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 10th, 2015
Our own net exposure screen dictated a more defensive position on July 21st 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
