Increasing Equity Exposure As Money Flows Turn Positive

By Lance Roberts | April 2, 2021

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


In this issue of “Increasing Equity Exposure As Money Flows Turn Positive.

  • Market Review And Update
  • Cognitive Dissonance
  • Valuations Dictate Long-Term Returns
  • Portfolio Positioning
  • #MacroView: Biden Stimulus Will Cut Poverty For One-Year
  • Sector & Market Analysis
  • 401k Plan Manager

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Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Catch Up On What You Missed Last Week

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Market Review & Update

Over the last several weeks, we have discussed how the “negative money flow” environment was keeping a lid on prices short-term. To wit:

“As discussed last week, the ‘sell signal’ triggering on a short-term basis coincides with our concerns of quarter-end rebalancing for pension funds. I suspect we may have some additional quarter-end rebalancing risk early next week. However, buying on Thursday next week, as second-quarter positioning gets underway, would not be surprising.

As such, hold positions early next week and look for weaknesses to add to exposures as needed.

Such turned out to be the case as the markets slopped around early in the week. However, that changed as markets exploded to new highs on Wednesday and Thursday as portfolio managers charged back into the stocks sold off during the Archegos debacle.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

As shown, the break out to new highs for the S&P 500 confirmed the positive turn in “money flows.” Notably, the breakout got further confirmation from combined “money flow” and “MACD” buy signals. 

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Yesterday’s “3-minutes” video goes into more detail about the turn of the “money flow” indicators as we enter one of the stronger months of the year. 

https://www.youtube.com/watch?v=plzNfnc4O0I

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

There Be Dragons

Given the confluence of those “buy signals” and “seasonality,” we did increase exposure to portfolios over the last two weeks. 

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

However, as we will discuss more in a moment, that increase in exposure does not come without risks.

As discussed last week, the dollar continued to gain strength and broke above the 200-day moving average. As shown below, sharp increases in the dollar tend to weigh on equity markets.

“The recent rotation to value has been primarily a function of a ‘weaker dollar,’ which boosts commodities. As noted, if economic growth does strengthen, leading to higher rates will attract foreign inflows into the dollar for a higher yield.Such also undermines corporate profitability, given that roughly 40% of corporate profits are from abroad.”

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Secondly, the number of stocks trading above their 200-dma is at extremes. Historically, when the “rising tide lifts EVERY boat,” such has usually been near markets’ peaks.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Lastly, interest rates remain a key to much of the ongoing advance. Sharply rising interest rates have always, without exception, led to a market decoupling. It isn’t a question of “if” it will happen. It’s only an issue of “what rate” pops the speculation. 

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

I know. It isn’t apparent.

“If you think there are risks, why increase exposure?”

Great question.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Cognitive Dissonance 

As a portfolio manager for other people’s money, I get tasked with two primary jobs. 

  1. Generate returns per financial planning goals and objectives; and,
  2. Don’t lose money.

Therefore, I have to take measured “portfolio risk” to create returns but remain aware of the “risks” which could lead to a loss of capital. 

On Thursday, I tweeted, as noted above, that we increased equity exposure due to the confluence of buy signals and the seasonally strong month of April. A response to that tweet provides the basis for discussing “portfolio management in a high-risk environment.” To wit:

I certainly understand his dismay. With valuations at some of the most extreme levels seen only outside of the “dot.com” bubble, why would you invest capital now?

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

To clarify, we have to distinguish between time frames, risk, and expected outcomes.

What Is Risk?

What is the definition of “risk?” 

The chance that an investment will lose value

Increasing risk does not suggest a positive outcome? We can use a mathematical example of “Russian Roulette” to prove the point.

The number of bullets, the prize for “surviving,” and the odds of “survival” are shown:

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

The point is simply while “more risk” equates to more reward, the consequences of a negative result increase markedly.

Blaise Pascal, a brilliant 17th-century mathematician, famously argued that:

“If God exists, belief would lead to infinite joy in heaven, while disbelief would lead to infinite damnation in hell. But, if God doesn’t exist, belief would have a finite cost, and disbelief would only have at best a finite benefit.”

Pascal concluded, given that we can never prove God’s existence, it’s probably wiser to assume he exists because infinite damnation is much worse than a finite cost.

Risk does not equal reward. “Risk” is a function of how much money you will lose when things don’t go as planned. The problem with being wrong, and facing the wrath of risk, is the loss of capital creates a negative effect to compounding that you can never recover.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

There is an essential aspect to the “power of compounding” the media never discusses. It ONLY WORKS when you do not lose money. As shown, after three straight years of 10% returns, a drawdown of just 10% cuts the average annual compound growth rate by 50%. Furthermore, it then requires a 30% return to regain the average rate of return required. In reality, chasing returns is much less critical to your long-term investment success than is commonly believed. 

Even in healthy markets with fair valuations, risks exist. But in markets with high valuations, the risk of a reversion increase as time marches on.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Valuations Dictate Returns Long-Term

Understanding what “risk” takes us to this vital point made by Michael Lebowitz in “Zen And The Art Of Risk Management.”

“In the short-term, price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over long periods, price changes are dependent on valuations. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.”

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

“The correlation of ten-year forward returns and CAPE is statistically significant with an R-squared of .4803. In other words, valuation matters in the long run. Conversely, there is no correlation between quarterly returns and CAPE.”

Such is an important point relative to our reader’s comment. 

In the short-term, worrying about high multiplies isn’t conducive to creating portfolio returns from one month to the next. As such, it isn’t “cognitive dissonance” that we are increasing exposure in a month that has a very high statistical probability of positive returns over the next 30-days. 

Fully Invested Bears

The problem in discussing “investment risk” is that such commentary is summarily dismissed as being “bearish,” By extension, such means we must be either sitting in cash or short the market. In either event, I have “missed out” on the last advance. 

Such reminds me of something famed Morgan Stanley strategist Gerard Minack said once:

The funny thing is there is a disconnect between what investors are saying and what they are doing. No one thinks all the problems the global financial crisis revealed have been healed. But, when you have an equity rally as you’ve seen for the past four or five years, everybody has had to participate.

What you’ve had are fully invested bears.”

While the mainstream media continues to skew individual’s expectations by chastising them for “not beating the market,” which is impossible to doour job is to participate in the markets with a bias toward capital preservation. As noted, the destruction of capital during market declines has the most significant impact on long-term portfolio performance.

From that view, as a portfolio manager, the idea of “fully invested bears” defines the reality of the markets we live with today. Despite the understanding that the markets are overly bullish, extended, and valued, we must stay invested or suffer potential “career risk” for underperformance. 

Such is the consequence of the Federal Reserve’s ongoing interventions. Portfolio managers must chase performance despite concerns of potential capital loss. In other words, we are all “fully invested bears.” We are all quite aware this will eventually end badly. However, in the short-term, no one is willing to take the risk of being grossly underexposed to Central Bank interventions.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Portfolio Update

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we are at full equity allocations, with a slight increase in the duration of bonds. Such leaves our portfolios at model weights in cash with bond durations shorter than our benchmark. 

Furthermore, we added an “index trading position.” Having a single index position in the portfolio allows us to increase exposure to markets as needed quickly and promptly reduce exposure if required. 

Lastly, we continue to carry a “barbell approach” in our portfolios. Such splits holdings between “reflation” trades such as Energy, Financials, and Materials and “growth” focused on Technology.

Therefore, with the breakout to new highs, the markets will likely stretch towards our year-end target of 4100.

After this discussion, it seems apropos to remind you of Bob Farrell’s “10-Investment Rules:”

  • Markets tend to return to the mean over time.
  • Excesses in one direction will lead to an opposite excess in the other direction.
  • There are no new eras — excesses are never permanent
  • Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways
  • The public buys the most at the top and the least at the bottom
  • Fear and greed are stronger than long-term resolve
  • Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names
  • Bear markets have three stages — sharp down, reflexive rebound, and a drawn-out fundamental downtrend
  • When all the experts and forecasts agree — something else is going to happen
  • Bull markets are more fun than bear markets

There is only one fact to remember:

“All bull markets last until they are over.” – Jim Dines

Just remember, “risk” is always “risk.”


The MacroView

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Performance Analysis

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data.  Readings above “80” are considered overbought, and below “20” is oversold. The current reading is 88.50 out of a possible 100.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Portfolio Positioning “Fear / Greed” Gauge

The “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90.  The current reading is 79.34 out of a possible 100.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • Table shows the price deviation above and below the weekly moving averages.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

      Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Low P/B, High-Value Score, High Dividend Screen

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

NEW!  Fundamental Growth Screen

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Aggressive Growth Strategy

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Portfolio / Client Update

I encourage you to read the full newsletter this week if you are concerned about why we increased equity exposure in light of the market’s fundamental long-term risks. 

However, let me repeat the critical paragraph for you:

“In the short-term, price changes of stocks are based solely on liquidity, or the balance of buyers and sellers. Over long periods, price changes are dependent on valuations. The following scatter plots compare CAPE valuations to subsequent 10-year and 3-month returns to highlight this fact.”

We understand the “risks” we are taking and are doing so in a measured and pragmatic approach. We understand the importance of creating returns in the short-term and the implications of long-term returns from excess valuations. 

With this understanding, you can appreciate why we increased our equity exposure last week. Currently, we are at full equity allocations, with a slight increase in the duration of bonds. Such leaves our portfolios at model weights in cash with bond durations shorter than our benchmark. 

Furthermore, we added an “index trading position.” Having a single index position in the portfolio allows us to increase exposure to markets as needed quickly and quickly reduce exposure if required. 

Lastly, we continue to carry a “barbell approach” in our portfolios. Such splits holdings between “reflation” trades such as Energy, Financials, and Materials and “growth” focused on Technology.

As always, we continue watching our indicators closely. However, support at the 50-dma continues to hold, which negates some downside risk in the short term.

Portfolio Changes

During the past week, we made minor changes to portfolios. We post all trades in real-time at RIAPRO.NET.

** Equity / ETF Portfolio – Trade Update ***

“As noted yesterday, we added to individual positions yesterday within portfolio models, and today we added our “trading index” positions to all models. As noted, with the quarter-end rebalancing behind us, and with April being one of the strongest performance months of the year within the seasonally strong cycle, we are upping exposure short-term to participate with a breakout to new highs.” – 4/1/21

Both Models:

  • Reduced SHY to 10% of the portfolio
  • Added a 5% position in SPY

“With our S&P 500 “money flow” models turning positive, along with money flows, we are adding exposure to portfolios for what tends to be a historically strong April period.  We are doing this in two phases – adding individual positions today, and shortly, we will add trading index positions in SPY and QQQ.” – 03/31/21

Equity Model:

  • Increased ALB to 4% of the portfolio.
  • Initiated a 2% in NXPI
  • Started a 2% in F
  • Selling 100% of CRM

ETF Model

  • Added 1% to LIT, increasing weight to 4%

As always, our short-term concern remains the protection of your portfolio. We have now shifted our focus from the election back to the economic recovery and where we go from here.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive

If you need help after reading the alert, do not hesitate to contact me.

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only, and one should not rely on it for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.  

Equity Exposure, Increasing Equity Exposure As Money Flows Turn Positive


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Lance Roberts is a Chief Portfolio Strategist/Economist for RIA Advisors. He is also the host of “The Lance Roberts Podcast” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter, Linked-In and YouTube
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