Investors Dodge A Bullet As Stocks Enter The Late-Cycle by Stephen Aust, MarketCycle Wealth Management
The gigantic market collapses of 2000 and 2008 were depressionary bear markets. Whenever the overall stock market drops more than 50% it is technically considered a depression and not a normal recession. [NOTE: Since this month’s blog is long, the “print function” can be found near the bottom of this page. Important client information is found throughout.]
After the “Great Depression” of 1929 the stock market remained volatile for several years yet it eventually did begin to calm down. The stock market then went on to experience two decades of strong and profitable gains. The “Great Recession of 2008” should actually have been named the “2nd Great Depression.” It is unrealistic to expect investors to behave normally so soon after such devastation.
This recent market correction that occurred during late 2015 and early 2016 exhibited ALL of the early signs and symptoms that preceded both 2000 and 2008 (except that our RECESSION Indicators gave us an extremely low chance of a concomitant recession). The market fundamentals and technicals completely broke down and risk levels were sky high. Between the preceding lengthy sideways period and the actual 15% drop, we experienced something similar to a full fledged bear market… and it could have been worse. We dodged a bullet. Readers of our paid membership REPORT site (link below) saw a wall of orange and red under the RISK section. The appropriate thing to do was to temporarily protect investment accounts and to wait for the all clear signal. I’m not saying to “time the market”… I’m saying: “don’t play during those infrequent periods when the genuine risk level is so obviously elevated.”
Now that the dust has settled the appropriate thing to do is to realize that the worst is behind us. We have to further realize that the future is, once again, very promising. In our opinion, with risk levels having fallen substantially, investors now need to be positioned fully bullish with all that this entails.
IMPORTANT: My sense is that the recent downturn coincided with the U.S. economy moving into a grey area somewhere between leaving the mid-cycle and entering the late-cycle. Entering the late-cycle still means that we have some strong stock market performance ahead of us… as long as one is in the correct positions. This would indicate a coming moderate rise in inflation associated with a moderate rise in commodity prices and that we are one step closer to an economic recession with its potential 25% to 33% stock drop. On March 16 it was reported that the Core inflation rate had risen to 2.3%; the Fed’s mandate is to keep interest rates at 2%, so inflation is here and the Fed will raise rates and investors will soon accept the inevitable. It is probable that commodity prices remain volatile but that they will gradually increase between now and until several months after the next recession begins… followed by a “?” shaped top and subsequent price collapse.
LATE-CYCLE? This is how MarketCycle’s client accounts are positioned:
- U.S. stocks in high relative strength sectors (that display both growth and value characteristics) and that pay dividends but that are also positively effected by rising interest rates
- Global value dividend payers that offer dynamic currency hedging
- Global natural resource stocks that pay dividends
- Floating-rate bonds, senior bank loans and floating-rate preferred shares
- Inflation protected Treasury-Bonds
- Dynamic currency allocation
It appears that commodities may have now bottomed (in late February) along with stocks, right when oil and industrial metals hit the downside targets that MarketCycle had repeatedly predicted. Commodities will still remain highly volatile because of the possibility of continuing U.S. Dollar strength, so caution should constantly be held in one’s mind. Commodities are NOT a long-term buy-and-hold asset because conditions are different than they were in 2001 (to 2008).
Commodities, which are a necessary part of the global economy, are currently being offered at fire-sale prices. In our opinion “PDBC” is the best of the commodity ETFs. It offers well-balanced exposure, a relatively low expense ratio, it is tax-advantaged as compared to other commodity funds, it generates 1099 tax reporting (rather than a complicated K-1), and for those who desire “Socially Responsible Investing” it is the only broad based commodity ETF that does not trade in animals as commodities.
The current sector breakdown for PDBC is:
“HAP” is the best equity (stock) ETF for those wishing to invest directly into (global) developed-market broad-based commodity producers (including alternative energy and water and gold) and HAP has the important benefit of paying a strong 3% dividend on top of capital gains. When viewed over longer expanses of time, most stocks have a built in upward price bias that pure commodities do not have. In a unique twist, low energy prices will benefit many of the non-oil commodity producers. Because we are currently in a secular bull market for stocks, I believe that HAP may outpace PDBC going forward. [DISCLOSURE: MarketCycle’s clients hold an allocation to “HAP.”] HAP was developed by famed commodity trader Jim Rogers. An interview quote by Jim Rogers has been floating around in the back of my head for the past decade: “Whatever success I have had has come from finding things that are cheap where a fundamental change is taking place… and buying.”
The current sector breakdown for HAP is:
Over the next decade commodities are likely to roll (up and down) sideways within a wide trading range. The likely swing ranges for gold and oil are listed on our paid-membership (daily) REPORT site (link below). If the next recession is a bad one, and I believe that it may be, then commodities may eventually drop to a new low.
Precious Metals appear to have discovered their very long-term (year 2000) bottom and are back above support (Chart posted here on March 3, 2016). For very well thought out reasons I held the belief that gold might follow the other commodities lower, but the trend is now bullish and the trend direction trumps any opinion that I might hold. [Please note that on the next four charts, it is easy to see the commodity free-fall that occurred in 2008.]
Industrial metals have hit their (2008) support bottom and subsequently bounced (Chart posted here on March 7, 2016):
Oil also appears to have found a possible intermediate-term bottom and it is now back above support (Chart posted on March 4, 2016):
Even natural gas, which some traders believe could go even lower, has reached the same levels that it was sitting at 20 years ago. (Chart posted here on March 7, 2016):
If you look at the chart above and view the years 1996 to 2000 on the far left (blue box) you can see what I view as one very possible scenario with commodities attempting to remain close to their new found bottom for years to come… but at these low levels, it doesn’t take much upward movement to create a rapid 100% gain.
So, commodities appear to be stabilizing and they have finally fallen to a low that offers extremely strong support. Even more importantly, commodities may be strengthening because the “smart money” is beginning to detect a whiff of inflation in the air or perhaps they are acknowledging that we have moved into the late-cycle.
Yes, Inflation is just now beginning to increase although it will remain at historically low levels over the intermediate-term. Treasury-Inflation-Protected-Securities (TIPS) just started paying a positive interest rate for the first time in several years. We will eventually experience quite high levels of inflation, but we are nowhere near that scenario at this point. Unlike regular Treasury-Bonds, as inflation ramps up, the yield on TIPS increases. [DISCLOSURE: MarketCycle’s clients hold an allocation to “TIP.”]
Core inflation is picking up:
Recession probability levels still remain below a 10% chance when looking out as far as 3 months.
MarketCycle’s “Buy the Dip” Indicator triggered on February 22nd. It rarely signals, but when it does, it has historically been important to go bullish with new funds. I believe that the stock market may be about to meander (up) further than analysts currently generally predict.
The U.S. stock market has endured a difficult past two years. Ultimately, stocks formed a “domed top” which is a very bearish pattern. On top of the domed top was a large head-and-shoulders formation and this was also bearish. When these patterns fail, it is quite bullish. The H-&-S failed first and then the dome formation failed, for the Dow, on March 16th. This next chart shows the volatile and weak U.S. stock market over the past two year period. Although there may be a slight pull-back in the near-term, I believe that our next extended move is “considerable higher.” [Our S&P-500 target is listed on our REPORT site… link below.]
As stated above, we are now likely entering into the late-cycle (coincides with the Fed raising rates). What happened the last time we entered the late-cycle and the Fed began to raise rates? It was very profitable! This last chart shows the period from mid-2004 to mid-2006 (and the period from mid-2006 to late 2007 is not shown, but it was even stronger). Stocks are shown in red/green and commodities are shown in dashed-purple. Despite the obvious volatility caused by unfounded fears over rising rates, this was a period when one would want to be fully invested:
SUMMARY: Investors dodged a bullet; the unusually high risk levels have abated, inflation is finally rising and this stock bull market is not over. It is time to re-embrace our fears and to, once again, be “uncomfortably long.”
The other day a well known childhood tune was repeatedly floating through my head. For the first time in my life I actually paid attention to the lyrics and realized how important each of the four verses are. It talks about the requirement of putting in (gentle and kind) effort yet always going with the flow (trend), maintaining a merry attitude while realizing that we can mentally and emotionally relax because: life is but a dream.
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A lemming hedging risk: