posted on 14 March 2016
As I stated last week:
This is where having a strict investment discipline is tested. When markets rally strongly, the inclination by most is to ignore their discipline and chase markets. During bullish trending markets, such lapses in discipline are forgiven by steadily rising markets. However, during bear markets, such deviations are often brutally punished.
Jeffrey Snider via Alhambra Partners may have the answer:
WAITING FOR CHANGE
As discussed throughout this weekend's missive, there is ample evidence suggesting a more cautionary approach remains the correct course of action for now. Therefore, we continue to wait, watch and prepare.
As stated last week:
Neither situation will make itself apparent in short order, so relax as we let the market dictate what actions we take next. "Guessing" at the markets has not typically been a successful and repeatable strategy. As stated above, while very short-term indicators have improved, the longer-term signals have not.
BONDS LOOK ATTRACTIVE
While stocks have had a significant surge recently, that short-covering and momentum push has shifted money out of bonds (safety) and back into equities (risk). This is something I specifically noted in last week's missive "Is It Time To Buy Bonds?"
With interest rates back into overbought territory temporarily, the flight from "safety" to "risk" may be nearing its end. While rates could very conceivably push from Friday's close of 1.98% to somewhere between 2.1% and 2.2%, such is not much room to play with.
Therefore, I am beginning to scale into short and intermediate duration bonds over the next couple of weeks as rates continue to push slightly higher. I expect that I will be well rewarded by the end of this year as rates reflect the current underlying economic fundamentals and retest recent lows or lower.
Like every Mom in the world has said at one time or another:
S.A.R.M. Model Allocation
Working With A Model Allocation
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 positioning, how much risk you are willing to take and what your expectations are. 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 and add more to cash and fixed income.
The Sector Allocation Rotation Model (SARM) is an example of a basic well-diversified portfolio. The purpose of the model is to look "under 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.
First, let me show you where we were at the end of January just prior to the February trouncing. As I stated then:
With risk assets primarily in the lagging and improving quadrants, the weak underpinnings of the market were clearly evident. Importantly, I stated then:
As noted above, I am now recommending beginning to scale back into "bonds" as the recent uptick in rates has reduced that overbought condition and have taken bonds to an underweight position in portfolios by reducing prices.
Here is the updated SARM model.
You will note that despite the recent rally, not much has changed since the end of January. Yes, risk assets have improved against safety assets, but not as significantly as one might expect given the sizable rally over the last several weeks.
With markets once again back to extremely overbought conditions, and fighting a declining 200-dma, the advantage of adding significantly to risk assets at this juncture is likely not advisable.
Therefore, there have been no changes to S.A.R.M. model in the past week.
The portfolio model remains unchanged this week with CASH to 50%, 35% in bonds, and 15% in equities.
It is completely OKAY if your current allocation to cash is different based on your personal risk tolerance. This is just a guide.
If the market can pull back and form a bottom at the 50-dma (establishing a higher low) and move the markets back into an oversold condition in the process, such would likely provide a reasonable opportunity to increase short-term equity exposure.
However, for longer-term investors, we need to see an improvement in the fundamental and economic backdrop to support a resumption of the bullish trend. Currently, there is no evidence of that occurring. Such is critically important as economic growth is directly related to P/E growth and stock market returns. This is because earnings/profit growth is directly linked to economic growth. Therefore, over the course of a full-market cycle, corporate profits cannot indefinitely grow faster than the economy.
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