Getting Fresh with the Markets – Part 2

While I highlighted JP Morgan’s sexy charts in my last post, now it’s time for my sexy charts.  It’s really a whole document, which you can find uploaded here. 

Aside from being more colorful and handsome, my weekly charts attempt to capture the movements of multiple markets, how they are performing relative to other markets, and if they are more risky based on a historical metric I use, among other data.  In short, I use it to identify trends in broad based ETFs, so that we can apply that to our portfolio construction, accordingly.

So here is a quick summary based on weekly data at the close of November 15^th and monthly data as of October 31^st: 

• It’s really amazing how the risk indicator has worked with domestic investment grade bonds.  In October bonds rallied but failed to pierce the risk indicator.  Since then bonds have moved down; though, did rally last week.
• And bonds have by and large had a positive return over the last 12 weeks.
• Another thing to note is the AGG (Aggregate Bond US Bond Index) chart.  Look at that fall!  But how much is AGG down over the last year?  -1.71%.  So really not that big of a deal in my mind.  To me this indicates that even in rising interest rate environments (when interest rates rise bond prices fall), there is little risk of huge portfolio loss from holding bonds.
• Note, the duration (a measure of a bond’s sensitivity to interest rate changes) of the AGG is still under 5, so it’s not like there is huge interest rate risk holding AGG.  This is different for longer dated bonds though.
• Munis still continue to suck wind against corporates, despite their recovery over the last 3 months.
• High yield has been relatively immune to the rise in interest rates.  This isn’t surprising as high yield is usually negatively correlated with Treasuries. 
• A recent trend of late is the outperformance of SPY (large caps) vs. IWM (Small Caps), which are actually flat over the last month.  I wonder if this is the sign of a tired rally as typically riskier flare leads.
• Alternatively, Growth has outperformed Value over the last few months, which may be a short-term move, but is a directional change at least for the time being.
• Developed Market stocks are up, but are still underperforming SPY over the past 12 months (and every other period listed).
• Emerging Market stocks are all over the place.  I love their valuation, but to me still seems like the trend is against them.
• Commodities in general seem to be consolidating, though Oil looks could be in a downtrend.
• The same goes for Real Estate.  In my opinion, rising rates are probably more hazardous to IYR (Real Estate ETF) than to AGG.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Getting Fresh with the Markets – Part 1

I have mentioned this before, but JP Morgan’s Guide to the Markets is really full of awesome charts, graphs, and data.  The edition for Q3 (note all data as of 10/31) can be found here.  Below are some of things I found of interest and how they affect your portfolio:

• From the market bottom in March 2009, the S&P 500 is up 174% and 23% above the prior 2007 peak.
• Best sector YTD is Consumer Discretionary, which is bullish given its cyclical nature.  Further, it’s trailing and forward PEs are still below historical norms.
• Most valuation levels on the markets seem reasonable, thus it doesn’t seem that valuation will dislodge the rally.  Though there is the exception of Shiller Price to Earnings Ratio, but even he admits this isn’t a short-term metric.
• One big market worry is profits as a % of GDP.  This is at an all-time high.  So if this reverts and profits are hurt this could affect the market or on the other hand valuations could keep rising.  This undoubtedly ties to the poor employment picture.
• Interesting to note that when yields are below 5% and interest rates go up, generally stock prices have a positive return.
• Corporate balance sheets are very strong with higher % of cash and lower % of leverage.
• The earnings yield is the reverse of the P/E ratio, in other words, earnings divided by price: by this measure, the markets are cheap.  Further, even if we get to the average valuation level on the earnings yield ration markets have historically followed with positive moves.
• Consumer balance sheets are improving and debt payments as a % of personal income look to be close to an all-time low.  The household deleveraging cycle may be over, and consumers may begin to have disposable income, something which the economy has missed dearly.
• To me employment still looks ugly. Much of the drop in the unemployment rate is a result of people dropping out of the work force. On the other side of that equation, I also read elsewhere the following: if all 3M open positions in the US were filled, unemployment would drop into the mid 4% range. This is largely due to a skills gap.
• Inflation as reflected by the CPI is still tame, so the Fed is really under no pressure, and can be accommodative, which is bullish for stocks.
• Our oil imports our dropping, though we are the largest consumer.  We also produce 12% of the world’s oil, second only to Saudi Arabia, and are expected to surpass them in 2015.
• Looking at the long-run chart on interest rates, it’s tough to tell if we have bottomed.  Though I will say on a subjective note that the current interest rate move up has felt different. 
• While the spread (the difference between two bonds with similar maturity) on high yields makes them look rich, municipal bonds look attractive. 
• While domestic stocks have blown through their 2007 peak, Developed and Emerging Market stocks have not.  This indicates that while the trend still favors the US, on the long-term basis these markets might be more attractive.  Emerging Markets in particular; however this was the case last year at this time, and those who made that bet – we didn’t – have been very disappointed this year.
• Consumption in Emerging Markets is on the rise while US consumption is falling.  This is good for a more balanced world economy.
• Europe still has some gaudy unemployment numbers, particularly in Spain and Greece where they eclipse 20%.
• US stocks have crushed every broad asset class YTD.
• 2013 should be the first year since 2005 since domestic equity funds will have positive fund flows.  Glass half full - more flows from retail investors can push the market higher.  Glass half empty -- retail investors don’t really move the market as evidenced by negative flows since 2009 despite a huge bull market. 

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

30 Minutes to Understand the US Economy

I cheated this week and am making one longer commentary, as opposed to two shorter ones.  This is due to my own personal time crunch, and the depth required for this subject.

Further, I am using Google Docs. for the deeper dive into this piece, and can be accessed here.    What is contained there is my summary notes of the 30 minute embedded video Ray Dalio put together entitled “How the Economic Machine Works”. 

Dalio runs the world’s largest hedge fund, the $120B Bridgewater Associates. This is the most simple and succinct explanation of how money and credit are used in transactions, the sum of which is our economy: why we have booms and busts, where we are at in the current cycle, what’s likely to happen moving forward, etc.  Dalio boils this all down to the most basic fundamentals, and makes everything easy to understand.

While I don’t believe these views are mainstream economic thought, they are much in line with my beliefs on how the economy works, and provides a practical means to explain what has happened in the past.  Those who follow a similar viewpoint have been right more often than their peers.  So click the link, use my outline to follow along, and in 30 minutes, you will better understand what makes our economy tick and destroy those who challenge you at cocktail parties.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

Buy and Hold Works, But May Not Be For Everyone

I believe the above stampede was engineered by a few hyenas at the behest of Scar in an attempt to kill the king, Mufasa, and his son, Simba.  While the Lion King certainly is not a film about investing, I do think the stampede scene illustrates what I believe to be a fundamental truth about investing – fear leads many to run for the exits all at once.  This undoubtedly is a horrible strategy, and the herd is guilty of buying at the top and selling at the bottom.

The way to avoid this is to build a diversified portfolio, dollar cost average into riskier assets (i.e. spread your purchases over time), and only look at it on occasion.  Almost everyone can do one and two, but the problem lies with #3.  Almost nobody can put their money aside and not look at it.  And if you can’t, chances are you will worry about it from time to time.

Certainly there is nothing wrong with worrying about your money.  In fact I believe worrying, if properly directed, leads to prudent asset management causing the investor to focus on risk as the primary driver of asset allocation.  However, when worry turns to fear and panic, it leads to catastrophe.

We recently met with a very large investment management company, who wanted to pitch us on their investment process.  It had a lot of merit: essentially they skew their investments to assets that have historically outperformed the market.  The issue is that they expected (really almost require) us to hold their investments through up markets and down markets, regardless whether we felt it was prudent for our client to liquidate given their risk level. 

They use a lot of data and numbers to tell their story and wanted us to “teach” our clients how to invest – buy and hold these asset classes until the end of time.  My issue isn’t with their style or their numbers, but they fail to realize an essential fact: when markets are in their darkest hours many investors aren’t built to handle that pain and need to abandon ship, which typically happens to be at the worst possible time.

So how can we as wealth managers prevent our clients from doing this?  The best way is to know your client. This approach will lead to suitable, diverse, portfolio construction, which should minimize portfolio draw downs.  This strategy and discipline should prevent a wholesale sell off for the very risk averse clients. While we aren’t selling at the bottom, we are certainly paring back the risk as markets decline, which by the way is another method to avoid the herd mentality and the risks associated with it.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.

So What, Who Cares

I have been willfully ignorant of whatever is going on in Washington. When I do hear snippets here and there on Bloomberg I want to do this:

If I listen at this point it will only be a detriment to prudent wealth management:

• T = 0: Self-inflicted issue (e.g. the debt ceiling) that could have a “catastrophic” impact on the markets and the economy starts being chatted about in investment circles

• T = 1: Self-inflicted issue begins to pick up steam as a “legitimate” threat; markets largely ignore

• T = 2: Politicians dig in and hope for a comprise is lost; markets pick up volatility

• T = 3: Now the only thing that will save us is a last minute deal; market moves down a few percent, not enough for me to put cash to work and buy (annoying), but also not triggering any sell signals for existing holdings

• T = 4: At the last minute whichever party is losing the popularity poll caves; market back to where it was before

• T = 5: Self-congratulating politicians save the world from a problem they created; everyone vomits

• T = 6: For real?  Those insufferable mutants only kicked the can down the road, again not solving their own problem

• T = 7: Wait until we get to do this same charade all over again

I am fairly sure the above blueprint can be written in stone.  Thus, if you care to tune out Washington like I do then take a nap for a month and that’s where we will be.

Note: The Debt Ceiling talks of August 2011 coincided with a near collapse in Europe, thus the almost 20% decline in the markets doesn’t count.

The views and opinions expressed herein are those of the author(s) noted and may or may not represent the views of Capital Analysts, Inc. or Lincoln Investment.  The material presented is provided for informational purposes only. Nothing contained herein should be construed as a recommendation to buy or sell any securities. As with all investments, past performance is no guarantee of future results. No person or system can predict the market. All investments are subject to risk, including the risk of principal loss.