Bearish

For today’s blog, I thought I would share with you some of the highlights that came out of our “ValueTrend Update” – a research report that we email to our clients regularly. This update keeps our clients informed on our current strategies, and our specific stock trades both current and pending. I won’t share the specific stock trading information here (you do have to be a client to be privy to that information), but I will share the most important points from the report.

Here it is:

There’s no other way we can describe our current outlook than to say “Bearish”. We’ve held a defensive stance through the first quarter of this year. Yes, we missed out on some upside as markets rallied in February and March. However, there is reason behind our madness. Allow us to point out some indicators that encourage a defensive position. Some are technical (crowd and price behaviour) indicators, some are fundamental (valuation and economic):

S&P

 

  • Non-confirmation between industrial & transportation stocks: Charles Dow pointed out 100 years ago that when the companies that make stuff (industrial s & technology stocks like Microsoft) aren’t shipping that stuff (rail, trucking, air) then you have a problem. Right now, as with last March (when we sold), the industrial s are not being supported by transport stock movements.
  • Smart money selling, dumb money buying: Retail investors such as small stock investors and mutual fund buyers are known to make decisions emotionally. They buy high and sell low. That’s why we call that group “dumb money”. Meanwhile, sophisticated traders, large institutions, pension managers and commercial hedgers are selling. They notoriously call the markets correctly, which is why we call them “smart money”. We track these groups independently. Take a guess how the smart and dumb money investors are positioning themselves…Hint: it’s not looking good for the dummies.
  • Déjà vu all over again: Been there, done that. That is, we’ve seen the S&P 500 hit 2130-ish over and over and over for 18 months now. And it’s gone as low as 1880 several times (last summer twice, and once this January). This week the S&P 500 hit just under 2080. The implied upside from there is about 3%. Do you know of a catalyst that could drive it through that level? We don’t. We think that’s the lid for now. The implied downside is about 9% if the S&P hits 1880 again. That’s a 3:1 risk to reward ratio. Would you take a $100 bet if all you could win was $3 and you could lose $9? Didn’t think so….
  • The Fed: Fed Chairperson Janice Yellen recently implied that the Fed will NOT raise rates for a while, given poor job numbers and world events. However, she is stuck between a rock & a hard place as far as stimulating growth again – she can’t go back on her words made back in late 2015 to become fiscally tighter. So, don’t expect more stimulus in the near term. The market is cut off from its favorite drug.
  • Seasonals: Sell in May and Go Away. Soon it will be the end of the best 6 months strategy.
  • Election: In this corner, we have extreme right winger Donald Trump promising to end free trade, build a wall and start World War 3. In the other corner we have extreme left wing candidate Bernie Sanders who wants to increase taxes and feed the sense of entitlement like his Canadian PM counterpart has. Somewhere in the middle we have Hilary Clinton, who is facing an enquiry into alleged email cover-ups, and Ted Cruz who recently posted a video of himself frying bacon by wrapping it around a machine gun and firing it.  Would you feel bullish knowing any of these people were in charge of the most powerful economy in the world? Expect volatility as the reality of these choices set in with investors. The historic pattern for markets during an election year is for volatility leading into an election, and then bullishness after the election is decided.
  • World events: More déjà vu from last year. Greece, China, Brazil, Europe, Japan—all in trouble (still). Or how about– ISIS, oil pricing, currencies, bond yields and immigrant challenges? Lots of issues in the world for the markets to get worried about.
  • Earnings and Valuation: According to www.multpl.com (chart below), the trailing PE ratio on the market is at the high end of its historic range at 22.6 times earnings. With the exception of the bubble 2001 and 2008 levels, you will note that trailing PE doesn’t like venturing much past the low 20’s before reversing.  Strength in the markets has been driven to a  large degree by these expanding multiples and not earnings growth.  Meanwhile, we enter into the current earnings season with the risk that earnings do not support the recent market strength. The result of a disappointing earnings season will very likely lead to weak markets.
  • Global Debt: Since the financial crisis many of the advanced economies have prudently reduced private debt, only to significantly increase public debt. In emerging economies and those economies less impacted by the financial crisis, the Bank for International Settlements points out, are now increasing private debt to record levels.  As the world struggles with this excessive use of leverage, we believe this represents an additional risk to markets.

MULTPL

 

OK, so we’re bearish. What are we doing about it?

 

  • Cash: In the equity platform, we hold cash. Lots of it.
  • Hedging: We’re gradually adding hedge positions to the equity platform. We recently began legging into the Horizons VIX ETF (which goes up when markets get more choppy) and the Ranger Bear ETF, which shorts about 30-40 stocks from the S&P 500. It goes up if markets go down. We’re looking to do more hedging by stepping into this type of position a bit at a time. “Slowly, slowly catchy monkey” as the Ashanti (Ghana) proverb goes.
  • Reducing growth stocks: We have been and expect to continue to reduce our growth stock positions.
  • Increasing defensive stocks: We recently bought defensive sectors like gold and consumer staples.  We’re looking to buy further into defensive stocks such as the REIT space, and possibly add some higher dividend plays or buy an ETF that plays that theme. The fancy term for this strategy of selling growth to buy defense is “beta reduction”.

21 Comments

  • Hi Keith – I’m with you on your bearishness but what timing do you forsee? Starting in May? And not sure if you will cover biotechs but last few days we’ve seen it really run – does it have legs and is it too late to get in now? Thanks so much!

    Reply
    • IBB looks to have based–hasn’t broken the trendline yet but its looking positive. It could be a sector that money is rotating into.
      Timing on a pullback is hard to predict–but typically things can peak in April or May. I spoke with my seasonal expert pal Brooke Thackray the other day–they guy is a walking rolodex of seasonal statistics–he told me that if the beginning of April is soft, it has historically increased the odds of a weak finish to the month. For what that’s worth.

      Reply
  • Keith,
    I had to step out for few hours and I came back and you have a new blog already. I do like your thinking here (on the same wave length in terms of raising cash and hedging, and getting more defensive). Are value stocks a safer position as well even though they may not be technically a defensive stock?

    By the Way, I am reading your book Sideways, and am enjoying it very much. I like your practical approach and how tied everything together.

    Reply
    • Hi Ron –thanks for grabbing the book and glad you are getting something out of it.
      Yes–value stocks can be more defensive than growth stocks–we look at defensive sectors as our low beta way of doing things–but if you can value a stock properly –sort of like that relatively unknown guy Warren Buffet guy does — then its a similar plan.

      Reply
  • Hey Keith,

    There are so many ads predicting a big crash in the stock market this year and those predictions are led by Peter schiff. Do you agree with his predictions?

    Reply
    • I don’t know if there will be a big crash, but I am not convinced as to the potential for the markets to rise through the 2135 lid before the election ends. I am also convinced that the market could return to 1880 in a correction (1880 was roughly the support level from last summer and January–or possibly the lows of January in the 1820 area), per the blog–and possibly as low as 1570-ish should things get really bad. Bear in mind, this extreme target is not a prediction–merely a potential, should the lows of last summer and this January not hold.

      Reply
  • Bill on Hillary-“She has had more women than me” Extreme immorality and criminality here. When China pegs the value of their currency we don’t have free trade. Trump is pro free trade. His threats of tariffs are a negotiating tactic. Much of what he is advocating is observing the rule of law. I like that he want to get along with Russia. Contrary to the utter rubbish published in the media, Putin is a rule of law guy and has been lecturing NATO on that matter for the better part of a decade.

    Reply
  • Risk to the bears is that we build a higher base up here to work off the overbought indicators and then take out the 2135.

    Reply
    • Yup–anything can happen
      As Howard Marks says ” You can’t predict. You can prepare.”
      i employ a strategy to go back in if that happens–3 day minimum(!), preferably 3% thorough the highs. Nobody says you cant change your stance on a new technical development.

      Reply
  • Keith,
    Further to your reply to Dave, my read is this is a bearish potential situation, i.e. a high risk/low reward scenario. Hedging to at least a net neutral position seems prudent. I don’t really see a consolidation or basing channel at the moment. I see a recent high at 2075 and a recent low at 2022. Does it make sense to use your 3 day rule with in conjunction with these recent high/low levels? The topping pattern (if that is what is occurring) is still being formed, it could be a rising wedge or a mini H&S pattern with a neckline at 2022.

    Another interesting indicator is the USD/JPY pair. If i’m reading this correctly, it’s another risk off indication.

    Reply
    • For what its worth, I added another leg into my VIX holdings today. I am taking my time on this, but when I saw markets reverse (again) intra-day from up solidly to paring off, I added to the position.
      For anyone interested–be aware that VIX trading is not a long termed game. Buy it, then sell it at one of my aforementioned resistance targets. These points typically take very little time to reach–days not weeks.

      Reply
  • IS THE MONTHLY CLOSING OF ANY IMPORTANCE IN ASSESSING A POSSIBLE MARKET CORRECTION TO 1880 ON $SPX. (I KEPT A SHORT POSITION ON THE U.S. MARKET). FROM WHAT I KNOW, MOST (IF NOT ALL) MARKETS IN THE WORLD ARE UNDER THE 20MONTH MOVING AVERAGE. THE U.S. MARKET SEEMS TO BE THE STRONGEST OF ALL BUT THAT 3% TO THE MAJOR RESISTANCE SEEMS CLOSE ENOUGH AND MANY ANALYSTS STARTS TO SEE A ROLLOVER COMING AS WELL.

    J.P.

    Reply
    • Depending on your time frame, you use the closing price of the appropriate charts. I tend to focus more on weekly rather than monthly charts for my work, then drill down to daily for neartermed work.

      Reply
  • Good strategy Keith. Have you considered using SH, the single short S&P as part of this strategy? Thx.

    Reply
    • No I hadn’t –you are the second reader to mention it so thanks for that, Lorne. My only holdback on USD traded securities is currency risk–I don’t mind paying a bit extra MER via a hedged inverse or similar ETF given possible currency up/down movements that might impact my trade. We saw this recently with our Euro play in FXE-which trades on US exchanges in USD-we made 6% on the units in a few weeks, went to sell, but the currency pretty much negated that (as the CDN$ recovered from its 0.69 lows).

      Reply
  • Trump has talked about eliminating the debt in eight years. Under the current economic system that would seem ridiculous. To achieve that he would have to kill the Federal Reserve and change the way money is created money is created (debt based) to something else. That would be a good thing. Wars have fought over that issue. The civil war to my read was over that issue not freedom for black slaves. It could mean very turbulent times. The people who have the right to create money out of nothing will not give up easily.

    Reply
  • Hi Keith- I know that you know of the HEDGE-N and SH-N ETFs and HIX and HIU in Canada. Is there any reason that you picked the two you mentioned in your article instead of these? Also, if you don’t mind answering this, what percentage do you have in these funds and what percent are you ‘net long’ in the market.
    One last question- Is there still a possibility that you may be running a fund available to the general public– I hope so.

    Thanks
    Randy

    Reply
    • Hi Randy
      I hold HDGE and HUV. I will be buying HIU at some point. Each has its own merit. I like HDGE because I view it as an added value play on a bearish strategy. The managers pick the most fundamentally overvalued stocks (according to their models) and short them. The downside with HDGE is they could analyse incorrectly – and it’s USD traded / non-hedged to CDN$. I hold 3% here.

      HUV is a play on the VIX. The VIX is quick moving and volatile – that’s both the positive and negative thing about this security. If it works, it will work well, if not, it will hurt. I am trading it nearer-termed rather than position trading. Its USD currency hedged. I have 5% here.

      HIU is a straight inverse play on the S&P 500, currency hedged as well. I have 2.5% here and may legging more money into it soon. All in I expect to have a total of 10% (current position)-15% hedge in place by month end or early May.

      Working on the fund….

      Reply
  • Hi again Keith. Something that gives me a hard time taking a bearish position are Canadian transports Transforce (TFI) and Trimac (TMA). Last April, when things started turning bad, those were some of the first to fall. There are looking way healthier. Do you look at those trucking companies as leading indicators of the TSX? I’m curious. If you have time to reply.

    Reply
    • Hi Joanne
      I look at the US industrial vs. transports-in fact, I almost exclusively look at US markets for macro analysis. Also– while some CDN transports look OK per your notation–some look not so great like CP, AC.
      Again though, I am focused on the US transports vs industrials as a group.

      Reply
      • Thanks for sharing your knowledge with the new generation of investors. Really appreciated.

        Reply

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