As a risk manager, I try to find and/or create models for as many different market inputs as possible. For example, we have models for corporate earnings, monetary conditions, interest rates, valuations, the U.S. economy, commodities, the global economy, inflation, volatility, overbought/sold conditions, investor sentiment, market momentum, breadth, volume relationships, trends, cycles, leading indicators, lagging indicators, risk/reward, and so on.
The idea here is to try and stay in tune with the “weight of the evidence.” To try and remove as much emotion and “gut” instinct as possible. And to basically keep portfolio risk levels in line with overall market conditions.
This isn’t always easy. In fact, it is rarely “easy.” However, we aren’t trying to make big market calls or place huge bets in the portfolios we run. No, our mandate is to try to “get it mostly right, most of the time.” And for this approach, using a “weight of the evidence” method (i.e. basing our portfolio’s risk levels on the conditions of our market models) using a plethora of market models certainly makes sense – well, to me anyway.
To be sure, the approach we employ has evolved over time and continues to do so every year. I’ve been at this game for a long time. It is scary to add up the years, but it will suffice to say that I’ve been responsible for managing the risk of the markets for clients (both advisors and individuals) since 1987. So, yea, it’s been a while, and I’ve seen a LOT over the years.
On that note, what we’re seeing in the current market is unusual, to say the least. When trying to “esplain” the market environment to clients, friends, and the occasional acquaintance who is foolish enough to ask my opinion, I find myself suggesting that despite all the modeling, all the research, and all data, we are actually in uncharted waters here – well, to a certain degree at least.
When chatting with my “market geek” friends, I’ve remarked many times this year that there are no models for some of the current market drivers. Other times, I’ve suggested that managers are trying to use market models for something that can’t be modeled. This gives me pause and/or provides a reason to sit back and question the environment from a big-picture standpoint.
The Tweeter-in-Chief
Exhibit A in my thinking here is the current administration in Washington. The President is an unconventional and almost unpredictable head of state, to say the least. We have learned that he will say almost anything at any time. And his preferred method of communication – Twitter – is also unique/unprecedented. Never before has a President communicated negotiating points in 140 characters or less at all hours of the day/night.
Yes, the markets have adjusted to the President’s style of communication and no longer lurch in one direction or another on every tweet storm. However, the markets still move on news/tweets on the important issues such as the current and/or proposed trade wars being waged.
But I ask you, how do we “model” for this? Do we try and take the trend or tenor of the President’s tweets on the China trade situation in order to determine the likelihood of a deal getting done? Do we try and place odds on the chances of the administration putting tariffs on French wine or German cars?
Or do we just ignore the whole issue and focus on market fundamentals?
Focus on the Fundamentals Instead?
The problem here is that while I believe market fundamentals such as monetary conditions, earnings, inflation, etc., win out in the long run, inputs on issues such as trade can/do impact the stock indices in the short run.
So, as an investor, if your time frame is somewhere between lunch and next month, then it’s probably a good idea to forget about anything but price and momentum models – and the news flow, of course. However, if you have a longer-term view, then keeping an eye on the fundamental models is a great way to stay on the right side of the market’s big-picture cycle.
Those Central Bankers
Then there is the Fed. Everybody knows that it doesn’t pay to “fight the Fed.” This isn’t new. However, the idea of global central bankers trying to actively manage the economic cycle through the use of QE certainly is.
I get it. The central bankers of the world don’t want to see another crisis. They don’t want to see a recession – anywhere – in the near term. And they definitely want to avoid the Japanese-style deflationary spiral. No, they’d prefer to see sustainable growth and a little inflation to make everybody on the planet feel warm and fuzzy about their 401K accounts and the value of their homes.
But come on. The result of the latest round of central bank intervention/management is pretty mind boggling. According to CNBC, the 10-year German bund yielded -0.412% Thursday morning. That’s right. If you buy the bund at current prices and hold it to maturity, you are guaranteed to lose money.
The German 30-year traded with a yield of 0.17%. France’s 10-year traded with a negative yield. Spanish yields are just above zero. And here’s the topper, Greece’s benchmark yield traded below 2% Thursday, which, while seemingly impossible, is below the yield of the U.S. 10-Year. Yowza!
We all know why this is happening. Draghi communicated that a rate cut is coming. Powell will cut rates this week. Six other countries have already cut rates. And what this means for traders is that the central bankers are likely to start buying bonds again. So, why not “shake hands with the government” and get in BEFORE the central banks start methodically buying every month?
I saw a report on Friday that $14 trillion of bonds now trade with negative yields. This is up from the reports of $13 trillion a short while back. According to SIFMA (Securities Industry and Financial Markets Association) the total size of the global bond market was $100.13 trillion as of 2017 (Source: Wikipedia). Thus, 14% of the bonds traded in the world now trade at negative rates. Wow.
Again, the game here is to “buy high and sell higher” (oh, and by the way, your buyer is guaranteed to be there once the QE game picks up again). So, buy your bonds now and plan on selling them to the central bankers down the road. Bingo.
I have three questions about all of this. First, does it REALLY make sense for Greek bonds to yield less than the U.S. bonds – I mean, seriously? Second, how does this end (can you say, “bubble”)? And finally, how the heck do we model for this unprecedented central bank intervention?
Oh, that’s right… silly me… I remember now. Don’t fight the Fed. Got it. What could possibly go wrong?
The Bottom Line
Please don’t think of me as a Negative Nancy here. Remember, I’m a card-carrying member of the-glass-is-at-least-half-full club – especially when it comes to the market. But the bottom line is history is replete with well intentioned “managed” economic plans. And since this synchronized global central bank planning thing is new, my thought is that being prepared to manage one’s exposure to risk going forward might not be a bad idea.
And yes, we’ve got a model or two for that.
Now let’s turn to the weekly review of our favorite indicators and market models…
The State of My Favorite Big-Picture Market Models
There are no changes to the Primary Cycle board this week. In reviewing the component models, the only complaint I have is the less-than stellar reading of our Intermediate-Term Market Model. However, it is important to note that this model incorporates mean reversion indicators, which at this stage of the move are starting to provide warnings. But other than that, the Primary Cycle board suggests investors should remain seated on the bull train.
This week’s mean percentage score of my 6 favorite models rose to 84.1% from 79% last week (Prior readings: 83.9%, 81.1%, 73.5%, 62.9%, 65.4%, 62.9%) while the median also improved to to 86.5% versus 80.0% last week (Prior readings: 86.7%, 82.5%, 68.5%, 66.3%, 71.3%, 68.8%, 62.5%).
The State of the Fundamental Backdrop
Once again, there is no movement in our Fundamental indicators. As I’ve been saying, the fundamental backdrop for the market remains in good shape.
The State of the Trend
As one would expect with the S&P 500 closing at new highs the end the week, the shorter-term trend indicators perked up last week. The near-term pullback that appeared to be in play at this time last week quickly fizzled out and the anticipated test of the 2950 level simply didn’t happen. The only nagging component of the Trend board is the fact that our Trading Mode indicators (there are 5) remain stuck in “mean reverting” mode. This tells us that while price is advancing, all is not right (yet?) in the indicator world.
The State of Internal Momentum
As I mentioned in the trend section, not everything is rosy in the indicator world. Exhibit A in the argument can be seen on the Momentum board. While the board is positive overall, it is worth noting that three component models remain in the neutral zone and as such are not (yet?) confirming the move. But overall, this is a minor condition that can be overlooked from a big-picture standpoint.
The State of the “Trade”
We have been talking recently about the idea of the table having been set for some corrective action. However, with the market moving to new highs instead, the “mean reversion” trade “table” will need to be reset. At this point, the place mats are on the table and the plates are being distributed. However, since the silverware and wine glasses are nowhere to be found, we may be looking at an extended “overbought” period, which can be classified as a “good overbought” condition. Yet, the news could still be an important factor in the game, so stay sharp out there.
Courage is what it takes to stand up and speak; courage is also what it takes to sit down and listen. – Winston Churchill
All the best,
David D. Moenning
Investment Strategist
Disclosures
At the time of publication, Mr. Moenning and/or Redwood Wealth Management, LLC held long positions in the following securities mentioned: None
Note that positions may change at any time.
Disclosures
NOT INVESTMENT ADVICE. The opinions and forecasts expressed herein are those of Mr. David Moenning and Redwood Wealth and may not actually come to pass. The opinions and viewpoints regarding the future of the markets should not be construed as investment recommendations. The analysis and information in this report is for informational purposes only. No part of the material presented in this report is intended as an investment recommendation or investment advice. Neither the information nor any opinion expressed constitutes a solicitation to purchase or sell securities or any investment program.
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Mr. Moenning and Redwood Wealth may at times have positions in the securities referred to and may make purchases or sales of these securities while publications are in circulation. Positions may change at any time.
The analysis provided is based on both technical and fundamental research and is provided “as is” without warranty of any kind, either expressed or implied. Although the information contained is derived from sources which are believed to be reliable, they cannot be guaranteed.
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