Category: Finding Benjamin

Knowing when to sell is always the hardest thing about investing. After years of rising prices, we all have a sense of worry about pending doom. But, really that “wall of worry” is a characteristic that remains pervasive through all RISING market trends. We always think the end is right around the corner. In my experience, it’s really when that sense of worry is gone and greed dominates the air space, that we have to seriously consider sticking our money under the mattress. But even sentiment toward the markets doesn’t just flip on one day. It erodes over time, just like market participation, and sector break downs, currency devaluations and confidence. Our job, inherent to our Net Exposure system, is to stack up all of this stuff in order to determine how much money we should have exposed to the markets. The weight of evidence is stacking up leading us to cut exposure (again).

 

Sentiment – Now Worse Than July!

 

Sentiment figures reported are almost always contrarian in nature. We monitor them through the good work of Jason Goepfert of Sentimentrader.com . Back in June and July, every seemed to be worried about a major decline (“smart” money and “dumb” money.). Dumb money is of course regularly wrong on the short term direction of the market and represents the vast majority of investors. Smart money is more often right on the future direction but not perfectly. When both groups are at extremes – opposite each other – these are the moments we need to be especially vigilant. Take a look a this YTD chart of the two groups, provided by Sentimentrader.com

 

 

There are several important things happening here. First, let your eye fall to the late July period when both smart and dump money readings were BOTH sitting on the .50 line. This was a time when we saw virtually no extreme readings which equals no opportunity to either sell or buy the market. From that time into the lows in late September, we had a clear set up to….. BUY. The Dumb money finally sold everything and the Smart money was at its most bullish confident position of the year (blue spike). This was when we sent out our note – Calling All Cars – Time to add to your accounts. Remember that? Now, here’s the important part. After a huge rebound in the market back up to the old highs as of yesterday, we now have exactly the opposite situation and really the second clear moment when Dumb money is again overly confident and Smart money is showing one of its lowest levels of confidence. As I said earlier, when we see extremes in both groups, we often have an actionable moment as investors. In a nutshell, from a sentiment perspective, this set up is far more serious than anything we have seen since February. This is not good and we have cut exposure in all portfolios today as a result.

 

Consumer Confidence – Weak

 

Along those lines, in the last several months, we have seen consumer confidence numbers get significantly weaker. Consumer confidence, like real estate and jobless claims has been one of those things that we have become accustomed to leaning on as an indication that the economy is still on strong footing. We couldn’t know what drives a consumer to feel confident (or not) but the survey results are what they are. If I had to guess, it would be some combination of basic fear (lots of negative news out there) and a brooding sense that our earned dollars are just not getting us as far as they used to. Personally I am disgusted with the new costs of healthcare insurance for my family and employees of our firm. Eating out has become almost prohibitively expensive, taxes are crushing everything by way of sales, property and income. Services are crazy expensive and that’s where we spend more and more of our money. How about your cable or mobile phone bill? Did you ever think you’d be spending $300/ month on that stuff? Yes some of this is discretionary. At the same time, I continue to hear only about how cheap gas is such a “Windfall” gain to households. Yes, I am saving approximately $40/ month now due to lower gas prices. My monthly healthcare premium just went up $400/ month. I can see you nodding your head in agreement. You get it. Back to the point. Consumer confidence falling in the weeks ahead of the biggest blow out moment in US consumption is also probably not a good thing. This adds to our growing stack of negative indicators, especially as it relates to the consumer discretionary sector. Note – take a quick look at what’s happening in the consumer sector (cyclicals/ discretionary). One name is keeping the entire sector afloat – Amazon. The rest of them have already sunk – Macys. The middle chart is the consumer discretionary ETF (XLY). This is a common story of winners and losers all within a sector. We’re seeing it in technology, financials, transportation and healthcare. It is the reason why I still like stock picking strategies now. At least they have a chance to pick off winners while your every day mutual fund or “packaged” investment portfolio with naturally own both winners and losers. Second note – do not buy Amazon now please. We cut our Amazon position in half last week putting a rather large gain in the bank for our New Power investors.

 

 

The ECB, the Federal Reserve and Other Stuff We’ll Never Understand

 

Today was one of those days that we could never understand. Why does the US dollar lose 2% when the ECB decides to cut rates and embark on another round of QE for Europe. The Euro should have declined leading to a rising US Dollar by the now broken rules of international finance. Why do our long term US Treasury bonds lose 2.72%? Do we suddenly have inflation in the system? Crazy. What I do see are two things happening. I see an entire financial system that is behaving oddly and I see modern portfolio theory failing badly. Modern portfolio theory says that when stocks fall, bonds rise is a flight to safety. So much for that. World stocks were down 1.4 – 3.5% today, bonds down in that range as well. Gold and select commodities were up slightly after making a six-year new low yesterday. Once again, I am entering ALL ASSET CLASSES DOWN YTD in my journal for today. Very odd.

 

Selling Pressure Still Dominant

 

Lowry’s Research does a great job of creating a Buying and Selling Pressure indicator, which is one of those inherent to our Net Exposure model. As you can see below, Selling Pressure moved to the dominant position in July and has remained so since even though we have seen all time new highs in the likes of the Nasdaq 100 and select other indices. I don’t like it. We were hoping to see Buying pressure regain the dominant position and it still might but a failure in the market now would accelerate the Selling pressure from it’s current dominant state. If we don’t see a quick rebound in stocks like tomorrow or early next week, the weight of this evidence will become heavy indeed.

 

 

Again, we never hear a clear bell indicating a top is now. Rather we see this weight of evidence unfold and let it paint a picture for us. For now, I don’t like what I see.

 

Sorry for the holiday lump of coal

Sam Jones

Thanksgiving weekend sort of marks the beginning of the end of the year for me. It acts like an intersection where we look both ways before stepping forward. For this update, we’ll look backwards at the challenges of 2015 and forward toward the developing landscape for 2016.

 

2015 – A Tough Year For Everyone

 

Actually, I’m going to say with clarity that 2015 will go down as the hardest year of managing money in my 22 year career. I’m going to complain for a moment but it will tell a story that you might not be aware of. If we back up the tape, we had/have geopolitical turmoil (Russia, ISIS, Greece), we have had global and sector level devastating bear markets (China, Energy, All Commodities, High Yield Bonds, Metals and Mining, Brazil and Emerging markets), blow ups in bell weather stocks like Walmart, Qualcomm and Caterpillar, Inc. We weathered through trendless equity markets (S&P 500 crossing above and below the 2100 level 40 times now?) and subsequent flash crashes of 13% (US Markets in late August). We have seen corporate earnings beat very low estimates but continue to get marginally weaker in absolute terms each quarter (Q3 aggregate corporate revenue growth was the lowest since 2009). Monetary policy has flipped three times by my count; between policies of support and easing rates to expansion angling to raise rates. The US dollar ripped strongly higher into May only to correct sharply through September, and now back out again to a new 4 year high. And in early November, I made a note in my investment journal in all caps – ALL ASSET CLASSES NOW DOWN YTD (bonds, stocks and commodities). Of course, things like a global pandemic (Ebola) reaching US soil created some issues as well. Real estate seems to be a bright spot along with continuing strength in employment, higher savings rates, and low inflation and yet there seems to be very little consumer demand in the system or certainly a willingness to invest in anything (individuals or corporate). Black Friday is a bust, no one shopping. Wow, what a year.

 

As trend followers, you might begin to understand the difficulty in finding good homes for investment capital that last more than a few days – or hours. Yes, I’m bitching and whining. We’re exhausted and tired of trading with nothing positive to show for it. Virtually all of our investment strategies are down on the year, a little, but strangely I’m thankful that we didn’t we have any blow ups at the same time. “Would have” or “should have” voices dominate my thoughts daily but I know this is just the nature of the beast. We’ve been here before. We follow our system which is built to allocate money appropriately and dynamically using sound design, controls and features. But it doesn’t guarantee perfect results. We’re not happy but we accept that some years are just tough for our style of management.

 

In October of 2014, at our annual client meeting, I stated clearly that we were entering a transition period for the financial markets. After six years of economic recovery from the great recession, the system was clearly ready to wean itself off of Federal Reserve life support and a zero interest rate policy. This was easy to see from a market perspective and we have played this well by holding positions that benefit from a rising US dollar, including investments in the US Dollar itself. What was less clear was the emergence of all the other stuff listed above. Just coincidence? Sympathetic events? But here’s the good news; we’re getting through it. 2016 is not going to be like 2015.

 

2016 – New Opportunities

 

I see more opportunities to make solid investment returns in 2016. I can’t say with any confidence what the broad market stock indices will do. We could see our current correction turn into a full blown bear market on the back of weak global demand and new signs of global recession or we could see the Dow at 20,000 by Labor Day. I can easily make a case for either scenario along with the hoards of market gurus pointing in exactly opposite directions. Historical precedent, seasonality, cycle work, technical and fundamental evidence are all conflicted. Passive indexing might be a (lucky) winner again like 2015, or it could be a source of great anxiety. We’re not willing to hold and hope for any specific outcome at this point. The chances of a real global bear market look higher closer to the end of the year in our view and that would be the case only AFTER the Federal Reserve has raised rates 3-4 times. Unfortunately, that is a consensus view and the market loves a good surprise. We need to remember that bear markets are cleansing events that wash away excess, reset value and offer investors real return opportunities; something we haven’t seen since 2009/10. If the broad market wants to blast higher, with classic late stage multiple expansion and stronger participation from multiple sectors and asset styles (not just Amazon and Netflix) that too presents return opportunities. These could come early in the year.

 

From a value perspective, there are plenty of options. The problem is that the best values continue to lose ground every week now. We will remain patient. Some of the very best value managers of mutual funds with brilliant long term track records are down double digits this year, some making new lows even last week. These are funds like Longleaf Partners, RS Partners, Heartland Value, Aegis Value, Third Ave Value and yes Berkshire Hathaway! When the broad US capitalization weighted stock indices like the S&P 500 finally buckle, we’ll be checking in daily with our value favorites. My guess is that they will suddenly begin to rise and never turn back having accumulated all the shares of the stuff that everyone hates now (energy, materials, metals, industrials, emerging markets, China, India). We are already finding attractive entry points for individual companies, now considered value plays, for our all stock strategies. At some point soon, we’ll also be able to pick up some best of class value ETFs and mutual funds for our Blended Asset strategies as well. These present enormous return opportunities.

 

I also see a developing opportunity in High Yield corporate bonds for all of our Income strategies. This asset class is very likely in a bubble and may have begun the process of bursting. High yield corporate bonds are already in a downward spiral and we have exited all positions across all strategies. Default rates are on the rise among energy and consumer discretionary issues and we have seen far too much late money chasing yields with false assumption surrounding the inherent risks. If the Federal Reserve embarks on a period of higher interest rates, High Yield will subsequently get smashed. We saw this happen in the year 2000 and 2008 associated with the collapse of global stocks; again after a short period of tightening by the Fed. Again, bear markets in any asset class create opportunities. The best and strongest returns for our Income models have both come in the years following deep sell offs in High Yield bonds. I am optimistic for these programs in the later half of 2016 and beyond and will be loud about recommending them to our clients when the time comes.

 

While 2015 was a just a messy year of chaos and disorder, we see 2016 as year of resolution with more clarity. Clarity does not have to mean rising prices but rather clearer trends with fewer unknowns. Last week, in my regular client reviews, I had several conversations about performance in the past year and what we expect looking forward. We haven’t made money so far in 2015 and that’s always a disappointment but all strategies are still within short striking distance (3-5%) of all-time highs. Given the opportunities, deep value discounts and larger risks I see in the market, I think the results of all risk managers or others committed to trend following or dynamic asset allocation will be profoundly better on a relative basis looking forward. Our least attractive moment is in the late stages of every bull market (now) to be followed by our most attractive moments as the market finds resolution (next). If I have a concise message to all clients in here, it would be this; Stay patient and you will be pleasantly surprised.

 

I hope everyone has a happy and carefree holiday season surrounded by your most important assets – friends, family and personal health.

 

Cheers!

Sam Jones

This update is more of an FYI piece regarding two of our strategies, specifically the New Power Strategy and the Foundations strategy. The intention is to provide a little real time education and insights into our systems and how we adapt to market conditions.

 

New Power

 

For those who have been involved since the beginning, you know that the title of this strategy is probably a misnomer, at least since 2012. At that time, late in the year, it became obvious to us that our original design and scope of the New Power was too narrowly focused on clean energy and clean technologies. The Ah Ha moment came when we recognized that the massive disruptions and “game changing” events happening in the energy complex were also happening in other industries. The world had become a very dynamic place at least from an investment perspective. In late 2012, we effectively split the portfolio in two. One half would remain committed to the energy revolution which includes transportation, and efficient building as wells as companies that are providing solutions to global resource scarcity. The other half was committed to companies from multiple sectors that are acting as pioneers in their industries (like Tesla), those who are facilitating consumer trends (like Amazon) or Integrating people and businesses (Linked In and Facebook). Here we see a lot of technology companies, relatively new public companies or those who are gobbling up market share through their attractive enterprises. New Power is, and has been, a Game Changers’ portfolio of stocks across all major industry groups.

 

The recent changes we are making are specifically to take positions in Chinese technology stocks (Baidu, Alibaba, Sina and Enersys so far). This process started in early October and continues today. Yes, we see the risks but there are several realities that we believe make this an attractive place to take small positions. First, we have seen the Chinese stock market as a whole correct nearly 32% in only six months. Prior to the correction, their markets were leading the world, outperforming most developed and undeveloped markets for the previous three years. Economically, China has been getting weaker, slowing to right around 6% annually. 6% ! Which country in the world is growing at even 1/3 of that rate? Zero is the answer. A hard landing does not seem likely to us and there is the real possibility that their stock markets are already building a constructive pattern for a new bull market. Second, we have Chinese demographics. China is home to one of the world’s largest populations… of young people. They are in the front end of their lives, gathering steam, spending money, building cities and infrastructure, generating income and for the first time in the country’s history, we are seeing the emergence of a middle class. I think it’s common knowledge that the US and most other developed countries are literally in the opposite situation on all fronts. As such, China’s share of global GDP continues to climb even through the recent “slowdown”. Finally, we have the final reality that the new and emerging Chinese middle class is going to behave much as we have in the last twenty years embracing companies like Apple, Amazon, Google, etc. China has their own local versions of these companies and these are the names we are buying as most are trading at deep discounts. Ironically, last week we reduced our position sizes in Amazon and Facebook back to their original investments as both have nearly doubled since purchase. We still love both names but have a little fear of heights given the recent moves.

 

From a portfolio allocation perspective, New Power can be a part of any portfolio as long as it doesn’t represent more than 10-15% of the total. In fact, for our younger clients with longer time horizons, I will recommend an allocation to New Power anytime. The volatility in this strategy is large but the intention is to generate commensurate returns over time. Personally, I have added to my New Power strategy account as I see the opportunity and like the focus of these investments.

 

Foundations

 

Our “Foundations” strategy is designed to be our most cost effective and probably most traditional investment portfolio offering. It invests in very low cost ETFs and index funds and employs a slower investment allocation approach using a blend of asset classes. Boring!, you might say. Sometimes boring works quite well and in fact this is one of those years. Foundations is tracking most of the broad stock indices nicely and doing so with almost 1/3 lower volatility. It also has a bear market safety mechanism that you won’t find in the typical passive asset allocation model – which you can do easily on your own. The safety mechanism is the same system that governs all of our investments strategies (Net exposure, Selection and Position sizing). All three of these criteria are at play in the Foundations model. Today we have made a change to the asset allocation mix using these criteria.

 

For the last three years, Foundations has carried little to no exposure in commodities. Commodities have been losing ground nearly every week since late 2012 making 12-15 year new lows in price in the last couple months. We are not yet ready to buy commodities aggressively but the environment is looking more and more attractive as a bottom potentially develops. Energy may have bottomed already. The important thing we are doing now is carving out some space in the portfolio for these types of positions. Commodities are similar to real estate in that both offer investors one of the few remaining sources of true asset class diversification. Treasury Bonds are done in serving that role. Our new carved out section of Foundations represents a total of 20% of assets with 10% available for real estate and 10% available for commodities. These are simply maximum guidelines and do not mandate full exposure at any time.

 

What we often see in our industry is a lot of rear view decision making. Every week, I am now seeing mutual funds and closed end funds in the emerging markets and commodities space, close permanently. Investors are giving up in these areas looking only at returns over the last three to five years and yanking their money – after realizing huge losses. Goldman Sachs has just shuttered their BRIC fund (Brazil, Russia, India and China). I won’t be surprise in the least if these are the leaders of 2016. Foundations already has a 30% allocation to World stock index funds, maybe we’ll find ourselves rotating into more international indices next year, as these have been the laggards in 2015. The final allocation for Foundations now looks like this:

 

30% World Stock Indices (The “world” includes the U.S.)

25% Sector Funds

10% Real Estate

10% Commodities

25% Tactical High Yield Bonds

 

That’s it for this week, just a little housekeeping with some embedded investor education. Big snow up here in Steamboat Springs, come and get it.

 

Cheers

Sam Jones

It has taken the US market two months to recover from the deceptive path laid out by Janet Yellen and the Federal Reserve at their September meeting.  At that time, they stood at the intersection of Expansion and Contraction streets and nearly blocked the expansion path directing all traffic down the contraction path.  Everyone knows, you should not fight the Fed right?  Well after 60 days of strong earnings and very clear expansionary economic reports as well as 9% rally in global markets, it seems their directions weren’t great and we’re now breaking down their verbal blockade.  This Fed is the most gutless I have encountered in my career and I have no confidence that they will make tough choices or the right choices when they need to.  We’re on our own now and we plan to ignore the Fed almost completely in the months ahead choosing to believe the evidence that stands tall.

 

Quality of This Rally

 

It’s been a little while since I sent an update so let’s get caught up.  The quality of this rally has been good on all fronts.  Breadth, volume, upside thrust, % of stocks above 50 day moving averages, and leadership all suggest this rally is more than just a snap back bear market move.  Even small caps have joined the party.  Now, no market is without some risk and I still see some concerning trends in the tell tale High Yield corporate bond sector which tripped back to a sell signal last Friday.  I also see a disturbing concentration of buying enthusiasm in the likes of Amazon, Netflix, Facebook, Google and Apple.  So while I see expanding breadth and participation, the price action in the S&P 500 is acting much stronger than the markets as a whole on the back of a few mega caps stocks.    Bespoke had a lot to say about this in their weekend report where they showed that the top 50 largest stocks in the S&P 500 are up +8.5%, while the bottom smallest 50 stocks are still down -14.1% YTD.  That is an enormous difference by historical standards and its sort of a mathematical miracle that the index itself is positive at all.  Nevertheless, the majority of evidence still points to the fact that the rally off the lows on September 28^th has been more than just a bear market bounce.

 

Now that the benchmark indices have rebounded all the way back to the very highs of the year (or within 2%), we should expect some new downside volatility.  I’m a bit late in saying this as the Dow is down 200 points as I write and slipping negative again YTD.  This is the place where the bears will try to push the market lower and take short positions.  It is the place where some (including ourselves) will sell weaker positions and use the pullback to fine tune portfolios toward new or persistent leadership.  On Friday, we sold our consumer staples funds, real estate funds and our most liquid High Yield corporate bonds.  New buys to replace those positions are ready to go.

 

Renewal of the US Dollar Uptrend

 

The US economy is doing just fine and the employment report on Friday was a BIG thing.  No only did the non-Farm payroll numbers blow out expectations (to the upside), but we are now seeing real and robust wage inflation.  We have been expecting this and now its hear.  At full employment, the only dial that can really budge is wage growth, which for every one, should be a wake up call that real inflation is coming perhaps for the first time in nearly a decade.  Bonds responded as they should and tanked.  The US dollar responded as it should and rocketed higher by 2%.  I won’t comment on what the Fed may or may not do.  This environment is the very track we were on until May of this year when weakness in China and weakness in the minds of our Federal reserve, worked to convince us that the global expansion was done.  Not so.  The expansion track is well worn from mid 2012 and still in place, but this time we have a few developing side paths.

 

Sector Strength and Weakness

 

One sector that needs specific attention is some developing weakness in the consumer discretionary stocks.  Again, Amazon, Apple, Netflix and their friends are members of the consumer discretionary sector, which seems to float higher every day.  But underneath these big names, there is plenty of carnage.  For instance,  Walmart is down 33% from the highs this year, almost the same number YTD.  Here it’s not a story of big versus small but of an entire sector that is under heavy selling pressure, EXCEPT for a few names.  We are sellers of the entire consumer sector from this point forward.  I was also surprised to learn that the consumer discretionary sector typically peaks on Thanksgiving Day.  So while we’re all at the malls snapping up discounts on Black Friday, you should be quietly dumping your consumer discretionary stocks.

 

On the flip side, we have financials and banks that are experiencing the opposite affect. This sector is springing higher under the hood with small cap names leading the charge and yet the sector as a whole hasn’t yet inspired us on the surface.  We are buyers of the financial and banking sectors from here on out using pullbacks to find entry points.

 

Energy is also carving out a new path in the expansion theme as most energy stocks clearly bottomed in September and are now in new bull market as defined by a 20% rise in prices.  We added several energy names to our portfolios in the month of October (2^nd, 5^th, 13^th and the 28^th).  Meanwhile the price of crude and other fossil fuels (nat gas, coal, etc), continues to lag and drag on the back of still strong oversupply issues.  Why are energy stock prices rising when the raw commodities are stuck?  Here in lies the leading and lagging nature of markets and economy.  We don’t know why!  And we won’t know why but we can assume that prices of energy stocks have already factored in the supply side concerns and are looking across to tighter supplies and rising demand.  Energy can do well from this extreme oversold condition as the average bull market run for the sector is historically 65%, meaning we are potentially only 1/3 of the way there.

Industrials and Materials sectors are also participating now as well offering stock pickers some nice options with very low valuations, very high free cash flow and high dividends.  We have also take positions here but with small allocations and specifically to domestic producers and manufacturers.

 

Things that look ugly to us are those that are recession trades, fear trades or sectors that expand only during periods of very low or falling interest rates.  Here we have real estate and REITS (We sold them on Friday).  We have utilities, healthcare, and consumer staples (also sold on Friday).  We also have Gold and Silver, which I suggested, would be a trade at best.  Gold should probably be sold as the US dollar uptrend seems to be reaffirmed.

 

With the rising US dollar, we also need to be very careful and non-committal to international holdings or companies that derive a lot of their revenue overseas.    Remember currency issues are a big driver of profits and returns.   In the next earnings cycle, you can bet big multinational companies are going to point to strength in the US dollar as a cause for weak earnings.   Domestic small caps should likewise surprise us to the upside in the first quarter of 2016. Of course, one can also just buy the rising US dollar as an investment, which we have also done in our “alternatives” basket of holdings.   We do still like China despite their very rough six month performance.   We believe China is in a secular bull market and increasing their share of global GDP every year.  It is our view that their stock market simply got ahead of the economy and has since reverted back to a more sustainable level.  The 30% plus pullback provided us with an entry point for Asia and we continue to hold those securities despite the move in the US dollar.  In this case, we will give it the benefit of the doubt.

 

So there is a lot going on with as many new opportunities as there are places to lose money.  All ships are not rising with the tide and this clearly takes more work and persistence to keep your money invested in the right places.  Frankly we don’t have much to show for the effort (yet) in terms of positive gains for the year but neither do we have any major disasters in any strategies.  Given the minefield facing investors this year, I’m grateful for that.

 

Stay tuned; the markets are going to be a bit bumpy in here.

 

Have a great week

 

Sam Jones

In late September, when the market was retesting the August lows, I made the comment that the situation, timing, price patterns, investor sentiment and smell of the market felt a lot like 1998.  Of course, the fact that I have first hand knowledge of market conditions in 1998 puts me in a very small group of money managers who have been doing this for too long.

 

Honestly, I hate to even offer up this guidance because someone will hold me to it and say, “You said, you said!”  If you’re willing to give me a little slack and just digest this information as background noise for a potential set up in market activity, then I will continue.  OK?

 

In 1998

 

1998 was one of the toughest years of my career and that’s why I remember it.  However, events in that year did an excellent job of washing out the naysayers and gave more aggressive investors an opportunity to buy a very quick discount in the markets ahead of one of the greatest years in stock market history (1999).  Now, it would be reckless if I didn’t also mention that 1999 was the exhaustive end to the secular bull market, marking levels not to be seen again for another 13 years!   The buying frenzy started in early October of 1998 and remained firmly in place until December of 1999 taking the Nasdaq up over 100% in just 12 months.  Now back to 1998 and why it seems possible that we’re repeating the past today.

 

In 1998, investors were very keen to what was going on in Asia and recognized new weakness in one of the fastest growing economies.  This from CNN in August of 1998 as gurus began to ask whether this was just a correction or the beginning of the widely anticipated bear market.

 

     “I think we are in a correction that was way overdue,” said Charles Pradilla, Cowen & Co. chief investment strategist. “There has been tremendous complacency by strategists about the Asia problem and        even up until last week everyone was raising their targets. The Asia problem is real.”  CNN, August 4^th, 1998

 

In August of this year, our markets buckled under the catalyst that China was slowing down.

 

Also at that time the Federal Reserve, under Greenspan, was talking about raising interest rates but ultimately didn’t do so until August of 1999 – one year later.  They felt like they couldn’t with heavy pressure from the IMF and China.   Sound familiar?

 

A year earlier, in 1997, the US dollar began to rise for the first time in the 90’s decade.  And by 1998 the uptrend in the US dollar was firmly in place.  Today, the US dollar uptrend has stalled a bit but the longer term picture is still a rising US dollar.  This trend began almost exactly one year ago in July of 2014.

 

In 1998, value investors were the most hated of all.  Along with small cap investment styles.  It was all about large cap growth.  Warren Buffett was a dog making the cover of Barron’s by the end of the year “What Happened Warren?”.  Berkshire Hathaway lost – 9.65% from the July highs through the end of that year while the S&P 500 gained another 6.6%.

 

On October 19th, 2015, CNN Money ran this article.

 

“Warrant Buffett’s Top Stocks are Dogs This Year”

 

Let’s see what else?

 

The price pattern and the very dates of the 1998 correction were almost identical to today’s market.

 

In 1998, prices put in a final peak in early July (check), fell in near free fall fashion to a low in late August (check), rebounded but ultimately retested the lows by late September (check) and then blasted higher starting in early October and never looked back (check???)

 

The magnitude of the market correction in 1998 was far more severe with losses of about 19% from highs to lows.  Our recent correction was only 12% from highs to lows.

 

Finally, valuations in late 1998 were very close to those of today’s market with a trailing P/E multiple of 19 on the S&P 500 then and now.

 

So yes, I do see many obvious similarities between the 1998 market and that of today.  The big question is whether or not this rebound will expand and develop into another strong year ahead like 1999, led by huge technology names.  Seems to already be happening if you’ve looked at recent charts of AMZN, FB, MSFT or GOOGL.  Today, I see a market that just turned green again for the year, with early breakouts to all time new highs in things like consumer staples and select technology.  I also see a lot of underperformance relative to benchmarks among managed money with lots and lots of professionals lagging.  With 47 market days left in the year, you can bet that the world of managed money will work extra hard and take extra big risks to “catch” the market which has surprised everyone with this recent rebound back up to the old highs.

 

Well not everyone J   https://www.allseasonfunds.com/redskyreport/10-02-2015-what-you-should-be-thinking-and-doing-now

 

Here’s a picture of the market correction in 1998 (middle of the chart just before the white pole where we could be in terms of today’s market).

 

 

That’s it for now – stay tuned as things are going to be pretty dynamic this week.

 

Cheers

 

Sam Jones

The purpose of this quarterly report is to help guide our current and prospective clients specifically regarding the design, methodology, and process behind our investment strategies.  We also work to offer a higher level of transparency into our investment strategies by showing unique perspectives on returns and risk profiles.  Subjectively, this is a self-effacing report openly critical of areas in which we still need work and similarly patting ourselves on the back when appropriate. While we are proud of our historical returns, future returns are what really matters.  We believe that investment success the direct result of excellent design, solid execution and regular self-critical evaluation.  That’s what this report is all about.

Relative Returns…To A Degree

I’m finishing up Dan Areily’s latest book called “Predictably Irrational” – The Hidden Forces That Shape Our Decisions.  It is fascinating and I’ve highlighted practically every page.  Dr. Areily is one of those special people with two brains, one with a Ph.D. in cognitive psychology and another with a Ph.D. in business administration.  He is a professor of Psychology and Behavioral Economics at Duke University.  The very first chapter is called “The Truth About Relativity” in which he offers several anecdotes regarding our flawed (irrational) choices using only the basis of comparison.  The chapter confirmed what we might instinctually know applying this principle to our investing behavior for better or for worse.

Human nature is such that we have a constant need to compare.  Dr. Areily states, “ most people don’t know what they want unless they see it in context”.  We all compare everything in our lives to something outside of our lives, every day.  How fit are we compared to our friends and family?  How old or young do we look compared to our peers?  How wealthy are we comparatively?  What kind of car does my business partner drive?  Do I live in a nicer house or neighborhood than you?  Where do you vacation?  Is this wine better than that wine? Comparisons typically come from personal observations and unfortunately, the media (false realities).

Rarely, do we rely on any sense of internal standards without having derived those standards from some early imprint, usually a parent’s values.  Most of us are psychologically uncomfortable with any choice that stands alone or is offered to us in absolute terms because we don’t trust it.  Take the new Apple watch, which is generally not selling as well as expected.  Why?  Well one could argue that it’s a stupid and unnecessary gadget (my opinion).  Dr. Areily would argue that the new Apple watch really has no peers in terms of stated functionality, has nothing to compare to and thus, our simply human brains don’t trust the price tag of $399.  Is that a good deal?  Who knows when we have no other peer in the space.  Apple has the added advantage of potentially setting the standard in pricing as the first to market.  This is called the Anchor Price.   But will that prove to be a “relatively” reasonable price?   We simply won’t know until there is a viable competitor for that product.  Consumers will continue to hold off until they have something to compare to.  Now let’s bring this knowledge back to the investing world.
If you think about our primary human decision making process as derived from comparisons, you can easily see why it’s so easy for us to accept an investment approach that is based on indexing and benchmarking.  John Bogle, the founder of the Vanguard funds, probably understood our human need for “relativity” more than investments.  We grasp for easy to understand, objective comparisons to help guide us through important decisions and what better way than to lean on widely accepted market benchmarks.  For instance, a typical question might be –  How am I doing compared to the market? But we never ask questions like – How is my net worth compared to where I should be (want to be) at this stage of my life?   Or more importantly, we might ask- Am I still recovering from losses from years ago, or making new highs?  The answer to these would require some digging among difficult to find comparisons.  As long as our money is doing relatively well compared to the market, we should feel some sense of success… we are told.

But like all things in life, seeking relative returns cannot be a pure objective in all situations, especially at extremes.  If I saw a guy living on the street in a cardboard box, I would not feel good living in a slightly better cardboard box.  Why then does Morningstar give a fund a 5 star rating to a fund that lost ONLY -46% compared to the stock market that lost -48% (2008 bear market)?  Because that fund did relatively well so it gets five shiny stars and yet our wealth could be decimated!  The world of relative index based investment objectives wants you to accept that outcome as a success.  That’s absurd even for an individual position in your portfolio.
Now we need to set some expectations for the future.  In the current market environment, there is a growing risk of both a protracted bear market in stocks and a new increased risk of a global economic recession as of September.  At this stage of the cycle, we need to know and respect the reality that bear markets are to be avoided as they have a historical precedent of erasing 2/3 of the previous bull market cycle gains (Investech Research).  Is the bull market over?  No one can say with confidence yet but there are some cracks in the foundation.  At the same time, we see evidence that we could still see another very strong thrust higher like one of those last gasp bull market runs in the late 90’s.  Either way, the market is operating at a higher risk level than any time in the last five years and we may be angling toward some unappealing extremes.  We should all be factoring this into our interest and pursuit of relative returns.
Seeking relative returns is a solid investment objective but not without some restraint.  Our Explicit Investing Creed clearly defines Success as generating relative (Asymmetric) returns compared to our benchmarks.  But we also add in the additional objective of limiting exposure to real “Risk” defined as an unrecoverable or semi-permanent loss of capital.  In fact, all of our investment strategies are described in terms of their relative risk (Annualized Standard Deviation) and return (Compound Rate of Return) metrics.  Here’s an example of that relative return comparison for our 15 year old Worldwide Sectors stock strategy.  Remember the last 15 years included two bear markets of 50% each!  The green dot represents our Worldwide strategy and the dark grey dot represents our easy to comprehend, comparative stock benchmark, the Dow Jones Global Stock Index.  Worldwide has historically produced superior returns and lower “risk” compared to the benchmark.
Worldwide Sectors Stock Strategy

Our High Dividend Global Stock strategy has a similar looking plot relative to the same benchmark but with a shorter history.  High Dividend continues to be our fastest growing program in Assets Under Management as well as one of our best performers on a 3 year basis.

High Dividend Global Stock strategy

Our long standing All Season flagship strategy looks similar with an additional benchmark of the Barclays Aggregate Bond index shown in light grey.

All Season Blended Asset Strategy

And one more example.  Below is our New Power Stock Strategy also designed to produce strong relative returns compared to its benchmark, the Powershares Clean Energy ETF (PBW).

Here’s a look at the same New Power strategy graphically.  The five year average annual returns net of all fees through today (10/12/15) have been +8.44% versus the benchmark which is showing an average annual loss of – 12.45%.  This is an example of a relative return at its very best.

In all cases, our relative returns compared to our benchmarks are strong (moving to the upper left corner of the charts).   So here’s the summary statement.  Seeking relative returns as an investment objective is fine and consistent with our human need to compare.  However, as in life, relativity cannot be held as the only standard for decision making especially when considering the potential for extremes.  Every investment strategy must have the ability to unhook from the relative return objective when the risk of permanent unrecoverable capital loss increases.  This is one of the primary value propositions inherent to our firm’s investment objectives across all strategies.

That’s it for this quarter’s Change of Seasons Report.

Please stay tuned to our regular Red Sky Report for a more detailed review of short term market conditions.

Cheers

Sam Jones

Well, the rebound rally from a successful retest of the August 25^th lows has been predictably large from a market perspective but as I suggested last update, winners and losers have been far different than anything we’ve seen thus far in 2015.  Regardless, all ships are rising and falling to the same drumbeat of broad market trends.  With correlations among stocks and sectors still very high, we need to stay focused on “the market” and where it’s going next.  In short, we’re not out of the woods yet.  Stocks in aggregate have moved up to a Make or Break Point as of today.  You should have a buy and a sell list ready.

 

From Lowry’s – October 7^th, 2015

 

“Any further advance that may take place over the near term is still to be considered a countertrend rally in what appears to be a bearish primary trend.”.   Personally, we don’t like to get in front of Lowry’s and call them wrong – because they rarely are.  However, I have seen them change their mind quickly upon compelling evidence.  Here’s what they are looking at in terms of pure technical evidence.  The S&P 500 on the daily charts has rebounded smartly up to the short term downtrend line, marked in blue, which is now 1996 on the index.  This level also marks the mid September high when the Federal Reserve essentially reversed their stance on future rate hikes.  Still mad at Janet for setting that trap.

 

 

Yesterday we saw a predictable pause at this level and there is a chance that prices will break above this important level adding some fire to the buying frenzy.  As I said last week, this situation feels, smells and tastes like 1998 when we had exactly zero pullbacks in a nearly 20% rally for stocks.  I call these lockout rallies – no easy entry points, except to chase prices higher.  We are not counting on that outcome, just open to it.

 

Even if the market manages to “break out” in the short term we still have some longer-term issues above.  Take a look at the weekly picture of the S&P 500 below.  Here the “primary” downtrend line is higher around 2060 on the S&P – also marked in blue.  So before you get too excited about five up days in a row, keep your eye on the bigger picture which is still unclear at best.

 

 

New Opportunities

 

I have said several times in the last couple months that there are some screamin’ deals in certain sectors (energy, materials, industrials, oversold tech) and countries (China, Japan and eventually Emerging Markets).  Guess what is leading the charge in the last week?  All of those things and we have taken small entry level positions in all lowering our cash position by 15-20% in all Tactical Equity and Blended Asset models.  At the same time, we continue to see things like Biotech, healthcare and select internet names actually lose ground.  Our leaders of the last four years may be giving up.  Rotations of this magnitude can catch a lot of people off guard owning exactly the wrong thing.  Thankfully, we have the luxury of cash, so we can simply buy the new leadership!

 

This would be an excellent time to show you how our models adjust Net Exposure relative to market trends so you get an idea of when our system starts to cut exposure (moving to cash) and when it adds exposure (buying stocks).  Take a look at our Worldwide Sectors strategy Cash position chart below.  Compare it to the weekly or daily charts of the S&P 500 above.

 

 

You will see that we began raising cash in June shown above as a percentage of total assets.  We added to cash in July and August and just recently reduced cash (bought more equities), as a short-term bottom became evident.  When stocks get toppy and experience broad based downtrends as we have seen since May, Net Exposure becomes the only thing that matters.  When stocks are in a primary uptrend, we tend to hold high exposure (low cash) but lean more on Selection criteria to generate returns and control our risk exposure.

 

So the stuff we’ve bought has mostly been in beaten down sectors where we see real value either in historically low prices and/ or higher dividends.  High Yield corporate bonds are also working hard to entice investors with near 7% yields and SOME price strength but it’s not enough price strength yet for us to take a strong position in our two Income models.  When the time is right, our income models will make some very nice, low risk returns which will be welcome to those who have been very patient for the last couple years of stagnant returns (3% in aggregate).

 

That’s it for this quick update, please RSVP to the annual meeting as we are filling up and space is limited.  The Quarterly Change of Seasons will be out in the next week or so.

 

Oh my, colorful Colorado living up to it’s name right now.  Amazing!

 

Cheers

 

Sam Jones

This update will be directed at your mind which no doubt has a lot of little voices stirring around.  Find yourself in the paragraphs below.

 

Entering the Best 6 Months For Stocks

 

Yes, the “Sell in May and Walk Away” thing seems to have worked again.  Actually, the mantra should be, “Sell in April and Buy in early October” but Wall Street might be challenged to produce a catchy rhyme with that one right?

 

If we were to break the year into two time zones (May-Oct) and (November – April), you can see some pretty notable differences in sector performance.  Data since 1984 to present.

 

 

Today we are facing a broad stock market that is oversold on an intermediate term basis.  That means valuations have come down significantly and there are now deals for investors willing to take them.  At the sector and country level, I see some very oversold, near extreme, discounts in stocks and indices but they are found in not so obvious places, certainly not in the brands you know and love like Amazon, Apple, Google, FB and Netflix (the Fab Five).   Here is a message for all investors of all ages.  The worst part of the year is now behind us from a historical average perspective.  That does not guarantee a happy 6 months ahead but the probabilities are now in our favor.

 

Behavioral Economics – Part 1000

 

We see plenty of evidence from a sentiment perspective that we are somewhere between 12 and 14 on the chart below.  Negativity and bearishness are at historic highs.  As contrarians, we get excited about that.  In fact, if the markets plow through the lows of August 24^th for just a quick and savage hit followed by some very robust buying, I’ll say, we’re at that magical #14 “I told you so” spot.

 

 

Now, as I mentioned above, “the market” may be following this behavioral script as described but “the market” is just a basket of stocks right?  There are sectors and stocks out there that on the other end of the spectrum.  The Fab Five could even be in zone 5 or 6.  In fact, I heard some talking head yesterday say these words, “Facebook at this price is a gift, I would double down”  See #6 above.  We have owned Facebook for several years in our New Power strategy (traded not held) with our first purchases made around the $24 level.  It hit a high of $98 in June.   While we aren’t quite ready to sell yet, we’re certainly not looking to double down.  Crazy.  Same for the others in the Fab Five.   The message to all investors of all ages is this; be emotionally prepared for some upside surprises.  Not all things will respond the same however.  Panic selling on August 24^th set the stage for a meaningful bottom.  Now we are seeing a more constructive and complex price structure around those same lows.  This is a near perfect set up for a very robust 4^th quarter rally.  This feels, smells and tastes a lot like 1998 for those who had money on the table then.  In that year, the markets bottomed on October 8^th and ran higher – much, much higher in a near lockout rally.  This is not a prediction, just an observation.

 

Investors With Current Income

 

You should be adding cash to your investment accounts now.  This will be the last time I say this.  Yes, you must throw good hard earned cash, sitting in great gobs in a bank earning zero into the stock market.   You should do this in the next 5 business days.  It is too early to buy aggressively yet but we’re getting very close and your money must be in place in take advantage of those buys if and when they happen.  If this is not a meaningful low in the markets and the beginning of something more sinister, then your cash infusion, will simply sit in cash in your investment account with us rather than the bank.  You’ll earn nothing either way but you will remain in a position to take investment opportunities as they come.  Eventually stocks will bottom and the chase for returns will emerge.  Remember, there is no opportunity for returns in a bank.

 

Investors Without Current Income

 

The same goes for you if you have accumulated sideline cash.  In most cases, those without current income are often living off of their investment accounts, social security or other pension income and don’t have much sideline cash.  You don’t have much to do here accept grind through this emotional moment.  Knowing that you rely on your investments and periodically watching them decline in value is part of the package.  If you are having trouble with this, there are several things you can do.

 

First, you can buy yourself a little peace of mind by sitting on 6-12 months worth of living expenses.  We do this for all our clients with systematic monthly withdrawals in place.  We hold 6 months worth of those living expenses in a sideline cash account and replenish that account once it is depleted, again every six months.  In doing so, you emotionally separate your living expenses from your investment balance.  The idea is to give your investments a longer time horizon to tolerate some market volatility without feeling like your going to eating cat food next month.

 

Another thing you can do is constantly work to cut your monthly living expenses.  I hate to say this publicly but I continue to see way too many retirees (or those with current income) subsidizing the living expenses of grown children.  With job openings at an all time high, there are many employment opportunities out there for able-bodied adult children.   Use this market decline and your anxiety as an excuse to have that overdue conversation with your children.

 

That’s all the advice and enlightenment I can muster for a Friday.  The market recovered from an AM bloodbath and is now positive.  Hmmmmm

 

Have a great weekend

 

Sam Jones

These are the hard days.  When stocks are down, portfolios are down, the world is down and headlines speak of nothing but The End.  How do we keep our sanity and stay in control in the face of it all?

 

Emotional Capital

 

In our world of risk management, we are always focused on preserving capital.  Of course, this happens to various degrees depending on the type of investment strategy we’re talking about.  Our stock strategies are allowed larger losses because stocks are naturally more volatile.  Our bond strategies don’t have to tolerate capital loss much at all but then again; they don’t offer the bigger gains either.   None of our strategies are bottomless but nothing is absolute in the investing world.   There is no such thing as investing without periodically experiencing some portfolio losses.  Anyone who offers such a thing is selling you something.  As we’ve always said, investors cannot avoid risk as much as manage it.  Now all of this is speaking to dollars and cents.   Emotional capital is also something to manage because it is subject to its own form of destruction in all markets!  Think about the guy who sat in cash with his entire net worth watching the US stock market rise for almost six full years and nearly 200% gains.  I have seen this situation more often than you think.  Now think about the girl who is still fully invested and hoping for a rebound in stocks to get out at a higher price.  Day after day, full invested, hoping, wishing, and not wanting to look.  She will sell at the lows like everyone locking in emotional (and financial) losses.  Bad decision making is a bit of a viral thing.  One bad decision, if left uncorrected (aka unsold) leads to more bad decision making.  We hold things too long (see trading error #1 from a few weeks ago).  Then we try to buy something too early in an effort to get back to our high balance faster only to go through that horror show of “OMG, THIS ISN’T THE LOW”.  Once our emotional capital is drained, we have no capacity to hold anything for very long.  This happens in the early phases of a new bull market when we should be buying AND HOLDING a lot of stock.  Instead we buy Apple at $100, sell it at $110 and watch it go to $600 without us (see trading error #2).  Or we can only get ourselves to buy $100 worth of Apple stock (Trading error #3).  Staying sane, as an investor is all about preserving your emotional capital in order to grow or preserve your wealth at the appropriate times.  Accept the fact that we will all lose money periodically, but keep those losses contained.

 

Looking back over the last 3-4 months, I can spot plenty of short-term trades that lost money.  These are buys that didn’t work out and were sold shortly thereafter for a small loss.  In fact we sold another position purchased in June for a small loss today (XHB – Homebuilders ETF).  Yes these add up and negatively impact our “returns”.  But, we also still have winners in our portfolios that were purchased 1-3 years ago, with larger gains and we hope to hold as long as they remain in fundamentally and technically favorable.  Last week, we sold our long standing leveraged healthcare position (HCPIX) that was purchased in 2012 and 2013.  We sold it because the long term trend turned down and we could no longer justify holding it.  We will own healthcare again and hope to buy it back at a lower level.  Did we sell at the top?  Hardly.  Did we capture a very nice long term gain?  Yes.  Was this gain larger than many of our short term losses combined?  Yes!  George Soros said it right.

 

 

 

Now with 50% or more in cash across all strategies, we have our emotional and financial capital intact, ready to buy when the situation presents itself.  This is how we keep our sanity.

 

 

But My Portfolio is Down $10,000, or $100,000 or $200,000!

 

Yes, yes I know and we don’t take losses of any kind lightly.  But we do measure them against the market, our expectations, our internal risk tolerance per strategy and most importantly our ability to recover from losses.  Currently, the aggregate total of our assets under management are down a little over 6% YTD.  This is a very rough number as it includes new accounts, terminating accounts, additions and withdrawals.  This year, we have had very little flow of accounts in terms of new or terminating accounts but we do have a natural 3% annual withdrawal rate from retirees and others living off of their investment balances.  All things considered, a 6% decline in Assets Under Management is probably too aggressive to be considered losses due entirely to market.  Either way, we’re not talking about a big number.  YTD, the US is the best looking horse in the glue factory and is down about 9%.  Take a look at the chart below as of last Friday.

Many global indices are now in full bear market territory, others are deep in corrections of 15-20%.  Recoverability is coming into question among these forever fully invested indices.  Some are already well beyond a level that we would consider reasonably recoverable as it will take years and years just to get back to the 52 week high levels.

 

 

 

We all feel the pain of wealth deterioration as it’s happening now.  Trust me, our personal accounts are right in there with yours.  However, we remain quite sane knowing that these are recoverable losses and now we are largely (literally a majority of assets) sitting in cash.  Recovery periods for the typical household invested with our firm, after full fledged bear markets, are often less than 18 months, sometimes less than 12 months.  For those pulling money out monthly for living expenses, these recovery periods can be longer.  For those willing or able to add money to investment accounts at market lows, recovery periods are shorter (hint!).   Then there is that investor that never recovers from a steep portfolio loss.  This in the investor that gives up, who sells everything in total disgust and anger.  This is the investor who has gone insane and feels there is no hope for a better tomorrow.  After selling everything, the better tomorrow arrives… and the virus spreads.

 

Behavioral finance is probably more important for investors to understand than actual finance when it comes to investing.  This is meant to be a feel good update at a dark moment for stocks.  All is well here at ASFA.

 

Give us your thoughts – Do you like more event driven updates?  Is this the type of content you want to hear?  Let us know.

 

Cheers

 

Sam Jones

As I mentioned a week ago, the US stock market gave us all another opportunity to cut out weaker positions or upgrade as desired with the revisit to the top of the range.  Now, six trading days later, prices across the board are down hard and revisiting an important support level (2044 on the S&P 500).  While a short-term bounce is likely now, more long-term warning flags are appearing, some for the first time since 2007.  There are critical moments in an investor’s lifetime when decisions regarding net exposure to various asset classes determines the future of your investment portfolio and thereby your very sense of long term financial security.  This is developing into one of those moments.

 

Who Is Driving the Markets?

 

I read an interesting statistic this week (can’t remember the source frankly) but I wrote it down.  Over 2/3 of the liquid investment assets in the United States, are now held by owners who are over 62 years.  Historically, that’s an incredibly high number and representative of our country’s demographics, which are relatively old by comparison to other parts of the world.  Furthermore, the bulk of the 60 somethings are in the baby boomer generation, which has seen some of the greatest wealth accumulation at the household level of any in our country’s history.  The point?  By age, anyone in their mid to late 60’s is naturally close to or beyond their retirement year.  These investors are naturally far more concerned about investment losses as they do not have the time horizon of a younger investor who is gainfully employed, nor do they have any further prospects for income by circumstance or choice.  We should all know and respect the fact that retirees might be quick(er) to pull the trigger on investments at the first signs of trouble than a market dominated by younger, longer-term investors.  With that said, it is becoming better understood that the next generation of younger investors fancy’s themselves to be “traders” not investors so perhaps the notion of investing for the long term is disappearing.  Conclusion – expect big, gapping markets where persistent trends are elusive.

 

Understanding Asset Class Rotation

 

Take a moment to look at the three-year chart below.  In purple, you see the S&P 500, Green, we have the Dow Jones Global Stock Index (our stock benchmark), in Yellow the Barclays Aggregate Bond index (our bond benchmark) and in Red the Commodities Index.

 

 

 

 

Three years ago, several months before the last presidential election, asset class performance began to diverge dramatically.  Bonds essentially went flat and are producing less than 2% annually including all interest payments (zero price appreciation).  Stocks across the globe surged higher until July of 2014 when most peaked as marked by the White pole in the middle of the graphic.  Meanwhile everything that “hurts if you dropped it on your foot” like industrials, commodities, copper, gold, silver, materials, etc. began a dramatic decline that continues today.  The downtrend in commodities really began accelerating also in July of 2014.  So for the last 12 months, since July 1^st of 2014, we have Commodities down -39%, Bonds up 2.46%, the Dow Jones World Stock Index down -2.04% and the S&P 500 index up 5.39%.  If you have made any money in the last year, you have had nearly all of your money in stocks and even then portfolio returns are probably sub-par.  Of course most portfolios hold a static group of diversified assets including stocks,  internationals, bonds and commodities, increasing the odds of a negative return over the last year.

 

Now let’s look at what is likely to happen next…

 

With the Fed on deck to raise rates this fall and global economies continuing to chug higher, we should expect another significant cycle rotation, which includes both risks and opportunities.  Stocks can continue to move higher but as we’ve already begun to see, returns will taper a bit and become the domain of selective stock pickers.  Stock index portfolios will become frustrating to investors as they are simply too broad and inclusive of everything (good and bad stocks) to really make productive headway in the coming environment.  Pickers will want to focus on quality companies with high free cash flow and lower relative valuations to peer groups without dipping too deep into the value pit.   Focus should remain on the non-interest sensitive groups.   Bonds should continue on their path of unproductive gains at best or begin to inflict some real pain.  Outflows from bonds have begun in earnest but this will be a tidal wave of an outflow on a long-term basis.  I believe this is just the beginning as the bond market represents the next area of real wealth destruction in the US looking forward.  Rising rates will find their way into rising borrowing costs and inflation to some degree as employees demand higher wages to cover increasing costs of living.  Higher wage expenses are passed on to consumers as higher prices – this is already happening.  I continue to believe that real inflation is under-reported in an effort to keep bond investors happy and complacent.  With or without inflation, US bond prices should head lower and interest rates move higher as long as the expansion in global economies continues.  At present there are very few signs of recession in the system.  Coinciding with a significant move down in bonds, cycle theory suggests that we should also look for a bottom in all things commodity oriented.  Commodities are in a death spiral now, creating some real value, and some day they will turn up offering investors a unique chance to enter a new asset class bull market.   Look for this moment on a failure in the bond market.

 

Also, coincident with the top in bonds and the bottom in commodities, we might expect to see the rise in the US dollar begin to stabilize a bit giving ground to many foreign currencies.  A falling US dollar will be a nice headwind for international investments again and we might also look to the very oversold emerging markets and China again after a failed attempt earlier this year.  Even Europe might find some footing again.  Stock valuations are far more attractive outside of the US now so we’ll all want to keep our eye on an improvement in price patterns nearer to this cycle rotation.

 

Warning Flags and Playing Defense

 

As I said in the intro, warning flags are now appearing.  While we still see the potential for new highs in the developed market indices as a final thrust in this six-year-old bull market, we are aware of the growing indications of deterioration in the current market.  Since mid June, the majority of our net exposure indicators have moved into negative positions including adverse monetary environment, overly bullish sentiment (still!), an important crossing of buying and selling pressure (chart below), continued weakness in important indices like Transportation and Utilities, a notable increase in selectivity, loss of leadership and now another failed attempt to make a new high on the last run.

 

 

 

 

In the short term, stocks are again oversold and trading right at important support.  In a healthier environment, absent all the negative evidence described above, I would be more optimistic and opportunistic about buying such dips.  In these situations, we are planning to sit on our oversized cash position and defensive holdings (healthcare, staples, real estate and specialty bonds) until our set of indicators improves.  Our all-stock tactical equity strategies are now 28-40% in cash.  Our Blended Asset models are also sitting on 15-25% cash but also carry securities and hedges with much lower correlation to the US stock market.  Income strategies are still sitting on nearly 60% cash.  For us to become more defensive than this, we would have to see the June lows broken to the downside and more confirmation that a major market top is in.  Neither has happened yet.

 

We must all remember that stocks and stock markets historically put in tops before the economic cycle.  Investors often make the mistake of relying only on the economic news and thus sticking with stocks through some very nasty downtrends only to find themselves selling at the lows months later when the economy finally buckles  – publically.   Markets lead the economy by 4-6 months!  We are quite aware of this fact and making adjustments as necessary on a daily basis now based on technical evidence.

 

Keep the faith, there are going to be some incredible investment opportunities coming out of the pending asset class rotation for those who know where to look and when to act.  In the meantime, we’ll stick with our game of playing defense and positioning ourselves to avoid taking a big market loss.

 

Have a great week, enjoy some time with friend and family, and know that you are in good hands.

 

Cheers

 

Sam Jones

Sticking With Strong Defense.. But Making Our Shopping List

 

Since the Federal Reserve spiked the punch bowl last Thursday, we have seen nothing but persistent selling pressure in the stock market.  Bonds have done a little dance in place but not made headway and most benchmark commodity stocks are losing 2-5% daily.  This is that time when you want to dump and hide expecting the worst as a retest of the August lows appears likely.  This is also the time to make a shopping list and ours is getting longer each day.

 

Failure at the Inflection Point

 

Thursday of last week now looks like a classic stock market failure at the inflection Point or “Red Zone” as we called it in our 9/1 Red Sky Report (https://www.allseasonfunds.com/redskyreport/09-01-2015-inflection-zone )

 

In the last few days, we have seen several things happen that make a retest of the August lows seem likely.  First, we have seen European Index funds, Latin American indices and unhedged Japan indices make new lows for the year yesterday.  China is not far behind.  Second, 72 stocks of the S&P 500 also quietly made 52 week new lows yesterday while the index is still 4.25% above those lows.  Now let’s remember what we’re talking about in terms of “the lows”.  Graphically, on a closing basis, the lows for the S&P 500 is 1867 and the Dow, 15,666.  However on an intraday basis on the 24^th of August, both benchmarks reached another 2% lower during the day which, to me, is the real “low” we need to be aware of.  I have seen many instances of a retest of the intraday lows that holds firm while on the surface, it looks like a failure based on closing prices.  These are the best setups for very strong rebound rallies and quite often the beginning of new bull market uptrends.  Still we’re talking about some significant downside from yesterday’s close either way.  Once again, we are not married to any outcome including a successful retest or failure of “the lows” at this point.  We are simply recognizing new selling pressure since last Thursday, which occurred at a rather obvious time and place as discuss in our previous note.  Since last Thursday, we have slightly raised cash again, almost to absurd levels, selling our small bank and semiconductor positions and adding a small well run income fund to our Blended Asset and Income strategies.  That’s it.  Our Net Exposure screen never made it past neutral so we had no reason to increase our net exposure.  The screen is now angling back into bearish territory.  Current cash ranges for our investment categories remain as follows:

 

Tactical Equity                       35-45%

Blended Asset                        46-62%

Income                                   60-84%

 

That’s a lot of cash… looking for a new home

 

Developing Opportunities

 

The nice part about nasty selling cycles is that all the junk gets washed away while good stuff doesn’t see as much selling or can even gain some ground.  Don’t confuse the term “good stuff” with things like short funds or gold, which are really hedges and fear trades.  No I’m talking about relative strength among sectors, styles and asset classes and we’re beginning to see which groups might be queued up for a big bang higher once the market stabilizes.

 

Value based investing styles have been hammered for the better part of five years now especially in the world arena.  Our High Dividend manager, Sean Powers sent this to me last week and it sparked my interest.  What you’re looking at below is a relative price chart comparing all things Value oriented to all things Growth oriented.  Value plays tend to be in non-cyclical sectors, pay dividends and trade at discounted valuations to peers or the market.  This is the domain of the Warren Buffets and David Dremens of the world.   As the chart shows, the MSCI World Value index is now at the same relative price level as it was in early 2000, again relative to the growth world.

 

 

Who cares?  We all should.  I have a small group of mutual funds that I keep my eyes on who are truly best in class in terms of management and commitment to style.  Longleaf Partners fund (LLPFX) is one of eight that I like.  Below you will find a chart of the LLPFX (in red) compared to the S&P 500 (in Green) from 1995 to the year 2007.  LLPFX is really on the small cap value side of the matrix but look what the fund did specifically around the year 2000 and beyond.  It continued to march strongly higher right in the face of a near 50% decline in the broad US stock market.

 

 

Again, relative performance of the value sector is right back where it was in the year 2000.  Could we see a repeat?  Based on the shear volume of very juicy value plays out there now, especially in financials, banks, oversold commodities, energy, emerging markets, and China (yes China), I know these guys are looking at a very long shopping list.  For the first time in nearly a decade, we might find ourselves taking positions in some of our old favorite value funds and let them do the decision making of what to buy.  I think we’re getting very close to that moment.

 

Dividend payers and MLPs are also on our radar now as well.  Both are back in play now that the Federal Reserve has pinned themselves to a zero interest rate policy for the foreseeable future.  Both groups will have to stop falling of course but wow do I see some attractive yields and deeply discounted stock out there.  Our All Season strategy, which has really underperformed this year, is looking to add some exposure here in the next 2-3 weeks.  Not kidding, I’m seeing 6-8% yields on stocks/ MLPs that are trading at half the market valuations.  But so far, value has been a trap.  I know, I’ve been caught more than once this year, thus some of the pain in All Season.  This round, it seems best to just let everything clear out including broad market selling pressure and pick up the good stuff on the other side wherever that lies.

 

I will shamelessly say to all those who are in a position to add to your investment accounts with sideline cash;  Do it now.  There are some clear and present opportunities developing. 

 

That’s it for this fine Wednesday.

 

Enjoy the Fall – top of the leaf colors here in Colorado

 

Sam Jones

Investors will be holding their collective breaths over the course of the next week or so.  The markets have moved back up to the top of the range from which we have seen so many failures over the course of the last year. This is a critical time for the global stock markets.  Either stocks will breakout to new highs and move up sustainably or investors will be very quick to jump ship and avoid taking another June type bath in their portfolios.  As such, this is an ideal moment to revisit your investing discipline and consider taking some action.  Let’s do that.

 

Setting Your Investment Goals

Of course everyone wants to make as much as they can in the way of investment returns but we all know that the path to success in real wealth creation is not often the quickest path (getting rich quickly) nor is it about making a big gain and then subsequently losing it all in the next bear market.  Our firm has an explicit investing creed and it goes like this:

 

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.

 

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

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

 

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

 

What you will notice is what our “creed” does not say, like beat the S&P 500 or this fund or that stock every time. Conversely it speaks to our inner sense of the right way to build wealth – making high risk-adjusted returns where the return ON your capital is just as important as the return OF your capital.  Today, we recognize that our more defensive systems and strategies will necessarily lag select stock only benchmarks.  We accept that as the price of pursuing “Success” as described above.

 

But You May Be Feeling Like This Now

There is a perception that returns are just out there, ready for the taking.  If only you can find them, get them, reach for them.  This is simply no longer the case.  Returns, the kind you make and keep, are elusive now.  Globally, stocks are barely positive since July of 2014 and most stock indices are negative since April of 2015.  Bonds are either flat or negative by 4-5% YTD.  Some sectors are up huge, like biotech and select internet, but others are down just as hard like basic materials, energy, metals, mining and utilities.

This is that zone in the investing cycle when you might repeatedly circle back to the leader board among mutual funds or look too long at a stock like Netflix (+130%) and wish you had all of your money in those big winners.  You might be enticed to make changes in your portfolio and quietly do a bit of return chasing, behind closed doors.   Last week, it was reported that $156 Billion came out of actively managed mutual funds and moved strongly into passive International ETFs and equity funds.  As I’ve said repeatedly, this is that time when bad behavior becomes pronounced.  Actively managed funds are typically those that attempt to trade away market risk or move proactively into better-valued positions.   Yes, they are lagging any of the passive indices but they will also be the very funds that offer real relative performance once the market trends actually turn lower.  Make no mistake; Pulling out of “safer” things and putting your money into “riskier” things now is simply the wrong choice.  That day is in the future.

To our many pre and post retirees – from a planning perspective we structure portfolios to at least meet your annual withdrawals.  Your withdrawals are quite regular but returns are not.  You will need to endure periods of flat returns or losses along the way (this can be a scary time).  But rest assured, there will be healthy gains on the other side of this Transition Year which looks like it may push into mid 2016.

To everyone else – There is never a time in your lnvesting life to become undisciplined.  Your investment must match your tolerance for periodic losses.  Everyone can “tolerate” gains of all types but loss tolerance is the important thing to really understand at a personal level.  Today, I see young and old becoming disconnected from their own risk tolerance and I’m hear to talk you down literally.  If you want opportunity, look down.  Look into the wildly oversold energy, metals, and basic materials sectors.  Even gold will one day rise from the ashes.  All are in steep declines, which will one day reverse.  There is an incredible buy developing in commodities but it’s still a bit too early.  After a few rate hikes, we might look again to utilities and other interest sensitives as well.  What are not attractive are things trading at insane multiples like names in the internet and biotech space.  We own several names in these sectors and continue to enjoy the ride higher but certainly not looking too add exposure here.

 

What They Don’t Want You To Know (or do) – #3

You won’t hear this type of commentary from anyone in the industry because most of the financial services industry is comprised of sales people with one goal – getting your assets invested under their company flag.  For #3 of this series, I’m going to tell you what I’m doing for my own personal account that might be counter to the common message in our industry.  I am queuing up cash to invest in stocks and commodities at a later time and lower levels.  I am not adding any new money to this market.  All 401k contributions, 529 contributions are now directed to cash where they will sit until I have a good reason to deploy cash like better values or a new surge in technical/ fundamental evidence.  Do yourself a favor and do not add new cash to your investments at this time.  I’ll let you know when to do so via our “Calling All Cars” alert.  I simply can’t be more of an industry contrarian than that.

 

This is not the end of the Bull Market Yet

Statistically, according to Jim Stack of Investech, a majority of bear markets have begun within 7 months of the first rate hike by the Fed.  I can easily see a quick deep correction in stocks surrounding the first rate hike then a strong move out to all time new highs in the subsequent months.  That last run to new highs could prove to be the last run of this bull market unless we see a real surge in earnings or economic activity.  Smart investors will be ready for maximum defense in the next 10-12 months with the knowledge that bear markets on average retrace 1/2  to 2/3 of the previous bull market gains.  We’re not interesting in riding through any such event given the enormous gains of this 6-year old bull market.

 

Consider This Today

Today, I see a market that is running into some new selling pressure just as it tags the old and very worn top of the range (S&P 2130).  If you feel over-exposed to the stock market, this would be an excellent moment to cut out or reduce lagging positions.  We did this today in several strategies.  If the market wants to break out to new highs, it will do so in the next week.  We can then redeploy short-term cash into positions that are leading the new surge higher and stay invested in a strong group of investments being careful not to chase the wildly overvalued segments of the market.  If the markets want to sell off hard and revisit the June lows, we have just cut exposure at the very highs of the year.

 

That’s it for now – stay tuned

Sam Jones

Here’s our quick take on what just happened with the Fed and what we might expect looking forward including the market’s reaction so far.

Foreign Aid “Act”

I no longer have confidence in the current Federal Reserve to make hard choices, at least under Janet Yellen.  Wall Street is now massively confused to say the least with their decision to not only leave rates at zero but made matters worse through commentary that sounded like we should expect a global depression!  I think most of Wall Street underestimated the US Federal Reserve’s stake in the foreign aid business because clearly this decision was not made based on US numbers.  Employment cost numbers have been on the rise since 2010, we are at full employment in all developed countries and they suggest we will not see any wage inflation for the next THREE YEARS? Job openings at all time highs with no available labor is a near perfect recipe for higher wage growth (aka inflation).

No, their choice and their commentary was more likely a response to some strong arming by the World Bank and several emerging market trading partners in an effort to keep those economies on their roads to recovery (Europe) or off of death row (for Emerging market economies).   On top of that, they are watching China pull nearly $85B out of treasuries in the last month to cover their own falling reserves.  A move to raise rates would have, could have, created more unwanted selling pressure.  Nod to that reality.  But to sell their decision as they did seems wildly disingenuous.  By the end of the year, all of this talk of global slow down with no signs of inflation will seem like a mistake.  But I suspect they know that already.  Count on a December rate hike based on a “surprising” recovery in economic activity and some new and “unforeseen” wage inflation.

Market Reaction

It’s a little tough to tell today given the quadruple witching day (options expirations) on Wall Street, but it seems obvious that the treasury bond market and interest sensitive sectors will get another breath of life at least for the next few months.  The banking and financial services sectors are under heavy selling pressure now that rates are stuck at the bottom again.  Stocks in general and the markets should do OK, although we wouldn’t recommend changing net exposure beyond levels established in July/August just yet.  The Fed is back in the monetary support mode now taking some of the scare out of the system.  Commodities are probably in trouble in the short term but may still be just working to carve out a long term low around these levels.  We were hopeful that commodities, materials, industrials and oil services stocks would come into play now with a rate hike but Yellen and company just put that opportunity on hold in the short term.   Freeport -McMoRan down -11% as I write.

The long-term trend of the rising US dollar has certainly been a driver of returns for the last couple years (for better or for worse).  Now, with the new Federal Reserve foreign aid “act”, we might see the US dollar continue to correct, possibly angle a bit lower in the coming months giving support for emerging markets and other international holdings.  Do not count on the end of the rising US dollar trend, however.  Currency moves are regularly 7-9 years long.  We are barely 2 years into the rising US dollar trend and it ain’t over by a long shot.  Gold may sucker a few investors in during this short cycle but it should be another trap on the way to lower prices ultimately.  All in, the Federal Reserve had an opportunity to do something great, to get capital engaged in productive investment rather than engineering earnings.  But instead, they opted to inflate the debt bubble even more and to push off the hard work and timeline for real fiscal responsibility.

The silver lining for investors in all of this is that we could be in store for a healthy fourth quarter now.  But not before we see more bottoming action in stocks for the remainder of September with a possible retest of the lows – Thanks Janet!

Today we sold our small banking position for a small loss, cut back on financials and bought a well run diversified income fund.  That’s it.  We’re already sitting on a pile of cash and intend to stay that way in the short term. Mid October is now looking quite nice for the launching pad to a healthy run higher in stock prices.   We’re making our shopping list now and finding some very juicy looking opportunities.  Who knows, maybe a rising stock market will give the Fed reason enough to do what should have done yesterday.

Have a great weekend!

Sam Jones

All eyes are on the Federal Reserve this week. Will they raise rates on Thursday or not?  It’s important to understand what’s going on now, as events in the coming months are likely to push us further down the road toward the End Game of which I have spoken for almost two years.  The End Game, as it unfolds, is the next period when debt and leverage begin to unwind again.  It will be a period full of risks but ultimately, very profitable opportunities.  In that context, investors need to monitor their own decision making process to avoid some classic errors.

The Real Cost of Low Rates – Financial Engineering

I don’t know if the Fed will raise rates or not on Thursday.  Based on today’s price action with stocks up big and bonds down big, the market thinks they will do so despite the statistical odds of less than 25%.  Economic evidence is mixed but certainly not recessionary here in the US so unless China really has the capacity to derail the globe, the odds are still good that we’ll see rate hikes sometime in the next 3-6 months, maybe even Thursday!  Regardless, we believe they should raise rates.  Why?

The answer is really simple to me.  We need to provide the catalyst for money to become more productive than it has been in the last six years.  Let me explain.  Right now, not unlike other historical periods of very low rates, corporations are using (exploiting) very low interest rates to do some rather egregious financial engineering of their earnings.  I’ve spoken of this before and here it is again.  They (companies like Apple) issue bonds at today’s very low rates, effectively borrowing money from investors and institutions at little to no cost.  Then they use the money to do things like Mergers, leveraged buyouts, share buybacks, or pay dividends to stockholders.  All of these things boost earnings artificially or make stock shares seem more attractive when the companies themselves might not have any real organic growth.  Apple is probably a bad example but they are guilty of financial engineering as much as any of them.  The outcome is mysteriously strong earnings with little to no real aggregate economic growth (GDP at 2-3%) and historically low productivity of that same capital.  The valuations guys who have been arguing that the markets are overvalued have a very good point when current earnings are viewed as temporary and conditional on the availability of very cheap credit (aka low interest rates).  Now you begin to see the gravity of the situation.  If and when “cheap credit” goes away and the Federal Reserve begins to increase the cost of credit by raising interest rates, then we immediately begin to question future earnings unless they are rather instantly replaced with real and robust economic growth.  If the Fed does not raise rates soon, we will simply inflate our earnings and credit bubbles even further.  And as Jimmy Cliff says, “the harder they come, the harder they fall”.

This is that time, the End Game, when the system must transition from a system of financially engineered earnings to actual demand driven profits earned the hard way – through productive use of capital.  We are way past the point where central banks could argue that they are supporting a weak economy.  Quite the opposite, they are likely supporting stock shares at the expense of the real economic growth with a zero interest rate policy! The good news is that there is a roughly $57 Trillion of capital out there in the hands of corporations worldwide.  The bad news is that it current represents 290% of actual global GDP.  This money needs to become more productive and won’t have a reason to do so until the cost of credit goes higher.  So what does all of this mean to investors?

Transition periods can be volatile with plenty of risks for investors including deep corrections and bear markets.  So far, the US stock market is down about 10% from the highs but we are the best looking horse in the glue factory.  Other countries are solidly negative in double digits with few exceptions.   This is that time when we need to banish preconceived notions about the future and follow our investing disciplines even if they argue with our emotions.  This week alone, I have heard strongly worded forecasts that stocks will run higher by 20-25% from here and others who say we should sell any rallies as we are now in the early stages of a bear market.  From our seat, we see a market that is in a new downtrend in the context of some longer-term indicators.  For instance, Lowry’s Buying and Selling pressure metrics show a market that has been under aggregate selling pressure since July (Red line crossed above the black line).   If Buying pressure can meaningfully retake selling pressure on any rebound in stocks, then the bull market can rage on but it’s going to take a lot of buying pressure and the Dow to trade above the 200 day moving average to get that done.

 

We don’t have an opinion on the possibility of that kind of buying enthusiasm, but we do know that we have just as much (I should say as little) money exposed to the market now as our system dictates through our Net Exposure analysis for each of our investment categories.  We also know that our Selection criteria is pointing us away from things that are interest sensitive like bonds and utilities and toward things that benefit in a rising interest rate, rising US dollar environment, like technology, banks and semiconductors.  Finally we know that taking concentrated bets on anything now is a huge gamble and our Position Sizing criteria does not have an overweight reading in anything.  When the selling is done and this correction or bear market ends, this same system will lead us into the right market exposure, the right sectors and some new convictions with overweight and underweight position sizes.  Our system is designed to avoid some of the classic and most costly investor errors and this is a good time to review those.

Types of Investment Errors (just the classics)

Type I – Buying High, Selling at the Lows

We are all familiar with this one but it continues to happen day after day after week after month.  Most investors are very unwilling to accept a small loss, say -5% as it represents some sort of personal failure.  Instead he holds his losing position, often bought very late in a trend, and then watches the stock fall another -20%.  Of course, he cannot accept a loss of that magnitude so the plan changes. Now he will wait for a rebound to sell at a better price – but it never comes.  The stock falls another 46% and he finally sells in total disgust for a massive loss.  We are seeing this now in energy and commodities stocks.  This is the domain of the Do-it-yourself investor and anyone who is a self-proclaimed long-term investor.  Now hear this; No one is a long-term investor.  They don’t exist.  Massive selling at the lows of every bear market, or more recently on August 21^st, is all the evidence I need. The error again is not accepting the small loss and holding on to something that was obviously in a downtrend for way too long.

Type II – Not Letting Winners Run

This one happens to professionals more often.  Honestly, we’re working on systems to help us avoid the risk of this error but haven’t got it mastered quite yet.

This is that situation when we buy something for $20, sell it for $25 and then watch the stock go to $600.  How do we know which stocks to hold?  How high is too high?  This takes some deeper knowledge and experience including changing parameters once a significant gain develops and recognizing leadership in individual company names.   This error is really an issue for stock investors only (not indices, mutual funds or ETFs)

Type III – No Commitment

Everyone is guilty of this one.  “I bought Amazon at $10!  But I only bought 10 shares”.  As George Soros famously says, “When you see it, bet big”.  We own a single winner but have not real money in the trade while sitting on a six-figure balance in Well Fargo checking account earning zero % interest.  Once again, knowledge and experience helps us identify when “it” is in front of us.  Position sizing criteria is a relatively new dial in our systems- only two years old.  We are working to rank and sort our holdings based on our own conviction and ongoing evidence.  High conviction will get larger position sizes, and visa versa.

If I had to make a closing statement it would be this; Markets will always create risks and opportunities for investors.  Worry less about what the Fed may or may not do and work to improve your investment systems to avoid the classic errors like those above.  If the End Game is upon us, let the event work for you!

That’s it for this edition – I’m likely to send a quick note on Friday after the Fed meeting to digest the markets’ reaction.

Cheers

Sam Jones

Today was another ugly day, capping off an ugly week for stocks.  Thus far, everything we see is still constructive toward the development of a meaningful bottom.  Because you asked – we are purposely sending out more frequent but brief updates for our clients and interested parties given the current volatility in the markets.  When things settle down and a new trend develops, you’ll hear from us less.  Beginning with the 4^thquarter, this Red Sky Report will become more event driven in timing, content and frequency breaking from nearly nine years of delivering on Mondays.   I won’t do Twitter on principle because I won’t be a part of the A.D.D. society.   But we’re happy to adapt to the interests of our clients as driven by the kind suggestions of our advisory board.  Please excuse my wild speculations with this update.

 

Mid to Late Stage of the Economic Cycle

 

After a week of pouring through winners (smaller losers) and losers (bigger losers) among the various investment asset classes, sectors, countries and style specific funds, the market situation today is becoming more clear as it relates to the economy, risks and opportunities.  Let me address what we see in that order.

 

First, the economy; Based on the continued show of healthy economic reports in the last several weeks and months and the Fed’s recent commentary suggesting rate hikes are still likely, we must all accept the high probability that we are in a mid to late stage of the larger economic cycle.  There are two take-aways from that statement.  The first is that we are a long way off from a recession and the financial markets rarely (if ever) experience sustained bear markets without the presence or high probability of a recession in the foreseeable future.  There is no recession in the foreseeable future according to most recent reports and longer-term trends (housing, employment, consumer confidence, low rates, cheap gas, rising US dollar, etc).   Smart investors will therefore continue to look at the recent mini-crash as a stiff and painful correction until further notice.  Good friend and smart fella, Paul Schatz of Heritage Capital in Connecticut, offered up these charts as possible anecdotes for the current market pattern compared to other similar “crashes” in the past include the mother of all (1987).  He’s doing a segment on CNBC on Wednesday on the closing bell on these crash patterns.  The patterns are pretty clear following exhaustive events like we saw in the week of August 24^th.   This is not a guarantee but a strong indication that history is now on our side.  The charts also suggest that we still need to see that messy complex bottom over the course of the next two months with several tests of the lows (intraday) before we can really get up and go again.

 

 

 

 

Second, we can take away the real possibility that the economy is actually on the verge of making the transition FROM the Mid-stage TO the Late-stages of the economic cycle.  Now this is where we will find new risks and very exciting new opportunities for investors so pay attention.  Evidence surround the shift from mid stage to late stage or from Stage III to Stage IV among business cycle gurus is coming from recent price trends among different asset classes as well as the fact that this transition typically and historically occurs at or near the first rate hikes by Central Bankers (October?).  So what should we be looking for?  Take a look at the graphic below from the business cycle guru Martin Pring.  From our seat, we believe we are not yet in the Stage IV (late stage) environment shown on the graphic but rather right on the line between Stage III and Stage IV.  Once the Fed raises rates, we should land firmly in Stage IV – but it hasn’t happened yet.

 

 

So what does all this mean in relation to future market trends, risks and opportunities?   Well for one, it gives us some grounded hope for the expectation that the bull market is not over yet and we might very easily see all time new highs in the coming quarters.  As I said, do not give up on this bull yet!  Stocks will also continue to be one of the best performing asset classes really until much later in the cycle when inflation and the “expense” of a higher interest rate environment begin to cut into consumer’s purchasing power.  We’re talking about an environment that has seen 3-4 rate hikes by the Federal Reserve from where we are today, potentially several quarters away.  But not all stocks will do well in this coming late stage cycle.  In fact, we’ll likely see a smaller and smaller group stocks carry the benchmark’s higher while it’s quite possible that many companies which are heavily in debt, over priced and have low free cash flow will suffer as borrowing costs rise.  Earnings for these companies will fall, as will their stock prices.  These are the classic “interest sensitive” groups like financials and utilities and they will be riskier holdings.

 

Meanwhile, other companies in the growth segment that might even benefit from a higher inflationary environment are likely to lead.  These are likely to be in the Technology, Healthcare, Industrials, Materials, Real Estate and Consumer Discretionary sectors.  What you might also have noticed in the graphic above is that Inflation Sensitive groups begin a new period of strength at the expense of bonds, which should be sold according to cycle theory.

 

So here’s the exciting opportunity I spoke of.  Commodities and the energy complex could see an intermediate to long-term bottom soon.  Both have been absolutely hammered by the markets in recent years and thrown out for dead.  Anything that hurts if you dropped it on your foot (metals, a barrel of oil, gold, mining, cement and other basic materials) is down 60-90% in the last 5 years trading at 10 and 12 year lows in price.  In classic fashion, S&P just lowered their rating on Freeport-Mcmoran – FCX (Mining company) to a sell.  Really?  The stock is down 80% and threatening to make a new 12 year low in price.  Contrarians are scribbling FCX, FCX, FCX all over their desks.

 

I believe there is a developing opportunity to buy back into the commodities sector (which includes energy) very nearly after the Fed’s first rate hike. Their day is coming and we will be ready to deploy some of the pile of cash we have accumulated since June, now nearly 50%.  Each of our equity and blended asset sets of strategies has buckets available to own commodities as they did in the early 2000s.  At full exposure, we will have 20-25% in commodities if conditions warrant.

 

Once again, we continue to view this mini-crash market meltdown as an opportunity to add some sideline cash to investments (Calling All Cars!) but be very patient in deploying that cash over the next 60 days.  As promised, I did so today for my kids 529 plans for 50% of my annual contribution.  Did you?  We also look at this broad market decline as an indication of a cycle change to possible late cycle inflationary leadership including some very attractive opportunities in the energy and commodities sectors.

 

That’s it for today – I hope that helps clear things up a bit and gives you some peace over the long labor day weekend.  Our offices will be closed on Monday in observance of the holiday.

 

Cheers

 

Sam Jones

The markets seem to be marching to the script pretty well with the healthy rebound off the lows of last Tuesday.  We sent out a special notice on Wednesday indicating that strong probability given the extreme oversold condition.  Now we are at an important inflection zone again.

 

What You Should Really Care About Now

 

As we’ve said repeatedly since our annual meeting last October, gains will be earned not given.  That means, we all need to be more tolerant of market volatility more so than the years prior to 2014, if we want to “earn” our returns.  The easy money is behind us and has been since October of 2014.  Now we have seen exactly what that means and feels like with the near vertical decline in the last two weeks of August when the markets lost almost 13% (intraday) in only four days.  Actually, if one were to get really granular, you’d say that the markets lost nearly 13% in a total of about 2.5 hours of heavy selling much of which happened in overnight trading during those four days.  For anyone trying to manage risk is such an environment, you might have felt some frustration.  Selling or profit taking had to be done well in advance of any actual price declines if one was to have completely sidestepped these four days.   We certainly did some selling in June, July and August, which helped limit losses, but it’s never enough for an event like that right?

 

Right now, all investors should be paying attention to their market exposure on a total portfolio basis.  We believe our net exposure positioning in close to correct with roughly 50-60% still held in select investments that are still showing good relative strength to the markets.  This applies to all Tactical Equity and Blended Asset strategies.  Income models have been 80-90% in cash for months and are now pending an increase in exposure to high yield and emerging market bonds now trading at more attractive levels.  Net exposure analysis is a strong form of asset allocation if we consider cash as a viable (short term) asset class.  When all things begin to rise and fall with almost perfectly corrected moves as we’ve seeing since mid August, the only thing that matters is how much you have on the table.  Once we get back to a more healthy market and correlations among sectors and asset styles (growth, value, large and small) drops, then we can rebuild a more exposed and diversified portfolio again.  But for now, it’s all about exposure to the market.

 

Inflection Zone

 

Take a quick look at the short-term daily chart below of the S&P 500 ETF – SPY from August 10^th through today’s close.

 

 

We see the very nasty decline that began on the 20^th of August around $205 and hit a panic low on the morning of Monday the 24^th marking a significant low around the $182.50 level.   Now, five trading days later, the index is angling back up to the breakdown point which was discussed in last Wednesday’s commentary as a high likelihood.  That level is roughly 2044 on the S&P 500 or $204.50 on the chart above.  On the chart, you see two horizontal red lines.  If the US market can hold above the lower red line in the next day or two, then we’ll likely see another run up to the upper red line at 2044.  We have now entered an Inflection Zone for the more important market trend.  What does that mean?  It means, in this zone, sellers will be given a very ripe opportunity to cut exposure again if they want to and get serious about capital preservation.  Based on the speed and acute pain of the near free fall in stock prices over the last couple weeks, I think it’s safe to say that many portfolios and investors still feel over exposed and might just take that opportunity to take profits.  On the other hand, buyers might be more enthusiastic than sellers between the two red lines taking us all the way back up to the old highs without ever revisiting the lows again.  What happens in this inflection Zone will determine the future of the markets for the rest of the year.

 

Oddly enough, the perfect pattern would call for a healthy multi-week congestion of prices below the top red line (2044).  This gives everyone a chance to get positioned for whatever they think is coming next.  Sellers would be given a chance to cut exposure and buyers would be given several opportunities to buy at discounted prices.  What we should hope for is another mild round of selling in the weeks ahead and another series of very strong up days that potentially takes prices out to all time new highs giving the bull market another breath of life.   If prices fail to make an all time new high in the next month and instead we see the steep down trend continue, then a more destructive bear market price pattern become more likely.

 

Looking at a longer term (weekly) chart of the same index, you get the idea that the long-term uptrend for stocks is now seriously in question.  The topping process that began last December has now resolved to the downside.  Is this just a stiff and quick correction or the beginning of something more sinister?  We simply don’t know yet – and NO ONE DOES!

 

 

 

 

As indicated in the note on the chart above, many of our positions hit sell stops when they broke down into the “red zone” .   This was the price and time zone when we raised cash to our current 40-50% level (from 16-25%).  We call that prudent risk management without guessing at the future.  Again, in these types of markets that take no prisoners, it’s all about exposure.  If, this turns out to be just a quick hit to the market, we can simply add back exposure in the same zone where we sold (or lower) with no harm done to our prospects for returns.  If this is the beginning of new bear market, we’ll be glad we cut exposure when we did.

 

That’s it for this week.  We may be sending out more special updates during the week considering the importance of this situation.  As always, feel free to call to discuss you personal situation if you feel the need.  Have a great week and know that we are on it daily with regards to your money and the market.

 

 

Cheers

Sam Jones

Another quick update for everyone.  We know you have very short term concerns so here are some comments regarding the market, performance and our plans in the very short term.

 

The Market

Yesterday saw a mini crash in the markets at the open.  This is no longer news as everyone heard about the 1,100 point drop in the Dow.  The silver lining to the day was that the market closed much higher than the intraday lows – down “only” 588 points.  Digesting a day like that is tough.  It’s hard to make sense of panic, frankly, but here’s what we derived.  The lows of yesterday AM will likely serve as an internal low for now meaning we could/ should see a healthy bounce for a few days from an extremely oversold condition.  From that point, we still expect to see the market CLOSE at the lows established yesterday just to wash out anyone who is still overinvested and hopeful.  Those levels are approximately 3-4% lower than where the market is trading today.  After all, the market is in the business of frustrating the maximum number of people possible and that would do it.  A complex, volatile bottoming process is necessary now before the market can start trending higher again and it would not surprise me to see that process drag on into October.   But, we are still in the camp that this is just another flash crash like 2010, 2011 and 2012 that will resolve to the upside unless the economy or earnings begin to show more signs of deterioration.   October looks to be the most likely place for the start of a nice year end rally so don’t give up on this bull market quite yet.  We’ll keep you in the loop as conditions unfold for better or for worse.

 

12 Month Performance Through Yesterday

At present our expectation is that the majority of the price damage for the markets and our equity strategies is behind us for this phase of the correction, perhaps even on a longer term basis.  With that assumption, we took a snapshot of our strategy performance relative to our equity benchmark, the MSCI World Stock Index over the last 12 months through yesterday.  We like to look critically at how well (or poorly) we have done in terms of mitigating losses at potential low points in the market (like yesterday).  The results are not positive in absolute terms but they are reasonable and even attractive on a relative basis again looking back over the last 12 months through yesterday.  These are unofficial numbers taken as a quick snapshot, but do represent strategy results net of all fees.

Take a look:

Benchmark return – 12 months ending 8/24/2015        -10.78%

Tactical Equity (highest risk strategies)

New Power                                                           -5.97%

High Dividend                                                       -1.33%

Worldwide Sectors                                                -6.96%

Blended Asset (moderate risk strategies)

All Season                                                             -5.99%

Foundations                                                          -2.64%

Gain Keeper Annuity                                             -3.18%

Income Strategies (lowest risk strategies)

Freeway High Income                                           -0.64%

Retirement Income                                                -1.85%

As risk managers, we are doing our job at limiting downside losses to a recoverable and reasonable level.  This is a dynamic thing and daily grind.  We are looking forward to getting back in the green regardless; as no one likes to see red.

 

Our Plans

Depending on the strength of any rebound from these extremely oversold market conditions, assuming we get one, we are likely to do one more round of selling to bring our cash position up just a bit.  As I said on Monday, we are almost at our maximum defensive position now after selling many positions last week when they broke stops.  However, we still have a few laggards that appear to be lagging even on this bounce (today).  We are simply getting comfortable for the bottoming process of the next 30-60 days when volatility can still keep you up at night.  If the lows of yesterday are just the first step down in a longer bear market, we’ll continue to migrate completely out of the market for full bear market defense.  It’s just too early to make that call.

Today we are likely to sell our only ETF bond position (LQD) because the risk reward probabilities now strongly favor stocks over bonds.  In addition, interest sensitive stocks and fund (real estate, utilities and bonds) have held up well through this mess but are now likely to underperform.

That it for this very quick and out of cycle update.

 

Cheers

Sam Jones

The long awaited correction in global financial markets is in full swing now, fear is at a maximum and selling just to get out has become an investment strategy.  For anyone with money in the markets, this last weekend was not fun as we ponder the possibility of wealth disappearing, of market crashes and long lasting bear markets.  I know you have lots of the same questions as we’ve been through this many times in the last 25 years.  Here are our answers.  Feel free to pass this on to any friends or family who need some peace of mind.

 

How are We Positioned Now?

 

After selling holdings methodically in June, July and August including many of our longer term positions last week we now have the highest cash position we have carried since the beginning of the last bear market in 2008.  Remaining positions held are generally in lower beta (risk) large cap stock funds, defensive sectors like consumer staples and healthcare, a few high dividend paying ETFs, alternative funds that have low or negative correlation to the market and select lower risk bonds.  These are all subject to being sold as well if necessary but that’s what we still own.    For this stage of the cycle, we are approaching one of our most defensive allocations of the last decade.  Of course, each of our strategies has a different tolerance for market risk so “defensive allocation” is relative.  Tactical Equity strategies have a higher tolerance for regular volatility as stock only programs.  Blended Asset strategies carry a lower total portfolio risk by diversifying across different asset classes.  And our Income models have the lowest tolerance for market risk and loss by ownership of only bonds as well as the application of our long standing market timing signals.

 

Below you will find our current cash positions as of the end of last week in each of our strategies organized by investment category:

 

Tactical Equity

New Power                            57%

Worldwide Sectors                42%

High Dividend                       27%

 

Blended Asset

All Season                             35% (+ bonds and hedges)

Gain Keeper Annuity             57%

Foundations                          42% (+ bonds)

 

Income

Retirement Income               84%

Freeway High Income          68%

Holding Tank                       100%

 

For any investment strategy, this is lots and lots and lots of cash, not to mention the defensive positioning of remaining holdings.  If the selling continues, we will hold up much better than the market and be in that delightful position to buy cheap stuff with our emotional and physical capital intact when a real bottom develops.

How Serious is This Decline?

 

This is a nasty correction in stocks without a doubt.  Last week pushed many indices into double digit losses from the highs and YTD with the 5.8% hit for the week.  This AM as I write, global markets are down hard (4-6%) on follow through selling in China and Europe.  While the twitter feeds and short term commentary is all about black Monday, we don’t see a crash in the works as much as a continuation of the heavy and indiscriminant selling that characterized last week.  Buyers are likely to emerge soon – more on this in a minute.    We have been waiting for a correction of at least 10% for over two years and now we have it.  I said a while ago that after such a long period of steadily rising prices and low volatility, the first real correction would feel terrible.  This feels terrible but so far, we are only looking at a long overdue correction in stocks barely tagging the very “normal” 10% decline threshold that we tend to see at least once a year.  It just hasn’t happened for a while so we all forget that it does happen right?

Every bear market begins with a steep correction, so let’s look at that possibility.  Is this the beginning of a new multi-month, multi- year bear market that erases 50-75% of the previous bull market’s gains?  Our answer is that it’s probably too early for that event given the current underlying STRENGTH in the macro economic variables.   Bespoke sent out a great piece last week called “Two Lies and a Truth”.  I will quote them because I couldn’t have said it any better.

 

“Lie Number 2:

The US is about to enter a recession.

 

This was, without doubt, one of the most absurd things we’ve heard in some time. A TV pundit, making claims that declining activity and currency pressures in EM Asia were going to push the United States into a new, broad decline in economic activity. If we had been the only ones watching that interview, we would find it hilarious, but instead we are just sad that there are inevitably those who might be badly deceived by yet another bomb thrower. Today existing home sales hit their highest level since 2007. The same goes for housing starts, out earlier this week. Jobless claims are near 40 year lows, even without adjusting for a drastically larger population and labor force. 2.9 million jobs have been added in the last year, at a growth rate of 2%. Workers are receiving raises as measured by median wage trackers or our analysis of what the Employment Cost Index says about blue collar workers. Auto sales are sitting near all time highs. Consumer debt is falling as a percentage of income and debt service payments as a percentage of disposable incomes are at all time lows. The government deficit is narrowing, banks have been recapitalized and deleveraged (and are lending at robust rates), and consumer confidence sits near post recession highs. All of this has come, once again and we emphasize, with declining debt loads for the households that create 70% of US GDP through consumption.”

Bespoke Investment Group, LLC July 20^th, 2015

 

Given the long list of strong macroeconomic conditions and lack of recession risk in the system, it would seem most likely that this decline proves to be a very steep and painful correction that finds buyers early taking prices back up toward to the highs of the year.  We are not married to that outcome by any means, just expecting it.  Remember, the Federal Reserve is on tap to raise rates because of the strength in the economy – not weakness!  We’ll be very watchful of the strength of that rebound which should start soon to indicate whether we expect a more protracted bear market ahead or all time new highs ahead.

With that said, considering the real weakness in China and now Europe economically, as well as the real wealth destruction in financial markets, we see the chances of a September rate hike by the Fed as slim to none.  If the US economy can continue to chug higher for the remainder of 2015, we could see a December rate or more likely a 2016 rate hike but those are now the first opportunities for the Fed.

 

What is Our Strategy Looking Forward?

 

As you might imagine, we’re not in a hurry to buy anything here.  I was pleasantly surprised to hear from several of our younger clients over the weekend asking if they should buy stocks now?  My advice was this.  Do not buy anything yet but get yourself in a position to do so now meaning feel free to add cash to investment accounts, identify money that you want to add to investment accounts, make retirement contributions or 529 contributions (to cash) as desired – See Calling All Cars Below for a more specific recommendation.  Our approach now looking forward is to carry current cash, potentially raising it slightly again if any rebound proves to be weak and short lived.  In the very short term (next week or two), we’re going to grind it out as markets are now at extreme oversold levels.  Statistically, within two weeks, we should see prices higher by 2-3% from where they are today.  Of course that rebound is likely to come from a lower level meaning it could be very strong.

As I said in the past many times, investing is a game of probabilities.  Today we have an extremely oversold market that is experiencing a near waterfall decline.  This hurts and we all want to have everything 100% in cash.  Perhaps that is the right choice but the probabilities are strongly against it.  Strong investors will be making a shopping list of things that are holding up better than the market (hard to identify now) possibly even buying a few things.  Weaker investors are still looking for a way out to cut the pain.  This is what creates a lot of market volatility.  Weaker hands moving to stronger hands in mass.  So far, the weaker hands are dominant but that will change.

 

Find Some Peace of Mind

 

If you are seeing red and can’t think straight.  Do these 5 things:

1.  Turn off the TV

2. Avoid reading short term headlines

3.  Stop holding your breath

4.  Go outside, take off your shoes, put feet in the grass for 5-7 minutes

5.  Know that the US stock market is a resilient animal and there is a mountain of cash that wants to buy cheap stocks out there.  Know that corrections create opportunities to make a return on your capital and we finally have an opportunity developing.  Know that you will look back on this time as a dark moment and glad that the situation has improved.

 

Feel free to call or contact us at any time if you need to talk.

Cheers

Sam Jones

Calling All Cars, 8/24/2015

I believe this is an opportunity to add approximately 50% of your planned annual contribution to investment accounts that are generally passively held like retirement plans, 401k plans or 529 education accounts (things you can’t trade).  We’ll look for another opportunity to deploy the remainder of your planned contributions later in the year.  Personally, I will be adding 50% of my annual 529 contribution to my kids’ accounts in the next few days.  That money will go to my current allocation directly which is 75% “Growth” portfolio and 25% cash as it has been for over a year now.  My kids are 13 and 11 just for reference so they won’t need their education money for at least another 5-7 years.  I share this as an example of how you might add to your investment accounts.  Please feel free to call or contact us if you need help with your individual situation.

Looking back over the last 12 months, we can see the market has been working hard to get ready for this widely anticipated event next month.  Selectivity has become very pronounced as seen through indices like the NYSE stock index down 2-3% since July of 2014.  Last week there was a notable shift and one that we’re watching closely.    It’s still too early to suggest that a new uptrend is upon us but there are some positive signs.

New Surge in Transportation and Utilities!

Transports and utilities have been two of the weakest spots in the market since the springtime.  Dow Theorist point to this weakness as a traditional predictive guide for future corrections or bear markets in the broader market.  We have pointed to this several times over the last 6 months.  But as of late July, both have suddenly seen a surge in buying pressure, broken short term down trends and began outperforming even the mighty S&P 500!  Dow theorists have got to be scratching their heads wondering if we’re getting ready for another broad market surge higher now.   So what’s going on?

Strangely, transportation is one of the most economically sensitive sectors (cyclicals) out there and act as a canary for real economic activity.  When no one is moving “stuff” (People, goods, raw materials) around the country or globe, it indicates economic activity is also slowing down.  Global economic activity is slowing; we know this.  So the surge is most likely a technical one based on a nearly historical wipe out in the energy sector driving down fuel costs and making transportation companies more profitable.  Regardless, strength in transportation is a welcome sign.

The move higher in utilities may likewise be just technically driven mostly via new attractive valuations plus healthy dividend income.  We do know that the Federal Reserve is going to raise SHORT TERM interest rates in September.  But utilities are not subject to SHORT TERM interest rate risk as they borrow money only on very long term maturities.  So, yes utilities are interest sensitive but only to long-term interest rates.  Since late January, long-term bonds lost 14% to the lows on June 30th.  Utilities also fell dramatically in sympathy by almost exactly the same amount (-14.6%).  Utilities were simply adjusting to the trend of higher long-term rates and are now finding good support and buying interest at the more attractive levels.  Furthermore, utilities are one of the favorite equity interest investments, as they tend to pay out higher dividends than the interest rate of even the best bonds out there.  When there is value in utilities and bonds are paying historically low rates, they will find buyers looking for income.

Small Caps Ready to Run Again?

Also in the last week, we saw some new strength in small caps, which have been under heavy selling pressure for the last few months.  Small caps are another one of those “Risk on/Risk off” asset groups indicating the mood of investors.  On several of the hard down days in the last couple weeks, small caps have held up relatively well and are now slightly more attractive than more overbought large caps.  Today, as I write, small caps are up over 1% while the S&P 500 is up barely .45%.  Healthy leadership by small caps is always welcome to market bulls and this provides more evidence that the internal condition of the market is now improving.  Keep in mind that small caps are not yet leading on an intermediate term basis, which is really one of the necessary ingredients before we see an improvement in our Net Exposure model.  So we have improvement but not a confirmed change in the status of our Net Exposure screen.

Buyer in the Hole!

Last Tuesday was an ugly day in the morning but by the afternoon, buyers had come to the rescue to see a positive close to the day.  The day formed a long “tail” which shows as a deep line on the bar chart below (marking the intraday lows with higher close).  This was a critical test for the market, as a close at the lows would have sealed in a new very steep downtrend for the broad US market.  On that day, we had quite a bit of money queued up for afternoon sells, as many of our positions would have broken stops.  Thankfully, we didn’t have to exercise those trades and held on.

There is the chance that the market was just tipping its toe in to test the water before taking a more committed plunge and that risk still remains today.  However, with the additional evidence as described above, I think the odds are good that the day represented more of an exhaustion of sellers rather than a test of lower levels.  A strong finish to the week on Friday, gave market technicians more confidence.  We’ll remain cautiously invested for now.

That’s it for the week – stay tuned and enjoy the last days of summer.

Sincerely,

Sam Jones

The word is out; the markets are under selling pressure and prices are down, down, down.  Well, at least the vast majority of prices, indices and world markets are down while a very select few are still hanging tough at new highs.  Such is the hallmark of an aging bull market.  There is still a chance for another stock market surge surrounding the Fed’s rate hike in September but for now defense is still the best option.

 

From Lowry’s…

 

“Over the past 16 months, our weekly reports have been outlining the process of increasing selectivity that characterizes an aging bull market. These reports have noted that this aging process, historically, begins with small cap stocks, eventually migrating to mid caps and, finally, to the large cap stocks.  And, thus far, this bull market has aged according to form.”

Lowry’s Research, August 10^th, 2015

 

Our own net exposure screen dictated a more defensive position on July 21^st when the markets again failed to make a new high.  Almost all strategies moved to 25% cash (or more) that week and have continued to follow stops on all positions, upgrading very gingerly to the mega cap stock indices along the way.   The last of our small caps were sold to cash last week and mid caps are now also on the chopping block.  Some of our favorite spotlight stocks like Fire Eye (FEYE) and Tesla (TSLA) in our New Power strategy also sadly hit stops and were sold recently.  As I’ve said several times in the last month(s), we do not plan to reinvest the cash raised from recent sells until our net exposure screen allows it.  That will take a real surge in over all buying pressure, on big volume with lots of participation from multiple sectors of the stock market.  On the surface it seems unlikely to expect that surge now but we remain open to all outcomes.

 

What any of our client or interested readers should understand is the pattern, or impact, of our risk management process on your money.  Specifically, it is important to recognize and accept the realities of what happens when a portfolio is incrementally moved into a more defensive position as the market carves out a longer term top.  At present, several of our strategies are negative on the year by 1-2% consistent now with several of the US stock indices like the Dow (-2.52% YTD).  Other stock indices are still positive barely like the S&P 500 (+0.91%).  If you think about the process of cutting exposure, it has to be done methodically and with good cause.  “Selling Everything” is a gamble and an emotional act that is not part of our practice.  That prospective moment to do so just doesn’t exist beyond a WAG (Wild Ass Guess) with relatively severe consequences of being wrong like taxes, transaction costs and of course being 100% in cash at a potential market low.  But incrementally cutting weaker holdings, as they drop in price down through moving stops and raising cash when upgrade options are limited is prudent.

 

Now, follow the logic.  Every week is not consecutively down in the markets.  In fact, down weeks, like last week are often followed by up weeks (this week?).  It’s just a game of magnitude when the down moves are stronger than up moves as we’ve witnessed since April of 2015.  This defines a downtrend.  If we are prudently selling positions to cash as they hit stops, we will necessarily not be as invested or exposed to the stock market during subsequent up weeks.  In the end, you will find your risk managed investment portfolio slowly lose some ground in the early months of a market top as they are doing now.  Eventually, the reduced exposure becomes a performance benefit as prices in the market continue to fall faster and faster while the losses in your risk management portfolio become smaller and smaller.  This is happening now as our portfolios have shown excellent relative strength since late July – although still falling slightly, they are falling much less than the global stock markets.  Furthermore, areas of real financial pain like energy, commodities, gold, emerging markets and China have been absent in our strategies as our Selection screens have lead to us more productive areas of the financial market.

 

On the flip side, when the market finally puts in a bottom and a new uptrend develops, we often see new leadership giving us the opportunity to not only “buy low” with raised cash but also to invest in those new leaders for the ride back up.  Too often, we see portfolios comprised of leaders from previous bull market cycles that are simply not participating in the current rising tide.  Energy stocks are an excellent example as they continue to make new lows against a market that is up dramatically in the last couple years.

 

Harry Could Be Right Some Day!

 

I really hate to forecast as it always gets me in trouble.  Forecasting serves no purpose from a practical stance, as every investor should adjust holdings based on empirical, current evidence.  Taking a stand on what you think might happen in the future is a 50% prospect at best.  But I do like to look at the big picture periodically as a long range guide and found a recent chart of the Labor Force Participation Rate (LFPR) compelling.  You might have heard of, or remember my commentary surrounding, Harry Dent who was a bit of a Wall Street favorite during the late 90’s.  He wrote several books like “The Great Boom Ahead”.   He was a big time keynote speaker for his for his work connecting demographic studies to stock market cycles with a great dose of predictive work.  Back in the late 90’s he was projecting the Dow Jones Industrial Average would trade as high as 38,000 based on the consumption habits and productivity of the giant Baby Boomer generation.  Of course Wall Street LOVED that and loved Harry.  And of course, 38,000 didn’t happen.  But to his credit, he did predictively point to a significant top of sorts for US stocks that began in year 2000 that proved prescient.

 

Now take a look at the chart below from Bespoke on the current Labor Force Participation Rate, which does Harry some justice in pointing to trends in voluntary employment.

 

 

 

What we see is a peak in employment as a percentage of the total employable labor force around the year 2000 and that rate continues to fall today.  Practically, what we’re looking at is a generational employment curve that bottomed in 1963 when baby boomers began working in earnest and peaked in the year 2000 when that same group began retiring in mass.  Bringing it home a bit, there has been plenty of conjecture about the real guts behind market appreciation being artificially earned while real economic activity hasn’t been proportionally robust.   The artificial gains argument comes from easy Fed money with near zero interest rates for the last six years, government debt spending and a great deal of strategic corporate accounting like share buybacks and will timed write offs.  What we are not seeing (yet) is real wage growth despite “full employment”, and real productive gains in economic activity, certainly not since 2013 when US GDP fell back to 2% or less.  Historically, any reading less than 2% has been on the way to negative growth (aka Recession).  We need to remember that retiring baby boomers create a subtle drag on the economy on a long-term basis as their incomes fade and subsequently spend less in retirement.  All in, we have that uncomfortable feeling that until the next generation gets to work at the LFPR turns higher, we should remain diligent and committed to risk management systems.  Harry Dents’ work pointed roughly to the years 2021-24 roughly as a turning point for demographics.  This is the future zone marking a changing of the guard when the next generation starts making some real money and contributing to the aggregate productivity of the US economy.  From a long range forecast perspective, this would potentially be a time to get very aggressive with long term ownership of deep value stocks ahead of a more authentic surge in economic activity where we might see 4-6% real GDP in the US.  These will be the Buffett days where bold investors take strong positions in the stocks trading at deep discounts.  Who knows, maybe the Dow can hit 38,000 on that demographic shift.  Harry will be right some day!  Between now and then and especially in the next 12 months, our commitment to any stock or fund will be highly influenced by our selectivity and net exposure analysis.

 

 

Have a great hot summer week

 

Sincerely,

 

Sam Jones