posted on 20 March 2016
by Lance Roberts, Clarity Financial
The last few weeks have certainly been interesting as we have watched Central Banks globally go "all in." From the G-20 meeting where an accord was apparently reached to both the ECB and Federal Reserve jumping on board to support ailing economies.
While I have maintained a cautious stance in portfolio allocations since May of last year, I have reiterated many times that interventions by Central Banks could change the shorter-term dynamic of the markets from bearish back to bullish. These past few weeks have seen exactly that occur.
The question that we must primarily try and answer this week is whether enough "technical repair" has been completed to warrant an increase in equity exposure in the portfolio model.
First, let's review the portfolio model performance as compared to the relative benchmark since last May when I first suggested reducing equities.
WHAT DID I MISS?
It is always interesting when I read the comments made on my strategy by others. The most common is:
Unfortunately, during the response/rebuttal process I discover numerous similarities between all of these individuals. They have generally only been investing post-financial crisis, have very little money and are generally "speculating" in some of the more dangerous of manners. During the next major market reversion, their arrogance will be turned into humility. It is unfortunate they will not listen to the advice of others who have lived through 30-years of market volatility and have already received their degree from USIM, or the "University of Stupid Investing Mistakes."
I have absolutely ZERO, none, nada, interest in chasing and index. For myself, and the clients that I work for, an index has absolutely no relation to specific goals or time frames. As I stated in "Benchmarking Is A Losing Bet:"
For myself, and those that I work for, I truly am investing for relatively long-term time frames of 5-20 years on average. This is because most people that have enough money saved up to actually warrant needing a professional manager are generally between the ages of 45-60 years of age, hence 5-20 year time frames before retirement.
Therefore, spending 5-years to get back to even following a major market reversion is not only unacceptable but devastating to the attainment of retirement objectives.
With this understanding, we can now look at how the portfolio model faired relative to its benchmark and the S&P 500 directly. (While March is not yet complete, I have updated performance through Thursday's close.)
(Disclaimer: The information provided below is for informational and educational purposes only. The following does not constitute a recommendation or solicitation and no warranties or representations are being made. Past performance is no guarantee of future results and use of this information is at ones on risk and peril.)
As you can see, the risk adjusted model has had substantially less volatility since the beginning of last year. Despite being primarily in cash and fixed income since last year, all that has been missed is roughly $500. Given the volatility since the beginning of this year, I am fairly certain that many would trade $500 for avoiding the plunges seen last summer and the beginning of this year. So, what did you really miss?
While the portfolios have been much more cautiously allocated over the last several months, the risk has been a break by the markets to the downside. As I examined in last week's missive, the fundamental, economic and technical backdrop is certainly NOT conducive for higher levels of long-term equity risk.
However, I have always balanced those arguments with a full understanding that massive, coordinated interventions by Central Banks could nullify the "bear case" in the short-term.
DID YELLEN RELEASE THE BULL?
So, the question we must now answer, is whether the recent actions by the BOJ, ECB and the Federal Reserve have provided the markets with enough "fire power" to return the markets back to a bullish trend?
Let's start with a short-term (daily) view as their are some interesting observations.
I have added some notations to the chart I posted earlier this week. As I stated then, there is a lot going on in this chart.
However, if the "bulls" have indeed return to the market, as is being suggested by the mainstream media, we should see longer term measures of market momentum and relative strength turning more positive.
As you will notice, there has been virtually no improvement in longer-term indicators at this point that would suggest a more "bullish" optimism is prevailing in the markets.
At the very bottom of the chart above is the number of stocks trading ABOVE the 200-dma on the S&P 500. Currently, with the overall index trading well above the 200-dma, only 58.6% of stocks are currently doing the same. This suggests a rather narrow rally over the last month and explains the lack of momentum of the overall index.
Even on a shorter-term time frame the recent rally has failed to reverse the negative trend of the market which has been a hallmark of "broadening topping" process seen at the peaks of the last two markets.
While my "emotions" are currently screaming to start increasing equity allocations at this juncture, there are several reasons why my discipline is keeping me from doing so currently:
NEVSKY ON THE ISSUE
I am not oblivious to the fact that Central Banks have aligned to once again drag forward future consumption to support economic growth, increase inflationary pressures and support higher asset prices. That is their goal. However, the success of their endeavors to date, other than boosting asset prices, have been negligible at best.
This also means that while economic data will continue to drag, the efforts will likely postpone a dip into more "recessionary" waters this year and simply push it forward into next. Simply put, Central Banks are continuing to "rearrange the deck chairs on the Titanic" rather than actually addressing the gaping holes in their respective economies. The belief by the Fed that the U.S. economy is "unsinkable" may eventually be their own undoing.
However, there are many that continue to monitor headline economic data as if it is gospel. There is a belief that government supported agencies are producing dependable economic data that can somehow be used to make investment policy decisions. Nothing could be further from the truth, which will only be made apparent next year when backward revisions reveal the errors in the seasonal adjustments of the data.
But it was Nevsky Capital that really brought this issue home. In a recent letter to their investors informing them of the closing of the firms fund, they stated:
I completely agree with Nevsky on this issue. The data is unreliable at best and manipulated at worst. For example, take a look at the chart below.
This chart CLEARLY shows that the number of "Births & Deaths" of businesses since the financial crisis have been on the decline. Yet, each month, when the market gets the jobs report, we see roughly 200k plus jobs created as shown in the chart below.
Included in those reports is an "ADJUSTMENT" by the Bureau of Economic Analysis to account for the number of new businesses (jobs) that were created during the reporting period.
The chart below shows the differential in employment gains since 2009 when removing the additions to the monthly employment number though the "Birth/Death" adjustment. Real employment gains would be roughly 4.43 million less if you actually accounted for the LOSS in jobs given the first chart above.
The "seasonal adjustment" problem runs through the entirety of economic data published by the various government agencies.
Is it intentional? Probably Not. Is it relevant? Absolutely.
Are you willing to bet your life savings on portfolio management strategies dependent on such data?
For all of these reasons, I remain cautious for now. That doesn't mean I will not change to a more bullish stance next week. However, I would prefer that the weight of evidence supports such a change before taking on additional portfolio risk.
One other point to think about.
If the economy is improving and inflationary pressures are on the rise, then why did the Federal Reserve just become MORE ACCOMMODATIVE with their monetary policy by reducing the number of rate hikes this year from 4 to 2? Furthermore, why did they just lower their economic forecasts....again?
Just something to think about.
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