The longer I’m in this business, the more I recognize the importance of investing with the dominant themes of the day. I’m going to talk a lot about this at the Annual Fire Side Chat on Thursday for those who are attending. This update will identify and define the concept of themes and how we can position our money to capitalize appropriately.
Up or Down
This is the easy one right? Is the stock market going up or it is going down? While some snicker and think that’s easy, we know that answering that simple question can be tough at times, especially at perceived turning points. This “Theme” is perhaps one of the most important to identify as an investor. In our shop, we look at the slope of the 200-day moving of the S&P 500 – shown in purple below on this chart. The white pole in the middle of the chart dropped on 8/7/2009
Is the point at which the 200-day moving average turned from sloping down to sloping up. Now for those who lived through the decline in 2007-2009, we know that the market actually put in the final low six months earlier in March of 2009. That low point was also 15% below the level in August when the moving average turned up. During those 6 months, we didn’t really know if the primary trend of the market was still down or whether or not a bottom was in. We had our suspicions but really everyone was just guessing at that point. Since August of 2009, the slope of the 200-day moving average has been trending solidly higher with the exception of one month in the summer of 2012. Now look at the upper left hand corner to today. We see… more of the same. We might suspect that the market is putting in a top and this might be the beginning of a topping period for stocks but really we’re still just guessing with no evidence to support our fear. The primary trend is up and that Theme should largely define your choices, exposure and your general opinion on the markets. Everything else is truly inconsequential noise.
Equities, Bonds, Commodities and Cash
Some think that just owning a bunch of stocks or stock index funds is the only way to invest. That might be true. I find that’s the case in one of two situations. The first is a person who is a naturally a gambler and views investing as a source of entertainment. The second is a person who has little to lose. Often these two situations are found in young investors who don’t yet know the feeling of losing a large pile of hard earned money. A typical mature investor’s portfolio will naturally tend to own stocks, bonds, maybe some commodities, internationals and possible some cash. This is diversification and it’s a good thing for obvious reasons. Now, the theme-oriented investor also knows that there is no such thing as a static mix of all of this stuff that will do well in every market, every year, bull or bear. No, we must understand where there are opportunities and were there are risks in each of these asset classes. The current theme for investors is really all about owning stock on an overweight basis. This is where opportunity lies on a relative and absolute basis. Bonds of most types are in a bubble and have been since 2012. One day, bonds will produce great pain for investors who sadly think of them as safe havens. That day may be next week, next year or in 3 years. I don’t know when. Until then, bond holdings are just going to provide underwhelming results with a high risk profile – no thanks! Commodities are probably in the same camp of unappealing investments now that the US dollar has launched into a long term uptrend. Until inflation really begins to show up in the form of higher costs for raw materials and higher labor rates, commodities are going to lag. So our theme here is about owning a large portion of stocks, but which types of stocks?
Cautionary Note – owning lots of stock is not appropriate for all investors especially those with little tolerance for regular volatility. If you can’t handle seeing your portfolio balance move up and DOWN, you’ll need to wait potentially in cash for other asset class opportunities to develop.
Types of Stocks
Of course, we can do the simple thing and own stock indices rather than working to stay in the right sector or the right company. For many DIY investors (most), this is still probably the right choice. But even in the indexers world, there are winning indices and losing indices. This year is a perfect example. You could own the S&P 500 and have no worries (so far) but your Small cap index fund is now down -6% YTD and falling like a stone every week. You could have everything in a domestic only stock fund and feel swell. Or you could have a few European stock funds that are also down 7-10% YTD. When dominant themes today are pronounced and persistent, we find that owning “sector” funds can also provide some outsized returns with less weekly volatility than owning the whole stock market via broad indices. Of course, you need to own the right sectors. I’ll provide a lot more detail on this on Thursday including what we think will be the safest and most productive places for your stock portfolio both domestically and internationally.
Timing is a theme as well, as in when to invest aggressively or when to play some defense, all the while recognizing that the primary trend is still up. As you might guess, in a raging bull market, trying to time every little top and bottom is a bit of a fool’s errand, so timing is the last and least important consideration to an investor. Conversely, when the market rolls over, our 200 day moving average has a negative slope and wealth is evaporating by the minute, timing means a lot more. In this market, we are considering “timing” from a couple perspectives. One is when we will deploy new client money into our models. For the most part, in a bull market time is your enemy when sitting on a pile of cash as prices have an upward bias. We are purposely more deliberate about NOT sitting in cash with new client money during bull markets and work hard to deploy an account in our strategy holdings within 30-60 days at the most. In a more adverse market, when timing matters, we are very patient with new client money. Case in point, we haven’t see more than 5% correction in stocks in almost 22 months! Waiting for that 10% correction, could be a long wait.
Second, we might use seasons to find new entry points for sectors or upgrade positions. Today is October 6th and we know that October has seen more bull market peaks than any other month of the year. It has also seen more market bottoms! It is also a month that marks the kickoff of the best half of the year from the seasonal perspective (November – April). Furthermore, this is a mid term election year and historical gains for the next three quarters average 24% in aggregate. Will it happen again? Or have we come too far already? What would derail this market? What will be the drivers of new highs? Lots of questions, lots of cross currents here. As I said, timing is tough in a bull market but there is a theme here that investors can and should lightly incorporate into their decision-making. For new money or upgrading positions, October is typically a good month for both. Let’s be focused on that opportunity from a timing perspective but avoid making assumptions about a given outcome.
In aggregate, there are definite themes that investors need to be aware of in order to orient a portfolio correctly. Without a doubt, failure to see, identify and align your portfolio with the dominant market themes (constantly) is the number one reason I see investor’s experience either disappointment or pain. Our job at ASFA is to match our investors with market themes in a tactical and dynamic way, making buy sell or hold decision every day on every position. We are paid to keep your money in the right place and out of the wrong place. This is our value.
Look forward to seeing you all on Thursday!