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):
- 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.
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”.