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posted on 11 April 2016

Monday Morning Call 11 April 2016

Written by , Clarity Financial

As discussed last week, there is a short-term buy signal currently in place due to the strong rally in March. To wit:

"In the chart below, you will note that the previous rallies which took the markets to very overbought short-term conditions (top part of the chart). However, those rallies did not reverse the sell-signal in the lower part of the chart.Each of these previous rallies subsequently failed taking stocks lower. This is why the allocation model remained exposed to lower levels of equity risk during this entire period."

SP500-MarketUpdate-040116-4

"Currently, as shown above, the short-term dynamics of the market have improved sufficiently enough to trigger an early "buy" signal. This suggests a moderate increase in equity exposure is warranted given a proper opportunity. However, to ensure that the current advance is not a "head-fake," as repeated seen previously, the market will need to reduce the current overbought condition without violating near-term support levels OR reversing the current buy signal."

This past week, the "backing and filling" market action began that necessary consolidation process has stayed above important support levels at the 200-dma. That process is likely not complete as of yet as shown below.

SPX-short-term-signals-040916

All of the very short-term signals are currently suggesting more corrective action is likely. However, as stated above, that corrective action must not violate important longer term support. If such a violation occurs over the next week or so, the opportunity to add "trading positions" to portfolios will be negated.

Furthermore, the short-term market breadth indicator is also rolling over confirming a short-term corrective process is likely in the works.

SP500-marketbreadth-040816

My friends over at iViewMarkets track the number of stocks on strong buys vs sells. That ratio is now approaching rather extreme levels which also confirms the current short-term overbought market condition.

Stong-Buy-Sell-Ratio-040916

I reiterate from last week:

"While the technical underpinnings of the market have improved short-term, the risk of increasing equity exposure this coming week is not favorable. However, on a pullback to support, currently 2000-2020 on the S&P 500, a tactical increase to equity exposure in the strongest sectors of the market may be viable."


S.A.R.M. Model Allocation

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.

Over the last couple of weeks, RISK based sectors have improved somewhat while SAFETY sectors have weakened. This is something I suggested had to occur previously as defensive sectors were extremely extended in terms of relative performance measures.

SARM-Rotation-040916

Industrials, Materials, and International sectors have been leading the charge over the last couple of weeks due to the decline in the US dollar. However, as noted last week:

"Interestingly, while the dollar has weakened somewhat, it is still well within the confines of its recent trading pattern. Furthermore, the recent advance in these sectors is out-sized relative to the previous declines in the dollar last year which suggests a short-covering squeeze in play."

Energy, Mid-Cap, and Small-Cap stocks have improved but are still lagging the S&P 500 index as a whole. Mid and Small-Cap sectors are also still well within a major downtrend. Furthermore, the companies that comprise the indices are most susceptible to economic weakness so caution remains advised.

Not surprisingly, the SAFETY sectors have begun to lag the broader market with Bonds, Staples, REIT's slowing their advance. I suggested adding bonds to portfolios several weeks ago when yields approached 2%. While that was a good call at that time, the decline in yields has come more quickly than expected as economic weakness gains traction. While it is not time to sell bonds just yet, it is also not an ideal entry point to add bonds either. Hold positions for now as I still suspect we will retest yield lows, or set new lows, by fall of this year.

Technology is trying to improve in the last week but is still lagging the S&P 500 as a whole.

Financial, Healthcare and Discretionary companies continue to lag at this point. While Discretionary stocks performance has improved in recent days, it is still too early to increase weightings to the sector currently.

I am updating the S.A.R.M. model to reflect potential portfolio allocation changes provided an entry point is obtained. Such an increase would move the current model allocation exposure back to 50% of Target Weightings in an equally weighted portfolio.

SARM-Allocation-Model-040916

What we are looking for is an improvement in the relative performance of each sector of the model as compared to the S&P 500. The next table compares each position in the model relative to the benchmark over a 1, 4, 12, 24 and 52-week basis. What we are looking for is relative improvement or weakness relative to index over time. For example, notice that sectors like Materials, Financial, Technology and Industrials were outperforming the S&P 500 12-weeks ago, but are now once again showing relative weakness.

SARM-PerformanceMeasures-040916

The last column is a sector specific "buy/sell" signal which is simply when the short-term weekly moving average has crossed above or below the long-term weekly average.

However, if the market does allow for an increase in equity exposure through a consolidation process, an increase in the model allocation to 50% of target weights will take model allocations to the following:

SARM-Allocation-Model-040916-2

However, as of this week, the portfolio model remains unchanged with CASH to 50%, 35% in bonds, and 15% in equities. Again, if the markets pull back to support, without violation of said support, I will suggest an increase in equity allocations.

As always, this is just a guide, not a recommendation. It is completely OKAY if your current allocation to cash is different based on your personal risk tolerance, time frames, and goals.

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.


THE REAL 401k PLAN MANAGER

The Real 401k Plan Manager - A Conservative Strategy For Long-Term Investors


401k-Plan-Manager-040916

There are 4-steps to allocation changes based on 25% reduction increments. As noted in the chart above a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.

401k-PlanManager-AllocationShift

Overbought Rally Fades

There has been little change from last week's analysis.

"While the market rally was quite exceptional over the last few weeks, it has done little to change the currently negative market trends back to positive. As shown in the 401k portfolio manager chart above, all sell signals remain in place currently with the exception of the short-term "ALERT" indicator. This initial signal suggests that we begin to watch for 'confirmation' of a turn in the markets back to positive. "

Starting next week we move into Q1 earnings reports. Most likely many companies will be estimates as they have been lowered to extremely low levels. However, we will want to focus on top-line revenue. The weakness in economic reports continues to suggest the overall environment is materially weaker than "operating and pro-forma" profits suggest.

I suspect the current "bullish action" will likely fail as we head into the summer months. With the technical damage to the market remaining over the intermediate and longer-term time frames, the reward of aggressively increasing allocations currently is still outweighed by the risk.

For longer-term investors, the markets have made virtually no progress since January of 2015. Therefore, there is little evidence to suggest stepping away from a more cautionary allocation...for now.

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

Current 401-k Allocation Model

The 401k plan allocation plan below follows the K.I.S.S. principal. By keeping the allocation extremely simplified it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree.)

401k-PlanManager-040216-5

401k Choice Matching List

The list below shows sample 401k plan funds for each major category. In reality, the majority of funds all track their indices fairly closely. Therefore, if you don't see your exact fund listed, look for a fund that is similar in nature.

401k-Selection-List

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