posted on 12 September 2016
Bonds Take It On The Chin?
This past week there was ample commentary suggesting interest rates were set to "soar" higher and the death of the "bond bull market" was finally here. While such commentary is always inevitable whenever rates rise for any given reason, it is hardly the case.
First of all, as I have stated previously, interest rates do not function in isolation. They are a function of economic growth over time as borrowing costs are driven by the demand for credit given the return on investment generated from borrowing activities. In other words, money isn't borrowed at 4% interest if the return on the use of those borrowed funds is 3%.
The chart below proves this.
Given that interest rates had gotten extremely oversold during the "Brexit," money poured into bonds for safety, it is not surprising to see rates have a reflexive move higher. What we saw on Friday was likely rate "shorts" being blown out of positions.
However, interest rates are now at extreme overbought levels only seen near peaks in interest movements AND pushing on the downtrend line from 2015. This will likely prove to be a decent opportunity to rebalance bond exposure to target levels in portfolios next week.
I will be adding more bonds to portfolios next week as well.
Interestingly, as I stated last week:
Importantly, while interest rates could possibly tick higher to the long-term downtrend line at 2.1%, (OMG, run for the hills), the reality is the economy is not growing strongly enough to support substantially higher rates which will push the economy more quickly towards the next recession.
Of course, during recessions interest rates fall sharply which is why I still suspect, given the majority of global economies in negative territory, them to ultimately approach zero.
Watch The Dollar
While the dollar stumbled slightly this week, the uptrend in the dollar remains intact. As I noted previously higher rates in the U.S., as compared to the rest of the world, will attract inflows. Such will continue to suppress both oil prices AND earnings. To wit:
Unlike the stock market which is pushing extreme overbought levels, the dollar is at an extreme oversold condition and has only started a potential move higher. This is something to pay very close attention to in the months ahead due to the dollar's impact on exports, earnings, and commodity prices.
As noted, with interest rates negative in many areas of the world, the push of capital into the U.S. for a higher return on reserves remains likely for now.
S.A.R.M. Sector Analysis & Weighting
As I have been repeatedly stating over the last few weeks, as boring as it has been, there has not been enough of a correction of the current overbought condition to justify increasing equity allocations in portfolios yet. This is despite the fact the model has been adjusted higher to represent the target levels of equity exposure we want to migrate toward.
Well, guess what, we finally broke to the downside. Read the "Time To Buy Or Sell" section in the main body of this missive above.
While actual portfolio equity risk weightings remain below our target of 75% again this week, the odds of a further correction next week keeps us on hold for now until we find a short-term bottom and can redetermine risk/reward ratios.
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 noted above, the recent spike in interest rates has now reached the top of the long-term downtrend and suggests that staples, utilities, and bonds will continue to improve in performance over the next couple of weeks. Such improvement will most likely coincide with an ongoing market consolidation or correction.
Notice in the next to last column to the right, the majority of sectors which have previously been pushing extreme levels of deviation from their long-term moving average have begun to correct those extremes. As I stated previously:
Importantly, if the current pullback is a "buy the dip" opportunity, the sectors that maintain their technical underpinnings and resolve the extreme deviations from short and long-term moving averages will provide good opportunities to add to portfolios.
The two charts below graphically show the relationship of each position's performance relative to the S&P 500 Index. If we are trying to "beat the index" over time, we want to overweight sectors/asset classes that are either improving in performance or outperforming the index, and underweight or exclude everything else.
Sectors Currently Outperforming by >1%
Sectors Currently Performing In Line <>1%
Sectors Currently Under Performing By >1%
Index/Other Asset Classes Out Performing S&P 500 By >1%
Index/Other Asset Classes Performing In-Line With S&P 500 <>1%
Index/Other Asset Classes Under Performing S&P 500 By >1%
The risk-adjusted equally weighted model has been increased to 75%. However, as stated above, further consolidation in the markets is needed before making any changes.
Such an increase will change model allocations to:
THE REAL 401k PLAN MANAGER
The Real 401k Plan Manager - A Conservative Strategy For Long-Term Investors
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.
As I stated last week:
This past Friday is a good example of what can happen if you "guessed wrong."
Over the past several weeks, I have continued to suggest reviewing portfolios, reducing risk, rebalancing and preparing for "whatever comes next." That advice remains this week in particular as we now begin a corrective process. On any bounce in the market early next week continue to clear up your portfolio allocation by:
Given the correction we are now on the lookout for the following two outcomes into which we can take further actions.
No one knows for sure where markets are headed in the next week, much less the next month, quarter, year, or five years. What we do know is that not managing risk in portfolios to hedge against something going wrong is far more detrimental to the achievement of long-term investment goals due to the inability to recover the "time" lost getting back to even.
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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