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On the Edge

After six months of very junky action in the world’s financial markets, it’s safe to say that investors are getting tired and frustrated.  As of June 11th, the Dow Jones Industrial Average is exactly 1 point higher than where it was on Dec. 29th, 2014.  At the same time, it hasn’t been as quiet as you might think.  This is a market of winners and losers and I wish the list would remain consistent.  As of this moment, the market situation has moved to “the edge”.  This is that place where we need to see buyers step up and support the market or we should be read to act defensively as further losses become a reality.  This update will give a quick market snapshot so you can see the edge I speak of as well, map out a possible bottom this summer and identify sectors, countries and investment styles that still look compelling to me now.


Volatility is low?


As a quick note stemming from the fine work of Lowry’s Research this AM, we are told that market volatility is extraordinarily low thus far in 2015.  Let’s take a look at volatility because the market doesn’t feel calm to anyone.  Here’s why.  On a point-to-point basis, with nothing more than 1 point to show for gains in 2015, one could argue that the stock market has flat lined.  Again, only looking at point-to-point numbers, that is the case.  As of June 11th, we have seen 112 market days.  During the time the Dow Jones Industrial average has moved a total of 12,669 points however!  Doing the math, we find an average daily move of 113 points/ day, just over .60%!  The same calculation for the S&P 500 shows an average daily move of 12.68 points, again around .60% daily moves.  These are relatively large numbers for a flat line market.  What we are seeing a market that has as many negative drivers as positive drivers giving it little reason to move sustainably in one direction.  But make no mistake, part of our collective anxiety has to do with the very high daily volatility we are seeing and feeling. 


Net Exposure Model  - Neg to Neutral short term,  Favorable long term.


After swinging slightly negative in the first week of June, our Net Exposure model actually improved slightly last week to almost exactly neutral (50 out of 100 points).  This calls for a “hold” mandate meaning stick with what you have and avoid the temptation to buy or sell until we have more directional reasons to due so.  Upgrades are ok.   One interesting development caused the improvement in the model.  It came from the contrarian sentiment piece where we saw a dramatic shift in the sentiment of the “Big Money” commercial hedgers.  According to Jason Goepfert of Sentiment Trader.com , the “Big Money” commercial hedgers showed a huge $10 Billion swing in their net exposure to be the highest level of exposure to stocks in more than three years.  What do they see?  I couldn’t say.   Meanwhile mom and pop, the small do it yourself investor, has simultaneously become as extremely bearish as we have seen anytime in the last 4-5 years.  Sentiment trader did some great work looking at forward returns for the S&P 500 when the spread between “Big money” and Mom and Pop become this wide (+100).  It has happened only 5 times since 1990 and the results are pretty incredible for the market.  In the short term (inside two months), the S&P 500 has run into trouble with some periods of loss ranging from -1.3% to -10.5% (1998).  Gains over the same time period were also pretty meager showing 2-3%.  But starting in the 3rd month after the +100 spread event (now), we see the S&P 500 put up some very nice numbers finishing with median gains of 12% after 6 months, 17.9% after 9 months and 20.8% after 12 months.  Again, these results are only looking at things from a sentiment perspective.  Much can happen both technically and fundamentally to change these outcomes. 


Timing a Bottom This Summer


I’m going to take a stab as at a possible timing scenario for a potential buying opportunity this summer.  Don’t hold me to it.  Given the current trend, which is messy and generally negative, I don’t see much catalyst for a big move higher between now and the end of the quarter.  July will usher in a new earnings season chuck full of more winners, losers and surprises.  Given the persistent strength in the US dollar and weakness of most foreign currencies, I think it’s still very likely that large cap earnings will continue to disappoint while domestic small caps that are not as exposed to currency risk, should continue to surprise to the upside.  Meanwhile, we have the Federal Reserve angling closer to lift off with raising the Federal Funds rate and they are still likely to do before Halloween by most measures, perhaps even September if we continue to wage inflation in the system.   Being the excellent forecasting mechanism that it is, the market may very well find one of those great tradable buying opportunities between now and the middle of August when most earnings reports are done and out in the public.  Greece will be behind us at that point one way or the other and most will have oriented to a Fed Rate hike by then.  So while you’re sitting on the beach, not thinking about the market, in the very heat of the summer, we could very well have a great moment to buy stocks.  Between now and then, we’re playing defense.


Resilient Investment Options For Now


Here’s the stuff I still like and intend to hold in our strategies as they have good ingredients and are not likely to be impacted by any of the above. 

Small Caps – For reasons outlined above – mostly growth

Homebuilders – Benefitting from low inventory and high demand for real estate.

Building material companies – same reason as above

Furniture and appliances – same reason

Japan – like the GDP growth and like the massive stimulus – devaluing the Yen.

Financials, Banks, Insurance, Brokerage – Benefit from higher rates

Broad based Healthcare – Demographics and Obamacare supportive for a long time

Select Technology – Cyber security, social media and internet mostly

I can’t say there is much I like outside of this short list so naturally, we’re going to be raising cash until that situation changes.

As a final note to all clients, please remember that market returns do not come in a straight line.  This is one of those times when big chunks of the financial markets are going to slip negative, many already have and moved into double digit losses.  Several of our strategies have slipped slightly negative YTD but I’m not worried about it.  That’s the nature of the beast.  We work hard to make the right choices for the future.  We keep our periodic losses manageable and recoverable and we make adjustments as necessary.  In five years, I don’t know if the markets will be higher or lower than they are today. Perhaps we are staring straight into the jaws of the next bear market; maybe this is just a pause in the great bull market. No one can know the answer beyond speculation.   But my confidence level for our strategies is much higher within that time frame as the vast majority of strategies and client account balances tend to make all time new highs regularly and within 18 months following major bear market declines.  Where will we be in five years?  Higher.

I’ll leave it at that – have a great week

Sam Jones