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posted on 16 May 2016

Monday Morning Call 16 May 2016

Written by , Clarity Financial

The ongoing correction last week violated the 50-dma which raises short-term positioning alarm bells. However, as discussed above, the market held support and the recent neckline at 2040.

Heading into next week, it will be critical for the market to hold support at 2040 and rally back above the 50-dma. A failure to do so will complete what currently appears to be another, in a series, of market topping processes.

SP500-Chart7-051316

Why I Have No Exposure To International Stocks

If you wanted to beat the S&P 500 this year, there has only been one real place to be - dividend stocks. While there has been ongoing rhetoric about how "cheap" international stocks look, performance, despite massive interventions by the ECB, has been quite abysmal.

SP500-Comparison-YTD-051416

However, it is not just this year, this has been the case since 2015. Having exposure to international and emerging market stocks has acted as a boat anchor to overall portfolio performance.

SP500-Comparison-ST-051416

But it's not just the last 16-months either. International and emerging market equities have been a performance drag since 2009.

SP500-Comparison-LT-051416

Lastly, while the short-term pop in emerging and international markets coincided with the ECB's "all-in" stimulus program, the realization of the lack of effectiveness of such programs in the Eurozone is already being realized.

SP500-Comparison-ST-051416-2

Furthermore, it is worth noting that while the S&P 500 is currently holding up better than its international counterparts, historical correlations (yellow highlights) suggests a much higher level of caution.

Intermediate-Term Setup Still Cautionary

As stated above, while the short-term analysis still suggests a potentially bullish setup (oversold condition) heading into next week, I do want to restate my words of caution from last week:

  1. We still remain in a major trading range that has yet to be resolved.

  2. Economic data remains weak both domestically and globally.

  3. Earnings continue to remain poor.

  4. We are moving into summer which historically tends to be weak.

  5. This is a Presidential election year which has historically also been weak.

Furthermore, as shown below, the current advance and topping process, remains in the confines currently of a "lower high and lower low" scenario. While it may not "feel" that way, we are still within the broader confines of a downward trending market.

As shown below, each of the last three peaks of market action has coincided with a downward trending topping process that eventually led to a fairly significant short-term correction. The current setup is eerily similar to that of last November.

SP500-Chart8-051316

As I have repeatedly stated over the last couple of weeks the current market setup feels like a "trap."

I remain cautious and already have an "inverse market" position loaded in our trading system to move portfolios quickly back to market neutral if markets break support.

I have not been, or am I currently, convicted about the potential of the market for a further advance from here. Again, this is why allocation models remain extremely underweight equity risk exposure currently.

Short-term portfolio management instructions currently remain:

  1. Tighten up stop-loss levels to current support levels for each position.

  2. Hedge portfolios against major market declines.

  3. Take profits in positions that have been big winners

  4. Sell laggards and losers

  5. Raise cash and rebalance portfolios to target weightings.


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 several weeks, RISK based sectors outpaced performance relative to SAFETY. However, last week, the level of outperformance has begun to fade.

SARM-Chart-051416

The rotation from defensive to "risk on" sectors is now complete and potentially signals a further short-term correction in the market is possible. However, for now:

LEADING: Energy, Materials, Industrials, Mid-cap, Small-cap, Discretionary. (REIT's are leading as investors chase risk and yield. Financials are rapidly improving playing catch-up)

LAGGING: Utilities, Gold, Bonds, Staples, Technology, Healthcare

The sector comparison chart below shows the 9-major sectors of the S&P 500.

Sector-Gallery-SP500-1-051416

The best sectors currently remain:

Discretionary, Industrials, Materials, Staples, Energy, Utilities and Financials.

In other markets the best opportunities are:

Sector-Gallery-Other-2-051416

Gold, Mid-Cap, Dividend Yield, Bonds, REIT's

However, as stated repeatedly, caution is highly advised.


S.A.R.M. Sector Analysis & Weighting

As stated above, the SARM Model is an "equally weighted model" adjusted for risk. The current risk weighting remains at 50% this week. It will require a move to new all-time highs in order to safely increase model allocations further at this juncture.

SARM-ModelPositions-051416

Relative performance of each sector of the model as compared to the S&P 500 is shown below. The table compares each position in the model relative to the benchmark over a 1, 4, 12, 24 and 52-week basis.

Historically speaking, sectors that are leading the markets higher continue to do so in the short-term and vice-versa. The relative improvement or weakness of each sector relative to index over time can show where money is flowing into and out of. Normally, these performance changes signal a change that last several weeks.

Currently, as expected, the recent surge in "risk" is coming to an end as rotation into Utilities and Bonds, or "safety" begins. This rotation suggests the current correction is likely not over as of yet which, again, suggests a more cautionary stance.

SARM-Model-Performance-051416

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. The number of sectors on "buy signals" has improved from just two a few weeks ago to 15 this past week. Sectors that are on buy signals tend to outperform in the near term.

The risk-adjusted equally weighted model remains from last week. No changes this week.

SARM-ModelPortfolio-051416

The portfolio model remains at 35% Cash, 35% Bonds, and 30% in Equities.

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-PlanManager-051416

NOTE: I have redesigned the 401k plan manager to accurately reflect the changes in the allocation model over time. I have overlaid the actual model changes on top of the indicators to reflect the timing of the changes relative to the signals.

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

Yep...Still Waiting

As discussed in the main section of the newsletter, the short-term dynamics have begun to deteriorate. With the longer-term structures still negative, the potential of a bigger correction has risen in the last week.

While the market pushed back into oversold territory last week, the failure to hold the 50-dma raises some red flags. While there is no need to make any changes to portfolios this week, as I have repeatedly stated, the markets are currently fraught with risk and should not be taken lightly.

As I stated last week:

"While our intermediate-term buy signals are in place, we must wait for a breakout of the markets to new highs before increasing the allocation model further. If such occurs, the model will quickly move in steps back to full equity allocations. Currently, however, the risk/reward ratio does not warrant a further increase at this time.

Therefore, we continue to wait for either a breakout of the market to new all-time highs, or a breakdown below support reversing recent actions. I will admit remaining trapped in 'limbo' is emotionally trying - but this is where investors typically make the biggest mistakes by trying to 'guess' at what the market will do next. We are better off to wait and let it 'tell' us."

That advice remains this week. I try and remain very sensitive to making changes to the model since many 401k plans have limits to switching funds.

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-AllocationModel-042316

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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