The starting gun has fired. It’s 2020 now and January is about to join 2019 in the rearview mirror. While past market performance is never a reliable indicator of future results, peaks like this can be informative. What we’re seeing now are crazy markets, and below we back this with facts and advice, not just bewildered eyes.
So, we’ll start this Monday’s Critical Signals Report by looking back…so we can spring forward/think ahead.
To take you behind our tent, we’ve prepared a simple chart that shares, dissects and broadly informs on What’s Happening Now.
Let’s Dig In
The chart below compares daily data on stocks (the S&P 500 Index), bonds (investment grade) and commodities, benchmarked against strategies that trade them – namely Commodity Trading Advisors (CTAs) on the one hand and hedge fund managers on the other. (Just to remind, your authors have been both.)
In this chart, to help you to differentiate market action from trading strategy, the market lines (stocks, bonds & commodities) are thick, while the CTA and hedge fund performance lines at the center of the graph are thin.
Finally, the chart is “normalized” with a common starting gun/date so we can easily track relative performance.
Top-to-bottom, here’s what we see… surprise-surprise: A Twilight Zone trading environment. Why? Because stocks (fat red) are ripping way too high compared to bonds (fat orange) and commodities (fat white).
The Experts Are Getting Smacked
Furthermore, and as you can see for yourself, hedge funds (thin blue) and CTA’s (thin white) are faring poorly.
Because their long/short trading strategies are geared to the bond and interest rate markets (orange), which are now effectively controlled by the Fed, not natural supply and demand. Pure distortion.
Note the extremely high correlation these trading strategies have with bonds in an interest rate market massively suppressed by Fed monetary policy.
Hedge funds and CTAs need free markets to both manage risk and make sane returns, not imprisoned markets, manipulated by central banks.
After all, hedge funds are designed to “hedge” risk, while a Fed supported stock market is designed to just go up, up and away.
While CTAs and hedge funds began to make a turn towards profitability last December and this January (capitalizing off the upturn in commodities), the big money is being made…you guessed it…in this monstrously stimulated stock market.
Over the 13-month period in the chart above, normalized returns in stocks have soundly beat bonds and have battered commodities.
Think nosebleed, folks, nosebleed…like those 4th-tier nosebleed seats in the 49ers’ stadium, where the tickets are cheap, where it’s lonely, where you can’t see the game beneath and where the risks of simply falling over the side are, well…calculable.
Past performance is never an indicator of future results, folks, and you can take that to the bank, as the rise we are seeing today and yesterday can’t guarantee a similar tomorrow. Sure, we called this melt-up, but that doesn’t mean you shouldn’t have a tissue (i.e. smart risk allocation) ready at such nosebleed levels…
More Nosebleed Indicators
Speaking of nosebleed, below are four more indicators with seats high up in the bleachers, namely Chart 1 which plots forward P/E ratios for the S&P 500 Index at the highest level in bull market history.
Chart 2 , however, reveals just how rigged the stock market is, as it plots a soaring S&P 500 Index against a tanking Purchasing Manager Index in the U.S., Eurozone, China and Japan.
Chart 3, plots a spread between the S&P Index and now falling interest rates, a pattern which reliably called the bluff just ahead of past recessions.
Should we be worried? Will history (i.e. a recession) repeat itself?
In a Twilight Zone, and an election year, it’s simply hard to say, as we’ve never seen a central bank this determined to kick a can. Never. Not ever.
Thus, rather than predict date and time of the fall, all we can do now is watch those interest rates-as they are a key indicator of an “Uh-Oh” moment once they start to rise.
And finally, there’s Chart 4, which plots a last line of resistance for the rising S&P 500. Will more QE and rate cuts (as well as robotically traded ETF purchases) push this rally past the resistance line?
That’s something we’ll be watching carefully.
As to our Storm Tracker during all these charades, a modest 30% reading (and hence cash allocation) remains in place as we head into February, and we hope you’ve enjoyed this reduced cash allocation percentage and bull-run, which we called in October…
BUT TAKE NOTE: Contributing Factors are changing… namely GDP is deteriorating, trend and leading indicators are worsening, yield curves are trying to invert again, and our Déjà Vu indicator just hit new warning highs as yields fall and stocks rise, thereby opening the “jaws” of a dangerous market “bite” even wider.
Let’s discuss all this and boil it down for you.
Let’s take growth in Gross Domestic Product (GDP) first. The Atlanta Fed’s January 17 forecast is not so rosy, having recently dipped to a 1.8% level from a prior 2.3% level not so long ago. Blue Chip consensus has dipped as well.
G lobal manufacturing (measured by purchasing manager data or PMI’s) is tumbling, not just in the United States but also in the Eurozone, China and Japan.
Let’s upsize Chart 2 above so we can see what’s happening. The S&P 500 Index, riding on the tailwind of a Fed gone wild and robo traders joining the current, seems not to care at all about such things like, well… fundamentals…
U.S. Yield Curve
And as to the U.S. Treasury Yield Curve, have a look. That brownish curve below is the yield curve one quarter ago. That yellow curve is the yield curve NOW.
See the dip reforming at the short end, suggesting the yield curve could invert all over again? Three segments to the yield curve were inverting at the end of last week, just after the Fed had launched a bazooka to straighten the curve out.
Folks, this is just crazy, and evidences a screaming disconnect between economic pains and a ripping stock market.
And amidst tumbling GDP growth, contracting global manufacturing, new threats of yield curve inversion and deteriorating trends and leading indicators, Déjà Vu (our trusty ‘canary in the coal mine’ for a next recession) hit new highs last week.
Actually, that makes sense…as the yield curve (interest rates) fall (i.e. the bottom part of the shark’s “jaw”) and stocks make new highs (i.e. the top part of the shark’s “jaw”), the spread (or “recessionary shark jaw”) widens.
Of course, the larger the Déjà Vu spread/jaws widens, the harder it will bite down on currently euphoric investors/markets when yields rise and stocks eventually fall. Trust us and stay tuned on that.
We know…this has been a rather technical CSR, shared this week for two reasons: (1) so you have a grasp of how we watch your back and (2) so you may have a sense of what’s good and what’s bad when it comes to What’s Happening Now.
Just Not Thrilled
Storm Tracker components are moving around, offsetting one another for now but threaten to accumulate to the downside for a higher reading-and thus a higher protective cash allocation.
To be blunt, we are just not thrilled with the market internals (fundamentals) we are seeing, notwithstanding our broader view as to why the U.S. could continue to rise relative to other countries.
Macro vs. micro. They both count and that’s where we are now, riding this bull and bear rodeo with tight reins.
Soon, we’ll be sharing how all of this impacts what we call “Your Portfolio” by way of not just cash positioning, but remainder positioning as well – i.e. what positions to hold now…and why.
Yes, current positioning tilts to the bullish side for now (because that’s what working now) and includes allocations to technology (iShares Expanded Tech-Software EFT, symbol IGV, which tracks the S&P North American Expanded Technology Software Index), disruptive innovation (ARK Innovation ETF, symbol ARK, that thematically invests in disruptive technologies) and medical devices (iShares U.S. Medical Devices, symbol IHI, that tracks the Dow Jones U.S. Select Medical Equipment Index).
All in, including a Storm Tracker Cash Allocation of 30%, Your Portfolio of current positions is up 5.09% for the month (2.0x the S&P 500 Index). And yes, that wasn’t a typo…that’s including 30% cash. You see, being conservatively invested in cash as a safeguard is just plain safe…and need not reduce overall portfolio performance.
Your Portfolio positions will and DO change with the market winds (Storm Tracker) and What’s Working Now, which include ETF picks constructed in Portfolio Builder, which we’ll be describing soon.
Bottom Line, gobbledygook aside, all you’ll really need to do is let us do the driving. How’s all that sound to you? That “Your Portfolio” product will be in your inbox soon. Just a few more weeks folks.
Be patient, we want to make it easy right out the gate.
More on all of this soon as we dot T’s and cross I’s for launch. In the meantime, stay tuned, stay informed and thus stay safe.
Matt & Tom
2 responses to “Crazy Markets: Here’s Why”
January 27 2020