEY for the next 10 years.

I was wrong, it was dead money for almost 11 years from that date.

Again, this is just my sense.  What do I know?  But you can quote me in 2024.

And finally, my sense on the recent Tax Reform Act is that many in our country are going to find themselves “not thrilled” with the changes in their tax liability when they finally get around to doing their taxes.  Those of us who make enough to have our deductions phased out completely and have to pay quarterly estimates already know that our taxes are going up with the new Tax act.  Many others are going to find out later, they just don’t know it yet.  When I made my last quarterly payment on June 15^th, I actually got a little nauseous and got up from my chair.  It went away but it was close.  Sept 15^th is coming soon.  When many people realize that the tax reform act was just a corporate tax give away and they see no changes (or an increase) in their tax liability, they are going to be pissed.  Taxes are just like inflation.  They are a silent killer of consumption and could be the catalyst for the beginning of a recession in 2019.

If Not Now, Then When?

So, if I pile up all of this extrasensory work and look at it through the eyes of your everyday retiree or someone sitting on a bunch of index funds or someone who is just trying to make ends meet, it feels like this is an obvious time to consider a few changes.  The idea is that we don’t want to be forced into making tough choices that have a negative affect on our lifestyle, standards of living or overall financial independence.  I don’t know the future anymore than the next guy, but my senses are firing that we’re approaching a period of time when good choices are going to be more scarce.  This is probably a time to ask and answer some tough questions that involve playing defense to protect what you have accumulated or generated in the way of returns.  I’ll give you a few examples.

Example #1 – If you are 2-3 years out from Retirement:

You probably need to critically look at the holdings in your current retirement account (401k, profit sharing plan, etc) and at least measure your stock market exposure.  Everything in a 401k plan is an index fund regardless of the name of the fund mind you.  Here’s the question.  Is your financial independence and freedom to retire dependent on the current value of your 401k plan?  If so and you are within 2-3 years of retirement, under what conditions will you reduce your stock market exposure.  More to the point, if not now, then when?  Will you wait until the markets are down 10%, 15% 30%?  Most people don’t do anything until they are really hurting and recognize that they are seriously threatening their post work livelihood.  I’ll answer the question for you.  If you’re that close to retirement and own a portfolio of passive stock indexes as most do, you should begin cutting your exposure or get much more defensive than you are.

We can help you by looking at your current holdings, available options and recommend a reallocation of your important retirement account to add significant downside protection.  We charge exactly zero dollars and offer this as a courtesy service to anyone. You might even consider the option of an “In Service Withdrawal” of your 401k assets to an IRA rollover if your plan allows it (must be at least 59.5 years old).  There are many more investment choices inside an IRA rollover registration than your typical 401k plan offerings. This can happen without closing down your 401k plan and continue contributing up to your last day work in many cases!

Example #2 – If you have built up a significant position in a stock:

We have seen this a lot in the last year.  Positions in Netflix, Facebook, Amazon, Apple etc that have appreciated enormously and might now represent an uncomfortable size of your total portfolio.  What do you do with that?  If you sell, you might generate a huge tax bill.  If you don’t, you could end up giving up a lot of your gains on the next downturn.  But what if it goes higher?  All good questions that need answers and a plan if you want to keep what you have made and exit the position over time, gracefully, at your discretion without a huge tax bill.  Again, I’ll ask the question:  If not now, then when – will you make a plan?  After the price of the security has fallen x%?  After it hits some arbitrary price?  I’ll answer the question.  The time to make a plan is now, not later when your options are limited.

Sean Powers, our new CIO, has a new programmatic solution for these situations using a new partner (Spider Rock Advisors) that offers an options overlay for highly concentrated stock positions.  Please contact us if you’re interested and Sean will explain in full detail.  It’s too complex for this forum.

To summarize, if I had to offer all investors one piece of advice, it would be this; Stay in the driver’s seat of your investments.  Remain in a position where you have good choices and options rather than making decisions under duress and panic.  This is the time where you have good choices to pick from in an environment that is going to become much more difficult.  If not now, then when will you act?  We’re here to help you make the right choices now.

Cheers

Sam Jones

Update on Three Opportunities

Well, it’s been a very dull month in the financial markets since our last update on July 12^th, and I know most of you are paying more attention to your time with friends and family, but things are starting to move again with some notable new leadership and trends developing.  We continue to believe the next 6-9 months are going to be critically important in terms of positioning your investments for what lies ahead.

Since Our Last Update

As you know, we provide updates when there are important things to talk about.  There hasn’t been much to talk about frankly as different segments of the market have generated equally unimpressive gains or losses in the last month.  For instance, large cap growth is up less than 0.50{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, small cap value is up 0.29{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, but the MSCI All Country World Index is down -0.45{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} through yesterday.  Bonds are up… +0.10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and commodities are down -0.29{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

Yawn

But, there are some interesting trends worth noting underneath a very quiet “market”.  Specifically, leadership and the orientation of the markets is changing its character to favor defensive sectors and recessionary asset classes.  You might be scratching your head as the business news cycle continues to focus on blow out earnings and a 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} GDP growth rate.  But, the market is clearly favoring defense since the last peak on June 12^th.  At the top of the list are the healthcare, utilities, consumer staples, investment grade and short term treasury bonds.  At the bottom of the leadership board are technology, financials, materials, commodities, and emerging markets.  This is not what strong risk appetite looks like. In fact, it is, quite the opposite.  As prices are now working their way back up to the January highs, we’re also seeing the condition of our Net Exposure model deteriorate again. In fact, as of August 10^th, our weighted average of indicators moved back to zero after hitting only a high of +6.  The range of values is +20 to -20 so again, we’re not really seeing anything to indicate near term strength or weakness.

 

As we have said many times this year, 2018 is going to be unproductive for most investors with significantly higher volatility.  That’s exactly what’s happening since the January peak.  Stay patient, there are opportunities coming!  Speaking of…

Three Big Opportunities – Getting Closer

 

To remind you, the three real opportunities for investors are as follows.

• A Cyclical Shift from Growth to Value

As we mentioned in the last update, we continue to see quiet but persistent accumulation in the deep value side of the market, while growth names are showing signs of fatigue.  Any owner of Facebook or Netflix shares can certainly understand what I’m talking about, as they are down more than 17{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and 18{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in the last month or two.  Meanwhile, deeply oversold names found in big box retail, airlines, select financials and pharma are now rocketing out of multi-year basing patterns.  This is exciting stuff for active managers like us as it provides a nice opportunity for us to grab shares among companies where real value lives and see those investments generate real returns.  What a concept!  Perhaps the markets are rational after all.  Really, most professionals in our business are just exhausted living in a market environment where the only perceptive “opportunity” is to buy something that is ridiculously overbought and hope to sell it at an even higher price.   Thankfully, that situation seems to be changing and we’re positioning ourselves appropriately.

• Emerging Markets/International Outperformance

Well, this certainly isn’t happening in 2018, as much as it did in 2017.  But, nothing has changed in our expectations.  YTD, aggregate emerging market (EM) funds and indices are down almost 10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, much more if you own the likes of Turkey!  But, we view this action as corrective within a longer term outperformance cycle that began as early as January of 2016.  Remember, EM was up 37{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} just in 2017.  Here’s the good news and a picture to follow.  Prices in most EM funds are fast approaching a serious long term support level established by the highs of the last decade.  We are only 2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} above that level and we expect to start rebuilding our EM position shortly.  The chart below shows the classic EEM exchange traded fund and the white support line drawn across the multiyear price tops (now support).   This again is where real value and growth lives among global indices.  This is where economy is actually rising and developing with real activity, not financial engineering built on massive debt and easy monetary policy like I see in some much of the developed world.  Stay focused and committed to EM and you will thank me in the next 5-7 years.  We’re getting ready to buy back in across all Tactical Equity and Blended Asset strategies assuming the conditions set up properly.

• Preserve Capital During the Next Bear Market

This is our 3^rd and probably most important “opportunity” that has yet to materialize.  We are not in a bear market and thus we are not yet in capital preservation mode.  With that said, there is some short term risk as prices are now approaching the old highs and our Net Exposure model isn’t giving us much reason to expect a broad based market move out to new highs yet.  Now that earnings season is really wrapping up and won’t provide much of a catalyst for higher prices for the rest of the quarter, we’re really just left with a lot of headline risk, continuing saga from the White House, trade war concerns, bad seasonality, etc.  In the short term, we won’t be surprised to see market volatility rise with some mild declines into October, perhaps November.  Then we have elections to contend with and you must know that Wall Street will hate it if congress flips back to Democratic control.  Don’t shoot the messenger, but the financial markets are married to a Republican controlled White House and Congress.  If that marriage breaks up, I’m going to expect a bear market to begin.  I have no idea what’s going to happen in November so prices might just flounder until we see the results just like the period prior to the presidential election in 2016.  Either way, there will be a time in the not too distant future, when preservation of capital is going to be the best opportunity you have.  Why?  Because we’ll have the OPPORTUNITY to buy back at much lower levels with our wealth intact and make some real money.

That’s it for now, stay tuned as the market seems to be waking up from its summer nap.

Cheers

Sam Jones

Investor Frustrations (Including Ours)

These are the hardest types of markets for experienced investors.  Count us in the camp of those who are maxing out on frustration.  This update will serve as a confession of sorts without wanting to sound defensive about our decision-making and current orientation of our three investment categories.  This is an important moment for all investors to stick to their knitting so feel free to lean on our discipline if you need some mental support.

Three HUGE Investment Opportunities – Not Working Yet    

Wouldn’t it be great if you saw an obvious opportunity (or three), plunk down your hard earned cash and it just rewarded you right away?  That happens occasionally but not often.  Typically we recognize opportunity and then we wait and wait and wait for it to show up.  We’re still in that waiting time now but getting closer to that great “I told you so period”.  It’s going to be really hard for us to contain our smugness in the future concerning all of the stupidity we see today where the dumb money continues to pile on to yesterdays’ winners.  We’ll try hard to be empathetic and compassionate but I’m not sure I’m going to be mature enough to wear those big boy pants.

Let’s review the three HUGE investment opportunities that we see looking out over the next 3-5 years.

• Emerging Markets will be one of the best performers.
• Market strength will shift from Growth to Value in a reversal of winners and losers
• Timely Risk Management by way of owning cash, commodities (maybe), bonds and other non-correlated asset classes will preserve your mental and physical capital giving the OPPORTUNITY to buy aggressively when others are selling in panic at much more attractive price levels.

As I said, none of these opportunities are really working yet, or at least being recognized by the financial media yet.  Emerging markets were leading the US domestic environment for much of 2017 but we were forced to close out those positions in May when our investments broke support and lost relative strength to the domestic stuff.  We’ll be back for another round once Emerging market funds push a little lower (about 5.3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to be exact).  Here’s a quick chart of the EEM exchange traded fund in red.  We believe it will work it’s way back to the white line which is now showing strong support from 2017 and provide another nice entry point for some outsized returns into 2019.

The Growth to Value thing is also pending recognition but we believe it has started behind the scenes.   I’ll give you an example by way of our High Dividend stock strategy, which now has a 25{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} commitment to “Deep Value” stocks.  Since the beginning of June, 4 of the 5 stocks in this particular sleeve are up between 13-15{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} through yesterday.  Meanwhile the mighty Nasdaq 100, the growth investor’s home base, is up a little over 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} with much higher daily and weekly price volatility.  Someone out there, besides us, is accumulating the value stocks and prices are quietly starting to surge ahead.  However, if one were looking only at the aggregate indices, this subtle shift would be hard to see.  Last week Sean Powers posted a chart of the relative strength between growth and value, which is clearly stretched as far as it was back at the top of the last dot.com bubble in 2000.  Here it is again.

Is this time different?  No it’s not. It’s never different, just subject to delays and patience.

What about the Risk Management Opportunity?  That may still be in play but it’s been very frustrating.  The mini-crash of January eliminated everyone’s gains for the year in about 13 minutes of time when the markets were actually open for trading.  As we said in early January, before the crash, parabolics never end well and this one didn’t either.  After a grinding few weeks in February and March, we finally saw a tradable low in early April from which we issued our first “Calling All Cars” for investors wishing to add new money.  It was a good call then.  Now, we’re up off of those lows but the condition of our net exposure model has been “leaking” lower as Sean puts it.  Last week it slipped negative for the first time since April and is currently bouncing around the zero line, let’s call it dead neutral.  With that guidance our risk management system isn’t providing us with enough evidence to stay fully invested.  As I write, the S&P 500 is pushing out to new rally highs and seems headed for a retest of the January highs.  Frustration!  Fear of losing is giving way to fear of missing out even as our indicators are not yet confirming this most recent rally.  Frustrating!  What we find interesting is that the recession trades and defensive asset classes are now our leaders since the highs in June.  What?  There is no sign of recession and yet the new leadership is found in utilities, consumer staples, healthcare and bonds!  What gives?  Perhaps the rumors of no recession in sight are not that reliable?  Somethin’ ain’t right sheriff.  So the opportunity to preserve capital and follow a well-defined risk management system has not played out well – yet.

Our Orientation By Investment Category

As a reminder, we have three different investment categories with several representative strategies in each.  Each category is designed to carry a torch in our client’s account portfolios.  Here’s how we are positioned in each of the three categories.

Tactical Equity Strategies (Worldwide Sectors, High Dividend and New Power)

All three strategies are carrying about 14{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash with the remainder invested in individual stocks and select World Stock Indices, according to strategy discipline.  Each of our client households has accounts in this category to various degrees so you should know that you have plenty of stock exposure by way of your Tactical Equity accounts.  The torch carried here is to track the stock market and participate in upside gains when they are available.  At the moment, selection is the name of the game with half of the market above the zero line and the other half below YTD.  See last week’s Red Sky Report.

Blended Asset Strategies (All Season, Gain Keeper Annuity and Foundations)

These three strategies pursue a more dynamic asset allocation approach where we shift assets to asset classes that offer the best risk adjusted returns.  That doesn’t mean the BEST or STRONGEST returns on a daily basis but rather the best returns for a given amount of daily volatility and price risk.  Our system here is leading us lightly toward defensive domestics stock funds but heavier now into commodities, the US dollar, real estate and bonds.  That’s right, the selection screens are moving us out of high beta stock funds and into non-correlated asset classes even as the stock market seems to be the best place for your money.  Risk adjusted relative strength is telling us a different story!  The torch carried by our Blended Asset strategies is now one of diversification against our Tactical Equity (stock only) strategies and a heavy stock market that is moving further and further out on the risk limb.

Income Strategies (Retirement Income and Freeway High Income)

The income strategies are finally becoming more productive and now fully invested in a variety of diversified bond funds. These include high yield municipal bonds, floating rate funds, investment grade corporates, emerging market debt and very short term treasury bonds and treasury bills.  This is not the set up for big gains in this strategy yet and won’t be until the High yield corporate bond market becomes more attractive, but we’re pleased to see all time new highs in these strategies in the last week with virtually zero stock market, inflation or interest rate risk exposure.  Again, all of our households should have exposure to our income strategies as part of their overall portfolios to varying degrees.  The torch carried here is about safety, security, income, mild growth, peace of mind and pure ballast against a nasty cycle in the world stock markets.

It Hurts to be Unconventional

As I said, the hardest times for experienced investors are times like these.  We see the risk in overblown growth stocks, we can taste it and smell it, but we feel our clients’ want and need for positive returns always.  Like many, we feel compelled to reach for gains and chase the market higher for fear that our clients will not like us sitting in things other than stocks like Facebook, Amazon, Netflix, etc.  Well, we’ve just been at this for too long, I suppose.   Having closed out those types of trades in late 2017 (sold Facebook, Amazon, Microsoft, Alibaba and many others), we’re going to stick to our knitting of following our system and patiently waiting for real value and opportunity.  That’s going to be a bit painful if the US stock market continues to blast higher because there isn’t much value or opportunity there anymore.   This message is therefore really about patience and understanding.  When markets are in transition, shifting from a healthy productive environment like 2017, to one that is more prone to losses and much higher volatility like 2018, we have to emotionally tell ourselves to stop reaching and wanting what is not readily available.  It’s hard and we feel that stress as much as anyone.

There are opportunities but not where the armchair investor is looking and maybe not now.  The opportunities are in names you’ve never heard of, in sectors that you’ve never invested in, in asset classes that you don’t understand.  Honestly, if the guy on the street would do a little homework, they might see it too but most don’t seem interested in actually learning or researching as much as just doing what seems obvious (always the wrong choice with investing in anything actually).   Indeed, we feel fairly confident that we are approaching another one of those textbook behavioral econ moments when the mass of investors are just blindly running with the herd not really aware of their exposure or what lies ahead.

I’ll finish by reiterating the lead sentence of our Explicit Investing Creed as it seems like a good time to do so.

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

I hope everyone is enjoying these hot days with a nice balance of work, fun, family and cold drinks.

Cheers

Sam Jones

Looking Back

It certainly has been an eventful first half of the year.  There has been a lot more movement in markets— both up and down. We wanted to give you a few bullet points on what has occurred so far this year and where we see opportunity going forward.

*The performance graphics that follow come from Bespoke Premium research and represent YTD performance figures through 6/30/2018.

A couple things to note:

• Volatility is on the rise. The calm of 2017 was highly unique to the point of setting records. There were no significant drawdowns in stocks and bonds were stable. Those days are gone. Be prepared for more movement in your portfolios as we return to a more normal market environment.
• Most global stock markets were lower the first half of the year. See the graphic of non-US markets below. The All Country World Index Ex-US was down 3.8{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}. The S&P 500 was a bright spot finishing up 1.66{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

• There was a big performance difference between small cap and large cap stocks, not to mention technology shares. US small caps were a solid winner through the end of June. We held small cap positions in Worldwide Sectors and in our Blended Asset models to take advantage of this out-performance.

• There was a wide disparity amongst sector performance here in the US. Consumer Discretionary, Technology, and Energy did well. Consumer staples did poorly.

• Commodity indices were positive, but almost wholly due to the rise in oil prices. Many other commodities were down, and in some cases, by quite a bit.

• There weren’t many places to hide in bond markets. Only short-term bonds, bills, and floating rate bonds provided any respite. US credit markets continued to act poorly, and even long-term US Treasuries were down 4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}. Emerging markets were even worse. The Barclays Aggregate, the most commonly used benchmark, was down 2.75{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

• Our net exposure model got more defensive on equities at the end of the quarter. Our goal is to preserve capital until there are better trends and valuations to exploit.

Looking Ahead

Despite most global stock and bond markets ending the quarter on a lower note there are some potential opportunities building.

• There could be a great opportunity to rotate out of growth into value. That relationship looks stretched relative to its history.

No one knows when this trend reverses, but it invariably does— and usually out of left field. Nothing lasts forever.

• If we are indeed late in the economic cycle, commodities and the basic materials sector should start outperforming. We can take advantage of that through some sector bets in our equity models and through outright commodity positions in our Blended Asset programs. We will likely look to do both if the signals line up.
• If stocks do get volatile and credit spreads widen, we will be on watch for opportunities to add corporate credit back into our Income models. These are great opportunities for us to add excess return over a passive approach.
• The message is that, while we are a bit cautious on broader stock indexes, we still see some opportunities to make money. As always, our investment process and approach to risk management will guide the way.

Enjoy the rest of your summer and stay cool!

Sean Powers, Chief Investment Officer

Stock Rebound is Failing  

First, I apologize for being out of touch for the last couple weeks.  We have lots of business “stuff” happening now including working with new households, integrating new software and working through some of our internal systems.  It’s all good and you’ll see the benefits soon but I haven’t had time for more frequent market updates.  Thankfully, there hasn’t been much to talk about… until now.  Settle in.

Net Exposure Model Going Negative Again

Backing up the tape a bit, our net exposure model switched back to a positive reading in the first week of April and has remained there until literally today assuming the markets are going to close around this level (-1.4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}).  While the signal has been positive, we wouldn’t call it robust or persistent over the course of the last several months.  We have offered clear advice like “Don’t get married to any positions” or “ we are buying rental positions only for short term trades”.

Last week we saw the beginning of real price declines starting first over in Asia (we sold our Asian ETF’s last week and finished selling the rest of our China position yesterday), then spilling into Europe (we never owned Europe) and now landing on our shores today with a pretty complete and comprehensive selling of all non-recession trades across the board.  As of Friday, our model went to zero exactly and will go negative with today’s price action in the markets, forcing us to raise at least 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash.  In most cases, we’ll have over 30{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash as we’re also hitting some significant stops.  Our guidance at this point suggests that the 3^rd quarter could be tough on stock prices even in the face of reasonably good earnings reports starting in just two weeks.  Financial headlines are all about Trump and his trade war.  They may be right but we’re really just reaching for a label or a justification for what the market wants to do anyway  – go down.  If I had to guess, given the set up and the conditions of our indicators, it seems likely that we could be just facing a stiff and steep correction in the 3^rd quarter.  But post elections, we need to have our physical and emotional capital intact for a potential great buying opportunity and a very healthy 4^th quarter rally.  That process starts by taking profits when you need to.

Recession Trades Firing Up Despite Unbridled Consumer Optimism

This is a classic example of a confusing moment in time for armchair investors.  Today, it was reported that consumer optimism about the FUTURE of the US economy hit an all time high.  I found it a little odd that the all time high number was 52{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}; doesn’t seem very high to me frankly. Are we just a nation of pessimists?  Anyway, that happened.  Meanwhile, starting last week, the entire market character flipped from a growth – buy it at any price – cyclical orientation to the exact opposite.  Now the recession trades are firing with healthcare, utilities, bonds, consumer staples and value leading up as all other “stuff” sees profit taking.   Today was that critical day when the important leadership groups really gave up.  This includes the FAANG stocks, financials which broke serious long term support and small caps.  I suppose we shouldn’t be surprised considering we said back in April to expect another top of some sort in early July.  July is 4 days away so let’s call it good.  That forecast was predicated on some very high level guesswork for which we won’t be accountable, but logically based on the timing of a potential recession in mid 2019 in the US.  Many things can and will change but so far, the timing of a potential market top now, seems to be consistent with the timing of an economic contraction next year.  Confusion therefore is really about the gap in timing between financial securities and main street events.  Remember, financial securities are priced today on the basis of expectations 6-9 months out.  What we see and feel from our observations of main street activity is really coincident with the current state of the economy.  These two worlds are often at odds.

Income Strategies Bridging the Gap Successfully (so far)

I know it’s been a while since we’ve seen any real returns coming from our two income models.  In fact, it’s been almost two full years.    Well I have some good news and I have some bad news.  The bad news is that we haven’t made much more than a 1-2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annually for the last 24 months.  The good news is that we haven’t lost any money in the last 12 months!  Yes, our income models are still based on the state and health of bond and credit markets across the globe.    Let me pause and show a quick performance graphic comparing our Freeway High Income strategy to several different bond funds.  Please also note our composite performance disclosure link at the bottom of each and every Red Sky Report.  This is just a graphical representation of the composite performance of our income strategy net of all fees looking at the last two years.

• Red = ASFA Freeway High Income strategy
• Green = I shares Barclays Aggregate Bond ETF
• Yellow = IShares 20+ years Treasury Bond ETF
• Violet = IShares 7-10 year Treasury Bond ETF
• Blue = IShares 1-3 year Treasury Bond ETF

Without posting numbers, it’s pretty easy to see that we have more or less successfully kept our clients’ “income” allocations intact for the last two years while bonds of all sorts and maturities have consistently lost ground on a total return basis.  In fact, we’ve made just under 3{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} over the period net of all fees.  During times like these our job is simply preservation of capital and selectively taking positions that do not carry any form of the price risks we’re still seeing in corporate bonds, high yield credit or long dated sovereign bonds.

But we’re not done yet!

There are two things that need to happen.

First, we need to see some signs that bonds are done falling and credit spreads are widening.  For that to happen, we need to see some pretty dramatic calamity still in corporate bonds including a large increase in defaults and re-pricing.  This hasn’t happened yet so we’re staying clear of any investment in this space.  The second event is that we need to see the Federal Reserve essentially reverse their tightening policy.  Now the crafty reader might understand that our Federal Reserve has a very long history of overshooting on cycles of interest rate hikes and we believe they will do so again.  So for the Fed to end rate hikes, we would need to be IN a recession with enough evidence for them to recognize that tightening is no longer needed.

Between now and then, we’re actually finding some good places to put our clients’ income money including municipal bonds, specialty income funds, floating rate funds and most recently, short term bond funds, which we believe, have already bottomed.  Short term bond funds carry very little price risk but are now paying almost 2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in annual yield with the last Fed Rate hike.  I hate to admit it, but 2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} actually isn’t bad for a liquid short term bond fund and it’s a lot better than you’ll find in most banks still.

All in, we would be very pleased if we could make 3-4{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} annually net of all fees while bridging this historic gap of bond market repricing.  On the other side, we’ll back up the truck and gobble up corporate bonds paying healthy yields of 8,10 even 12{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

The ASFA Retirement Income and Freeway High Income strategies are appropriate programs for any who are looking for stable income and a flexible bond portfolio that adjusts exposure according to risks and opportunities.

Next week, we’ll provide an update on the historic spread in performance between Value and Growth as we expect to see a reversion to the mean starting soon.  This could be one of the greatest investment opportunities of the last decade so stay tuned.

Have a great week!

Sam Jones

When I was a kid I remember “blue light” specials at K-mart. If you remember, the concept was to spark customer buying by offering a temporary sale in a department of the store. It seemed like a random process, but there was probably a science behind it.

In a bit of irony, we think there may have been a “blue light” special for the retail sector in the US last week. Time will tell whether this is a cyclical or secular move, but the body of evidence existed to allocate some capital in this sector.

Let’s dig a little deeper into why retail, and why now.

Before I review the thesis behind our recent investment into retail I want to take a moment to go through our investment process as a whole.

We use a process to manage portfolios. Our construct was born out of both experience and research with the goal of having a game plan for every market environment. We can’t tell the future, but we can create an action plan based on a set of conditions. It all boils down to probabilities.

From the graphic above you can see there are three phases starting with net exposure (how invested are we) all the way down to position size. I want to focus on the middle section of that graphic—Selection– in the context of buying into several retail names and retail sector funds last week.

There are multiple criteria we use to screen where to deploy capital. Sentiment, relative strength, valuations, and diversification to name a few. Let’s review each for the retail sector.

Sentiment

This variable is a bit tricky and usually not the final arbiter. But, it is a part of our analysis.

We are looking for negative sentiment that has brought prices and valuations down. The concept is that everything bad gets baked into the price—lower earnings, tighter margins, and competitive pressures, etc.

The retail environment has certainly changed over the last 20 years. The rise of Amazon, amongst others has put tremendous pressure on the margins and profitability of many retail operations, and in some cases like Toys R Us, put companies out of business. Most have written off the sector. A day doesn’t seemingly go by without an article calling for the death of retail.

Valuations

Due to the competitive pressures mentioned above valuations have come down to below market multiples in many instances. Earnings estimates have come down dragging prices with them. Let’s take Kohl’s (KSS); one of the names we bought.

From Morningstar we can see:

• Price to earnings is below the market.
• Single digit price to cash flow.
• Double digit return on equity despite a very competitive environment.

One added kicker with this name is the overall yield delivered to an investor. Attached is a table outlining the dividend yield and buyback yield for Kohl’s. It has delivered 6{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} a year to investors over a trailing twelve-month period.

Relative Strength

We like to monitor how particular sectors are performing relative to the broader stock market. As you can see the SPDR retail ETF (symbol: XRT) started to marginally outperform the market over the last couple of months.  But in the last couple weeks, the outperformance has accelerated (rising blue line in the chart below).

For us, price action is the final arbiter to put money to work. The price breakouts within the sector and the relative strength are confirmations that the risk / reward have moved in our favor.

We ended up buying several individual retail equities, including Kohl’s (symbol: KSS), Dillards (symbol: DDS), AutoZone (symbol: AZO), along with the Rydex Retail sector mutual fund (symbol: RYRIX) as a result of this analysis. We never know how a particular investment will perform, but as always, we will actively manage the risk of this position should our thesis change.

We see a lot of bearish news in the financial press these days. Get ready for the next recession, or stock markets are at all-time high valuations—beware! While we certainly understand some of the concern, as this retail example illustrates, we are still seeing some great opportunity to buy cheaper equities in places that you wouldn’t expect. You just have to go below the passive indexes to find them.

Have a great day!

Sean Powers, Chief Investment Officer

Your Current Investment Strategy Should Be Clear

I read a lot, I look at a lot of charts and I listen to a lot of client concerns during regular reviews.  If I close my eyes and find that quiet place, I sense confusion in the system right now.  Outside of the White House, there isn’t really much confusion if one assesses some simple truths leading us to some clear strategic choices with our money.

Tactical versus Strategic

Let me preempt this update with a quick bit of financial education.  Tactical moves are those that you might make on a shorter time frame.  By shorter, we’re talking about months, not days.  Here we can find sector rotation moves, intermediate-term market trends, identify times to cut some exposure and other times to add back exposure.  Tactical can be a date with an investment, rather than a marriage.  You’ve heard me talking in April about adding back market exposure with “rental” positions in free to trade indexes.  I know that I won’t own them for long but when we see a low-risk entry point in a toppy market, “rentals” are a good option.  Strategy is conversely a longer-term play.  Here we look at asset class performance over longer time periods, we focus on valuation differences across countries, we might factor in long term plays like the death of brick and mortar retail, the aging of American demographics or the evolution of how we use energy.  These are strategic considerations that can and should dominate our core commitments over longer periods of time.  For this update, let’s focus on the clear and unequivocal strategic realities in an effort to reduce confusion and help us put our money in the right place.

Sovereign Debt (aka Treasury Bonds) is in a Bear Market Globally

This is not up for debate.  It is what it is.  Sovereign debt like Treasury bonds, are down nearly 15{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}, shorter term bonds are approaching double digit losses from the highs, corporate bonds are down but have not yet reflected rising underlying defaults (see Toys R Us bonds), etc.  It’s worse outside the US.

As a matter of practice, Investors should not have their money in asset classes that are in bear markets.   Right?

Warning – do not touch.

Today, we own only Floating rate funds which are still annualizing close to 5{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and a sprinkling of tax free municipal bonds which continue to trend higher as investors realize that the tax reform act is a zero sum benefit to individuals.  That’s it.  Our bond allocations are sitting snuggly in cash waiting for a more attractive environment to make some real money.  In the meantime, we’re clipping some income coupons, paying for fees and inflation but that’s about it.

The good news is that bonds have been unproductive investments for nearly 6 years and they are rebuilding value in the process.  I would guess that by early 2019, we’re going to see some very attractive opportunities in all types of bonds and our income strategies will produce some excellent results with a fraction of the stock market risk.   Sit tight, we’re in the driver’s seat on this and the story will end well.

Global Stocks are Still Trending Higher

If one simply observes the slope of the long term moving averages, we see a rising slope for both the 50 and 200 day moving average for almost all indices.  The Russell 2000 jut poked out to an all time new high as did several other equity sectors.  While the jolt of higher volatility in January and February brought “trend” into question, it has subsequently bounced higher and the uptrend is still intact.  Things are even a bit extended to the upside in the short term, so we’re not surprised and actually welcome a bit of a pullback now to keep things in check, hopefully extending these price gains into a healthy summer rally.

Strategically, we should still own stocks because they are trending higher.

Our “Trend” indicator is our largest weighting in our Net Exposure model operating in a range of -4 to +4 .  The current value is a +4.  What to buy is another story but I would still consider sticking with “rentals” from here on out.  You know that we expect a significant market peak this summer, possibly July and a bear market in 2019.  Stocks are the next in line to experience a reset of some variety.  The typical pattern is the same.  Bonds peak, then stocks, then commodities, in that order with various lead and lag times.  So let’s not get passive about anything in our stock portfolios.  Selectivity will dominate from here on out so if doing your daily push ups to stay in the right place is too much for you, it’s not wrong to begin cutting back on stock exposure in general.  We are still sitting on 15-25{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} cash.  We might get it to work, and we might just sit on it if we don’t find enough reason to deploy.

If you don’t like push-ups, we’ll do em for you…

Commodities Have Started a New Bull Market

I don’t know the future, but the new uptrend in commodities is clear.  I’m going to call it a new bull market at this point.    I spoke to this last week.  It started with oil, spread to basic materials and is now drawing in strength in metals, mining and other classic hard asset plays.  You might remember the rolling 10-year return chart shown last week for commodities, which might quicken your pulse a bit.  Commodities have not been this attractive since the early 30’s and we might see a whopper of a move higher for much longer than people think.  Along those lines, allocations to commodities inside investor portfolios are also at an all time low.  When the flaming eyeball of big money begins to rebuild their commodity positions, there is a leveraging effect in prices for this relatively small segment of the financial markets.  Here’s a one year chart of the very generic commodities index shown in Red versus the S&P 500 shown in Green.  Commodities are appreciating at a 3:1 ratio to stocks since last June.

Strategically, we should own Commodities and look for opportunities to accumulate exposure (aka buy pullbacks).

Other Stuff

There are a lot of strategic themes that I find very attractive from a longer perspective if one is willing to tolerate some volatility along the way.

In no particular order, these are the themes that should remain on your computer sticky notes:

Aging Baby Boomer population   = healthcare, biotech and fountain of youth

New Energy Evolution                       = Alternatives to carbon based energy use

Person to Person Transactions     = Payment systems, Block Chain (but not Crypto)

Sharing Economy                                = Uber, Airbnb and company cuts costs

Cyber Security                                      = New industry with long legs

Robotics                                                  = Tough on labor, good for profits

Internet of Things                                = Stuff talking to Stuff adding efficiency

There are more, but these are the big ones.

That’s it for this update, just trying to clear up some confusion.

Get outside and enjoy the spring time!

Cheers

Sam Jones

Back to a WINning World

Gerald Ford brought the acronym, “W.I.N.” to the American public encouraging thrift and savings in the administration’s fight to Whip Inflation Now.  They made cute buttons but I’m not sure that anyone would be dorky enough to wear one even in 1974.  The evidence of what we see today is completely at odds with what we are told or hear regarding inflationary pressure that is building in the system.  Here’s what we SEE and what every investor needs to know about where to put their money now.

Late Cycle Evidence

I’m not going to call it inflation anymore because there seems to be a clear and purposeful intent to convince the American public that inflationary pressures are not real, present or existent, and we should expect the campaign to continue for several reasons.  The first is that our bond market would simply collapse if we all agreed that inflationary risk is rising dramatically.  The US debt to GDP is way off the chart, now 329{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} as of the end of the last year.  As Steve Blumenthal of CMG Capital points out, trouble usually begins when any country’s debt to GDP rises above 90{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.

We’re not alone. This is a global thing and it will end very badly.

• Japan 590{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• France 480{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Germany 279{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Greece 360{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• S. Korea 357{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Netherlands 725{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Denmark 585{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Canada 332{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Italy 360{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Portugal 488{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Ireland 828{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Spain 397{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Sweden 467{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• Switzerland 382{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}
• UK 476{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}

So of course, any notion that inflation (whoops) is rising would be unwelcome news to the issuers of debt who happen to be the same entities that report inflation numbers – da Gubermint.   The other main reason is that our entitlement programs like social security and Medicare are indexed to the government reported inflation numbers.  If inflation rises, then all of these payments must also rise according to the COLA (Cost of Living Adjustment) rules.  Social Security and Medicare are not solvent as is.  So once again, as a country, we literally can’t afford to report inflation honestly or accurately.

Let’s use the phrase “Late Cycle Evidence” instead of the word Inflation so as to be consistent with what you’re hearing.

Here’s the evidence that we’re in a very Late Cycle environment – which are contributing factors to rising prices and a rising cost of living.

Tariffs, Trade Wars and Protectionism                                 Check!
Rising wage pressure                                                                   Starting now – Check!
Full Employment and labor shortage                                    Check! Check!
Strength in Commodities                                                            Check
Bond market falling apart                                                           Check
Stock Market becoming selective                                            Check
Rising US dollar                                                                                Check
Rising Healthcare costs                                                                CHECK OMG
Rising essential services costs (Trash, Water, Utils)          Check!
Rising housing costs (rent and ownership)                            Check!
Overstimulus with tax reform act                                              Check!
Federal Reserve raising Interest rates (x6)                            Check

These are the recessionary pressures in the system today.

None                                                                                                     Check

No joke, there are none today.

Investment Options During Late Cycles

Honestly, at this stage of the cycle, there aren’t many places to invest in outside of inflation hedges, commodities and a few currency trades.  Bonds suffer, stocks stagnate and become selective making it tough to make money broadly.  But commodities are kings here for a while so we need to get a bit unconventional with our portfolios (our specialty!).   This is a typical intraday performance screen of a diversified portfolio that I am seeing more and more often.  Forget all the symbols, just look at the colors.  Green is up and Red is down on the day.

There are two things that are up:  Commodities and the US Dollar.  That’s it.  Basic materials and small caps are hanging in there but there really aren’t many places to look for strength.

Here’s another eye opening chart that our CIO, Sean Powers sent me yesterday.  It shows the 10-year rolling annualized returns for commodities.  If you have any sense of fate—or believe in the concept of reversion to  the mean—you’d have to believe that commodities are likely to rise from  here and run hot for many years.  Not possible?  It’s possible. We haven’t seen commodities this oversold since 1934!

Emerging markets are the bottom of the list and under some serious pressure as of late.  These countries tend to rely more on borrowing so when borrowing costs rise, they run into trouble.  We have cut back dramatically on our emerging market positions and reallocated those funds to commodities, energy and domestic small caps.

Overall, our Net Exposure model is still positive as of last Friday (+9 out of a range of +20 to -20) so we need to give this market the benefit of the doubt.  However, several of our indicators are angling back toward zero including seasonality which is now fully negative (Sell in May and go Away).  Buy pullbacks is the right approach still but consider a heavier allocation to those Late Cycle investment options when you’re ready to hit the buy button.  If you don’t know what or how or when,  give us a call.

That’s it for now and dust off those WIN buttons!

Stay tuned.

Sam Jones

Investing In Climate Science Recap

A huge thanks to all who braved the trip into Boulder to attend our first off campus Solution Series, hosted by The Rocky Mountain Institute (www.rmi.org).  We have been supporters of RMI as members of their own Solutions Council for years and I will shamelessly say, this non-profit organization is turning the needle on climate change.  They are doing the hard work to make change in policy, products, behavior, vision, and research right in the face of a rather hostile environment for all things progressive, clean and green.  RMI is also a source of research for our New Power strategy (www.newpowerfund.com)  where we are taking an ownership interest in game changing companies for our clients as shareholders.

If you’re interested in getting caught up with their “Global Market Based Solutions to Climate Change”, I would encourage you to subscribe (free) to the RMI  Spark newsletter.  Here’s the link:   https://www.rmi.org/donate/subscribe/

Interested Donors can also find plenty of opportunities to participate on their site through their Innovators circle or Solutions Council.

Recap of Discussion Points

After a quick building tour where we walked through a Net Zero multilevel building complete with a vertical solar array acting as an exterior wall, we started a panel discussion moderated by our own, Sean Powers.

Alex Glaser of Harbor Research and Thomas Blank of RMI opened our eyes to their worlds of innovative technology and Trends in the big industry, respectively.         

Topics covered included:

The Convergence of Energy Technology and Information Technology

The Internet of Things

Battery and Energy Storage

Smart Grid, Smart Home, Smart car and Smart Garage!

Modern utility models and pricing structures

The impact of tariffs on the solar industry

Electrification of the Transportation system

Investment options in all of the above

The general sense from our audience was one of surprise.  Most of the attendees were not aware of how fast things are moving and the scale of dynamic change happening today in the way we address and use energy.  We presented options for investors including some preferred funds and ETFS as well as a “cheat sheet” of some leading stocks in each sectors.  Please let us know if you’d like a copy.

Thank you again to everyone who made the trip and we plan to continue this education series perhaps doing a deeper dive into specific areas of interest.  And thank you to Megan Shean of RMI and Kris Dickey of All Season for making this event possible.

Stay tuned.

Sam Jones

President

All Season Financial Advisors, Inc.

Investing in the Last 12 Months of the Bull

Despite what is becoming a consensus view that the bull market is over, we see compelling evidence that there is at least another 12 months of higher prices as well as the potential for some healthy double-digit gains before the fat lady does her thing.  In this update, we’ll provide an overview of a still favorable environment for patient investors who know where to look, as well as our best guess at timing.  Please remember, today’s guidance can change quickly for any number of reasons.  Nevertheless, it’s good to have an adjustable plan at all times.

Buying Dips Until We See Signs of a Recession

Let me get this important statement out of the way.  We are heading for a recession in the US economy, perhaps even globally.  It appears likely to begin in the next 18-24 months by our estimates and there will be a great deal of wealth destruction both on Main and Wall Street when things really get upside down.   But between now and then, there is the potential for nimble and experienced investors to make some very real returns.   On the other hand, if you don’t know what you’re doing, making long term bets with illiquid investments (investment real estate, private equity and such) or passively holding and hoping, you’re likely to get smashed.  As Jared Dillian of the Daily Dirtnap (my new fav) likes to say, “the last 9 months of every bull is like trying to pick up nickels in front of a steamroller”.  From our view, based on some very solid historical precedents as well as the current condition of leading economic indicators, there are a lot more than nickels on the path ahead and we still have enough time to reach for them.

In the last update, I made an important statement.  Some of you caught it and commented.  I said,  “so far, we have only seen an increase in volatility, but not RISK as we define it”.  So how do we define “risk”?  Risk to us is the high probability of semi permanent or unrecoverable loss of capital associated with bear markets.  These are the types of losses that take years and years to recover which means we need to strictly avoid them because…. Because… well you know the answer.

Because Life Is Short

            No individual investor has a long enough investing career to waste 7, 10 or 13 years going through a major loss and recovery cycle.   Can’t happen?  It just did.  From March of 2000 to July of 2013, the US stock market lost more than 45{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} twice and failed to make a sustainable new high. Life is too short to run the risk of going through that nonsense.

So again, we have seen a very notable increase in price volatility but the probability (Risk) of a bear market having begun already is still very small. More on this in a minute.  Moreover, statistically, the last 12 months of a long and profitable bull market in stocks can provide investors with some of the strongest returns of the whole multiyear uptrend.  In fact, the average gain in the US stock market in the final 12 months is 16{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} with a range of +10{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to +30{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} (these are not nickels) according to an impressive piece of forecasting research from Guggenheim Investments in November of 2017.

The million-dollar question is of course, when is month “0” (start of the recession).  We’ll get into the details of that guesswork in a minute but we placed a red square on the chart above where we think we are today.

As a general investing rule, investors should continue to focus on buying market pullbacks, even somewhat deep corrections, until there are identifiable signs of a recession.  The current bull market in stocks started way back in March of 2009 and we have had deep corrections of 10-15{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} several times between now and then (2011, 2012, 2015, 2016 and now again in 2018).  Investors who aggressively bought the lows of each of these corrections have made a lot of money.  In the previous bull market leading up to the final peak in 2000, we also had several deep corrections, one of which stands out to me as substantially similar to the situation I see today.  1998 was a brutal year for investors.  Stocks ran up +22{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} into July of 1998, fell dramatically into October by -19{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and then ripped higher to finish the year +26{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  It was murder for trend followers but those who stuck with the bull market were rewarded again in 1999 with another year of 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} gains.  We see the current situation as substantially similar to the last 18-24 months leading up the final top in stocks in 2000 including the potential for the current correction in stocks to be deeper and scarier than many are prepared for.

But here’s the critical information.  There are still no identifiable signs of a recession yet.  Yes, we see the condition of our economic indicators as consistent with all other late business cycles, but in their current state, we shouldn’t expect the US economy to actually contract until at least the second half of 2019.  Without getting into the details, these are the classic warnings we watch for signs of  recession:

• Tightness in the labor market (watching for high wage pressure)
• Condition of the Treasury bond yield curve (inversions are bad)
• Restrictive monetary policy from the Fed (raising rates too far)
• Decline in Leading Economic Indicators (for at least 4-6 months)
• High yield credit spreads (widening as defaults rise)
• A drop in consumer confidence and spending (for 3-6 months)

So again, the condition of each of these indicators is in a state that clearly indicates we are in the late stages of the business cycle and that the risks of a recession are rising, but more importantly, we cannot identify any signs of recession today.  So until further notice, our plan is to buy corrections with the anticipation that there are still some very worthwhile returns ahead.  Now let’s try to be more specific about timing.

Timing Considerations

Timing is everything.  As regular readers know, we have been sitting on a lot of cash since February moving between 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} and 40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654}.  We have put a lot of long term gains in our pocket and moved into more of a trading protocol with our equity models attempting to buy short term lows with free to trade index positions and no real intention to hold them long term.  We call these “Rentals”.  We did so recently in early April but most of those buys have thus far been relatively unproductive as prices don’t seem ready to run yet.  In fact, it has been noteworthy that the markets are now selling the same companies that are reporting some blow out earnings.  When the market sells off on good news, that’s a sign of distribution and lower prices ahead based on some very negative sentiment.

We may find ourselves back into heavy cash if we don’t see buyers show up in the next several sessions.  As I mentioned above, we could be looking at another 1998 scenario quite easily (a hard and fast down 25{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} with a full recovery by year end).  In fact, for those who have been at this a very long time, the crash of 1987 (down 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} in a day) was also the same condition of a price shock with no identifiable signs of a recession.  Investors who understand markets,  bought the lows in 1987 and made a ton of money in the years immediately following the disaster.

Back to the issue of timing.

By current estimates, a US recession looks most likely to begin somewhere around the second half of 2019.  This is now later than some of our earlier work before the tax reform act was put into law.  Trade wars, inflation and the pace of rate hikes could easily change the timing of our future recession but for now, we’re seeing the third quarter of 2019 as a likely time period for a recession in the US.

Now we also know that stocks tend to peak out on average 6-9 months ahead of a recession (when a recession becomes identifiable!).  At that point, we need to get on the sell side of things, abandon our buy the dips orientation and get very, very defensive. We are now in April of 2018 so by looking at a calendar, we can estimate that we should be looking for a final top in stocks in the first quarter of 2019.  For all the gamers out there, that means we should be looking for an opportunity to buy the bottom of this correction (See Calling All Cars on April 5^th) and ride prices higher through year end and into the first quarter of 2019 when we should plan to sell aggressively and prepare for a bear market in stocks.  I can’t be more specific than that and it won’t work out as predictably as that, but that’s what the tea leaves are suggesting at this time.

It’s Still a Market of Stocks

I’ll finish with this reminder.  We’re still seeing a ton of value in different pockets of the market.  There is real value for investors who are strong enough to look away from the glamour of the FAANG stocks as homes for their hard earned money.  We haven’t yet seen real accumulation in the value areas and may not until the broad market buckles, but we do have our buy list ready.  In the bear market of 2000- 2003, we made money for our clients every year because we similarly had plenty of opportunities to make returns where the market offered value, just like today.  Timing is everything but we’re excited with the prospects.

That’s it for now.

Stay tuned!

Sam Jones

Leaders and Lessons

Since our last update, “Calling All Cars” when we suggested the technical set up for the market was good enough to invest some of your cash (1/3), we’ve seen more positive developments.  But so far, the major market averages haven’t really gone anywhere.  We’re still expecting higher prices from this level and here’s where you can find the relative strength leaders.

New Leadership

The leadership that we’re seeing today really started back in February but has persisted now into April.  That’s a good thing.  We want to see new leadership stick and so far that’s happening.  Sadly for many, the new leaders are not what you’ll find in the vast majority of investor portfolios, which continue to hold and hope with large multinational growth stocks.  Here’s a short list of the new leadership across countries, sectors, styles and asset classes.

• Utilities
• Energy
• Commodities
• Real Estate
• Small Cap Value
• Long Term US Govt Bonds
• Small Cap Growth
• Electronics
• Japan
• Mid Cap Growth
• Telecom

These are all things that are outperforming the S&P 500 since the February lows.

Virtually everything else is underperforming currently and thus does not qualify as a leader.

Now some of these would probably be considered fear trades or runs toward safety as stocks are now moving 1-2{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} up and down based on the tweet du jour.  Bonds and Utilities fall into this camp and we would continue to recommend avoiding these sectors and asset classes that depend on a falling interest rate environment.

But the others look pretty good and we’re focusing on these to add back some net exposure.  In the last week, we have followed our Net Exposure guide, which has moved from a -8 to a -2 (last week) and is now flipping positive with a buy signal from the High Yield market.  Subsequently, cash in our tactical equity models has moved from nearly 40{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} to around 20{1de7caaf0b891e8de3ff5bef940389bb3ad66cfa642e6e11bdb96925e6e15654} depending on the strategy.

Commodities and hard asset investments that stand to benefit from continued global economic growth as well as the inevitable rebuilding of America’s “nostalgic” infrastructure, are especially interesting to us now.

“The state of Mississippi’s bridges are in such bad shape that the governor has ordered at least 102 closed this week.”  WSJ, April 12^th, 2018.

What other reasons do we have to like commodities and hard asset stocks?

Well first, they are just about the only place to find real value in the financial markets.  We’re finding stocks that have single digit P/Es , high free cash flow and improving return on equity numbers.  Second, the business cycle says that commodities and hard assets should be next to run higher as stocks carve out a long term peak (maybe this summer?) and bonds continue to fall.  Finally, PPI (Producer Price Index) and CPI (Consumer Price Index) reports this week confounded the forecasters and showed inflation is now kicking up significantly.  It’s not hard to see in this chart from Bespoke.

Just wait until the tariff wars kick in.  Protectionism is INFLATIONARY – write that down and expect it.

Personal Opinion side note – Trump is full of hot air on practically all things, except trade.  He’s not bluffing.  This is not some tactic in the “Art of the Deal”.  And now he has fired his advisors who questioned his choices, replacing them with yes men (Kudlow and Co.).  We’re going to have a trade war and it will be Trump’s legacy.  Actually, it’s already happening.  Mega cap domestic companies that rely on importing cheap goods as well as select exporters are going to suffer.  No wonder we’re seeing strength in domestic small caps that source and sell everything right here in the US of A.

So we like commodities and hard asset investments.

We have also found this level to be a reasonable place to buy some of our existing positions for a lot of new money that has arrived at our door in the last several months.  What a perfect segue.

I want to tell you a client story with a lesson for all to consider.

Lessons from our Clients

I have omitted names to protect privacy but this happened last week.  A long time client had some significant money outside of our management with another advisor.  She called us to discuss bringing everything over to All Season Financial.  In that conversation, we asked why.

“Why are you wanting to bring your outside assets to All Season Financial?”, we asked.

She gave five reasons that I hear in various forms nearly every day

• Simplify and Consolidate – There is a real benefit to having all investments in one place.  Everyone can see everything, measure success and returns, make sure every investment serves a unique purpose in the whole portfolio and create cost efficiencies with higher assets under management in term of fees and expenses.
• Pleased with All Season’s performance in all markets.  We never hit home runs but we are consistent about our returns in all market conditions.  Our clients understand that consistency and timely capital preservation is likely to become more important now than in years past.
• See the whole picture – This sort of gets back to the benefit of consolidation but in this example, our client wanted us to manage and calculate the required minimum distributions on all of her IRAs and handle monthly cash flow needs rather than having to work out the math herself across different custodians and advisors.
• “They would charge huge commissions to sell my stocks” – It’s sort of mind boggling to me that various brokerage firms and most banks still charge high commissions for stock trades.  Fidelity charges $4.95 to buy or sell up to 10,000 shares of anything.  In this case, our client had a bunch of stocks held away from us and wanted to bring them over in kind so we could gradually sell them at Fidelity without the huge commissions.  Makes sense!
• IRAs held inside an Annuity – This one makes me crazy and I see it all the time.  Our client had a substantial IRA that was invested in an annuity.  IRAs are already tax deferred and thus they do not need the tax deferral offered by the annuity insurance contract.  The only reason you would ever see this situation is because the broker wanted to earn a commission on the sale of the insurance contract.  Shameful but very standard in our industry.  This type of practice is the very reason why the brokerage world is lobbying hard to avoid execution of the new Fiduciary Rules.  We welcome them as we’ve been uncompromising fiduciaries (not product salesman) for our clients since inception in the 90’s.  If you ever have a question about whether your broker/Advisor is a Fiduciary (acting in your best interest), ask them to show you in writing all sources of revenue to them associated with your accounts.  You might not like what you see.

Hopefully, you see the lessons in this commentary.    There are a lot of sharks in our business that are not sitting on the same side of the table as their clients.  They are sales people, product pushers and commission grabbers to put it bluntly.  Today, you really have to ask because everyone says they are your “advisor”.  But follow the money and you’ll find another truth.

That’s it for now – stay tuned.

Sam Jones