Uncategorized, Weekly Update

Shifting Central Bank Strategy Could Bring the End of the Bull Market

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Published December 1, 2017


Below is an excerpt from a recent article from Per Sterling that talks about the impact of the Federal Reserve’s policy of providing substantial amounts of “cheap” money. What happens as the Fed shifts away from that policy and toward one where they are pulling BACK the cheap money?

“It is almost as if all investors have reached a state of perfect Zen, where they feel that they know all and understand all, and thus feel no fear or need to alter their current course. The bad news is that this is a textbook example of the type of complacency and investor overconfidence that ultimately almost always ends very badly. The chart below shows that the stock market is in rarefied air here with the time between significant market moves at an extreme.

Duration between two 3%+ Drawdowns

However, history also teaches us that, while measurables like valuation and sentiment can tell you much about upside potential and downside risk, they tell you virtually nothing about the timing of an inflection point or the ultimate catalyst for the reversal. The most obvious potential candidate for a catalyst is the anticipated reversal of the past decade’s global monetary stimulus.
For over nine years, the world’s central banks have been an investor’s best friend, but their policies are about to turn from being a tailwind to being a headwind for asset prices. There has already been a notable impact on market internals, where the capital markets are transitioning out of an environment where everything gained value due to monetary stimulus, and largely without regard for a security’s unique fundamentals, to one where securities are starting to trade based specifically on those unique fundamentals. For evidence, you need look no further than the fact that, in 2017, 30% of all S&P 500 stocks are down on the year, while 40% of S&P stocks are up by at least 20%.

This sea-change is prompting an increasing amount of speculation about whether or not one of the longest-running equity bull markets in history is finally running out of steam. It is a very interesting question, at least from an academic perspective. Whether or not it is a question worth pondering from a pragmatic perspective is another matter entirely, as will be discussed.

In the meantime, what we know as a matter of fact is that the central banks have been so successful in their quest to reflate the prices of financial assets that most major asset classes, including equities, debt, and securitized real estate are now quite expensive based upon traditional measures of value. For example, the cyclically-adjusted price-to-earnings multiple (CAPE Ratio) just hit a level of 31.2, which means that the Standard & Poor’s 500 Index is now valued at almost twice its average ratio of only 16.8. However, here too, one needs to question the practical implications of this fact.

After all, of the 15 equity bear markets that have taken place since the end of World War II, six or seven of them (depending on whether you are benchmarking the CAPE Ratio or the P/E Ratio) actually began when the markets were selling at below-average valuations. Of equal importance, it is not that unusual for markets to trade for months, if not years, at multiples that are overvalued based upon their averages.

The fact is that markets rarely trade at fair value, and instead spend their long cycles vacillating between extremes of overbought and oversold, and normally ultimately moving further in each direction than almost anyone expects. However, this is not to suggest that valuations do not matter, as risk/adjusted returns have historically been much more favorable when valuations are low than when they are high. Even so, valuation has historically proven to be a very poor timing tool, particularly when you consider that even very overvalued equity markets have historically averaged modestly positive returns over three, five, and ten year periods.”

At TimingCube, we have proven that timing markets is quite profitable. We simply look at the trend of the market price and react accordingly. Our models do not consider whether stocks are perceived to be over or under-valued. As the article above notes, those valuation conditions can persist for long periods of time. We have found that the price of stocks and whether investors are willing to buy or sell at prevailing prices is the best indicator of the enthusiasm of investors toward stocks. This bullish period will end at some point. Our models will react accordingly and will protect our gains and give us an opportunity to profit from the next market move.

If you want more signals on more market sectors and asset classes, try out our FP Research Multi-Asset model portfolio. Signals on everything from bonds to U.S. stocks, from energy stocks to real estate trusts. All available at one website so you can be more informed as the market changes. www.fpresearch.com

Market Update

Investors trickled back into the markets after the long Thanksgiving weekend leaving stocks unchanged in the Monday session on little new news. The prospective Federal Reserve Chair, Jerome Powell, had reassuring comments for investors in his Tuesday confirmation hearing. The perceived stability of Fed policy under Mr. Powell kicked financial stocks into high gear Tuesday leaving the broad market higher by +1.0%. Stocks ignored a missile test by North Korea, an action that not long ago would have caused markets to at least dip lower. Financials rallied again Wednesday leading most stocks upward. A sharp profit-taking selloff in the tech sector offset that rally, however, pushing the Nasdaq down -1.3% while the broad market held flat. Optimism about the prospect of a tax reform bill encouraged investors Thursday sending stocks higher by +0.8%. A bit of weakness Friday turned briefly into a market rout on word that President Trump’s former National Security Advisor Michael Flynn has agreed to testify against his former boss. Stocks were down 1-2% at their worst before bouncing back to cut their losses by about half to a -0.4% reduction.

The Nasdaq 100 (QQQ) finally ended a more than two month streak of winning weeks. The tech and consumer heavy index gave back -1.13% for the week, essentially reversing the prior week’s gain. The Nasdaq was alone in its weakness as strength elsewhere pushed the S&P 500 (SPY) higher by +1.57%. The small-cap Russell 2000 (IWM) lifted +1.37%.

Warm wishes and until next week.