can be confusing. To try to cut through the chatter and investment slang, we present this monthly view to you. We want to give you a 50,000-foot view of market conditions updated as our view evolves. Currently, our Investment Climate Indicator remains at Stormy. Stormy means that bear market rules apply, and we believe could be a period of wealth destruction. HEY, JUNE…DON’T MAKE IT BAD
(with apologies to all 5 Beatles and their fans)
It’s a Fine Time For “Aggressive Capital Preservation”
May was a disturbing month for investors who believe the easy money in investing will go on forever. Maybe it was concerns about slowing global growth, slowing corporate earnings, a budding trade war or something else. Regardless, you get the sense that the markets are less patient now than earlier this year when it comes to seeing what happens. Sometimes in investing, they ring the proverbial bell and the sellers pile on. To push the Beatles reference perhaps a bit too far, Helter Skelter can ensue.And while one month is just that…a month…it does appear more likely that things are playing out according to the “Eye of the Hurricane” scenario I have discussed here all year. In fact, since I edged my proprietary Investment Climate Indicator (ICR) from its 2nd most risky level (Overcast) to its riskiest (Stormy) back in late January 2018, the S&P 500 Index (including dividends) is down 1.7%.Following a roughly 350% rally from the depths of the Financial Crisis back in 2009, that’s a footnote. But without a doubt, there are shifting winds in this storm. As a result, investors need to start accounting for the risk-management side of their personal financial plan. Thinking with only the reward-seeking part of their brain is more likely to backfire than at any point since many in the millennial generation were still in school.And for retirees, the focus on what I refer to as “aggressive capital preservation” should be primary. Does that mean your investment choices have narrowed to a lockbox, stuffing cash under your mattress, or CDs? Not at all. That’s why this monthly report tracks 100 different ETFs, each representing a segment of the global investment markets. But, the biggest mistake one can make right now is to ignore the blowing winds and assume your portfolio will stand up to it.As I mentioned in last month’s report, “The current stock market environment reminds me of a hurricane. Specifically, the eye of the hurricane. The sunny, calm, respite between the front and back sides of the storm…we must keep reminding ourselves that at some point, the market will return to its unfinished business from late last year…while anything is possible, I’d prefer to keep emotions at bay and recognize that we are more likely in the eye of the storm than in the clear.” One month later, investors are scrambling to learn what tariffs are (they are not good for anyone, by the way), when and if China will give in to U.S. demands or vice-versa, and earnings from the companies in the S&P 500 have slowed dramatically. Add to this the fading “sugar high” of the 2018 U.S. income tax cut, and the ever-ballooning deficit. Put it all together and you can see why the most important market indicator…the price of securities…is starting to garner attention. As I said last month, “Hockey is a three-period game, and as avid fans know, the first period is the one where there is a lot of activity, but the most meaningful events tend to occur later on. Given the combination of market stimuli, it would not surprise me at all to see 2019 follow a similar script. It won’t be quiet forever, and I suggest using this time to evaluate whether you are sufficiently set up to continue meeting your objectives should things get louder.” Na Na Na Na….Hey June.
In May, the S&P 500 Index fell 6.38%, which erased all of its gains since mid-February. So, 2019 has been 6 weeks of surging stock prices, followed by 3 ½ months of zip. That’s going to happen. But there are technical signals that imply that there could be more downside ahead as 2019 rolls on. One of many key technical indicators I track (the 20-day moving average versus the 50-day moving average of the S&P 500) just went negative as May ended. More often than not, this type of “crossover” has been a tip of the iceberg, not a signal that a significant price bottom was near.
Last month, I wrote that the bond market was getting weird. In May, it got weirder. Interest rates on long-term U.S. Treasuries plunged. The 10-year U.S. Treasury Bond yield closed May at 2.14%. That is down from over 3.20% last November. This may end up being the bond market’s version of the “sugar high” in stocks I noted above. Depending on who you ask, the 10-year yield, which is what mortgages and many other financial transactions are based on, is falling due to the market’s belief that the Federal Reserve will lower interest rates.I am telling you right now: if that happens, it is NOT good news. It will be sign that the Fed is willing to manipulate rates to prolong an economic boom that probably should have been allowed to soften a few years ago. That’s when the Fed stimulated the economy for a 4th time since the Financial Crisis, and produced an even higher level of speculation, overconfidence and yield-reaching investor behavior than I have seen in 33 years in this business.Regardless of the reasons for the drop in 10-year Treasury rates, the rest of the bond market is indicating to me that the years of debt buildup by government, consumers and many corporations is now becoming a concern. Watch this area closely. I will help you do that through my comments below.
ARE BONDS THE DEVIL?
Key Market Stress Points Valuation – Stocks are still historically overvalued, with the Shiller CAPE version of the price/earnings ratio near its 1929 level. The S&P 500 just posted one of its very best 10-year returns in history. Those tend to be indicators of tops, not bottoms. Index mania – Assets continue to pile into S&P 500 Index funds. This groupthink will likely contribute to creating the next bear market panic. Credit – Mortgage debt is approaching its 2008 peak. Massive growth in consumer credit is unsustainable. Bond market risks – approximately 50% of bonds in investment grade bond funds are rated BBB, the lowest of the 4 possible rating categories. This is like when too many people try to jam onto the subway car. Sentiment – IPO-fever has intensified, as it did in the dot-com boom. TV coverage of the stock market is dominated by companies that don’t make a profit. Geopolitical – Trade talks are in limbo, and U.S. political wrangling continues unabated.
My portfolios have pivoted toward the low end of the risk spectrum, now that stocks have appeared to make a double top around the 2,900 area in the S&P 500. There is always the potential for a short, sharp move higher, based on news flow. Still, defensive investing should be front-of-mind. The first four months of 2019 may have been the proverbial melt-up.As I have stated before, I am not a bull or a bear, I am a realist and a devout risk-manager. Consider the issues. Debt builds unchecked at the consumer, government and corporate level. This is happening while geopolitical strife mounts, and the middle class continues to vanish. So, as optimistic as we would all like to be about the financial markets, we have no choice to be on guard. After all, a break in confidence can go a long way toward reversing some of the massive excesses that have built up.Be careful, understand what you own, and respect the laws of gravity.Related: The Difference Between Investment Risk and Volatility Enhancements to the Sungarden ETF 100 list:
This is a group of 100 ETFs I track to get a general sense of global market conditions for investors over the time periods shown. Since last month’s report, we have made several key improvements to the Sungarden ETF 100. By replacing some securities, and creating a separate benchmarks section, we now believe the list can serve as a helpful, widely diverse universe of ETFs that help investors fill in the pieces of whatever asset allocation pie they are creating. In our opinion, the securities in this list offer a combination of breadth and liquidity that allows it to save the investor a significant amount of research time.
Ssshhh! The average 1-year return of this wide-ranging group of 100 ETFs is right around zero. I truly believe most investors have no idea that stock and bond returns have likely entered an era of lower returns.
May was another great example of how traditional investment diversification is more a sales tool for brokers than an investment reality. The 10 broad market indicators here all fell pretty hard last month. When markets fall, diversification among stocks of different sizes and characteristics is of little value. They fall together.
REITs were the only positive sector in May, but they appear to be in more of a holding pattern than a true up-move. We’ll see. Meanwhile, energy stocks bear the brunt of a lower outlook for global commerce.
In yet another reminder of how quickly prices can fall in a frothy stock market, seven of the 19 industries we now track lost 10% or more in a month. Equity investing is not for the risk-intolerant.
A new entrant to the Thematic list is an ETF that tracks a common hedging strategy known as merger arbitrage. It held up well in May. Low volatility stocks did relatively well, too. But count me as a very suspicious observer of that one, for reasons too numerous to detail in this space.
TDIV, a new entrant to the Sungarden ETF 100, dropped over 10% in May. This ETF invests in Nasdaq Tech stocks that pay dividends (many Nasdaq leaders don’t).
This is a new category in the Sungarden ETF 100. It replaced the Allocation category, whose members now appear as part of a Benchmarks section outside the ETF 100 list. They are joined by the S&P 500 ETF, Barclays Aggregate Bond ETF, and the MSCI Global Equity ETF. In particular, cannabis and robotics stocks had a tough May.
India and Latin America are about the only global equity bright spots the past 12 months.
There is no question that U.S. Treasury ETFs are having an excellent year. It could continue, but at some point, it hits a wall when rates can no longer fall, and it renders bond returns uselessly low. This was the case for several years until about a year ago. It appears we are going there again.
As I mentioned earlier this year, price declines in high yield and convertible bonds are likely to be early warning signs that credit market conditions are being recognized for how dire they have become. Many provided more evidence that we are getting there.
International bonds, currency and commodities are now all one big happy family within the Sungarden ETF 100. That said, oil investors were not happy in May, and have not been for the past 12 months.Source for all ETF data: Ycharts.com