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The Long Hot Summer

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


Cash at a Minimum


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




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


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


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


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


Mass Sell Dates         S&P 500          Treasury Bonds          Commodities

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

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

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


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


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


Short Squeeze


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


Defense to Offense


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

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


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


Have a great week


Sam Jones