Category: Finding Benjamin

Another Reason to Read the Red Sky Report

 

At All Season Financial Advisors, we do our best to communicate effectively. Our regular Red Sky Reports assist in client awareness and serve as timely alerts to the dedicated reader. We hope that all of you are willing to read our weekly digest, but understand that there are hundreds (if not thousands) of other “up to the moment” media to consume on any given day.

In this edition of the Red Sky Report, we wish to draw specific attention to our periodic “Calling All Cars” announcements. We have used the “Calling All Cars” term for over a decade to indicate when we see a buying opportunity in the market. These periodic alerts serve as a tailwind or tipping point in the decision-making process to those with cash reserves sitting on the sidelines. As your investment advisor, it is our job not only to manage the money you have entrusted to us but to inform you when we are convinced of a buying opportunity.

Take a look at the S&P 500 over the last decade annotated with comments from Red Sky Reports and Calling All Cars announcements.

 

We aim to use this edition of the Red Sky Report as a one-two punch in regard to building confidence in our firm. First, we would like for our clients to review the Red Sky Report regularly for updates to market forecast, trends, and signals. Specifically, keep a look out for reports that carry our “Calling All Cars” title. Secondly, we want to provide “proof” in the pudding, while maintaining that humble pie is appropriate for all occasions.

In general, the “Calling All Cars” announcements should resonate strongly with investors that hold longer time horizon type accounts (IRA, 401(k), 529 and other retirement accounts) but is not a limited announcement pertaining only to these investors. These retirement accounts regularly have yearly maximum contribution amounts and are often spread between multiple providers, former employers, or institutions. We hope to use the data presented above to spur into action anyone that has cash sitting on the sideline, an underperforming account, or an account with a former employer/outside institution. These accounts may be used to your benefit as we calculate the next “Buy Zone” and deploy new funds appropriately across our strategies.

Please take a look at your accounts, those held with All Season and those held elsewhere, and let us know if we might be able to further assist in your specific situation.

 

Best,

 

Alex Osmond

Putting Your Money With The Mega Trends

It’s been a few weeks since my last update. That tends to happen around year end. My apologies. This is an important update for all investors (clients and non-clients). Why? Because there are some new asset class trends and accelerating older trends that you must clearly understand if you plan to make a return on your capital for the next decade plus.

 

The “New” Relationship Between Bonds and Stocks

 

Everyone who has been investing since the late 90’s understands that Treasury Bonds and Domestic stocks move higher with almost perfect negative correlation. When stocks are up, bonds are down in a “risk on” trade. When stocks are down, bonds are up in a “flight to safety”. The net effect for most passive investment strategies was a very long-term environment in which an investor could simply own the well-publicized 60/40 (stocks/bonds) portfolio and do quite well with very few changes, costs or concerns. As of the end of last year, we believe that long-term relationship has come to an end. Now, Treasury bonds are pricing in a growth economy and early signs of inflation (higher wage pressure, higher Producer Prices and stronger demand (PMI) globally). Today, we can’t say that stocks and bonds are tracking together with positive correlation yet as they did prior to the year 2000 but they are certainly angling that way, and ultimately will once inflation takes hold. As strange as it seems, this is not really new. Bonds and stocks trended together from the early 80’s all the way through the late 90’s as the main concern then was fighting inflation. We’re headed back in that direction now as there are signs everywhere that the age of deflationary pressure is coming to an end.

 

Bloomberg did an article on this today and we agree.

https://www.bloomberg.com/news/articles/2017-01-10/forget-30-years-of-stock-and-bond-divergence-bernstein-says

What will this mean to the common investor with the 60/40 portfolio?

 

Several things:

First, the 60/40 portfolio was built and maintained on the premise of diversification among non-correlated asset classes. And it did so quite well. But when two asset classes in a portfolio become positively correlated, meaning move directionally the same, our diversification goes away. Stocks and bonds will soon begin trending together if we see a continuation of the inflationary pressures we see today. That means they will both rise and fall at the same time. The bears are arguing that the return potential for both US Treasury bonds and US stocks has approached zero for the next 7-10 years (GMO, Ned Davis and Co.) based on valuations. We’re not convinced of that. But, we do understand that bonds will not save one’s portfolio from a stock market decline looking ahead. In fact, they may ultimately be the cause of a stock market decline in the form of rising interest rates!

Second, in order to make and keep your returns from this point forward, investors are going to have to become trend followers and have systems in place to cut stock and bond market exposure rather dramatically. I would also include a trend following system to engage with commodities and other inflation hedges at this stage – more on this in a minute. Most investors don’t have a clue how or when to own commodities in an investment portfolio. Of course, this is what we do and have done for the last 25 years.

Finally, selection on the stock side of a portfolio will be infinitely more important than is has been in the last seven years. By selection, we mean the ability to find and stick with leadership while avoiding laggards and out of favor sectors, countries, etc. Stock pickers will move to the front of the performance line again as they are capable of concentrating assets in the leadership sectors and the leading stocks. “Selection” is our second process screen behind Net Exposure and we spend a lot of time on this focus. In the current environment, selection criteria would choose late cycle leadership and tangible value segments including financials, banks, energy, materials, metals, and technology. Healthcare, utilities, consumer staples and other defensive sectors should be avoided for now. Commodities (but not gold necessarily) may also be on the very cusp of a new long-term buy signal after forming a perfect base over the last couple years. Here are a few examples of what we’re seeing.

 

 

 

 

Watch Commodities! The environment is nearly perfect for a big run higher.

 

Today, the US stock market is still rising strongly from the low last February. We have been “Buying the dips” since that time including through Brexit and our own surprising elections. Returns have been healthy and we expect that to continue, as there are no real signs of technical deterioration yet. But this is not a time for complacency. Valuations are high, earnings are coming in fast and the Trump factor could be very disruptive.

 

Accelerating Older Trends

 

In an effort to save time and space, I’ll be brief by listing several established trends that are accelerating and beginning to change the look and feel of our economic standards. Here they are:

• The Death of Big Box Retail – Amazon is eating everyone’s lunch. Brick and mortar retail is giving ground every day to on-line sales. Those who have failed to adapt, will not make it. Macy’s and Kohls just announced massive layoffs and store closings. Walmart is struggling. Sears is probably gone. Trump will not save these jobs or stop the long and persistent death march of big box retail.

• Energy Revolution – Electrification of transportation, Utility-scale smart grids, mega move from coal to natural gas, renewable energy adoption are already well past the point of fads. Costs, economics, and 25-year power purchase agreements are driving an acceleration in this trend. No doubt, there will be tests ahead with the new administration but we must remember that some of the best years for the energy revolution occurred under GW Bush.
• Fountain of Youth – Another accelerating trend in consumer healthcare preferences. The baby boomers started it with body part replacements and other “enhancements” but the trend has obviously been accelerating into genomics, biotech, medical devices and other methods of allowing us to live longer, pain-free, active lives. The world will pay whatever it can for the fountain of youth. Healthcare insurers and providers may be challenged in the wake of changes coming to the ACA but the global need and demand for cost effective healthcare solutions is just getting started. The question will really be about who pays more than anything. Healthcare will also be one of the best sources of employment looking forward as human-to-human care is really hard to automate. Someone should tweet Donald.
• Technology Replacing Humans – You know this one and it’s also accelerating. I saw a video of a robot laying bricks a few weeks ago. The US is not going to become a global manufacturer until our wages are the same or lower than foreign wages- probably not in my lifetime. So labor is going to be challenged unless it can find a lucrative home in industries that cannot be automated or fulfilled better by a semiconductor.
• The Rise of Developing Markets – This trend is also accelerating as we continue to see China, Latin America and the Developing world gain share of global GDP. The US and Developed Europe are not the growth centers anymore for a number of reasons. These trends have been in place since the late 90’s and they will continue. If you are a US fortune 500 company, you cannot ignore the source of your revenues as more than 50% are now generated overseas. Yahoo is barely alive today and has almost no enterprise value beyond their lucky stake in Alibaba (China’s Amazon).

 

The times they are a changin’ – faster and faster. We’re working hard every day to keep our clients’ money in the right place, at the right time.

 

Until next time

 

Sam Jones

Cyber Security “Brush-Update”

 

**All Season Financial Advisors has not previously been targeted by any cyber-security threats**

 

Recent events warrant an announcement regarding personal information security and the risks of negligent authentication processes (aka “Social Engineering”) regarding financial and informational data. I do not mean to invoke the moment in as far as using couriers to pass along important information, but with such high-level “hacking” going on, we would be remiss for leaving low-level cyber-security scams, hacks, social engineering threats and avoidable mistakes absent from the media of our clients (and non-clients).

As I am not a cyber-security expert, please consider this article as a brush-up and update (Brush-Update) course and not a comprehensive guideline.

 

Scam 1: Buying a House

 

Criminals have been known to enter the accounts of Real Estate agents and monitor email correspondence. At the right times, these criminals fabricate an email instructing buyers to wire money into false bank accounts. Once sent, these escrow and other payments are many times unrecoverable by any means.

 

Thoughts on Scam 1:

 

Many email providers will alert users when an email account has been logged into from a new device. Be aware that the criminal could just delete this email never allowing the target to know. A step in the right direction in regard to email safety is to have a phone number associated with it for access and authentication in the case of criminal activity.

When executing wires, ensure instructions are accurate! Enough said. Do not send a wire to an account you are unfamiliar with. Agents, Advisors, Bankers and other professionals should be doing their best to protect clients from sending false wires but clients have the final say. When in doubt, call the receiving party to confirm the wire information. Use the same phone number you have always used, not the one in the wire instruction email if it is different.

 

Scam 2: Alerts About your Account

 

Criminals pretending to be a service provider will email saying there is an issue with an account and prompt the target to type their username and password, many times onto a page that is not the company “Home Page”. This scam allows the criminals access to all types of accounts.

 

Thoughts on Scam 2:

 

The alert scam can be used to gain access to any type of online account. Shopping, Email, Banking, Enterprise and Company software. Be aware and know what to look for. When a service provider indicates a problem, inspect the sender of the email. Ensure the email is actually coming from a legitimate looking address. Also, do not put your credentials into any website other than that of the service provider. Attempt to fix the “issue” by going through the provider, not through the links on a suspect email.

 

Scams 3-5 Brought to us by Laura Shin, Contributor to Forbes.com and her conversations with Michele Fincher and Chris Hadnagy of Social Engineer, an agency that offers consultation and training in social engineering. See the full article for more detail.

 

Scam 3: The IRS Scam

 

From the holidays through to the end of the tax season on April 15, hackers call the target from a “spoofed” phone number — one that masks the caller’s true number and replaces it with a number from, in this case, the Washington, D.C. area — and claims they are calling from the Internal Revenue Service. In this case, the hacker typically knows a lot of information about the target already — the name of the person who is supposed to answer, their address, etc. “The assumption is they’re getting this data off the dark web, usually from one of the health care breaches,” says Hadnagy. 

They usually say that an older tax return, maybe from three or five years ago, has accrued late debt, usually around $2,000-$5,000. “They’re not saying ‘you owe us $50,000,” but a number that most people could afford to scrounge up,” says Hadnagy.

If the target falls for it, the hacker says that because the debt has previously been unpaid, bank transfers and credit card payments are not accepted and that the only form of payment possible is a money transfer through a service similar to Western Union (though not Western Union itself) that is nonrefundable and non-traceable.

 

Scam 4: Ransomware

 

Hackers are also now convincing their targets to install malicious software onto their computer that then encrypts all their data. The hacker then locks it so it’s inaccessible to the victim, and the software then also explains that the computer is now locked and demands a ransom before the hacker will unlock the computer for you.

Victims are told to go to one particular site or to call one particular number, where the ransom could be anywhere from hundreds to thousands of dollars. Payments are demanded by credit card, bank transfer, a money transfer service like Western Union or Paygram, PayPal and bitcoin. Unfortunately, often, the hacker will take the ransom but not unlock the computer, so now they have both your money or credit card information and also your data, which can allow them into all kinds of other accounts. 

The social engineering part of this scam happens several ways. 

Perhaps one day you’re browsing the web, when suddenly, a warning that looks like a federal warning, say, from the FBI, pops up saying, “Child pornography was found on your computer. You’re being reported to the FBI. You can avoid this by paying this fine.” But when you click, it downloads the encryption program onto your computer.

Or maybe you get a call from Microsoft saying that the company logged data from your machine that looks malicious, so they want access to your machine. (In this case, the hackers typically target older people.) The Microsoft customer service rep has you install a program called Tame Bureau, which is used for customer support all over the globe, which then gives the attacker control to install their encryption program onto your computer.

Or, maybe you just receive an email offering a coupon or free screen saver, but when you open it, it installs software that takes over your computer and encrypts the drive.

 

Scam 5: Business Email Compromise scams

 

In a so-called BEC scam, the hacker aims to get into an email account and obtain the financial data stored there, whether it’s bank statements, login information or other financial data such as verifications of wire transfers or payments in and out of your account.

Sometimes they’ll gain access to the email account by sending the victim a document containing malware. Once opened, the malware infects the computer, allowing the attacker to browse the machine remotely. In the recent case of John Podesta’s email, the hackers sent him a password reset email that linked to a fake page. There, he gave the attackers his email password (called credential harvesting), which gave them the ability to browse his email. 

In one variation of a BEC scam, if, say, the CEO’s email was compromised, a malicious attacker could impersonate him or her and send an email to the head of finance, saying, “I’m heading out of town for the holidays and will be on a plane and out of reach for the next several hours, but we need to make a wire transfer asap to bank account #XXXXXXX.”

This is especially common when people are traveling or when people work together but don’t necessarily know each other personally. “This tactic uses the sense of authority or legitimacy,” says Fincher. “If my boss tells me to wire money, I’m not going to question it.”

So if you’ve got 30-character random unique passwords on every account, don’t think you’re immune to a hack. “Social engineering, in general, isn’t about how smart technically you are,” says Fincher. “It’s about what connects you to others, what makes you curious and angry and what might make you act without thinking.” 

Please review your personal exposure and information hygiene appropriately. Know the red flags and stay up to date on proper procedures and industry norms.

 

All the best,

 

Alex Osmond

New Power – Ready to Run?

 

It’s been a while since I did an update on our most speculative stock strategy called New Power, but there are some recent developments that have me excited about this program. I’ll do my best to help you see what I see.

 

What Is New Power?

 

For those who are not aware, our New Power strategy is really a “game changers” strategy with a heavy focus on stocks found in the energy and transportation revolutions, emerging technologies, and healthy lifestyle industries. As we say on our New Power Fund website ( www.newpowerfund.com):

 

New Power is a bright green choice for discriminating investors in a time of great change across many industries. This is an investment strategy that captures great entrepreneurial passion for the future.

 

Investment Sectors Include:

 

Solar, Wind, Geothermal, Wave and Tidal Power, Natural Gas, Green Building, Efficient Transportation, Driverless Vehicles, “Shared” Economy, Energy Efficiency, Clean Air/ Water, Batteries and EnergyStorage, Distributed Energy, Smart Grid Technologies, Recycling, Organic Food, Mobile Innovations, E-Wallet and Payment systems, Healthcare and Biotech, On-line Education, Business Services, Cyber Security, Social Media, Internet, 3D printing and more.

 

In essence, we’re really looking to place investment dollars with progressive forward-looking companies that are changing the game in their own industries in productive, constructive and non-abusive way. The path is not always smooth to this end, as New Power has seen very wild times in terms of return. Since May of 2013, New Power has outperformed the mighty S&P 500, but investors have had to tolerate some high volatility along the way. New Power is not risk managed beyond timely selection and ownership of our various holdings. We do not recommend more than 10-15% of anyone’s total portfolio value to be invested in New Power given it’s speculative nature.

 

New Power May be Ready to Run Again

 

Here’s what I see happening across many of the investment options we have within this strategy. I see a lot of base building and potential upside in several of our focus sectors. I’ll start with renewable energy companies (things like wind and Solar as well as their supporting technologies and suppliers). For several years, these companies have been in a near free fall, consistent with trends in traditional natural gas and coal. To be clear, the welfare of renewable energy is not tied to the price of oil as many think. After all, Solar and Wind companies provide electricity and are therefore competitors with coal and natural gas, which also generate electricity right? Oil and gasoline prices are relevant to the electrification of the transportation system (PHEVs and EVs) but not as much as you might think. The cost equivalent of a gallon of gas in term of Kilowatt-hours is about .98 cents/ gallon (and falling). Even now as gas prices are hovering at 1986 prices around $2.00/gallon, electric cars are still a better “deal” in terms of driving costs. 2016 has already seen another record year of purchases of Fully electric and Plug in Hybrid Electric Vehicles despite the historically low gasoline prices. But something is changing on a grander scale now. Now for the first time in almost five years, we are seeing a potential long term bottom in the price of natural gas and this could have magnifying ripple effects for the renewable energy industry looking forward. Here’s a 3-year chart of UNG, the Natural Gas pure commodity ETF.

 

 

 

We have little doubt that March of 2016 will prove to be the long term low for natural gas prices. The question is, are we seeing a new uptrend develop now or does this industry need to base at this level for years before heading higher? From a technical perspective, this is the type of chart pattern that looks incredibly constructive and promising. Now to the ripple effect for renewables. The fall in natural gas prices has forced the solar and wind industries to get very lean and mean in their own production and installation costs in order to survive in the last several years. Many have not. But this could be a situation where the survivors get all the marbles. Higher natural gas prices will drive utilities to consider generating power from renewables with or without the dwindling tax credits. Wind power generation for long term utility scale contracts is now down to .02/watt in select markets, far lower than coal and natural gas. Solar is closer to .05-.07/watt which is still very cost competitive. Solar and Wind generation costs continue to fall with higher productivity as technological improvements do their magic. So higher natural gas prices create a strong market incentive for utilities, commercial, industrial and residential customers to shift to comparatively LOWER cost renewables. I never thought I would say that but here we are! Needless to say, we’ll be keeping our eyes focused on the chart patterns in our universe of renewable energy stocks.

 

Healthy lifestyle stocks, specifically organic food distributors, are also basing at the same time. This is another focus sector for New Power. We took some very nice profits on White Wave (WWAV) in July after they announced their acquisition by Danone but have not carried any healthy lifestyle stocks since. Other choices like Whole Foods (WFM) and Hain Celestial (HAIN) have seen their stock prices drop dramatically by almost 50% in the last several years. But now they seem to be working to develop a bottom in price as well. Take a look at Whole Foods.

 

 

Sellers are starting to look a little exhausted and unable to take the price to a new low since November of last year. This again is the type of technical chart pattern that makes us excited and we’ll keep this one on the front burner for a potential buy. You have to know and believe that companies like Whole Foods are more than just cyclical stocks associated with economic cycles. They are more about lifestyles and choices. People who eat healthy foods are not likely to go back to eating fast food – ever. They will pay more for their food because it is one of those important and positive life choices they make.

 

The final New Power sector that we find attractive is among LED light manufacturers. Companies like Cree (CREE) shown below have also been basing since last November but have yet to run. Like renewable energy, the costs to manufacture and purchase LED light bulbs has fallen by nearly 70% in the last couple years making profits very difficult for these companies. But now, when we go to the hardware or grocery store to get light bulbs, we reach for the LED because a pack of 6 costs $30, not $125. The cost savings and longevity of LED lighting is undeniable; having them installed is one of the easiest ways to add high-efficiency components to any home or business. Now, making the jump to LED is affordable and it makes sense. Here again, we have a stock like CREE trading at a significant discount while the macro drivers behind their core product are improving daily. We like that.

 

 

We bought CREE too early at the end of 2015 and have weathered through some undesirable volatility in recent months. But unless the lows are broken to the downside, we’ll keep our hand in this game.

 

All in, I see a lot of sectors, industries and specific companies in our New Power universe that are building some long term bases in price and offering some significant return opportunities. It goes without saying that if we don’t have our first woman president in place by November, the landscape for these progressive industries could change dramatically, then all bets are off. It’s going to be an exciting Fall.

 

Stay tuned.

 

Sam Jones

I am told during boot camp for the marines, there is the ever present option for participants to ring out, meaning they literally walk up to a bell, ring it, and pack their bags. Late last year, I had several updates talking about how market tops rarely have a bell ringing moment to indicate when THE top is in. They tend to be choppy, long, drawn out affairs. That is not so for bottoms when we hear “bells” very clearly. Mind you, I’m not calling this a firm bottom but it looks like it may be the beginnings of a bottom based on the extreme levels of sentiment registered yesterday. This update will be very brief and simply add some data to yesterday’s speculation that we were seeing a Washout of sorts.

 

Just The Facts

 

From the good work of Bespoke (love those guys) this am, here are the probabilities and averages for the market’s performance following a moment when sentiment hits an extreme. In this case, the measuring stick was the AAII survey of investor’s “bullishness” which hit a low yesterday of 17, truly extreme by modern standards. AAII represents an intelligent and focused group of DIY investors, mostly retirees subjectively. They pride themselves on not being part of the herd mentality and sentiment figures. While they are not the worst offenders as a group, the historical stats show that they are very much part of the herd, often buying high and selling at the lows. Bespoke did the homework on what happens to the S&P 500 following AAII “Bullish” readings below 20. Here’s the output looking at all periods post 1988.

 

S&P 500 Performance                  1 month             3 months                6 months

 

Average                                   2.05%                  6.51%                    13.38%

Median                                    1.48%                  5.37%                    13.69%

% Positive                                  70%                   92.6%                     96.3%

 

In more recent history, mostly in the 2000’s, the numbers have not been quite as strong with a single outlier year (2008) in which we saw negative performance from each of the 1,3 and 6 month periods, but still very respectable.

 

You’ve heard me say in the past that investing is a game of probabilities. When the odds are in our favor, we need to step up, when they are not, we need to play defense. Given the numbers above, it seems the odds are now in our favor. Be very careful if you’re one of those DIY investors and please do not interpret this as an instruction to load up today. Our guidance suggests that the first quarter of 2016 is going to be tough – the whole thing. We plan to identify leadership, look for new uptrends and make very judicious purchases from now into the end of the quarter.

 

That’s it for this update; just some numbers to back up yesterday’s speculation.

 

Cheers

 

Sam Jones

What’s the Risk?

 

Perhaps a better question is, where is the risk in the market today? I see a lot of herd type investor activity in today’s market that is largely reacting to headlines and negative news. As such, this is an important moment for investors to reaffirm their investment process and their tolerance for volatility (not risk). Without these guidelines, you are going to serially make bad decisions with your money (buying high and selling low). Here’s what our clients should know in relation to today’s market conditions.

 

The Bull Market is Still Alive and Well

 

In the last few days, we’ve seen some volatility in the markets, all markets. This includes stocks, bonds and commodities. We’ve seen some heavy, indiscriminant selling across every sector, country and asset class in the range of 2-3%. The anxiety in the system is almost tangible but few can really explain why the herd is suddenly on the run. The hard down day of last Friday was like a loud rifle shot in the early am hours – and the herd is now on the run.

 

What happened last Friday? Nothing, beyond the fact that there are more sellers than buyers looking for an opportunity to lighten up ahead of the Fed, Elections and Earnings. Let’s make up an acronym shall we? Let’s call it FEEAR (Fed, Elections and EARnings). But let’s back up and look where we are in the bigger picture. Stock markets across the globe have just recently broken up out of a consolidation and deep correction that lasted nearly two years dating back to the middle of 2014. And the breakout to all time new highs (US market) happened with all the thrust, breadth, volume and fanfare that we usually see at the very beginning of new bull markets! Wow, what a nice surprise to see a healthy surge this late in the game. While stocks are not cheap, there is very little technically that indicates, so far, that this new surge is over or that a bull market peak is in. In fact, what we are seeing so far is a rather orderly round of normal market volatility following a rather lengthy period of abnormally low volatility.

 

As I mentioned last week, we do see the “risk” structure of the markets rising a bit as well but only slightly and mostly due to widely anticipated FEEAR events in the coming months. This is a time to raise SOME cash as I said last week but we’re a long way from enough evidence to get really defensive. Remember volatility and risk are two different things. Volatility is something every investor must tolerate to various degrees. Risk, which we think of as the event that causes significant, or semi-permanent harm to your financial situation, is to be avoided. So far, we see volatility but not so much risk in the system. When does volatility become risk? It happens when the long term price trends turn down. Today, you would be hard pressed to find a chart that is a downtrend.

 

Opportunity to Upgrade

 

As I mentioned last week, we have raised about 25% cash in recent weeks from a nearly 100% invested position. This is prudent given the rise in volatility and a subtle increase in market risk looking ahead. This event has also presented us with an opportunity to potentially upgrade our positions. Let me be specific. Since the second half of 2015, the market has shown a strong preference for a certain side of the market. Specifically, we have seen defensive, income-bearing securities capture the lion’s share of capital as investors chase yield among “safe” things like consumer staples, utilities, healthcare, dividend paying funds, Treasury bonds and preferred securities. It’s been a nice ride and we’ve enjoyed healthy gains from these sectors in our clients’ portfolios as well. In the process, this side of the market has become overvalued on an historic level. Utilities, for instance, as a sector is trading at a forward P/E of nearly 20! That is absurd for an industry that rarely sees more than 5% return on Capital. Consumer staples aren’t much better from a valuation perspective. If one is convinced that the US economy is going recessionary (and we’re not in that camp), then defensive sectors are often seen as a good safe harbor for your money. But, at these prices, you might be putting your money where the real risk lies. Dividend paying funds and stocks have also been the darlings of the last 12 months. Now with the prospects of higher rates ahead, dividend payers are likely to come under pressure, leading the markets lower. And thus, this time of increased volatility presents a great opportunity to upgrade these positions. Recent sales in our portfolios have been among dividend payers, REITS, investment grade corporate bonds and preferred securities. As this pullback within a bull market runs its course, we’ll work to identify new leadership that is a better value and perhaps better aligned with a developing cycle of tighter monetary conditions, and get that money back to work. We are still in the mode of buying dips until further notice.

 

Looking at New Value

 

We still see opportunities from a value perspective in commodities, emerging markets, energy (to some degree), financials, banks, industrials, materials and oversold technology. These are likely to be in our focused universe as we look to deploy some of the cash from recent sales. Remember that the US stock market in aggregate is still expensive however, and forward returns given valuations for US stocks are in the low single digits (2-3%) until we see our next deep correction or bear market. Outside of emerging market debt, I would say that sovereign debt of any kind is unattractive, including all forms of bonds offered by the US government. But there is real growth and real value outside the US and in oversold hard asset groups.

 

Queue Up Cash Now

 

If I were to offer all investors some advice, it would be this: Find and identify cash that is idle, sitting in banks earning nothing or otherwise earmarked for longer term investment. Get it in a place where it can be deployed quickly. In our shop, we have our Holding Tank strategy at Fidelity that serves this purpose and is now earning some nice returns again (about 4%/ year). Holding Tank is free for all clients of ASFA. There will be an attractive moment to deploy this cash into longer term investments in the next several months, perhaps on the other side of elections or sometime in the 4th quarter of this year. For our 529 investors and any who are looking to add cash to passive investments, like 401k accounts, we’ll plan to send out a “Calling All Cars” instruction if and when the markets provide a lower risk entry point.

 

Just a brief update to offer a little perspective.

 

Have a great week

 

Sam Jones

Another Squall

 

It’s been smooth sailing since July for global financial markets, a little too smooth. Now we find ourselves facing another healthy squall as sellers are taking some profits ahead of the Fed meeting on the 20^th, the end of the quarter and the election in November. While we’re not at all surprised to see this happening, there was something very notable about the character of last week’s declines.

 

Net Exposure Model Moves Us to 25% Cash

 

By the end of today, our strategies will be roughly 25% in cash, 29% in some cases. The weight of evidence generated by a several key indicators suggests that carrying SOME higher cash beyond the middle of September is now prudent. We’re jumping the gun a bit given the Federal Reserve calendar and the market’s apparent sensitivity to the prospect of higher rates. And we have no idea if the Fed will act or not on the 20^th, but there are other things beyond the Fed that are driving the risk structure of the markets higher. One is valuation, which we have spoken of at length. The “market” is overvalued by practically any metric. However, there are still pockets of attractive sectors like industrials, energy and financials.

 

Unfortunately, when the “the market” decides to sell off, it takes the good and the bad with it. A highly valued market struggles to move higher sustainably and is simply more prone to selling pressure. This is the situation we are in today and we view this entire “surge” from the lows in February as an extension of a very old and tired long term bull market. Is it over? We have no idea but market risk is obviously on the rise. Second is the state of the economy. In recent weeks, we’ve seen some pretty terrible reports released, especially among manufacturing and service sectors as well as over all business condition surveys. Consumer confidence is hanging in there, barely. Momentum models have been on buy signals but are now fading fast. So strangely, just as the Fed is talking up the prospect of an improving economy, the recent stats aren’t very impressive. Tough job to be a Fed Governor right now.

 

Finally, we see some price deterioration happening among the canaries. These are high yield credit securities like junk bonds as well as small caps and other assets classes that tend to be more sensitive to market jitters. With breadth and volume measures confirming the selling pressure of last week as significant, we have enough evidence in our Net Exposure model to raise a little cash now.

 

The Regime of Lower Inflation

 

I mentioned in the intro that there was something very notable about last week’s selling. This has been the subject of several past updates but I want to reiterate here again. The entire financial services industry, which includes the do-it-yourself investor all the way through the huge financial institutions managing Trillions for large pensions, endowments and foundations, is still largely built on the foundation of modern portfolio theory. The theory says that if one is good about maintaining a diversified mix of global securities across multiple asset classes (stocks, bonds, commodities, real estate, etc) then we should enjoy healthy total returns while minimizing the downside risk of loss. That is true and has been true for nearly 30 years. 30 years seems like a long time but really we’re talking about the experience of one, maybe two generations of investors. So in economic time, this is actually a very short history. During this time, we have seen the likes of John Bogle and the Vanguard funds make indexing seem like a no-brainer, where the only consideration is cost. Less cost is better right because we assume that the design of our diversified global securities portfolio will manage all risk. But this widely accepted truth relies on an environment of lower inflation or deflation and now zero or even negative interest rates (borrowing costs).

 

Tom Brakke, author of The Research Puzzle, said it well in his post on 9/8/2016.

 

“It has all been part of one economic regime of lower inflation, lower interest rates, and globalization, accompanied by a flood of assets into the investment industry and the erection of the superstructures of practice and belief that grew along with it. It’s really not much of a slice of history — yet that’s the limited window that supports most investment recommendations and plans.”

 

Last week, stock markets felt some pain for sure with the S&P 500 losing 2.39%. But what really hurt was the fact that bonds also lost 2.25% on the week. Bond positions are held for their safety net features. We put up with their lousy, or near zero interest payments, because we “know” that they will provide some ballast to wavering stock portfolio during stock market squalls. But critical investors will note that during each sell off in stocks since 2014, the effectiveness of that ballast has been less and less. And last week for nearly the first time in recent history, we saw the safety side of most “modern” portfolios lose just as much as the stock side. We have seen only squalls in stocks in recent years, but nothing really devastating. Our concern is that too many portfolios, and vast sums of market capital, are not built to weather a different type of storm when it finally comes.

 

So if bonds are no longer going to be an effective hedge or non-correlated asset class against a stock portfolio, what is an investor to do? This is a huge question and quite possible the driver behind the incredible growth of the liquid alternatives securities in recent years. Everyone is a self proclaim quant now. Everyone thinks they have the secret recipe were they can simply trade away market risk without relying on non-correlated asset classes like bonds. They assume that their system will get them out just in time. The reality is that very few have any experience with this beyond the last couple years. Furthermore, risk managers in aggregate, are just as guilty of building their long/short, arbitrage and managed futures and momentum models on the back of the same falling interest rate environment as the passive index investor crowd. The path forward will not be the same as the path we have just traveled. Perhaps we are coming up on a crossroads? This will be time when all market participants must be open to the unknown, recognizing perhaps a new regime and putting our hard earned capital where it needs to go, rather than relying on models that suddenly don’t work anymore. We humbly offer that we do not have the answers because we haven’t seen the real face of the new environment yet. No one has. But, it seems inevitable that we will in the coming years. Perhaps sooner than most are prepared for. This is where our experience and flexibility in portfolio design matters. We are prepared, willing and able to evolve as risk managers, which is likely to be the most important stance an investor can take as we looking forward. We will find a way that allows us to continue generating asymmetric returns for our clients just as we have done since the mid 90’s.

 

More on that as conditions unfold.

 

Have a great week and know that you are in good hands as we make portfolio adjustments according to current market conditions – as always.

 

Cheers

 

Sam Jones

It’s funny to hear and see when investors magically forget their near panicked emotional state of just 45 days ago. Now that the markets have just recovered from the “worst start of the year in history”, all is forgiven, all if forgotten. As good contrarians, this makes us nervous. We get squirmy when the mass of investors gets too confident – as they are today.

 

 

A Teaching Moment

 

They say you haven’t mastered something until you can teach it. While no one can ever say they have mastered the world of investing, I am leading an “investment boot camp” for a group of very bright eighth graders who have opted out of standardized state testing. It’s been an interesting exercise to prepare for the class. It took me back to the very foundations of investing in a section I’m calling “Orienting for Success” including various rules regarding risk management, following primary trends, the impact of compounding etc. I am also finding myself choosing to focus on many of the areas of investing that the academic world often omits –like the importance of investor psychology and becoming an icy contrarian. Today, I did my normal market push ups; looking at all the trend indicators, walking through each and every one of our positions through the lens of hold or sell. As I did so, I had those foundational rules buzzing around in my head and it helped me to see things more clearly. The next month will likely provide several teaching moments for investors. We’ll learn if in fact the stock market is carving out a larger bear market-topping pattern. We’ll know if and when the broad indices fail to make a new high and instead we see selling pressure fire up again in the coming weeks. In the next month, we’ll also learn whether or not the Fed’s dovish stance toward monetary policy (they think the US economy is too weak to raise rates) is right or whether they are just afraid to pull the trigger and be blamed for another 10% decline in stocks. We’ll also learn in the next month if the collapse in energy prices is over or if recent strength and stability is just transitory in a much longer and larger move lower.

 

The very basic rules of risk management suggest that we should be on guard right here and right now. Investors, especially those who tend to be more emotionally reactive (“dumb money”) are now psychologically too bullish and optimistic again. Likewise, our more well-informed investors (“Smart money”) are much less so. See below from Sentimentrader.com

Furthermore, practically every sector and equity index is now in overbought territory and prices have moved predictably right up to rather serious resistance levels (old highs and downtrend lines) – graphically shown from Bespoke this AM below.

 

 

 

 

As I said last week, this is not a time to load up on stocks, perhaps just the opposite. Those same basic rules say to invest in line with the primary trend of the stock market. From my seat, the long-term primary uptrend in stocks dating back to March of 2009, ended in July of 2015 (S&P 500 and the Dow), some would point to November of 2014 (NYSE, Small Caps, internationals and commodities) as the top. Maybe prices will breakout to an all time new high, breaking the current pattern and extinguishing the risk of a real bear market. But thus far, the primary trend for the US stock market is either undetermined or down depending on your chosen benchmark index. Therefore, our investment portfolios should remain defensive or be prepared to get that way on the first signs of trouble from here.

 

Staying Defensive – for now

 

In our strategies, we used the recent correction in the markets to upgrade a few of our holdings from overbought “stuff” to oversold “stuff”. Predominantly, this has been a move away from growth and toward more traditional value plays. Some of those moves have driven us toward consumer staples, utilities, low volatility ETFs and dividend payers. Things that were sold were predominantly in overbought technology, healthcare and finance sectors as well a pure growth ETFs. Other action items in the last month or two have been adding back our high yield income securities exposure through emerging market debt, corporate bonds and preferred securities all of which generated clean buy signals in late February. We find these to be an attractive, lower-risk way to play the current rebound in the stock market rather than adding more equity or chasing stocks higher. In the last month, I saw a lot of gambling with things like energy stocks on the assumption that oil has bottomed. Back to the basics; I just see a downtrend in energy that might be working to find a base. That’s about all I can say that’s positive about the price action. Now energy is in a deep retreat again and I’m not seeing much conviction behind those bottom fishing buys. Beyond our value buys in February and re-engaging our high yield allocations, our Blended Asset strategies haven’t done much in the way of changing our exposure to the equity markets. Our tactical equity models like Worldwide Sectors, High Dividend, and New Power have also maintained their defensive positioning through the swift down and up of the markets in the last couple of months. As we move into the next earnings cycle and companies bring forward their results, we’ll know if the markets have done a good job of pricing in the expected earnings, shot too high or even too low. That’s what earnings season is all about, confirmation!

 

Remember, you don’t need to be nervous – because we’re nervous and responding accordingly.

 

Have a peaceful week –happy spring.

 

Sam Jones

Thoughts on Real Estate

 

 

Many of our clients are getting caught up in the real estate “thing” again. I think it’s time to take the pulse of this important segment of our economy.

 

Back in 2003

 

Almost exactly 13 years ago, I stood in front of our clients at our annual dinner with a picture showing the cover of a recent Economist magazine. It was a hot air balloon house attached to Earth (in place of the basket). The title read, “The Houses That Saved the World”. Most articles in that issue talked about the rise of real estate prices and how that sector was keeping the global economy alive and thriving. Indeed – and for almost another three years that was the case.

 

 

 

The point I was trying to make then was that real estate had entered a bubble phase and the ultimate and inevitable decline in prices would be severe, creating perhaps one on the greatest recessions of our day. That proposition was not well received. In fact, I can remember a few audible Boos! Tough crowd. As it turned out, we were early with that warning but the outcome was nonetheless even more destructive than we proposed. The Great Recession was caused by the popping of a credit bubble/real estate bubbles, which began in late 2006, shredding the financial markets and banking sectors 18 months later. Now let’s bring things forward to today.

 

Today, real estate prices across the majority of major metropolitan areas of the country have…….not yet recovered from their peaks in 2006 (one decade and counting). Seven of them have pushed out to new highs and we’re proud to say that Denver, CO is leading that charge. Take a look.

 

 

One can look at this chart from a half full or half empty perspective. The half full view says, there is still upside potential in real estate and many markets are still discounted. The half empty view says, real estate prices in all but a few markets are still in a secular trend that is bearish and unproductive. We did use the term “dead money” with regards to real estate back in 2006 and that label does seem to be accurate in describing all but a few metro areas.

 

For aggressive, opportunistic investor types, real estate did offer perhaps a generational buying opportunity back around 2012 when it appears most markets finally found a long term low in prices. The good news is that prices continue to rise steadily from that low with strong demand and low supply. If we had to guess, we would suggest that this “recovery” in prices still has further to go, but not a lot further.

 

Looking forward, we see a rough road for real estate again starting sometime in the next 12-18 months. The basis of that statement is based on three facts. The first is fact that prices will have recovered more by then giving those who bought near the top in 2006 that sense that they can get out at the same price they paid without much damage, other than 12 years of lost opportunity. Another factor will be the cost to borrow money, which we anticipate to be significantly higher by then. Higher borrowing costs are a negative for real estate prices on an exponential basis. And finally, we see property taxes as the last deep well of taxation for our needy and underfunded state and local governments. Income and sale tax rates are already absurdly high and suggestions to raise either will be met with some serious resistance. But property taxes outside of the east coast are still relatively low. We are already hearing and seeing local public schools and state governments planning to float higher mill levies in upcoming November ballots. All in, we have a real estate market that feels expensive (but could go even higher), but is potentially on the verge of a surge in supply (from 2006 buyers), higher borrowing (from higher rates) and carrying costs (higher taxes). While we’re not looking for a real estate wipe out or anything close to the last downturn, this is simply not a good set up and quite the opposite of what we would consider an attractive investment. When prices are low and rates are coming down from a higher level, then you should be ready with your bag of cash to buy.

 

The group I’m most nervous about is the Millennials. They are just now getting confident enough, solvent enough, gainfully employed enough, to buy their first homes. This is a generation that grew up seeing and feeling household financial disasters all around them. They are gun shy to pull the trigger on any financial commitment. And now, they are buying their first homes in an environment that is less than ideal. I can only hope that the bulk will continue to hold off and rent until we see some real opportunities develop again in real estate. I’ll take a wild guess and say sometime after the year 2020.

 

Please don’t shoot the messenger. We always call it as we see it and recognize that real estate is always near and dear to everyone as your home and something you love to own. Real estate pricing on the way up is always a local and regional thing, some markets are stronger than others. But when the tide goes out, all ships fall, just like any other asset class. So timing is everything and that includes real estate. We hope this helps in any decisions you might be considering in this important asset class.

 

Cheers

 

Sam Jones

$9 Trillion Reasons

 

Today, the widely anticipated commentary from Janet Yellen was delivered. I listened to the majority of her statement, until I couldn’t stay awake. All said, I think the Fed’s position on interest rates and the possibility of a September rate hike is about exactly the same as it has been all year. December is still likely/ possible but we’ll see.

 

Talk, Talk, Talk

 

It seems, the Federal Reserve is purposely trying to talk the markets into believing that a rate hike is possible, even imminent. I don’t really understand why, as there is really very little pressure coming from inflation (yet) and the urgency to reload the interest rate gun is simply not present. Their position all year has been the same. In plain speak they want the markets, credit markets specifically, to know that they could raise rates and would like to stay on a patient track of doing so starting last December. Nothing has changed from that stance as far I heard today. Today the markets are selling off a bit, interest sensitive sectors are leading lower (utils and consumer) while those sectors that benefit from, or unaffected by, higher rates, are still in the green (Banks, select tech and healthcare). I don’t really see anything dramatic either way. Interestingly, Gold, high yield bonds and emerging market bonds are all up today at the same time indicating that the markets aren’t really taking the threat of a September rate hike very seriously.

 

$9 Trillion Reasons

 

Today, there is $9 Trillion worth of developed market sovereign debt held at negative interest rates. Returns for these bonds if held to maturity are negative, as implied. Crazy I know. These are mostly the domain of Japan and Europe. Negative rates in these countries drive their investors to sell and alternatively buy US Treasuries , which are still paying something positive (1.5%). In the process, all of this purchasing of US Treasuries leads to a stronger US Dollar and even lower interest rates. When the Fed raises short term rates, even more money would flood into the US with the relatively more attractive yields. In the process, the US Dollar gets another push higher which is very notably bad for many of our fortune 500 companies who derive more than 50% of their revenue overseas. So you begin to see why the Fed is a bit trapped. They don’t want foreign investors to literally own the entire Treasury market, they don’t want to see the US Dollar rising, but they also recognize the risks of overinflated asset prices under a monetary policy that is too lose for too long (like the days of Greenspan). They are stuck in prison of non-action, so they will do their very best to talk, talk and talk us down (see above).

 

Small Window Remains for Returns in 2016

 

If the markets don’t bite too hard on the Federal bait by selling off sharply now, there is a high likelihood that prices will resume the uptrend and make another all time new high in the first two weeks of September. AFTER THAT, worries of an actual rate hike during the next Sept 20^th Fed meeting will reemerge, then we are only 45 days from election drama, then we have the more real possibility of a rate hike at the December Fed meeting. All of this happens in a new earnings reporting cycle as well. It seems prudent to say, make hay while you can.

 

Just a quick note to give our take on “the news”.

 

Regards,

 

Sam Jones

There is one question I am repeatedly asked now and it’s a good one.

 

Is It Too Late To Get In?

 

That’s the question. Before I answer, I want to back up for a minute and take advantage of this opportunity to do a little investor education. The question of “should I get back in?” implies that one is not invested now or at some point in time became underinvested. Now we all know there is as much risk in trying to time the market as there is in remaining passively invested through all market conditions. Our system finds a healthy and productive middle ground that is based on a weight of evidence approach looking at both fundamental and technical indicators. The industry calls this dynamic or tactical asset allocation. It is a gradual, disciplined, and prudent approach to managing money. But we don’t make all in or all out decisions, ever. Specifically, as conditions deteriorate, our Net Exposure system will dictate that we sell our weaker holdings and carry more cash, effectively becoming less invested. The same is true in the opposite as conditions improve.

 

Back to the point. In late February, there were several early warnings that the markets had just put in some sort of meaningful low, perhaps for the year. By March and early April, we saw enough buying enthusiasm combined with breadth thrusts and expanding 52-week new highs to suggest that the February lows were likely the end of the two-year correction in stocks. A new confirmed uptrend in global stocks was underway – 5 months ago. We began buying then and worked up to fully invested position by the end of June. The Brexit shock in June was probably the last chance to buy a good pullback in the uptrend that was already well underway. We said so here – https://www.allseasonfunds.com/redskyreport/06-24-16-just-what-we-needed.

 

Several investors I have spoken to this summer are waiting for the volume in the market to pick up before “getting back in”. Volume is essentially a measure or buying or selling enthusiasm. The theory is that volume confirms a given price move as legitimate (or not). This summer we have seen prices rise to all time new highs on relatively light volume suggesting the move up is a fake, bound to reverse or illegitimate somehow. Bespoke provided some nice research that says, volume doesn’t matter as much as you think.

 

 

Pretty eye opening piece of research!

 

So the time to “get in” if you were under invested or not invested at all for whatever reason, was several months ago as the best and lowest risk entry point. In a respectful way, I will say this plainly again as I have done before. If you do not have a system that governs your investment program on a daily basis and helps you adjust your portfolio to market conditions as they unfold, I would find someone who does and pay them to manage your money. If you do have a system, good for you; you probably aren’t asking this question.

 

The Answer

 

I do still see SOME opportunities now for investors who are looking to “get back in” or those who are just looking to deploy more accumulated cash into their investment accounts. However, most of the opportunities are not in obvious places.The US market in aggregate is still overvalued and still overbought but that condition can persist for a long time as we’ve seen in protracted bull markets. We view this uptrend as an extension of the five-year-old bull market in the US stock market but probably not more than that. From a pure market timing perspective, we think the next 60-80 days will see a dramatic increase in daily and weekly price volatility meaning we’ll see many more 1% days, up and down. With good reason, investors are very nervous about the upcoming election cycle and I won’t be surprised to see some subjective selling closer to the end of August just to take profits ahead of the political storm. But for now, buyers are in the driver’s seat and the vast majority of stocks are on the rise across multiple sectors and countries.

 

 

Looking at specific opportunities, we probably need to dig a bit beyond the standard benchmark US indices at this point. Two of the most attractive big picture opportunities I see now are commodities and developing markets (emerging markets). Typically, both move in sync, as they tend to march to the same macro factors so it makes sense that we’re seeing combined strength now. In the last week, emerging markets (EEM, EEMV, IEMG) and any of the standard commodity ETFs (DBC) have accelerated their August uptrends putting them on the leader board for the month. Commodities and Emerging markets have been massive global underperformers since 2011 relative to just about anything else. In the process, these markets have become attractively valued again. Furthermore, institutional investors have become significantly underweight in both, relative to their asset allocation models. We won’t be surprised to see them buck current consensus opinion and do very well in the coming years.

 

We also see developing opportunities in banks and financials, if you have an appetite for sectors. Yes, we have heard the news that interest rates are falling and will remain or zero or negative for years and years. We simply choose to close our ears and open our eyes to what we see today. To that end, we see real value and we are beginning to see technical chart patterns that look constructive. However, from a timing perspective, we would put both sectors on a watch list rather than an active buy list. Banks are likely to do well once interest rate begin to rise persistently. And financials tend to do well shortly after the arrival of a recession. We are not predicting either a sharp rise in interest rates, nor the beginning of a recession in 2016, but 2017 might see both. As we get closer to the end of the year and specifically beyond elections, we should all keep an eye on these two key sectors. The potential for significant returns is very real.

 

The final opportunity I see today is still in the high yield securities world. These are investment and low-grade corporate bonds, high yielding emerging market debt, preferred securities and convertible securities. I would also include Build America Bonds and High yield municipal bonds in the list. All are in well established uptrends, making new highs every week and still look very attractive relative to the 10 year Treasury bond. Like most things, these are no longer cheap, but they do offer a nice blend of capital gains and income for investors. I have no doubt that both of our Income models will hit double digits returns by the end of this year as these strategies remain 100% invested in all of the above. These are not securities that one can buy and hold but we do often see long uptrends lasting 12-18 months. The current uptrend is just six months old.

All told, it is late to be adding new money to the markets. But we do recognize some asset classes, countries, sectors and hybrid type securities that still offer some opportunity. We would advise caution with any new money, as we get closer to elections starting now with a keen eye toward selectivity. This is still the time to seek safe returns, but not necessarily maximum returns (Nod to W. Buffett).

 

 

Next week, I plan to present our thoughts about real estate. We’re getting a lot of questions on this subject again and it seems pretty obvious that we’re approaching an important moment in time. Stay tuned

 

Have a great last week of summer for all of you parents out there!

 

Cheers

 

Sam Jones

Many are calling this breakout to new highs a new bull market.While we can call it whatever we’d like, the price action we’re seeing today is nothing new.It is simply another surge higher in an on-going bull market that began in 2009.So what can we expect from this surge and what makes us nervous?

 

Support Should Hold

 

After nearly two years of a painful congestion in stock prices, the markets have finally become more constructive and more productive in terms of real returns for investors.It’s a welcome change.We’re seeing all time new highs again in a majority of indices and sectors.With our technical hats on, we can draw a few lines in the sand designating key support levels.Any pullback in the S&P 500 should hold about 2100 or 4970 on the Nasdaq Composite.Investors should be back in the buy-the-dips mode but avoid chasing short term bursts higher if possible.So far, we haven’t seen even a mild pullback making this a difficult tactic.Failure to hold above these support levels for whatever reason would be alarming, making this break out, look more like a fake out.

 

The Correlation Between Oil and Equities

 

There has been an oddly high correlation between trends in equity prices and the price of oil.While stocks and the stock market in aggregate have been very strong since the beginning of the new quarter, oil prices have been heading lower.We need to watch this carefully.The technical damage for the commodity now trading below $43 raises a bit of a warning flag for “the markets” based on the recent correlation.But, so far, the markets seem to be shrugging it off.Looking backwards, I couldn’t guess why the correlation has been so high, beyond some sense that oil prices might represent some indication of economic activity.We think that’s nonsense.When the supply of oil is 50% greater than anytime in history, as it is today, we can’t look at price the same way; as a linear function of demand coming from economic activity.Low oil prices are a bonus to consumers and tough on oil companies. So the thing to watch is not really the falling price of oil but rather the market’s reaction.I can only hope (and partially expect), the markets will break the oddly high correlation of the past 6 months.We’ll see.

 

Earnings and Valuations

 

One thing we are NOT seeing so far among 2nd quarter corporate reports, are any really robust bottom line blow out earnings.Revenues are about the same as we have seen for the last several years – modestly positive.But, one of the real changes thus far is the degree to which earnings are beating exceptionally low analyst expectations. This is a chart from Bespoke showing the percentage of companies beating earnings expectations.

 

 

Since 2011, the percentage of companies beating expectations each quarter has come in close to 60%, very consistently.Today, we’re running at 67%, indicating that analysts were just too negative going into this quarter’s reporting period.Of course that could change in the next 30 days.So, the burst higher in stocks is partially driven by upside surprises in earnings, but only relative to very negative expectations.At the same time, when we look at valuations, we see that the S&P 500 is now just more expensive than it was at the last peaks in 2014 and 2015.Unfortunately, when valuations hit these levels in the past, forward returns looking out 12-18 months have not been impressive (less than 2% annually, which is more than the current dividend on the index).So, at least from this perspective, our surge higher in prices should come with some tempered expectations in terms of duration and magnitude.

 

US Dollar on the Rise (Again)

 

A rising US dollar makes for a difficult environment for investors.Typically a rising US dollar is tough on international, income and credit holdings.Also, we need to remember that almost 50% of earnings for the mighty 500 stocks in the S&P are generated from overseas revenues.A rising US Dollar also gives the Federal Reserve more reason to raise interest rates.I think it’s safe to say that a great deal of the volatility in equities that we’ve seen in the last two years has been rooted in the 2013 rise of the US dollar and other currency trends around the world.Today, the US dollar is stable and still below the 100 level of two years ago, but the technical chart pattern indicates we could see a break out to new highs in the coming months.There is simply too much going on in global currency markets to make an accurate forecast so we can only watch and observe current price.Gold investors will want to watch this very closely as well, as a rising US dollar is the arch enemy of precious metals.We have already taken our very healthy profits on gold and will watch what happens next as the US dollar trend looks to be moving up again.

 

Disruptive Politics

 

And then there is this issue.I couldn’t guess at what might happen, or the markets’ response.I’ve been asked 1000 times and my answer is still the same… I don’t know.What I do know is that we are seeing historic lows again in daily volatility.I will be shocked if that condition persists going into the 4th quarter.We should all prepare for some wild price swings, as we get closer to the general election.This is not the time to go way out on that limb of chasing high beta stocks as you might easily find yourself selling the same names in the next few months to cut out some drama in your portfolio.I’ll repeat Buffett’s words of wisdom again.This is a time to seek out safe returns but not maximum returns.We’re on that program 100%.

 

That’s it for this week.I hope everyone is enjoying the summer time with friends and family.

 

Cheers

 

Sam Jones

Is there such a saying as 26^th time is a charm? Doubtful. Yes, after 25 unsuccessful attempts by the S&P 500 to break and hold above the 2100 level, it finally happened. The trouble that began almost 2 years ago, driving volatility higher and stock prices lower, seems to have come to an end. Now things are HOT and investors are scrambling to get LONG for the SUMMER.

 

Cash at a Minimum

 

Back in May, we provided a high level view of where the markets and the economy were from the cyclical perspective.Of course, this is just our opinion but largely based on darn good homework, analysis and input from some very dependable research shops.The link to that update, called “May the 4^th Be With Us” is below if you want to read it.Nothing has changed from that time despite the madness in the UK, the complete change of plans for the Federal Reserve and a near waterfall decline in stocks earlier this month.It’s probably worth your time to review.

 

https://www.allseasonfunds.com/redskyreport/05-05-16-may-the-4th-be-with-us

 

One of the main takeaways from that update, was the call for investors to keep their cash holdings to a minimum and remain largely invested.We are solidly in a Stage 3 environment now, which tends to offer investors many profitable opportunities.Specifically, this is what we had to say.

 

“Cash should be held to a minimum during this phase as all three asset classes (stocks, bonds and commodities) are all generally rising in unison. When there are presumptively so many things to own, why sit in cash?” – Red Sky Report, May 4, 2016
 

 

So we got that one right as our Blended Asset and Income strategies have remained almost fully invested since early June.All Tactical Equity strategies have been allocating cash or removing hedges through the months of May and June as well and are now approaching fully invested status.These are the adjustments we make according to the mandates of our Net Exposure model and one of our key value propositions for our clients. You might glance at your most recent statements.We think you’ll be pleased at what you see in terms of results this year, which are on track to hit double-digit gains by year-end in most cases.

 

Looking out across the landscape of investor behavior, I see several things happening now along this line of thinking.The most obvious thing I see is that investors are sitting on huge piles cash and largely underinvested.Based on the flow of funds data, we know that a great many investors sold their holdings at three different windows of time in the last 12 months.All three dates were near panic days for investors selling and all were largely news/fear/speculation driven with little to do with real changes in economic information. Fear of what the Fed might do, fear of a global recession, fear of politics, fear of Brexit, etc. Below you will find those “Sell” dates and the subsequent returns for Stocks (S&P 500), Bonds (20 year Treasury) and Commodities (Commodity Index) since those dates through yesterday.

 

Mass Sell Dates         S&P 500          Treasury Bonds          Commodities

August 25^th, ’15          +14.4%             +17.07%                          +2.21%

January 20^th, ’16        +14.9%              +13.6%                           +24.7%

June 27^th, ’16             +6.8%                +2.4%                             -1.07%

 

Those who sold at the lows in panic mode without a system or the discipline to follow a system are now feeling two things.First, they are correctly feeling like they made a mistake in all cases.And second, they are now wondering how and when they will get reinvested.Selling everything is a gamble – always – and the odds are radically against that decision being a good one.Very occasionally yes, but very often not.The decision also carries the extra burden of figuring out how and when to get back in.Lots of unproductive brain damage if one is managing their money on a reactive, emotional basis.

 

So we know that many investors with billions of investment capital are going to work extra hard now to get their cash reinvested, now that prices have finally moved out to an all time new high.This is fuel for higher stock prices, starting now. New highs lead to higher highs after two years of almost no returns.

 

Short Squeeze

 

We also know that sentiment toward the markets has been negative, almost absurdly so.We have reported on those figures in the last month, which show up as very low levels of bullishness (Sentimentrader, Bespoke and others).When institutional managers and retail investors, to a degree, get negative on the markets, they tend to increase their short positions.These are securities designed to make money when markets fall.Now that the markets are NOT falling, those with short positions are getting squeezed and are forced to sell.The same effect comes into play.Selling a short position is the same as buying new stock, which drives prices higher again.

 

Defense to Offense

 

Finally, as we move into 2^nd quarter reporting period, we are coming off of a cycle that strongly favored defensive sectors like consumer staples, utilities and telecom.These are the high dividend payers that everyone has fallen in love with over the last year or so.As the market has recovered from the Brexit thing, we’re already seeing a very clear rotation out of these defensive sectors and into offensive sectors, like technology, biotech, internet, consumer discretionary, industrials, emerging markets and small caps.In their last weekend report, Bespoke used some strong language warning investors specifically about new risks that have developed in the utilities sector.Typically this is one of those safe haven sectors that grows a bit and kicks off some reasonable dividends.After a year of investors’ chasing utilities up to current levels, we now see utilities as one of the most expensive sectors in the market!With a P/E of 19.51, Utilities are now more expensive than the Technology and materials sectors.At the same time, the dividend yield has fallen below it’s median of the last 16 years.Every other sector in the markets is simultaneously offering above median dividend yields.

Its not that we hate Utilities but we feel there are now better options.We sold all utility positions yesterday and plan to reinvest our healthy gains into something more offensive in the next week.

 

All said, it seems likely that a new uptrend in the US stock market has begun.We are thankfully in the right place and have the right (full) exposure for this environment.It’s nice to make some money after a long dry spell.Looking forward, this rally could be short and sweet, as elections will come into the picture as we get close to the end of the quarter.For now, we’ll enjoy the ride.

 

Have a great week

 

Sam Jones

So now we’ve seen another reminder of what happens to markets when investors panic. Last Friday was a beast of a day throughout stock markets around the world as they reacted sharply to the Brexit news. Today wasn’t much better. What I find interesting is not the predictable market reaction to the news but what’s happening around the event. Here we begin to see some real insights into the nature of the current financial market environment.

 

#1 Google Search – What is Brexit?

 

Last Friday, the number one term searched on Google was…. “What is Brexit?”. I chuckled too. 10 out of 10 people on the street couldn’t give you a single detail on the BREXIT thing, but they definitely sold stocks anyway. In fact, as the numbers and damage reports come in, it seems that more wealth was destroyed on Friday ($2.8 Trillion) than over the course of the entire stock market crash in October of 1987 when the US market lost over 20% in one day. So let’s digest this information a bit to help us understand the nature of the beast. First, investors are not investors anymore. They are news consumers, buying and selling according to which news item is trending. They watch and listen and hear what sources like Yahoo Finance tell them and they react without thinking. Or they might tune into someone named Jim Rogers (need to Google that name at some point because no one knows who Jim Rogers is). Jim makes a big bold statement to the news, supporting his personal short position against stocks, that we are about to see the worst bear market in history. One person offers his opinion, on one day, and suddenly, he has the gift of sight. He KNOWS the future and thus investors should ACT on his FORECAST! I’m using BIG BOLD caps to emphasize how ridiculous this is. Selling causes more selling because someone must know something right? Well….. no, actually. I won’t bother giving my own opinion on what I think we might see in the way of an economic or market impact stemming from the UK’s departure from the European Union. After all, it would be a total guess and without any substantive evidence because no one knows. Later, like 6-12 months from now, we’ll be able to look back and see what “things” changed and took a new direction as of last Friday. But for now, I won’t waste your time. If investors are this sensitive to news they don’t understand, we can rest assured that the negatives associated with behavioral economics are going to be an impactful part of the market cycle for a long long time. In other words, we can clearly count on the fact that investors, who do not have their own system to invest, or the knowledge or skills to do it themselves, will continue to buy high and sell low.

 

Here’s another insight about the nature of the beast. Investors do not know what BREXIT means but they know that this thing is causing a great deal of portfolio pain as the news is consumed. What we must understand and respect is that investors can see and feel their wealth disappearing now on a minute by minute basis, usually on their phone at work. Perhaps they have alerts set up that say, “HEY, your portfolio is getting crushed, do something about it”. Once again, the impact of our instant information ecosystem and how investors process it means we should expect a highly reactionary market environment. What this means to us, is that we should not be reactive, really ever, but strive to remain in the drivers’ seat of risk management by constantly adjusting our Net Exposure, Selection and Position sizes appropriately – and not exclusively when a news item shocks us into action! Two weeks ago, in this update, I said the following as my first sentence.

 

There’s a lot I don’t like about the market action since my last update – 6/17/2016

 

At that time, we made several adjustments to our blended asset and tactical equity strategies to adapt to the changing character of the markets which was showing real concern for the fate of Europe (as well as oil, financials, banks and transportation sectors). Those changes have kept us largely out of harms way. We sold down or eliminated many of our sector fund positions, we reduced our allocations to high beta stocks and left intact our core holdings in defensive, income bearing securities. Our clients’ portfolios were only slightly damaged last week. In fact, those with larger allocations to our Income models saw those accounts move out to all time new highs. These are the days when our process of generating asymmetric returns across our clients’ portfolios, begins to shine.

 

Betterment Knows Better?

 

This news headline caught my eye. Betterment is one of the new Robo advisors that take investors’ money and puts it into a “robotic”, automated investment programs so investors don’t have to think, I mean worry, about their portfolios. I have said many, many times that the process of managing investments is not a thing that can be automated as much as we would all like. I do appreciate the concept of portfolio modeling and academic research, but I also know from 22 years of doing this, that it just isn’t that easy. Please re-read above if you need to know why. So, apparently on the day of the panic, Betterment shut down their platform for about four hours, fearing that $4.8 Billion worth of investors might want to do some selling. Apparently they know better and are now not making it possible for investors to act on their own money when they want to. They said that they took this step to protect their investors from paying some transaction fees. So if I want out of the market and I don’t mind paying transaction costs, Betterment says, sorry you can’t get out because we have shut down our system. Wow! The real issue here is about control. In our shop we simply have a power of attorney to trade our client’s accounts but we do not restrict our client’s ability to act on their own money in any way if they so choose. I will say with high confidence that this unknown policy, invoked by Betterment in a moment of market panic, will not go unnoticed or unpunished. It could be the end of Betterment and a serious knock to the future of Robo advisors.

 

 

Here’s the short version of what happened from Reuters:

 

Betterment LLC, an automated financial adviser, suspended all trading on Friday morning as Britain’s vote to quit the European Union sent a shock wave through global financial markets, The Wall Street Journal reported.

 

Clients were not aware of the halt, which ran from the market’s 9:30 a.m. open until noon, the Journal said.

 

The company, which manages $4.8 billion, took the step to protect investors from paying the higher transaction costs associated with buying and selling securities during times of extreme market volatility, the WSJ said.

 

Betterment was not immediately available for comment.

 

Looking forward, the Brexit vote will have some impact on global economics and global financial markets but we can’t say what that might look like yet. Today, global financial markets are breaking down more than anyone would like as the likes of the S&P 500 are now trading back below it’s 200 day moving average. Stocks are now stretched to the downside while things like bonds and gold are stretched to the upside. I’m going to expect reversals in both groups starting this week and then we’ll reassess based on winners and losers.

 

I hope everyone is enjoying the summer and staying away from the news!

 

Cheers

 

Sam Jones

No really. As I’m watching global stock sell off by 3% accompanied by all but bonds, gold, the US Dollar and the Yen, I’m realizing that this is exactly what we need to see as a POTENTIAL set up for all time new highs in the 3^rd quarter.

 

Doubt – The Necessary Evil

 

Going into this week, I made mention of the fact that the AAII sentiment polls were still hovering at one of their lowest levels of bullishness in recent years. Meanwhile, other shorter term polls which tend to track stocks very closely were obviously more in the bullish camp as the S&P 500 threatened to make a new high for the year – yesterday. The two measures were incongruous with each other and it didn’t make sense. Now that markets around the world are panicking on the BREXIT news, we would expect all sentiment polls and surveys to swing back together toward the bear camp. What a nice set up for a strong and healthy stock rally! It will take a couple weeks and some slightly lower prices (maybe another 2% lower) to really get everyone convinced that all hope is lost.

 

Now hear this. Never, not ever, not once in history, has investment sentiment correctly predicted a bear market. Bear markets start with near complete euphoria with headlines like “Are You Rich Yet?” We’re closer to the other end of the spectrum in terms of headlines with plenty of doom and gloom everywhere. Remember, human nature is one of the few dependable indicators left that remains contrarian to the direction of stock prices. Why? Because we are simple creatures. We get afraid when we lose money and we get greedy and optimistic when we make money. Sentiment figures represent the combined affect of a capitalist society that lives and dies by purchasing power. If we didn’t care about the daily condition of our wealth, sentiment numbers wouldn’t be useful. But alas… we do. So now that doubt has become the dominant theme among investors in terms of psychology, we should remain open to the real possibility that the 3^rd quarter could surprise many with an upside outcome.

 

Under the Hood of Valuation Concerns

 

Valuations for the market as a whole are high by historical standards. Many have argued that valuations at these levels suggest a compressed return environment until we see one of two things happen. Either earnings will need to start expanding in absolute terms on the back of improving economic conditions or we would need to see stocks fall dramatically to a level where prices are relatively cheap again. At present, there is still very little evidence that the US economy is angling toward recession. In fact, for the last two months, the net total of economic indicators across multiple sides of the economy (housing, manufacturing, consumer, inflation, employment etc) is showing a positive trend higher.

 

It seems that February/March may have been the low point (-14) in the current economic cycle, which obviously corresponded to the most recent low in stocks. Now the trend in both is up. Earnings and stock prices do tend to follow economic trends pretty closely.

 

If we dig a little deeper into valuations, we still see two interesting opportunities. The first is that 6 of the 10 major sectors of the market are showing substantially lower valuations than the S&P 500 as an aggregate. Only four sectors are showing higher than market valuations and one of them is energy, which is now in full recovery mode. Valuations for energy will not fall back until we see earnings expand, which could be very soon. That would leave only 3 of 10 sectors showing above average valuations. Strangely enough, the most overvalued three sectors are all the defensive sectors (Utilities, Consumer Staples and Healthcare). Are investors convinced that the economy is headed toward recession? Maybe but there is most likely another more compelling reason why “the three” sectors have pushed out to higher prices driving up their valuations. The reason is also the second opportunity from the fundamental camp and it has to do with relative dividend yields. Take a look at this chart, also from Bespoke.

What you might recognize is that a great many stocks now offer dividend yields that are not only greater than the S&P 500 but also greater than the best Treasury bonds. Guess which sectors offer the greatest yields? – Utilities, Staples and Healthcare!

 

So investors who are scared about a recession might gravitate toward these defensive groups but others are clearly chasing dividends. No surprise these three groups have the highest relative valuations.

 

In summary, we have to look at aggregate market valuations critically. Yes, they are high but there are still a lot of sectors that are clearly cheap, especially those that do better in an expanding economy. Furthermore, those that are relatively high are still offering investors some real value in the form of regular dividends. Honestly, I hear this high valuation argument almost daily now. But “market” valuation cannot be your only variable in your decision of whether or not to participate in stock investing. Remember, valuations were at this same level in 1996 and stocks ran much, much higher for another four years averaging over 20%/yr. (not a forecast).

 

Earnings in Q3 Set for favorable Year Over Year comps

 

Finally, investors should know that the 2^nd quarter marks the end of a very tough period for year over year earnings comparisons. Looking forward it will be much easier for companies to beat their 2^nd quarter, 2015, which were very soft and low by the standards of 2013 and 2014. There will be winners and losers but we should NOT be surprised to see and hear about earnings’ expansion stories on a year over year basis. Also backing earnings is the fact that one year ago, the US dollar was a lot higher than it is today and energy was in a near free fall. Now energy is stabilizing and not acting like the earnings’ anchor that has it has been.

 

Just thought I would offer a little optimism for everyone on an otherwise nasty day for stocks. Always the contrarian.

 

Have a great weekend

 

Sam Jones

There’s a lot I don’t like about the market action since my last update on 6/8, which admittedly had a bullish tone to it. Such is the plight of anyone attempting to provide a written analysis of current market conditions, as we can easily look silly the moment we hit “send”. Nevertheless, the market theme of resilience in the fact of massively negative sentiment and several serious headwinds still seems to be intact – for now. I’ll review some of what I do and don’t like about this market and finish with some guidance for our clients regarding changes we’re making to our tactical equity strategies in an effort to improve our upside/downside metrics (aka asymmetric returns).

 

On the Upside

 

I like the fact that our market canaries are still singing. These are the more sensitive sides to the market that typically cave before we see a final top in the larger, broader stock market. These are high yield corporate bonds and small caps both of which have seen mild pullbacks in the last couple weeks but only back to their rising moving averages and newly established uptrend lines. So far, this is constructive but we do need to see some strength in both asset classes right here, right now if the market rally is to continue.

 

I also like seeing a great many stocks and equity-income oriented groups continue to push higher, many making all time new highs. This is constructive and gives investors a reason to stay engaged with investing. Dividend payers, REITS, consumer staples, utilities and telecom are all up double digits YTD. This is not a recommendation to buy these as much as calling out the real performance. It really feels like a free lunch in terms of the risk and reward metrics coming from these sectors, which don’t typically offer investors such a profitable experience. Reminder- there is no free lunch in investing, usually someone is eating your lunch as a matter of fact.

 

I like the fact that sentiment is still remarkably negative as shown by the near multi year lows in the number of bulls among AAII sentiment surveys. As I mentioned last update, negative sentiment is the hallmark of new, healthy market rallies, not the beginning of terrible bear markets. Is the AAII group suddenly right on the future direction of the markets? Not likely as they are just as human as they ever were, hating markets that are trading lower and loving markets that are trading higher. The hate today simply reflects nearly 24 months of unproductive markets. The question is, has this cycle also produced some new upside opportunities? Sentiment contrarians would say yes.

 

I also like the fact that the Fed is most likely on hold now in terms of their rate hike schedule probably until the end of 2016 given the slew of issues affecting their policy decisions. We must remember that this Fed, under Yellen, is probably one of the most sensitive we have seen in modern history to global events. They see and recognize that we have become a global economic ecosystem with very clear cause and effect impacts of currency, trade, politics, commodity prices, wars, etc. across borders. I’m not saying they are wrong in doing so, in fact I think it’s about time they did. But, US Federal Reserve policy will not longer operate in a vacuum. It will factor in things like the Brexit vote next week. It will factor the flow of money across nations driven by currency differences. It will factor in negative interest rate credit markets showing up all over the world now. With all those factors, we shouldn’t be surprised if the Fed goes down this path VERY slowly. As investors, we like liquidity and supportive monetary policy and that’s what we have now for the foreseeable future.

 

On the Downside

 

I don’t like the fact that Oil prices have seen some very real technical damage in the last week. The market wants to see stability in the energy sector and this isn’t helping. I don’t like that economically sensitive sectors like transportation look like they want to break down through significant support. I don’t like that financials continue to lead lower as they still represent one of the largest weights in the US markets. Along those lines, some of leadership is also starting to look terrible like the FANG stocks of last year (Facebook, Amazon, Netflix and Google). Europe completely fell out of bed in the last week and broke a four month uptrend. But we’ll see what happens on the Brexit vote. I expect a “no” vote and I expect Europe to rally strongly (just a guess) as a result. I also don’t like seeing the VIX volatility index spiking like it did, up nearly 30% in a just a few days and it did so as Treasury bonds made a strong all time new high. This type of market action has come with heavy down moves in stocks in the past, give or take a week. Technically, I also don’t like seeing our breadth measures turn negative which they did on Wednesday and sell side volume has been on the rise confirming the down move as potentially something more than just a correction.

 

Needless to say, we’re on edge now with the markets hovering again at the same highs of the last two years where we have seen failures in the past. June is statistically the worst month of the year for stocks with an average loss for the month of -2%. Perhaps we’re just seeing a little seasonal weakness, or perhaps it will devolve into something more. At this point, we just have to wait and see.

 

The Quest for Asymmetric Returns

 

We have three strategies that fall into our “Tactical Equity” investment category. They are New Power, High Dividend and Worldwide Sectors. All three are equity only strategies using individual stocks and ETFs. All three approach the markets from a different angle focusing on different types of equities. New Power is purely speculative investing in game changers, newer companies and emerging technologies. High Dividend chases leadership in the dividend growth world. And Worldwide sectors owns “sector” funds adjusting weightings according to the market and economic cycle. Worldwide, also has a growing allocation to international index ETFs, now up to 30% of the strategy. All three strategies in our tactical equity category are under scrutiny by our management team as we feel we need to do better at generating asymmetric returns for our clients. These strategies have made nice gains during this bull market but they have also seen more downside losses in the process than we like. The age old quest is on – How can we make more and lose less? The holy grail right? Our quest is now a daily research project. We are looking at asset class returns and risk metrics, the impact of manager subjectivity, the impact of hedging and adjusting exposure for better or for worse. We are looking at the impacts of trading in terms of costs, taxes, etc. We are considering the degree to which our clients can tolerate downside losses in pursuit of gains. In essence, we are working to evaluate was is working well and what is not in terms of upside and downside capture ratios. In all honesty, we don’t like much of what we see with these strategies in recent years. Our tactical equity strategies are not providing the types of asymmetric returns that we’re clearly getting out of our blended asset and Income strategies at least in the last 4-5 years. The upside is not enough and the downside is too much for our liking.

 

Here’s the good news; we’re starting to see and find some very attractive new approaches that have more to do with portfolio construction and less to do with trading or manager subjectivity. We’re getting close to finding solutions for each of the three tactical equity strategies that should dramatically improve our asymmetry. As clients, you should be smiling. We feel confident that the changes we’re working on and developing now will be more appropriate and productive looking forward as they will be more aligned with market opportunities and trends. Remember, there is no investment strategy that works well in all markets nor is there an investment strategy that never needs adjustment. Think about how the markets move today, the securities we use and the near perfect efficiency we see in processing information. The internal features of the market today are vastly different than the past and thus the methods behind our strategies need to be adjusted over time as well. I’m thankful we have that flexibility. We will have more detail on strategy changes as they are defined and integrated.

 

 

That’s it for now, stay tuned!

 

Sam Jones

The market seems to be angling for a break out to new highs; in some cases it has already done so. Just when it had everyone convinced the bull market was over. Investors who were participants in the 90’s, have seen this before. Here’s what you can expect.

 

Not Done Yet

 

I was mountain biking with a good friend, Josh, who is a mortgage broker here in Steamboat a few weeks ago. We like to talk on the way up, as it seems to hurt less. He was telling me that June would be his largest month on record for volume of new mortgages, second only to June of 2007. Then he hesitated and said, “and we know how that ended”. The implication was that we must be at another long term peak. For many investors, it’s hard not to give into the expectation that prices must peak now because we’re simply afraid of heights. More to the point, many believe the market peaked 15 months ago and must ultimately yield to a devastating bear market. That feeling is everywhere. In fact, as of the end of May, investor bullish sentiment had reached one of its lowest readings in more than a decade. The American Association of Individual Investors (AAII) showed only 19% bulls at the end of the month, with over 50% choosing to be “neutral”. This is extraordinary. I mentioned this in the last update as a condition that does NOT typically yield a bear market but one that is ready to move higher. Bespoke confirmed with some terrific research about forward returns under these conditions. Take a look at the Red bars, which show the forward returns for the S&P 500 over various time periods when AAII sentiment figures reached these pessimistic levels in the past. Wow!

I told Josh that strangely one of the things I have struggled with the most in client conversations is “talking up” the possibility that this bull market is not over yet. With the intent of setting client expectations, we should all understand clearly what kind of opportunities and risks lay ahead, all things considered.

 

Strong but Short Move Higher

 

If the markets really want to break out to new highs in the aggregate using the S&P 500 as a “market” proxy, we would need to see a solid close above 2130 which was the high level set over a year ago. Today, we’re only a few points away. As most investors know, stocks have gone no where in almost two years with several sectors like energy and commodities causing a great deal of pocket pain. Small caps and internationals have also dramatically underperformed as well, down nearly 20% from the highs at their worst. Now the situation is far more constructive with nearly all countries, asset classes, sectors and styles of investing, moving higher in sync. Many have broken long down trends in the last two weeks as well. The rally off the lows in February has been broad based with plenty of supportive technical evidence like breadth and volume. So for now, it seems likely that the lows in February were not the BEGINNING of a bear market but rather the exhaustive END of a long and unproductive market correction that began in the summer of 2014 (no typo). Remember, the end of the 2008 bear market finished much the same way with an exhaustive capitulation type selling cycle in early 2009. In the first three months of 2009, stock prices were down almost -26%! But, once prices finally reversed to the upside, we saw explosive growth for several years. Make no mistake, the situation now is not the beginning of a new bull market however, quite the opposite. The US stock market is already up off the lows by nearly 200%, valuations are still very close to one of the highest levels we have seen in modern history. Investor margin debt is also at an all time high and now liquidity is in question with the Federal Reserve’s new policy of raising rates – slowly.

 

 

There are only two things that drive stock prices. One is earnings and the other is liquidity. I would add that investor appetite would have to be a close third as there must be some underlying level of confidence for investors to commit to ownership. Today, earnings are unimpressive having peaked in terms of marginal growth at the same time as stocks in late 2014. Plainly stated, any sustainable surge in stock prices from here will have to go hand in hand with a surge in earnings and some real evidence of new economic growth. It is possible? It’s very possible. I would point to the falling US dollar as a catalyst for higher earnings. I would point to a cycle of labor replacement where companies are laying off older more expensive workers and replacing them with younger new employees who are quite talented and hungry to start their careers even at entry level pay. Labor replacement is a quick way to boost earnings without changing your business very much. I would also point to pending fiscal stimulus, which I’m beginning to see. These are the government, shovel ready, jobs that serve as economic stimulus instead of the more ineffective monetary stimulus. We won’t see this until 2017 with a new administration. Finally, I’m seeing new and resurgent demand from outside the US coming from Asia, Emerging markets and parts of Europe. If China can finish their economic soft landing soon, we could see a dramatic pick up in global economic demand and earnings.

 

 

From the liquidity side, we have to remember that even if the Fed raises rates, they are coming off of years of Zero Interest Rates and years of QE. They can raise rates 8-10 times and we would just be back on par with a “normal” central bank interest rate environment. Some are arguing that liquidity is drying up. I would argue that we have liquidity everywhere, like a flood, and it wouldn’t hurt us a bit to do some mopping up.

 

All told, the opportunity exists for stocks to move higher from here. Our best guess in terms of magnitude is roughly 12-15% higher if earnings can accelerate a bit and we continue to see surging economic indicators with near full employment. But, we shouldn’t expect a lot more than that from a longer term perspective. Ultimately, global stock markets will give in to another painful bear market just as they have done for the last century. This looks like an extension of the current bull market, but not the birth of a new bull market. Set your expectations accordingly.

 

Jim Stack of Investech had a great piece of advice for all investors, which I’ll share with you in my own words. He said, this is the environment to pursue SAFE profits, but not try to MAXIMIZE profits. The wisdom of ages. We are doing just that in all strategies. While we are nearly fully invested again, a quick look at our holdings will show a nice blend of offensive and defensive positions, leaning on income generators, value styles and oversold sectors instead of chasing areas of the market that are clearly still absurdly overbought.

 

We’ll enjoy this wave of returns for as long as it lasts keeping our eyes on the big picture.

 

That’s it for this week, stay cool!

 

Cheers

 

Sam Jones

The Federal Reserve is talking again, working hard to (re)convince the financial world that rate hikes are still possible and coming soon. If we believe the message, and we trust they are looking at good data, we need to be aware that we could be looking at a significant change in the character of the US economy and thereby our investment choices looking forward.

 

Dependent on Which Data?

 

The Federal Reserve is steering the US economy with words alone. Guessing what they will say is not a good investment strategy as their message seems to change from one quarter to the next. Nevertheless, their words do have an impact on global currencies and credit markets leading to changes in leadership and preferences among stocks. Last week we heard the message that rate hikes are still very much a possibility in the coming months but decisions will be dependent on the data. Wouldn’t we all like to know which data they’re talking about? I looked for an hour and found nothing consistent suggesting there was a specific set of data they were looking at. We should all conclude that they are just looking at a lot of data and hoping to make the right decisions regarding the current trends in prices, costs and labor. Needless to say, they are driving an enormous ship in uncharted territory so even a slight wrong turn can have some rather serious consequences. You can imagine why they would want to consider everything (all data) and move very slowly. On the other hand, we could also see the Fed failing to act when they need to in the proverbial “paralysis by analysis”. If I were the Federal Reserve, these are some of the data points that might suggest rate hikes are still possible.

 

Rising Labor Costs – Still at full employment with SOME new signs of wage pressure. This is inflationary.

 

Cost of Materials – All things that hurt if you dropped them on your foot have been rising sharply since February (metals, wood, a barrel of oil). This is also inflationary.

 

Higher Global PMI Index – Purchasing Managers Index had its first rise in nearly four months. This is notable as this is often an early sign of an economic rebound.

 

Earnings Guidance Higher – For the first time in 18 quarters (yes you read that right), corporations actually offered net positive future guidance for their earnings this quarter. This is big!

 

Global Risks Diminishing – The US Federal Reserve is now operating like the world economic police. They are factoring in the impacts of global trade including the health of our trading partners. This was their comment from recent minutes.

 

“A few participants judged it appropriate to increase the target range for the federal funds rate at this meeting, citing their assessments that downside risks associated with global economic and financial developments had diminished substantially since early this year.” 

 

Average House Prices Make a New High – Those who still own their homes are feeling some wealth effect again associated with their home prices. Homebuilders are busy, inventories still very low. Real Estate price trends are not done moving higher on basic supply and demand. Raising rates a bit won’t kill the trend.

 

Energy Crisis is Abating – It’s hard to get excited about energy anytime soon but the number of bankruptcies, mergers, drop in active drilling rigs, and some price stability indicate that the energy complex is beginning to heal. It will take years but the acute part of the POP in the energy bubble is now over.

 

On the other side of the discussion, we have some variables that don’t inspire me (acting as the Federal Reserve) to raise rates. This is a slow and sluggish US economy that is starving for demand. Will raising rates help that situation? Probably not. On the other hand, supply side efforts called QE or keeping rates at zero have done zero to spark the engine beyond a little tailwind to real estate. China is an unknown but not in great shape. Furthermore, I have to worry what Wall Street will say about me if I raise rates. It is a popularity contest after all right?

 

Just looking at the weight of evidence, I wouldn’t be in a hurry to increase rates again but the data does suggest that I have enough reasons to do so perhaps sooner than many expect.

 

Changes in Investment Choices

 

If the Federal Reserve does move forward with raising rates, we can expect the US dollar to continue on with its uptrend that began nearly three years ago. Last week, may have marked a significant low point in that longer term uptrend. A rising US dollar environment for investors requires more work and selectivity for investors. Specifically, we need to get our money a lot more focused in companies with high free cash flow, low debt, and those that generate most of their revenue domestically. On the bond side, we become critical of all Treasury bond oriented income. Commodities can continue to do well as a late stage leader with the exception of gold and silver, which are simply inverse US dollar trades.

 

Sector strength should favor banks and financials, tech and semiconductors, healthcare, industrials, materials and consumer staples. Losers can be consumer discretionary and utilities. Dividend payers become less attractive in a rising rate environment as well.

 

Also, watch small caps in here as a rising US dollar is supportive of small and domestic areas of the market since they derive most of their revenue in the US and profits are not hurt by adverse exchange rates.

 

We are beginning to follow these trends in our own strategies, leaning on our selection screens now more than our net exposure screens. Last week we sold ½ of our gold position for a very tidy gain and will sell the remainder today. We also bought small positions in financials and semiconductors via individual names as well as sector-oriented funds and ETFs. As a reminder, this is what we do for our clients. We do our homework; we understand how the market works and where we should be looking for new opportunities. We keep our clients’ money in the right places making adjustments only when needed.

 

And to answer your question, yes the broad US stock market can move out to new highs even as interest rates are rising. In fact, rising interest rates are supportive and indicative of a stronger, expanding economy at least up to a point. A stronger economy leads to stronger earnings, which lead to stronger stock prices in very general terms. Ultimately, when short term rates push up past 4.5%, the historical patterns tell us that financial markets feel the headwind and run into trouble. But we’re a long long way from 4.5%. Today, we need to respect the market pattern, which has been troubled, toppy and flat since mid 2014 – see the chart below. At the same time, we still need to remain open to something unthinkable – an all time new high.

 

 

 

That’s it for this week. Get out and enjoy one of the best times of the year!

 

Cheers

 

Sam Jones

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

 

Best Six Months?

 

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

 

Europe – 5.11%

World Stocks – 3.13%

S&P 500 – 2.20%

Nasdaq Comp – 7.40%

Nasdaq 100 – 8.00%

Russell Small Caps – 5.86%

Commodities – 6.35%

 

 

Apple -21.59%

Netflix -16.58%

 

Hedge Fund Indices -8%-10%

 

Barclays Agg Bond +3.20%

 

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

 

Where Are We?

 

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

 

 

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

 

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

 

Cycles and Asset Classes

 

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

 

 

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

 

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

 

As we say in our Explicit Investing Creed:

 

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

 

Hope you had a super Star Wars Day!

 

Sincerely,

Sam “Jedi” Jones

It’s so predictable to see the same financial headlines every time the market bounces back up to the old highs. Why pay an asset manager who is destined to underperform most stock indices right? Why not just buy the free to own Vanguard Index funds and forget it? I’ll give you two reasons. This update will build on last week’s commentary (False Expectations) offering you more surprising realities. This update is especially important and timely as we are just now beginning to see a very significant, perhaps generational type, rotation in asset class performance.

 

180 Years of Market Drawdowns

 

Ben Carlson, from “A Wealth of Common Sense”, recently highlighted a piece of research called 180 Years of Market Drawdowns – originally created by hedge fund manager Robert Frey. Here’s the link to Ben’s commentary, which is worth a read if you have the time.

 

http://awealthofcommonsense.com/2016/04/180-years-of-market-drawdowns/

The gist of the research pointed to a simple fact that the financial service industry loves to ignore. It is simply this; Drawdowns, or periodic losses in the market are a lot more common than most investors might be aware. Of course, our industry would like you to think that stocks just go up and up and up all the time, making new highs regularly. The truth, going all the way back to the 1800’s is that the stock market spends more than a quarter of “the time” in a period of loss of recovery (aka not making new highs). Now magnitude is everything, right, because we might say, that’s not so bad! If stocks go up 75% of the time and are in some form of drawdown only 25% of the time, those are good odds. I just buy and hold an index fund! But when we look at the magnitude of drawdowns and measure them, we also recognize that these losses can be enormous, normally wiping out 50-60% of all previous bull market gains on average in a very short period of time. We saw it happen not once, but twice in the first decade of the 2000’s. Now if investors had ice in their veins and did not sell anything at the lows, then one could argue that for long term investors, prices do in fact generally go up. But we know with hard evidence from years of research in behavioral finance, that investors do sell at the lows making recovery nearly impossible. Here’s a clip of the historical market drawdowns including their frequency and magnitude.

Statistically, here’s how it breaks out according to Ben.

 

Drawdowns (losses)                      % of the Time

5-10%                                                  12.8%

10-20%                                                 13.1%

20% or more                                         23.1%

 

It is the “or more” event that really crushes investors.

 

So the first and best reason anyone should pay an asset manager is that they have the capacity to reduce their exposure to market drawdowns and keep their portfolio capital and wealth intact. Said another way, you should NOT pay an asset manager who does not have that capacity. You should in fact just buy an index fund and save yourself some money. Our clients know that we are strictly in the business of offering risk managed investment strategies to High Net Worth households (or those on their way). Our mantra is “Create Wealth, Defend It” and we will shamelessly say that is always worth paying for.

 

The 60/40 Myth

 

The second reason why anyone should pay an asset manager has to do with the myth of the 60/40 model promoted by the passive index fund world. The 60/40 model suggests that an investor need only buy 60% stocks and 40% bonds, indexes of course, and that’s the best anyone can ever do over time. Bear with me as we walk down the road of risk and return statistics via something called the Efficient Frontier, a favorite of aging academics. The efficient frontier is a curve showing an assumed relationship between risk and return for various blends of stocks and bonds. The idea is that a portfolio with heavier weight in stocks versus bonds will naturally show higher risk AND return properties. The standard curve using data from the last 50 years, looks like this.

 

 

Now, if we dig deeper into the data, we find that the shape of this curve changes radically on shorter periods of time. Below, you’ll see the shape of this same curve plotted by each decade. As we discussed last week, the relationship between risk and return for stocks and bonds radically changes over time periods as short as a decade and we might be very close to just such a change now. Think about bonds and where they sit today at near zero interest rates. Where can they go from here? Some countries are playing with weapons of mass destruction by allowing negative interest rates on their bonds. That won’t (can’t) last. The more likely outcome is an environment where bonds, assumed to be in the low risk, low return side of the curve, will in fact create negative returns for your 60/40 portfolio as rates begin to rise again over time. This changes the curve and thereby changes the outcome of your portfolio unless significant adjustments are made in your portfolio asset allocation on a timely basis. This is what we do for our clients.

 

• 
  •        Source Greg Morris – “Questionable Practices 2015”

 

Understanding that this concept may be beyond your patience for financial theory, let me break it down to simple terms. Nearly every decade in the last 50 years we have seen rather dramatic shifts in the risk to return characteristics of stocks and bonds. A manager who is capable of recognizing these shifts early in the rotation can save your portfolio from experiencing an undesirable outcome. As anyone who owned a standard “balanced” fund through 2008 knows, losses can still be dramatic, devastating and recoverable only after many many years of positive gains. Again, paying for a manager’s ability to dynamically shift your money to overweight or underweight an asset class at an appropriate time is…. Priceless.

 

A timely reminder while we wait to hear from the Federal Reserve regarding their plans to raise interest rates in June!

 

Have a great week!

 

Sam Jones

 

 

Follow Us on LinkedIn!

 

 

After years of dragging our feet, we have created and launched an All Season Financial Advisors’ LinkedIn page. We invite you to check it out and “follow us” by clicking on the link above.

 

Why should you follow us? Several reasons…..

 

• We know many of you are already using LinkedIn and we want to be there too.
• We will be posting all Red Sky Reports here, which are much easier to read on mobile devices.
• We will also link to our favorite articles on topics like personal finance, tax strategy and other information that we think you will want to read.
• We will post announcements for upcoming Solution Series Live events as well as invites to other company events.
• You can easily link up your friends, family and work associates with your favorite money manager (wink).

If you’re not on LinkedIn already, it’s free and easy to sign up. Think of it like Facebook for important information like what’s happening with your money.

 

We hope you’ll join us!