As we clip off the first two weeks of October, the markets are now moving into the seasonally strong investment period of each year between November and May. The recent rally off of the lows of September has been strong enough to reverse some of the extremely bearish sentiment which provides some catalyst for an advance into the end of the year.
However, any advance that occurs from current levels is likely to be a struggle without much of a risk/reward advantage. Stocktraders' Almanac recently penned much of the same stating:
"To recap, we issued our Seasonal MACD Buy Signal after the close on October 5. Current investor sentiment readings do appear to be setting up in support of a year-end rally. According to Investors Intelligence latest Advisors Sentiment survey, the percent of bullish advisors has rebounded nicely to 36.5% after hitting a multi-year low of 24.7% at the end of September. Bearish and correction advisors are currently at 31.2% and 32.3%, respectively. This is a healthy amount of skepticism which leaves room for the market to work its way higher.
Sadly the current fundamental situation is not a positive, but many of the weak and/or tepid data is backwards looking. For starters, this week's September Retail Sales figures were a disappointment coming in at a seasonally adjusted rate of just 0.1% when compared to August. Motor vehicle sales were the brightest part of the report and accounted for the gain. Apparently lower fuel prices are helping some, just not as much as many had expected. I suspect the market's wild ride in September was the largest reason consumers held back, at least partially. Holding onto some additional cash after making a major purchase while the news is full of negative stock market headlines does seem rational.
Recent inflation data is also something to be concerned about, although it is something of a double-edged sword as the lower it goes, the lower inflation expectations go and the less likely the Fed is to raise rates. The Fed meets again later this month and it would be absolutely shocking for them to make any move this month. Actually, it would be surprising if more than ten words are changed from September's statement. Recent jobs market data has softened, notably average hourly earnings. This combined with the recent plunge in the Consumer and Producer Price Indices (CPI & PPI) suggest the Fed might actually have to take rates negative.
It would seem the Fed has just a few options at this point; leave rates alone and wait, consider taking rates negative or possibly more QE. A final possibility could be to just undue several decades of tweaks designed to mask inflation. The Fed was aggressive in fighting deflation a few years ago, so it is only reasonably to assume they will do so this time around. Cheap money has fueled record dividends and share buybacks which has been bullish for stocks. A short-term stock market bump is the most probable outcome as long as the Fed does not raise rates.
We are bullish again after spending much of the summer on the defense however, our current bullish stance is not a strong as it was last year at this time or at the start of previous "Best Six Months."
Economic data this time around is mixed at best and borderline gloomy at worst while typical pre-election-year forces have failed to prop the market up this year. Most economic data tends to be backward looking while the stock market tends to look forward. Earnings are expected to rebound next year and the Fed is most likely going to remain accommodative in the face of recent labor market and inflation data. We do expect the market to make a run back towards its recent record highs sometime during the "Best Six Months," but we do not see a tremendous amount of upside potential after that."
If you do nothing else, read the bold points.
Yes, the move back to old highs IS a possibility. However, such a move is based on the assumption that:
The Fed does not raise interest rates
Earnings reverse which will require a weaker US dollar, substantially strong oil prices and a pickup in global growth
Inflation remains tame but does not become outright deflation.
Interest rates remain low.
Economic growth shows signs of resilience.
That is quite a list of "IF's" which leaves open a very wide range of possibilities that something goes wrong.
Therefore, I suggest remaining very attentive to portfolio allocations and risk management as we work through the next few months into 2016.
How To Play It
As shown in the main body of this newsletter above, all major "SELL" signals, with the exception of one, are currently registered which suggests being more cautious in portfolio allocations.
I did not say be ALL in cash. I said be more cautious.
Currently, the portfolio model is running at a 50% allocation to equities which will not be adjusted upward just yet until some of the resistance at 2040 is taken out. Also, with the markets extremely overbought, some pullback is necessary to more safely increase exposure.
If the markets can clear resistance, and consolidate enough to work off some of the current very overbought condition, a safer entry point can be obtained to increase exposure for the seasonally strong period.
For now, the recommendations for rebalancing portfolios remain a prudent course of action to allow for an opportunistic increase in equity risk in the weeks ahead.
Working With A Model Allocation
Let's review the model.
NOTE: The following is for example purposes ONLY. It is in no way a suggestion, recommendation, or implication as to any portfolio allocation model currently in use. It is simply an illustration of how to overweight or underweight a model allocation structure.
Again, this is just for educational purposes, and I am not making any specific recommendations.This is simply a guide to assist you in thinking about your own personal position, how much risk you are willing to take and what your expectations are. From that starting point design a base allocation model and weight it accordingly. The closer you want to track the S&P 500 Index, the less fixed income, real estate and cash your portfolio should have. For a more conservative allocation reduce allocations to equities."
Got it? Okay.
Last week, I stated that on a rally this week, which has now occurred, to begin reducing the model holdings to align with the target model allocation by:
First, let's review the Sector Allocation Rotation Model.
The Sector Allocation Rotation Model (SARM) is an example of a basic well-diversified portfolio. The purpose of the model is to look "beneath the hood" of a portfolio to see what parts of the engine are driving returns versus detracting from it. From this analysis, we can then determine where to overweight sectors that are leading performance, reduce in areas lagging, and eliminate those areas that are dragging.
The Sector Allocation Rotation Model continues to deteriorate suggesting that markets are significantly weaker than they appear. As suggested all through this missive, a reflexive bounce in the market can be traded but not bought.
As discussed two weeks ago, the market was due for an oversold bounce. That bounce has now occurred. However, with the markets now moving into the "seasonally strong period" of the year, it is possible that the markets could begin attempting to trade in a more consolidated pattern over the next couple of months. This provides shorter-term investors with an opportunity to potentially add some selective exposure over the next few weeks.
Last week, I recommended taking profits in fixed income as rates had reached their target levels. That advice has worked out well and provides some additional cash reserves to the portfolio.
Over two months ago, I began recommending reducing/eliminating exposure in basic materials, energy, industrials and international stocks as the brief leadership on expectations of economic recovery failed along with those hopes. As I stated last week:
"However, those sectors have become extremely oversold and the recent bounce in these sectors likely have some more room to run. This also includes international stocks which have begun to show improvement as well. From a short-term trading opportunity only, for now, these sectors can be selectively added to during market corrections. Again, this is a trading opportunity that will likely have a fairly short-trigger. "
Mid-capitalization stocks have started to show signs of improvement temporarily as well, but Small-cap stocks should continue to be avoided for now. Volatility risk is substantially higher in these areas and are better used during a firm growth cycle versus a weak one. As I said last week:
"While we are seeing some short-term improvement in performance, the risk is still too elevated to additional exposure now. However, there could be a tradeable opportunity in the weeks ahead."
It is still prudent to REDUCE bond allocations in portfolios back to original allocations (take profits).
The same advice for bonds applies to UTILITIES and REITS which have also performed very well as of late.
Healthcare, Staples and Discretionary stocks are beginning to show signs of more signficant deterioration. This is particularly the case in Healthcare which should be reduced in portfolios along with Financials for now.
The recent bounce in the market has achieved initial goals for cleaning up portfolios and reducing overall equity risk. The recommendations for "pruning and trimming" exposure over the past couple of months has already done a big chunk of this workso there should be relatively only minor changes needed currently.
S.A.R.M. Model Allocation
I stated last week that according to the S.A.R.M. model, those actions, on a reflexive bounce in the markets, would potentially include:
On Pullbacks - ADD materials
On Pullbacks - ADD industrials
On Pullbacks - ADD energy
Eliminating international/emerging markets
Eliminating small capitalization
Hold mid capitalization
These actions would rebalance the example portfolio to the following:
With the rally over this past week, there is now a potential for a short-term rally through the end of the year. As you will notice in the SAMPLE model below cash was reduced to 29% of the portfolio. This is for a SHORT-TERM trading opportunity only. If you a longer-term investor it is advisable to wait for a clearer bull-market confirmation to be made.
It is completely OKAY if your current allocation to cash is different based on your personal risk tolerance.
As you can see, there are not DRASTIC movements being made. Just incremental changes to reducing overall portfolio volatility risks. However, if the expected bounce fails at resistance, then further reductions will be required in accordance with the risk reduction modeling.
Remember, as investors, our job is not to try and capture every single relative point gain of the market as it rises. While we certainly want to participate in the rise, our JOB is to protect our capital against substantial losses in the future. A methodology that regularly harvests gains, reduces risk and keeps the portfolio focused on longer-term goals will lead to a more successful outcome.
401-k Plan Manager
Year End Market Rally...Maybe
As stated above, the markets are now moving into the "seasonally strong" time of the year. Therefore, after months of cleaning up portfolios, reducing risk and rebalancing allocations accordingly, portfolios should be in fairly healthy shape.
While there may be a tradeable opportunity in the markets over the next couple of months, there is a substantial risk of a further correction ahead as weakening fundamentals combined with deteriorating fundamentals weigh on sentiment.
Therefore, for those that are much more risk IN-tolerant, using rallies to reduce further risk in portfolios, and raise cash, is completely acceptable.
HOWEVER, for longer-term investors, while the market is decidedly under pressure, it has not broken the bullish trend that began in 2009. It is the break of that trend that will denote a change from a bullish to bearish market and require further allocation reductions. Currently, a break and close below the October lows will denote such a change. Again, that has NOT occurred as of yet.
In the short-term, the markets are oversold enough for a bounce, however, such short-term bounces should be used for a continuation of portfolio rebalancing processes.
As discussed in the sector allocation section, there is a potential short-term trading opportunity in the more distressed areas of the market. However, I suggest such only with the highest degree of caution and uncertainty. Any trade will likely be very short-lived.
Continue to review your current portfolio holdings and make adjustments as needed.
"1) HARVEST: Reduce "winners" back to original portfolio weights. This does NOT mean sell the whole position. You pluck the tomatoes off the vine, not yank the whole vine out of the ground.
2) WEED: Sell losers and laggards and remove them garden. If you do not sell losers and laggards, they reduce the performance of the portfolio over time by absorbing "nutrients" that could be used for more productive plants. The first rule of thumb in investing "sell losers short." So, why are you still hanging onto the weeds?
3) FERTILIZE AND WATER: Add savings on a regular basis.A garden cannot grow if the soil is depleted of nutrients or lost to erosion. Likewise, a portfolio cannot grow if capital is not contributed regularly to replace capital lost due to erosion and loss. If you think you will NOT EVER LOSE money investing in the markets...then STOP investing immediately.
4) WATCH THE WEATHER: Pay attention to markets. A garden can quickly be destroyed by a winter freeze or a drought. Not paying attention to the major market trends can have devastating effects on your portfolio if you fail to see the turn for the worse. As with a garden, it has never been harmful to put protections in place for expected bad weather that didn't occur. Likewise, a portfolio protected against "risk" in the short-term, never harmed investors in the long-term."
If you need help after reading the alert; don't hesitate to contact me.
Current 401-k Allocation Model
30% Cash + All Future Contributions
Primary concern is the protection of investment capital. Examples: Stable Value, Money Market, Retirement Reserves
35% Fixed Income (Bonds)
Bond Funds reflect the direction of interest rates. Examples: Short Duration, Total Return and Real Return Funds
30% Equity (Stocks)
The vast majority of stock funds track an index. Therefore, select ONE fund from each category.
Keep It Simple.
15% Equity Income, Balanced or Conservative Allocation
15% Large Cap Growth (S&P 500 Index)
0% International Large Cap Value
0% Mid-Cap Growth
Common 401K Plan Holdings By Class
Retirement Savings Trust
Fidelity MIP Fund
Short Term Bond
Pimco Total Return
Pimco Real Return
Pimco Investment Grade Bond
Vanguard Intermediate Bond
Vanguard Total Bond Market
Babson Bond Fund
Lord Abbett Income
Fidelity Corporate Bond
Western Asset Mortgage Backed Bond
Blackrock Total Return
Blackrock Intermediate Bond
American Funds Bond Fund Of America
Dodge & Cox Income Fund
Doubleline Total Return
American Founds Capital World G&l
Vanguard Total International Index
Blackrock Global Allocation Fund
Fidelity International Growth Fund
Dodge & Cox International
Invesco International Core Equity
Goldman Sachs International Growth Opp.
Vanguard Total Stock Market
Vanguard S&P 500 Index
Vanguard Capital Opportunities
Vanguard Growth Index
Fidelity Large Cap Growth
Fidelity Blue Chip
Fidelity Capital Appreciation
Dodge & Cox Stock
Hartford Capital Appreciation
American Funds AMCAP
American Funds Growth Fund Of America
Oakmark Growth Fund
C-Fund (Common Assets)
ALL TARGET DATE FUNDS 2020 or Later
Vanguard Balanced Index
Vanguard Wellington Fund
Vanguard Windsor Fund
Vanguard Asset Allocation
Fidelity Balanced Fund
Fidelity Equity Income
Fidelity Growth & Income
American Funds Balanced
American Funds Income Fund
ALL TARGET DATE FUNDS 2020 or Sooner
Vanguard Mid Cap Growth
Fidelity Mid Cap Growth
Artisan Mid Cap
Goldman Sachs Growth Opportunities
Harbor Mid Cap Growth
Goldman Sachs Small/Mid Cap Opp.
Fidelity Low Price Stock Fund
Columbia Acorn US
Federated Kaufman Small Cap
Invesco Small Cap
The above represents a selection of some of the most common funds found in 401k plans. If you do not see your SPECIFIC fund listed simply choose one that closely resembles the examples herein. All funds perform relatively similarly within their respective fund classes.
I will modify this list over time as the asset allocation model changes to reflect international holdings, emerging markets, commodities , etc. as the model changes to reflect the addition of those holdings.
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. At times, the positions of Mr. Roberts will be contrary to the positions that STA Wealth Management recommends and implements for its clients' accounts. All information provided is strictly for informational and educational purposes and should not be construed to be a solicitation to buy or sell any securities.
It is highly recommended that you read the full website disclaimer and utilize any information provided on this site at your own risk. Past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level, be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and applicable laws, the content may no longer be reflective of current opinions or positions of Mr. Roberts. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his or her individual situation, he or she is encouraged to consult with the professional advisor of his or her choosing.
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