May 26th, 2015
by Lance Roberts, StreetTalk Live
A Memorial Day Message
Before I get into this weekend’s missive, I want to take this opportunity, as I do every year, to remind readers of the importance of Memorial Day.
For many of our youth today, Memorial Day is simply a day off from work, a reason to “pop a top” and fire up the Bar-B-Q or simply sleep in late, visit with friends or family or go shopping to get in on the many “deals.” Yes, for many, Memorial Day is a holiday like any other. But it’s not.
As Ronald Reagan said in 1986:
"Today is the day we put aside to remember fallen heroes and to pray that no heroes will ever have to die for us again. It’s a day of thanks for the valor of others, a day to remember the splendor of America and those of her children who rest in this cemetery and others. It’s a day to be with the family and remember.
I know that many veterans of Vietnam will gather today, some of them perhaps by the wall. And they’re still helping each other on. They were quite a group, the boys of Vietnam—boys who fought a terrible and vicious war without enough support from home, boys who were dodging bullets while we debated the efficacy of the battle. It was often our poor who fought in that war; it was the unpampered boys of the working class who picked up the rifles and went on the march. They learned not to rely on us; they learned to rely on each other. And they were special in another way: They chose to be faithful. They chose to reject the fashionable skepticism of their time. They chose to believe and answer the call of duty. They had the wild, wild courage of youth. They seized certainty from the heart of an ambivalent age; they stood for something.
And we owe them something, those boys. We owe them first a promise: That just as they did not forget their missing comrades, neither, ever, will we. And there are other promises. We must always remember that peace is a fragile thing that needs constant vigilance. We owe them a promise to look at the world with a steady gaze and, perhaps, a resigned toughness, knowing that we have adversaries in the world and challenges and the only way to meet them and maintain the peace is by staying strong.
That, of course, is the lesson of this century, a lesson learned in the Sudetenland, in Poland, in Hungary, in Czechoslovakia, in Cambodia. If we really care about peace, we must stay strong. If we really care about peace, we must, through our strength, demonstrate our unwillingness to accept an ending of the peace. We must be strong enough to create peace where it does not exist and strong enough to protect it where it does. That’s the lesson of this century and, I think, of this day.And that’s all I wanted to say. The rest of my contribution is to leave this great place to its peace, a peace it has earned.”
Our freedoms are precious and few. Yet, since the turn of the century we have willfully given some of our freedoms away in the name of national security or being politically correct. Those freedoms were bought and paid for through blood – the highest price paid of all.
George Orwell, in his classic book 1984, pointed out the dangers of governmental control. Yet even though most of us were required to read the book in school we missed the vital lessons he sought to teach. Such as pervasive government surveillance is bad, the censorship and rewriting of history changes societal thinking and the constant fear of an unseen external enemy is a great way to control a large group of people. Any of this sound familiar?
On this Memorial Day, it is important to remember that while our fathers, sons and daughters fought external enemies to protect our country and our freedoms, but an enemy can also be within.
That fight can only be fought at the ballot box.
I sincerely want to thank each and every veteran and their families for the duty, their courage and their sacrifice. It is because of you that we have the ability to live in the greatest country in the world. A country where any child can achieve their dreams, become a hero, a leader or even President. A country where freedom still rings, liberty still lives and the pursuit of happiness is still an opportunity.
Unlike many countries where individuals are jailed or executed, we have the ability to disagree on political ideologies, debate the issues of our time or argue over the direction of our country. It is our freedom to follow and express our religious beliefs. It is our choice to pursue our own paths. However, we should not forget that those freedoms are deeply rooted in the blood, sweat and tears of the individuals who fought and died for them. For that, we are eternally grateful.
To all of you who served…Thank YOU and hope you had a happy and blessed Memorial Day.
Market Confirms Breakout
About a month ago, I discussed the market was approaching an important decision point. To wit:
"Since the end of the 2012, coincident with the Federal Reserve's implementation of QE3, the market has been on an unrelenting bullish trajectory that has defied weakening underlying economic data and market fundamentals. In other words, price momentum has deviated from underlying fundamentals as investor exuberance has escalated.
While price volatility has certainly increased in recent months, I have maintained a fully allocated portfolio model as the primary bullish trend has remained intact. However, it is worth noting that the current bullish trend is extremely long by historical standards."
"I have also noted the historical buy and sell points as noted by long term MACD trends. Importantly, the MACD indicator is very close to issuing only its 5th signal since the turn of the century. While this does not mean that the next "financial crisis" is set to be unleashed upon the financial world, such signals have only been associated with previous major market tops."
From the broader macro-technical perspective, the current bullish trend remains very much intact despite deterioration in market liquidity, equity outflows and weak fundamentals. The chart below, courtesy of Business Insider, tells the tale very clearly.
It is with this background that I want to update the technical underpinnings of the market. In my previous report, I showed the following chart of the market remaining trapped in a tightening pattern of higher lows and lower highs. This type of action is like the compression of spring.
I stated previously that I expected the consolidation to resolve itself to the upside due to the underlying momentum in the markets. As I discussed in this past weekend's newsletter, the resolution of that consolidation has now been achieved.
"This [breakout] suggests that portfolios should remain FULLY ALLOCATED to equities for the time being as the tendency for the markets remains upwardly biased."
Since the portfolio model remains fully allocated to the market, the break out of the consolidation simply confirms that the "bulls" remain in charge of the market. No action is required other than routine portfolio risk management protocols as previously discussed in "Bull Market Most Overbought/Leveraged In History."
It Is What It Is...
I want to be quite clear about my comments. My job is to manage portfolios in a manner to participate in markets when they are rising and protect capital when they are not. Therefore, focusing on WHY markets are rising is of little importance because portfolios are already invested. My attention needs to be directed toward WHAT may cause markets to buckle unexpectedly. It is because of that analysis that I am often viewed as a "bear." In reality, I am agnostic, and because I am discussing the markets bullish breakout it does NOT mean that I have somehow changed my views.
IT IS WHAT IT IS. Denying the fact markets are rising, and failing to participate in the short term, is just as damaging as participating in a sharp market decline. In BOTH events, I am destroying client capital.
The reality is that the breakout to the upside of the consolidation range IS BULLISH and suggests that markets will go higher in the SHORT TERM.
However, time frames are crucially important. Analysis of short-term market actions are like "7-day weather forecasts." They are accurate within the first couple of days but start needing revisions as new data is received. Whiile the breakout could last a day, a week, or a month - it will eventually end. The breakout DOES NOT mean that we are beginning the next great secular bull market and that investors should pile in with reckless abandon.
As I noted previously, the underlying technicals of the market continue to suggest an environment where downside risk grossly outweighs the potential for reward.
"In order to reinforce the importance of the "buy/sell" indications driven by price momentum, I have stepped the chart out to a much longer time frame on a MONTHLY price basis. As shown, the MACD indicator at the bottom of the chart is confirmed by the price momentum oscillator just above it. Since 1999, there have only been four prior signals with each being critical turning points in the markets."
"Furthermore, the markets are long overdue for a more substantial market correction of 10%, or more, following one of the longest unabated bull market runs in history."
Speaking of long and unabated bull market runs, here are a couple of charts to think about while trying to assess overall portfolio investment risk.
The first chart is the NYSE leading up to the peak of the "Dot.Com" bubble in 2000. Notice that the market went through a consolidation process and then broke out to the final "peak" before the crash began.
Moreover, here is the NYSE again and the recent consolidation and breakout.
Notice that in both cases the relative strength of the advance was deteriorating well before the final peak of the markets.
Here is something else. Industrial stocks are directly tied to economic activity. The transportation of products, people, etc. are all directly related to the strength of actual activity in the overall economy. When the economy is "booming," both industrials and transportation related companies should be participating equally. However, when the "demand" begins to wane in the early stages of a slowdown, the slower activity will develop in the transportation sector.
The chart below shows Dow Industrials versus Dow Transports in 2000. Notice the divergence in the transportation sector from the industrials. Eventually, industrials caught up to the underlying economic weakness telegraphed by the transportation sector.
Here is the same analysis currently. Notice the problem?
While I do not like historical comparisons, in general because markets rarely play out exactly the same, the warning signs that we are in a late market stage advance are pretty evident.
One of the most critical mistakes that investors repeatedly make is trying to apply long-term macro analysis to their portfolio management. As I discussed last time:
This is where the disconnect exists between fundamental and economic analysis and portfolio risk management exists. While there is interesting discussion daily on the current economic or fundamental backdrop as it relates to the markets, the reality is that these measures are of little use in actually managing portfolios in the short-term where investors actually operate."
This is what is called a "duration mismatch."
Fundamental and economic data points are extremely slow to mature, and even slower to have an impact on investor behavior. I have frequently written about the fallacy of long-term investment objectives and actual investor behaviors. As repeatedly shown by Dalbar studies, despite what investors and advisors say about long-term investing, the reality is that actions clearly speak of much shorter-term realities.
Case in point is the ongoing debate about valuations. Valuations are currently at the second highest level in history. (discussed here). Because the market continues to rise in price, due primarily to a flood of Central Bank liquidity, it is has been concluded that "this time is different." It isn't.
While the longer-term market dynamics suggest the risk to investment portfolios, being overweight cash in a rising market will lead to "career risk" for portfolio managers and advisors. The markets are sending short-term bullish signals that should be viewed constructively in the short-term, and portfolios should remain tilted more heavily towards equity exposure.
This does not mean that the current bull market will not eventually end - it will. The longer the bull market advances unabated, the greater the risk becomes of a significant correction. This is where prudent portfolio management and risk controls will pay large dividends over the media's "buy and hold" mentality.
The Ten Things You Will And Won't Do When The Correction Comes via The Irrelevant Investor blog:
I) You will not buy low or sell high.
II) You will cut your winners and let your losers run.
III) You will wish you owned more of what’s going up and less of what’s going down.
IV) You will be fearful when others are fearful.
V) You will fight the trend.
VI) You will not buy when there is blood in the streets.
VII) You will spend too much time worrying about low probability outcomes.
VII) You will invest for the long-term, or until we get a ten percent correction, whichever comes first.
IX) You will go broke taking small profits.
X) You will not just sit there, you’ll do something.
Pay attention. When the time to act comes…I will let you know. The majority of investors, advisors and portfolio managers will react emotionally to the decline. You need to be prepared, willing and be proactive, rather than reactive, to the correction when it comes.
Hope you had a happy and safe Memorial Day weekend.
Disclaimer: All content in this newsletter, and on Streettalklive.com, is solely the view and opinion of Lance Roberts. Mr. Roberts is a member of STA Wealth Management; however, STA Wealth Management does not directly subscribe to, endorse or utilize the analysis provided in this newsletter or on Streettalklive.com in developing investment objectives or portfolios for its clients. Please read the full disclaimer at the bottom of this report.