Happy 2018! For investors, the New Year has kicked off in grand style with the S&P 500 up over 6% as of this writing.(1) The market action has been explained by the media as a “melt up” or a “FOMO rally” (fear of missing out). Regardless of what you call it, the rally has been broad based and very powerful. In this letter, we will attempt to spell out what we view as the strengths of the rally, what concerns us, and how & why our portfolios are positioned as they are.
The Backdrop
As 2017 came to a close, fewer global economies were in recession than at any other time in modern history.(2) Europe is humming, Japan seems to have finally emerged from a nearly 30-year recession, emerging markets have once again been a catalyst for growth and the US continues its nearly 9-year economic expansion. Clearly this coordinated growth and related strong corporate earnings have fueled global equity markets. The US reduction in corporate tax rates is just the latest fuel added to this mix.
Richard Bernstein, who we follow very closely, often says, “’Good” or “bad” doesn’t matter; markets care about “better” or “worse.’” So perhaps the right question to ask is “can things get much better?” Time will tell on that, but we know that some elements which may eventually provide a head wind to the market are beginning to show. Interest rates appear to be going up as the yield on the 10-year Treasury bond has moved from a low of 1.33% in July 2016 to recently over 2.65%.(3) Higher bond yields present competition to stock investments. The Fed raised interest rates three times in 2017 and are suggesting three additional hikes this year are likely.(4) While the Fed is suggesting they are not necessarily tightening monetary policy - instead normalizing it – the fact of the matter is higher rates eventually slow economic growth.
We have written several times about the fact that this rally has been widely under-owned and discounted by investors of all types: funds, institutions and individuals as evidenced by Merrill Lynch’s Sell Side Indicator. Since the financial crisis, this indicator has regularly shown an excessive amount of bearishness on the part of investors(5) – a historically positive contrarian indicator for the market. Indeed, as investors have been overly pessimistic, markets have moved consistently higher. Recently, this indicator has indicated that the pessimistic phase may be over as investors have improved their outlook markedly. This could be an early sign of a change coming. Consider what Warren Buffett has said of his investment philosophy, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful”.
The duration of the economic expansion and the stock market advance are clear, both have been in full swing since 2009 – a full nine years. However, what has the markets return been over the past 10 or 20 years? It all depends on where you start comparing from. For example, from its low in March of ‘09 the S&P 500 is up over 300%, an incredible move. But, from its peak in March of ’00 it is up only 78% over the past 18 years roughly 4.5% per year – not that great.(6) My point is that returns are often a matter of perspective.
Our Approach
We remain confident in our approach that utilizes the 50 & 200 day moving averages to detect trends in a variety of asset classes. This approach has caused us to overweight equities and underweight fixed income for the vast majority of the past 5 years.(7) When you think back to all that has occurred over that time, from terrorism to nuclear threats to unpredictable political environments it was very tempting for clients to want to move to the sidelines. Of course, in hindsight, that would have been the wrong move. Our gut instinct was often to reduce equities in our models, but our belief in our process caused us to sit tight and hold even when it was uncomfortable to do so. No approach is perfect – ours included – but following our discipline has allowed us to get our fair share of the upside of the market while having a specific sell strategy when things start to get break down.
Looking back on the last meaningful downturn in the market is helpful in understanding our process. In July of 2015 our moderate model was approximately 67% equity, close to the maximum we can go in stocks. That Summer Russia invaded Ukraine and the markets started to get jittery. By the end of July, the moving averages had broken down for our European holdings as well as our International holdings. In August, we started the month at 54% equity and in September one equity class after another broke down so that by mid-September we were down to 35% equity in accounts.(8) People forget that by February ’16 the S&P was down over 15% from its recent high.(9) In contrast, our moderate accounts were generally off not more than 6%.(10) Clients were not happy to be down and neither were we. But, coming back from being down 6% is much easier and quicker than coming back from being down 15%. We tell clients all the time, by the time the markets break down you will wish we had sold earlier and so will we. But, the fact is that our process has done a good job of getting out of harms’ way in a timely manner and has provided the discipline to stay invested even when it was uncomfortable to do so.
Current Positioning
We are at or near maximum levels of equity in each of our models. We are also at or near minimums in fixed income in each of our models. Alternatives are neutrally weighted per our benchmarks. Within equities we are more overweight international than at any time since we founded TRUE. Over half of our equities are now international – a reflection of better foreign economic growth rates as well as persistent under performance of international equities until last year. We think that this combination of factors bodes well for the out performance of international stocks for the next several years.
Another area that we think looks attractive are commodities. With coordinated international growth, it stands to reason that increasing utilization of commodities is likely to occur. Additionally, because of the poor returns of the commodity complex over the past decade or so, this asset class has not garnered much interest from investors.(11) We believe that could change; being in the asset class early may be beneficial.
2017 Tax Reporting Statements
Year-End Investment Reports, as well as 1099R and 5498 Forms for IRA accounts (Traditional, Rollover, Roth, SEP) are now available online. If your document delivery preference is US mail, you should receive them in about two weeks.
For all other accounts, tax statements will begin to be available mid-February. For most accounts, 1099 tax statements are posted online and/or mailed by February 15th; however, a limited number of forms for accounts that hold mutual funds pending reclassification, or certain complex securities including unit investment trusts, mortgage pool securities, and real estate investment trusts are mailed and posted online by March 15th (contingent upon Fidelity’s receipt of a mailing deadline extension from the IRS). This later mailing cycle minimizes the need for corrected tax forms. If you have not received your tax documents by the end of March, please let us know.
Perspective
Some events in life just stop you in your tracks. We have had three of those in the first few weeks of this year that have profoundly impacted our family here at TRUE. Events like this are reminders that life is precious and fragile, and encourage us to appreciate those people who are important in our lives. Please take the time to tell your loved ones you love them and don’t take anything for granted.
In gratitude,
Brett, Steve & Becky
1,3,6,9,Capital markets data provided by Thomson ONE®
2 TheoTrade Analysis Team, TheoTrade, LLC, 2018 Expected To Have The Fewest Countries In A Recession Ever,Fx Street (Nov. 13 2017).
4 Merrill Lynch RIC Report® (Jan. 9 2014)
5 Merrill Lynch Sell Side Indicator (Dec. 1 2017)
7,8 TRUE Davis Altman Investment Committee
10 Model performance calculated by Envestnet® Performance represents the results of actual trading in a representative account managed according to TPWA’s investment strategy for the time period January 1, 2013 through December 31, 2017. Results reflect the deduction of a model advisory fee, transaction expenses, the reinvestment of dividends and interest, and internal expenses of investments. Actual results of TPWA clients managed according to this strategy varied materially, and there is no assurance the same or similar performance would be obtained. Returns represented are for illustrative purposes only. These materials are provided by True Private Wealth Advisors, LLC (“TPWA” or the “Firm") for informational purposes only and may contain content that is not suitable for all investors. No portion of this commentary is to be construed as the rendering of personalized investment, tax or legal advice. Past performance may not be indicative of future results and may have been impacted by market events and economic conditions that will not prevail in the future. There can be no assurance the views and opinions expressed in this letter will come to pass. Investing involves the potential for gains and the risk of loss, and diversification does not necessarily guarantee profitability or protection from declining markets. Certain information included within is derived from third-party sources that TPWA believes to be reputable; however, the Firm makes no representations with regard to the accuracy or timeliness of such information and assumes to liability for any resulting damages.
11 Richard Bernstein Advisors – Insights Dec.2017
