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Exit Stage IV

Exit Stage IV

            There is a lot to be said for the regular practice of identifying stages of the business cycle.  Regular readers know that we lean on our cycle work, especially from the source, Martin Pring who devised appropriate asset allocation models for the six stages.  This work is the genesis of our company brand “All Season Financial” as well as our mantra of “Create Wealth/ Defend It”.    Here’s where we are in the business cycle, how you should be allocated (by asset types) and what comes next.

The Very Basics

First, a quick and oversimplified graphic from Pring.com who did the majority of his work in the mid ‘90s.It’s still very valid today (sorry for the picture quality – ‘90s ya know)

Let’s put some dates and performance strings together on Stocks (S&P 500), Commodities (Commodity Index - DBC) and Bonds (20-year Treasury Bond - TLT) to verify the past and identify the present

Stage II the Recovery phase - January of 2010 (bear market lows) – Jan of 2015

            During Stage II we expect stocks and bonds to perform the best as we climb out of a bear market low and the economy begins to recover while commodities lose ground as we are still in a deflationary environment.This was an unnaturally long Stage II in terms of duration as the Fed kept interest rates artificially low for far too long. 

Here are the numbers for that time period

 S&P 500          +81%

TLT                 +62%

DBC                 -46%   

Stage III –  January of 2015 – July of 2016

This is the Expansion stage when Stocks continue higher but inflationary pressures, rising costs of money, and full employment give commodities some support.Meanwhile this is where the Federal Reserve can no longer justify keeping rates at zero, so they start a long gradual increase.  During these times, we are told that inflation doesn’t exist, when it clearly does, and the Fed begins to respond.  The Fed raised rates for the first time on December 17th of 2015 thus began Stage III! Stage III is also that euphoric moment where all three food groups are trending up.  Unfortunately, in the current cycle it only lasted two quarters or 128 days.

Here are the numbers:

S&P 500          +12%

TLT                 +14%

DBC                 +25%

Stage IV – July of 2016 – Sept of 2018

            Here we have a position that you may have heard recently – “Late Stage Economy”.  This is where the markets get more selective, reaching for growth at almost any cost (think FAANG stocks, and Bitcoin and Pot stocks).  This is where we recognize a growing economy but one that is starting to struggle in select areas leading to a rise in mergers and acquisitions to keep profits up.   This is where Corporate earnings are strong but have a hard time exceeding already high expectations.  This is where the feeling of confidence is at a peak as wealth returns to the masses.This is where we see interest sensitive things like Home Builders and Financials buckle early as they can’t make it in an environment of rising interest rates.  This is where Republicans move into the White House with the promise to cut taxes (Taxes are only an issue when incomes and wealth are on the rise).This is where we are today.

Here are the numbers

S&P 500                     +38%

TLT                             -13%

DBC                             +17%

*Home Builders         -27% (since January of 2018)

*Financials                 -9% (since January of 2018)

Stage V/VI – October 2018 - ??

            Now, here’s the real point we want to make.  There is growing evidence that for the first time in a decade, we may be jumping to Stage V and VI, and it seems to be happening all at once.  Stage V is notable as it often covers the beginning of bear markets for stocks as the market orients for a pending economic recession.  Unfortunately, bonds are not yet productive, so they don’t offer much of a safety net.  This has been the situation since January of 2018 and it has just accelerated now as of October.  BUT, we may also be jumping right to Stage VI where stocks, bonds, and commodities are all down in sync.  This has been exactly the case since the beginning of October and wow is it tough!  It feels like one of those no-where-to-run environments which is why we have nearly 70% in cash and short-term bonds (cash proxies) at the moment.  

Here are the numbers since the beginning of October not including today (Dow -2% + Commodities -3.5%, Bonds were flattish)

S&P 500         -7.66%

TLT                 -1.46%

DBC                 -10.29%

Today we sold the last piece of our commodity exposure to cash after cutting it down by 50% in mid-October.  We had high hopes, but we follow our stops (period).  Oil is breaking below $40/ Barrel, wow!

From an asset allocation approach, for young and old, looking only at the prospects for returns by asset class, we want to be very lightly invested at this time.

Pring would suggest an asset allocation that looks like this:

20-30% Stocks (mostly defensives and quality names or sectors)

20-30% Bonds (still short term)

40-50% Cash

These are our current allocations across our client households if you care to take a peek at your account asset allocations.  It’s the right allocation for this market and this stage of the business cycle. 

What Comes Next?

            I’m glad you asked.  Well, our first and most important job is to be patient and wait for new opportunities to develop across multiple asset classes.  This is happening right now.  High yield bond spreads are widening at .30-.50% daily.Stocks are getting cheaper by the week.Commodities are already trading at a discount but getting even more attractive.  Emerging markets are rebuilding value.  Value stocks are already very attractive and will be some of our next set of buys.  Growth stock like the high-flying technology names in FAANG is done for a while.  They will surge again and lead higher after more substantial declines, after many months and years, after an economic recession has come and gone, after investors have kicked them out of their portfolios in total disgust. 

            Prices do not need to move down in a straight line remember, and they rarely do in a longer period of price declines.  We will see bear market bounces and we’re due for one about now as we retest the October lows.   But each bounce is an opportunity to get on sides with your portfolio asset allocation as described above.

            Beyond 2018, we see some potential for durable low in 2019 depending on signs of a recession in the US.  If there is no US recession, then we should only expect stocks to fall another 8-10% from here (total of 18-20% declines) before heading out to all time new highs.  We could see a durable lows by the first quarter of 2019.  If recession does show up, the downside could be significant and further out.  Either way, strong defense is important now.

That’s it for this week – You’re in good hands.

Please feel free to call us with questions about your current 401k allocations or anything else that you feel might not be allocated appropriately.  This is a free analysis for our current clients or interested parties. 

Happy Thanksgiving to everyone!


Sam Jones