- Market Melts Up As Fed Turns On Liquidity Firehose
- Opportunities In A Melt-Up
- 2020 – The Futility Of Predictions & Understanding The Risks
- Financial Planning Corner
- Sector & Market Analysis
- 401k Plan Manager
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Market Melts Up
“We are so overbought, and this is feeling like a panicky-just-get-me-in buy day. Be careful about being impressed.” – Kevin Muir
Let me start this week, taking the lead from my dear friend Victor Adair of Polar Futures Group:
“The S&P 500 keep printing new ‘all-time highs’ while complacency reigns even as the CNN Fear & Greed index is flashing extreme greed. Volatility is ultra-low across all markets, the put/call ratio is at a 5 year low and credit spreads are tight. People are reaching for yield, and have no interest in buying downside protection. AAPL is up 100% in 12 months, but TSLA has more than doubled in just 6-months…a poster child for the market’s current exuberance!”
As we discussed previously, the market has been primarily lifted by the largest companies in the S&P 500. In our interview with Thomas Thorton of Hedge Fund Telemetry it was noted that Apple and Microsoft have made up 38% of the YTD rally in the market. Another 38% was supported by the next 15-largest stocks with the remainder brought up by the other 483 stocks in the index.
As I noted in our MacroView Outlook for 2020, and as Victor notes above, the levels of outright complacency and bullishness have reached extremes. The following is our composite “Fear/Greed” gauge with is based on actual market positioning between individuals and professional investors. Since this is a 4-week moving average, it moves more slowly, but with short-term readings spiking higher, I would expect this gauge to be well entrenched at the “Greed” level by year-end.
As Victor notes, this is quite a swing from where we were just one year ago as the markets were in the midst of a near 20% decline.
“A year ago today the CNN index was flashing extreme fear…the S+P index was at 18-month lows…having fallen nearly 20% in less than 3 months…but just a couple of days later it began to rally and is now up ~37% from those lows.”
Why the change?
Two words: Monetary Stimulus
While the media continually droned on about the “Trade War,” the primary reason for the reversal in the markets was the massive reversal in monetary policy.
As Stanley Druckenmiller said this week:
“You have very low unemployment. You have fiscal stimulus in Japan. You have fiscal stimulus and a lot of confidence coming to Britain. We are running a trillion-dollar deficit at full employment. Apparently, we are going to have some sort of green stimulus in Europe. And we have negative real rates everywhere, and negative absolute rates in a lot of places. So with that kind of unprecedented monetary stimulus relative to the circumstances, it’s hard to have anything other than a constructive view on the markets, risk, and the economy in the intermediate-term.”
He is right,
However, this stimulus is the largest ever outside of a “recession” or “financial crisis,” which should lead to the obvious question of “what exactly is going on we don’t know about?”
Over the last 3-months the Fed has been fighting a “repo inferno” flooding the overnight lending market with billions in short-term funding. While the Federal Reserve accurately states this is NOT “Quantitative Easing,” market participants didn’t get the memo. The market has risen in every single week the Fed has been active, despite collapsing fundamentals. (h/t ZeroHedge)
As we have noted over the past year, we have remained primarily allocated toward equity exposure, but have also worked around the edges hedging risk, raising stop levels, and remaining primarily domestic-focused. Given our outlook for a steeper yield curve earlier this year, we also shorted duration in our bond allocations, increased credit quality, and carried a slightly higher than normal level of cash.
Currently, that remains the case with the exception that we have now started to make a small shift into value as the momentum trade is now exceptionally extended. The chart below shows the relative performance of momentum versus value which is currently at a level last seen in 2000.
With the markets extremely deviated from long-term trends, extremely complacent, and overly bullish (as noted above), the shift towards value adds a defensive component to our portfolio risk management strategy (more on this in our MacroView)
While none of this means the next “bear market” is lurking, it does suggest that a fairly decent 5-10% correction is likely over the next couple of months.
As we head into the final few trading days of the year, it is worth reminding you of “the rules” we penned in last week’s missive. These processes follow our basic rules of portfolio management, which you can apply to your portfolio as well to reduce overall volatility risk.
- Tighten up stop-loss levels to current support levels for each position.
- Hedge portfolios against major market declines.
- Take profits in positions that have been big winners
- Sell laggards and losers
- Raise cash and rebalance portfolios to target weightings.
Notice, nothing in there says, “sell everything and go to cash.”
Remember, our job as investors is pretty simple – protect our investment capital from short-term destruction, so we can play the long-term investment game.
Of course, if the Fed fails to “extinguish” whatever “blaze” they are currently battling, then we will begin to have a very different conversation about risk, positioning, and liquidity.
Opportunities In A Melt Up
In June, we shared with our RIA Pro subscribers our strategy for playing the “UN-Invesion” of the yield curve using an under-followed sector of the market, agency REITs. This sector not only pays shareholders double-digit dividends, but was also trading at a very cheap valuation. Such is quite the rarity in today’s markets! Since then, the shares are up nearly 5%, and we have clipped generous coupons.
Since then, we have been looking for the next opportunity to create returns without taking on excess risk, and for that we have been digging around one of the most beaten-up sectors of the market.
Last week, we presented RIA Pro readers another high dividend stock, and sector play, trading at a dirt-cheap level. This recent selection offers a similar value proposition and a 9.60% dividend. Like the recommendation in June, we also purchased the security for our clients.
Join us at RIA Pro to learn more about this position, as well as gain our unique daily market intelligence, access to our portfolios, a wealth of technical, and fundamental information, 401k Planner, and much more.
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The Macro View
If you need help or have questions, we are always glad to help. Just email me.
Wishing You A Very Merry Christmas
Financial Planning Corner
You’ll be hearing more about more specific strategies to diversify soon, but don’t hesitate to give me any suggestions or questions.
by Danny Ratliff, CFP®, ChFC®
Market & Sector Analysis
Data Analysis Of The Market & Sectors For Traders
S&P 500 Tear Sheet
ETF Model Relative Performance Analysis
Sector & Market Analysis:
Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels
Improving – Energy (XLE)
The improvement in Energy has stalled for now as the rotation to “value” gave way back to momentum for the “QE Chase.” As noted last week, Energy needed to break above the downtrend to become an attractive candidate for portfolios. That has now occurred, but with the sector VERY overbought, wait for a bit of correction that does NOT violate the breakout to add holdings. We recently added 1/2 position in AMLP to portfolios and are looking to add XLE on a break above the 200-dma.
Current Positions: 1/2 AMLP
Outperforming – Technology (XLK), Healthcare (XLV), Industrials (XLI), Financials (XLF)
Financials have been running hard on Fed rate cuts and more QE. The sector is extremely overbought and extended and due for a correction. Take profits and be patient to add exposure.
Industrials, which perform better when the Fed is active with QE, broke out to new highs recently, but has since stalled and started to consolidate at a high level. Given the sector is extremely overbought, we will look to add, but will wait for this correction to play out first.
Technology and Healthcare have been the leaders as of late. Healthcare made a sharp recovery from weakening to leading relative to the overall market, and the sector is now grossly overbought and extended. As recommended, we took profits in XLV reducing it from overweight to portfolio weight. Like everything else, XLK is extremely overbought so wait for a correction to add exposure.
Current Positions: 1/2 weight XLI, Full weight XLK, XLV
No sectors in the weakening category.
Current Position: N/A
Lagging – Real Estate (XLRE), Staples (XLP), Discretionary (XLY), Communications (XLC), Materials (XLB), and Utilities (XLU)
Despite Staples remaining in the “lagging” category this past week, the sector continues to ratchet new highs. Momentum remains strong, but the sector is GROSSLY extended and overbought. Take profits.
Discretionary remains a laggard but is threatening to finally breakout to the upside which would be very bullish for the sector. With consumer spending and economic growth remaining stable for now, this is likely. Remain long positions currently, and we may overweight holdings on a confirmed breakout.
Communications broke out to new highs, and is gaining some momentum. We remain long our position currently, but given the sector is very overbought, be patient for a better entry point.
XLRE has been weak as of late as interest rates have been on the rise, however, support is holding and the rise in rates has stalled this past week. XLU, on the other hand, is retesting hold highs and is overbought. We remain long both of these sectors currently, and continue to use them as a defensive hedge against short-term corrections for now.
Current Position: Target weight XLC, XLY, XLP, XLRE, 1/2 weight XLB
Market By Market
Small-Cap (SLY) and Mid Cap (MDY) – Small- and Mid-caps broke out of the previous ranges as the rotation to risk continues. This past week, we added to our small-cap holdings with a small-cap value ETF as discussed last week. We still expect a pullback in the market where we will look to add to our holdings provided we aren’t stopped out.
Current Position: KGGIX, Added SLYV
Emerging, International (EEM) & Total International Markets (EFA)
Emerging and International Markets, rallied recently on news of a “trade deal” and finally clearly broke above important resistance. As discussed last week, we added positions in both emerging market and international value positions
Current Position: Added EFV and DEM
Dividends (VYM), Market (IVV), and Equal Weight (RSP) – These positions are our long-term “core” positions for the portfolio given that over the long-term markets do rise with economic growth and inflation. Currently, the short-term bullish trend is positive, and our core positions are providing the “base” around which we overweight/underweight our allocations based on our outlook.
Be aware that all of our core positions are EXTREMELY overbought. A short-term correction or consolidation is likely before a further advance can be made.
Current Position: RSP, VYM, IVV
Gold (GLD) – Gold is holding support at the $140 level and has registered a buy signal. GDX has also held support and turned higher with a triggered buy signal. We have taken our holdings back to full-weights after taking profits earlier this year.
Current Position: GDX (Gold Miners), IAU (Gold)
Bonds (TLT) –
Bonds rallied back to the 50-dma but failed previously. Bonds remain under pressure currently as the Fed goes all-in on the year-end “liquidity plunge.” We remain long our current bond holdings and recommend no changes at this time.
Current Positions: DBLTX, SHY, IEF
Sector / Market Recommendations
The table below shows thoughts on specific actions related to the current market environment.
(These are not recommendations or solicitations to take any action. This is for informational purposes only related to market extremes and contrarian positioning within portfolios. Use at your own risk and peril.)
This past week, the market put in a strong pre-Christmas week as “Santa Claus” came to Wall Street early carrying a whole bag full of “Fed Liquidity.”
Please read our “MacroView” this week which discusses our views for 2020.
Over the last couple of weeks, we have discussed looking for the opportunity to add exposure to small and mid-caps, international and emerging markets, as well as industrials, materials, and energy.
We have made some recent additions to portfolio in these areas over the last couple of weeks, and are continuing to look for opportunities as they present themselves. However, with the markets as extended as they are currently, we are going to “pause” and wait for our next opportunity to present itself.
As noted last week, we have been “picking through the ruble” of the energy sector looking for a couple of tradeable ideas in the sector. We did add a position that we will continue to build into opportunistically. You can read the research note here.
This past week we added to our Small-Cap value play of KGGIX by pairing it with a Small-Cap Value Index (SLYV). We also added some international and emerging market value as well which also throws off a combined 4% dividend yield.
As noted previously, and as discussed this past week, the addition of the small-cap value fund is a long-term structure we will build into over the next several quarters. The rotation to value has not truly started yet, but when it does, it will be a big winner for the portfolio. In the short-term it will likely drag on performance, so please be aware this is a long-term macro theme we are building into.
- New clients: We are holding off onboarding new client assets until we see some corrective action or consolidation in the market.
- Equity Model: We bought positions in SLYV, EFV and DEM
- ETF Model: Same as the Equity Model.
Note for new clients:
It is important to understand that when we add to our equity allocations, ALL purchases are initially “trades” that can, and will, be closed out quickly if they fail to work as anticipated. This is why we “step” into positions initially. Once a “trade” begins to work as anticipated, it is then brought to the appropriate portfolio weight and becomes a long-term investment. We will unwind these actions either by reducing, selling, or hedging if the market environment changes for the worse.
THE REAL 401k PLAN MANAGER
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Model performance is based on a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. This is strictly for informational and educational purposes only and should not be relied upon for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.
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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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