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posted on 18 April 2016

The Monday Morning Call 18 April

Written by , Clarity Financial

As I have stated before, the markets are potentially close to breaking out of current downtrend resistance which would set the markets up for a push to old highs. As I also stated, we are discussing a situation where investment risk is far"outweighed" by the potential for reward.

However, you can't manage money without taking on some inherent risk of loss, after all, that is the very nature of investing itself.


Last week, the market began a "backing and filling" process which was necessary to work off some of the overbought condition. Unfortunately, stocks rocketed higher this week following to "secret Fed meetings on the markets" that spooked investors back into the markets. Subsequently, the overbought condition has remained overbought.


All of the very short-term signals are currently suggesting more corrective action is likely. However, such 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.

This note from Horseman Global is very interesting with respect to the current technical signals being sent. (And hence my concern of this being a trap.)

"A lot of this relatively strong performance came through the use of non-consensus trades such as long yen, Japanese Government Bonds and treasuries.This has meant that we have not been forced to cover our short book, and in fact remain record short. Many other funds have been forced to cover short positions, and are now less net short at much higher prices than six or seven weeks ago. The nature of short selling is that shorts reduce in size when working, encouraging us to add more when they have already fallen, and grow in size when rallying encouraging us to cover.

The other reason that I like short squeezes, is that the best time to short is when other investors have suffered so much psychological damage from being short, they have promised themselves to never short again.

However, I can hear you say, how do you know this is just a short squeeze, and not the beginning of something much more substantial? While equities are trying to send a bullish tune:

  • The 200-day moving average is now trending down for S&P, Dax and the Nikkei. This is not bullish.

  • Furthermore, yield curves in the US, Japan, and Europe have flattened. This is not bullish.

  • The Yen is rallying. This is not bullish.

  • We have seen substantial covering by the market. This is not bullish.

To my mind, if you want to be short, this looks about as good as it gets."

BEFORE you readily dismiss Horseman for being "bearish," you may want to pay attention to their returns.


Okay, so with that said, this week we will be watching for the market to break above its downtrend at 2080 with some level of conviction. As I will review below, the allocation model is already set to increase to 50% equity exposure if this should occur.

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 three weeks, RISK based sectors have improved as SAFETY sectors have come under continued pressure. This is something I suggested had to occur previously as defensive sectors were extremely extended in terms of relative performance measures.


Importantly, such action is also common in late stages of bullish rallies.

Industrials, Materials, Mid-Cap and International sectors have been leading the charge over the last three 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, Discretionary, and Small-Cap stocks have improved but are still lagging the S&P 500 index as a whole.

Note: While Mid and Small-Cap sectors are improving, they are also still contained in an important 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, Utilities & REIT's are beginning to lag in performance. Some profit taking in these sectors is advisable if you have not done so previously.

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

Financial and Healthcare companies continue to lag at this point.

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.


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.


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:


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 - A Conservative Strategy For Long-Term Investors


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.


Market Spikes On Fed Meetings

This past week, the market spiked higher as the Federal Reserve engaged in "emergency secret meetings" to discuss the capital markets. Market participants took this as a sign such could mean further accommodation to the markets in the future.

With that, what bit of oversold condition that was present from the previous week's sloshing about, was quickly eviscerated as stocks pushed up to the current downtrend resistance.

While I still suspect the current "bullish action" will likely fail as we head into the summer months. The short-term picture has improved by pushing our first official "buy signal" back to positive territory. IF the markets can significantly break above the downtrend at 2080 in the next week, I will likely suggest increasing exposure modestly in plans.

However, 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. So, any equity additions should be done with extreme caution and an "itchy trigger finger."

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 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.


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