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posted on 15 December 2015

Portfolio Strategy And Analysis

by Lance Roberts, Clarity Financial

Recent Correction Sets Up Short-Term Trade

As I stated in the main part of this weekly missive, the market was due for a correction back to support to set up a more seasonal year-end rally. The correction has accomplished most of that work, BUT I suspect we could see a bit more weakness next week.

Just this past week, StockTrader's Almanac suggested much of the same. To wit:

"Even before the month of December arrived, expectations were running high for the market in the final month of 2015. Historically, the market is rarely down in December and when it is it is usually just barely. Remember, this is for the full month. History has also shown a tendency for the market to be weaker during the first part of the month as tax-loss selling and yearend portfolio restructuring has been happening sooner and sooner in recent years.

It seems reasonable to assume that some of this has been taking place already this month. Some of the year's biggest losers have been hit the hardest lately specifically, energy-related stocks and crude oil. Tax-loss selling appears to only be exacerbating broad commodity weakness that has existed all year. It does not look like the global economy is decelerating further. As long as the market can hold its November lows between now and mid-month December, then the market is still on track for a typical yearend rally that has historically commenced around mid-month."

(That sure does sound awfully familiar. Oh yes, I wrote that at the beginning of November.)


As I have reiterated over the last several weeks, the rally and subsequent correction are playing right along with previous expectations.

However, as I have also noted, this is only a "set up" for more nimble and short-term focused traders. As I discussed in detail recently, the underlying dynamics of the market are substantially weak and on a longer-term basis are more akin to market peaks than the beginning of new bull market advances.

While anything is certainly "possible," when it comes to investing your personal savings it is always more prudent to side with what is "probable." As John Maynard Keynes once stated:

"It is always better to be approximately right, than precisely wrong."

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.

S.A.R.M. Current

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 which 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.

Over the last several weeks I have suggested waiting for a correction back to support that was combined with an oversold condition for entering short-term trading positions.

As of today, both of those criteria have now been met.


This set-up provides an opportunity for a tradeable rally in the improving and leading sectors of the market. (Stay with "winners" as they tend to be safer for short-term trading opportunities.)

  • Adding To: Energy, Industrials, Materials, and Technology this week as shown in the model allocation below.

  • Watching: Healthcare, Staples, Discretionary and International for some improvement before further increasing exposure in those areas.

  • Selling/Profit Taking: Bonds, Utilities, REITS

It is still recommended to take profits in fixed income as rates had reached their target levels. REDUCE bond allocations in portfolios back to original allocations (take profits).

Small and Mid-capitalization stocks continue to struggle and should 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.

The same advice for bonds applies to UTILITIES and REITS which have also performed very well as of late. However, that outperformance is has faded 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 work so there should be relatively only minor changes needed currently.

S.A.R.M. Model Allocation

I have adjusted the SARM Model to reflect the changes discussed above.

  • Add Materials

  • Add Industrials

  • Hold Discretionary

  • Add Energy

  • Add Technology

  • Reduce Utilities

  • Hold Staples

  • Hold Healthcare

  • Hold Financials

  • Reduce REITs

  • Reduce Bonds

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 30% 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.

401K Plan Manager


Market Sets Up For Seasonal Rally

As discussed above, the recent pullback to support, and reaching oversold conditions, sets the markets up for a seasonal rally into the end of the year.

However, as cautioned, such a rally could well be short-lived so caution is advised.

The 401k Model is NOT being tactically adjusted at this time because the suggestion of a tradeable rally is far different that an increase in risk for long-term investors. The current market environment is NOT conducive for a long-term allocation adjustment.

Portfolio management rules still apply for now. If the recent market volatility has made your nervous as of late, you are probably carrying too much risk in your portfolio.

As always, your portfolio, much like a garden, must be tended too in much the same way. By doing so, it will ensure that it prospers and grows over time and yields a fruitful bounty.

  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."

As I have discussed many times in the past, the trend of the market is still positive and there is no reason to become extremely defensive as of yet. However, this does not mean to become complacent in your portfolio management practices either.

If you need help after reading the alert; don't hesitate to contact me.

Current 401-k Allocation Model


401k Choice Matching List


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