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posted on 06 June 2016

Monday Morning Call 06 June

Written by , Clarity Financial

Almost, but no cigar.

As stated at the start of this week's missive, the story this past week was the market failing, again, to break and hold above 2100.

SP500-Chart1-060416

With the market now overbought on a WEEKLY basis, there is little "fuel in the tank" effectively to substantially drive prices higher in the short-term. Therefore, with risk outweighing reward at the moment, a more cautious stance to portfolio management should be considered.

Secondly, IF this market is going to advance towards old highs, it must accomplish a breakout above 2100 on Monday. Otherwise, the overbought condition of the market, combined with a technical failure at resistance, will likely bring sellers into the market.

A look at a daily trading chart confirms the same.

SP500-Chart12060416

As shown in the top part of the chart above, when the markets are as overbought as they are now, it has generally been at, or near, a peak in the market. With the market still confined in a longer=term broad downtrend, it will require a move to new all-time highs to put the reward/risk ratio back in the favor of investors.

While technically many underpinnings of the market have improved, it has not yet been enough to confirm the "bull market" is back.

Stops & Hedges

SP500-Chart4-060416

I am leaving my stops in place this week at the current support level at 2040 as shown above. However, a break below 2080 next week will send a warning that will likely lead to stops being triggered.

Furthermore, as stated previously, I have also positioned a short-market hedge in portfolios to reduce to overall allocation to market neutral in the event the market breaks 2000. I am leaving that trigger level in place this week as a breach of such level would be a violation of both the 200-dma (currently at 2010) and the psychological support levels of 2000.

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 I have been discussing the move of RISK based sectors which have outpaced performance relative to SAFETY. Starting two weeks ago, that level of outperformance began to fade rather significantly suggesting the risk-based rally was coming to its inevitable conclusion. This week may have been the beginning of that end.

SARM-Chart-060416

Health Care and Financials continued to improve last week, but Discretionary lost footing slipping back from a previously leading position. While Energy, Basic Materials, Mid-Cap, Small-Cap and International continue to provide leadership, relative outperformance has weakened markedly.

As I stated last week:

"Such action suggests the recently rally last week may well be close to its conclusion."

LEADING: Energy, Materials, Mid-cap, Small-cap, and International

IMPROVING: Financials, Health Care, and Discretionary

LAGGING: Utilities, Gold, Bonds, Staples, Technology, Industrials, & REITs

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

Sector-Glance-1-060416

The previous week's "beta driven" rally was enough to reverse many of the warnings previously discussed by pushing many of the sectors back above their broken short-term moving averages.

However, the Discretionary, Industrial, Energy, Utility, and Financial sectors are all very close to reversing into weakness. Some attention should be paid to these sectors next week.

Furthermore, the large advance in Health Care is likely complete for now which suggests some profit taking and rebalancing in the sector.

The same can be seen in Small-Cap and Mid-Cap stocks where the advance has gone too far too fast in a catch-up rotation move. Bonds also paced a tremendous move last week, as money rotated from equity risk to safety.

Sector-Glance-2-060416

What is particularly interesting is the recent move in "beta related" stocks given the tremendous beating these sectors took the last time the Fed hiked interest rates.

Given the recent spat of weak economic data, the chase for beta is likely a reflection of "bets" being made the Fed will once again "punt" on hiking rates at the next meeting.


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-ModelAllocation-060416

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.

As stated above, Bonds, Health Care, and International all improved in relative performance from last week.

SARM-RelativePerformance-060416

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 18 this past week. Sectors that are on buy signals tend to outperform in the near term.

As I stated above, the technical backdrop of the market has indeed improved. If the market is going to make a break for all-time highs, that time is now.

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

SARM-Model-Portfolio-052116

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-060416

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

No Breakout...Yet

As discussed in the main section of the newsletter, the short-term dynamics improved last week as the market pushed higher to overhead resistance. The negative for the week was the extremely light volume and failure to break above that resistance.

Therefore, there are no changes to the 401k model this week as risk/reward is still not balanced enough to justify taking on additional model 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-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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