RISK levels are still higher than average despite the fact that it is generally not recognized as such; market internals are still showing some weakness, although this improved during the last week of September. Higher risk levels may eventually reduce without a correction but the odds are still higher that a correction will occur before the end of the year. This is a time for caution; stay with one’s stock positions but temporarily hedge the position. Luckily, MarketCycle’s chosen protective hedge, which has had the potential to protect all of its strong stock position this past quarter, has moved higher since taking the position, right along with stocks. We are making profit and we have literally almost no downside risk. This is good.
Market RISK has nothing to do with news or mass killings in Las Vegas or politics or war or even with “world leaders” calling each other childish names like “Dotard” or “Little Rocket Man.” Risk has to do with either the economy or corporations losing their tailwinds, for various reasons, or from market internals weakening in response to an over-heated market needing to let off a little steam. This steam release can come in either the form of a rapid but temporary downward market correction or by a more prolonged sideways malaise… or by vastly slower upward gains (which is what has been happening over the past couple of months).
In a rare interview with Harvard Business School that was published online earlier this month, (it has since been taken down) value investor Seth Klarman spoke at length about his investment process, philosophy and the changes value investors have had to overcome during the past decade. Klarman’s hedge fund, the Boston-based Baupost has one of Read More
RISK is not being currently acknowledged or even recognized by the gigantic and highly leveraged hedge fund industry. Hedge funds, which have the word “hedge” in their name for a reason, are currently at record NON-HEDGED levels. Even Long-Short hedge funds hold almost no short positions. This is not good; this is dangerous. If everyone rushes for the door at the same time, it will be extremely difficult for them to put protection on their client’s accounts at anywhere near a good price or a good time (and it may induce panic). If risk is recognized as being higher than normal, then one must hedge before any drop, not after.
The market has now gone over 15 months without a normal and routine 5% correction. This is very close to record territory since this is only the fourth time, in the entire history of the universe, that the stock market has gone this long without a 5% correction. Although some professionals will disagree with me on this, in my opinion this is also not a good thing. Most people are prone toward Recency Bias where they believe that what has been happening recently will continue to happen as a sort of “new normal.” But everything moves through a cycle. Markets move through a market cycle despite any temporary glitches in the pattern. And the longer it takes for the market to pack down its gains (and form a new base from which to move higher) the bigger an eventual correction could be. So, instead of a normal 5% drop, we may get a bigger drop when it does come. This means that protection on portfolios is currently (and temporarily) important even if it were to slightly cut into profits… at least until the risk level decreases. MarketCycle’s Primary Risk Indicator (which is proprietary) has never failed to correctly recognize high risk periods and so far, every single one of the signals has resulted in either a market correction of deeper proportions, usually over 15%… or in the protective asset moving higher right along with stocks. So, no pullbacks during the past 15 months? This chart shows the normal zig-zagging pattern of a bull market with its normal pullbacks:
However, the S&P-500 is not too high above its 200 day-moving-average (IE, not above 8%) so the “bigger drop” may not be too severe. This means that the S&P-500 is more likely to eventually temporarily correct by 10% than it is to drop 20%. This chart shows how high or low the S&P-500 is relative to its 200 day-moving-average (percentage shown on far right = currently 5.6% above the 200). Since financial assets love their 200 day-moving-average, if they get too far above or below it, like the proverbial Prodigal Son, they rush back home to it (which is why Bitcoin will eventually crash!):
As I keep saying, we are still in a cyclical stock bull market within the confines of a Secular Bull Market. This is what the stock market looks like off of the 2009 bottom; it is still within the walls of its rising trend channel and the late stage’s final euphoric blow-off, when it arrives, should send it higher at a more rapid rate:
AND stocks are still above their short-term rising trendline off of the more recent 2016 bottom. If stocks break below this line for more than two days, they may temporarily correct (rapidly) lower. The reason for the fall would be automatic sell orders already placed below this line by short-term technical analyst traders, making it a self-fulfilling prophecy for these speculators. Chart shown since Trump’s Electoral-College win:
The bond market is also still in an extreme long-term bull market that started in the early 1980s. When this gigantic bubble eventually unwinds, this will cause the U.S. stock market to keep moving through its Secular Bull Market (that started in October of 2011) as the money flows toward stocks (over the next dozen years or more). It will also drive the value of the U.S. Dollar quite high. On this chart, the S&P-500 is shown in green and bonds are shown in red/green. Notice that both can move up together, however, whenever stocks fall hard, bonds ALWAYS move higher, protecting any stock losses. Hedging with Treasury-bonds will be more difficult in the future (as the Secular Cycle progresses) and investment managers will need to know what they are doing.
AND this: President Trump’s tax proposal, despite what the White House is saying to reporters, will drop taxes on the richest, increase them on the poorest and, after taking in the effects of eliminating the ability to write off state, local and property taxes, will ultimately increase taxes on the middle class (this last effect is not shown on this next chart). The proposed elimination of the Alternative Minimum Tax (AMT) would also help the richest Americans. For instance, for Trump’s 2005 taxes, the only tax return which the public has seen (two pages were leaked) it shows that the elimination of the AMT would have saved Trump $31.5-Million in that year alone… but in public, he wrongly states that his taxes would go up under the new plan and they obviously wouldn’t. The White House believes that the resultant increased government deficit level will be paid for via increased growth in the economy (the “Trickle Down Theory”) however, this is unlikely to happen, especially with the coming increases to the military expenditures and the apparent inability to eliminate the rampant fraud in the area of welfare. The government deficit is likely to grow by additional $-Trillions but we may not have to “pay the piper” for another dozen years:
SUMMARY: Near-term = potential higher risk; we’ve gone too long without a correction. Long-term = continued cyclical bull market in stocks with a likely eurhoric bullish period before the market finally tops. A slowly and steadily rising late-stage (of the market cycle) is the most difficult market condition in which to reap out-performance. Economic-recession is likely still over one year away. Near-term recession chances are less than 2% two months out.
PORTFOLIO PERFORMANCE 2017 year to date (all three shown without a management fee):
- Buy & Hold Index (roughly 66% stocks and 33% bonds)
- Hedge Fund Performance Index
Remember that MarketCycle Wealth Management is in the business of managing your investment account using proprietary, lower-risk, advanced techniques. The low fee is a tax write-off and the first 3 months are at no charge.
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Article by Stephen Aust, MarketCycle Wealth Management