NOBODY knows what is NEXT

NOBODY knows Jack or Jill about what is next for markets or the economy, I don’t care what people say or how convicted they are in their belief. Investors that make big investments on their best guess (or forecast, projection, thesis, etc.) are having a very tough go of it in this market.  Very popular mutual funds and hedge funds have suffered big losses in the last year and many have closed.  When central bank intervention dominates asset markets traditional methods like fundamental and technical analysis do not work well.  Eventually market forces correct imbalances and policy makers hope they can correct some of those imbalances before they self-correct.  All we really know is what we can observe right NOW.  Even history can’t be relied upon to guide decisions because, while this time may not be any different, the timing may be very different.  Meaning, markets can stay disconnected from reality for much longer than anyone expects.  Then again, they could self-correction tomorrow.  Or, they could move in very unexpected direction.  For example, not many people are suggesting Treasury yields will rise the balance of 2016 but it could happen especially if the Fed does end up raising rates throughout the balance of the year.

One way to address all the market uncertainty is to deploy several different investment strategies with various levels of risk aimed at navigating different outcomes over the long-term.  That is the approach I have developed at Dightman Capital.  It is really quite straight forward and uses basic index oriented asset classes in unique combination.  One set of strategies maintains exposure to asset class but combines the investments in very unique ways.  Another strategy uses a timing mechanism designed to avoid sustained market declines.  The outcome when these strategies are combined may represent an overall lower correlation to the stock market, lower downside volatility and a higher overall risk-adjusted return.

Consider international stock markets that are either flat or down since 2008.  Despite massive policy intervention designed to lift markets, international stocks remain a challenging investment.  What worked in the U.S. (QE, ZIRP) clearly did not work in many other countries.  Of course, some countries also implemented austerity measures and Japan is in a completely different league overall.  Here is the thing, despite EEMEFA2008being “cheap” at times it has been difficult to generate gains from international markets during the last 8 years!  There have been periods where international markets outperformed U.S. markets and it is likely that dynamic will one day return but it is impossible to know WHEN.  Some exposure to international market for long-term growth investors probably makes since but one thing to keep in mind.  The benchmarks we use to measure long-term stock market performance here in the U.S. is generally based on the S&P 500, which is a U.S. based stock index.

(EFA – International Developed Stock Markets, EEM – International Emerging Stock Markets)

In terms of the U.S. stock market, it has pulled back the last several weeks after a strong recovery rally that kicked off in February.  Many commentators have predicted a total collapse of the market any day and while that could certainly happen, so far U.S. stocks have held up.  One thing investors can do to potentially avoid sustained bear market declines is to deploy a simple timing based system.  I used one very successfully in 2008.

For example, downside volatility in the U.S. stock market the last 9 months has put my Adaptive Growth timing system in a transition mode.  Meaning, it triggered a reduction in risk last summer when markets started to fall.  You can see in the graph where the black line crosses below the blue line.  While the strategy is nearly fully invested now as a result of the black line moving above the blue line, some cash has been held back in case stocks do not fully escape the current correction.  The Adaptive Growth strategy is suggesting stocks remain in a transition mode and until they clearly move out of this status the strategy will remain a little defensive.

$SPXTrig1

$SPXTrig2The Adaptive Growth strategy also incorporates another signal that has recently signaled a defensive move.  This is a longer-term trigger and suggests more declines may be ahead.  However, since the Adaptive Growth strategy is in a transition period I don’t have to take immediate action because I am already under invested and prepared to take further defensive action if conditions deteriorate.  If markets continue to rally I am already participating and ready to add more growth investments.  If a more conservative move is signaled here too I ready to take action.  This is not a purely mechanical system.  As I have described there is an element of interpretation involved but overall it is a pretty simple and straight forward system and I have been using it for years.

In terms of economic data driving corporate earnings, we continue to take two steps forward and one step back.  Most of the economic data suggests a mildly improving environment accompanied by an occasional disappointment.  The construction industry appears to be one of the primary contributors to current economic growth.  Both new construction along with remodeling appear to be helping companies like Home Depot  (HD) and material suppliers like Vulcan Materials Co. (VMC) perform well in this market.HD_VMC

The chart of Vulcan and Home Depot show their prices rising steadily the last three years and near all time highs.  As both companies move into new high territory, along with many other stocks, there is reason to believe stocks could rally into the summer.  At least that is what is happening NOW.

In terms of new innovation, General Electric (GE) is busy reinventing itself and its latest announcement could be a game changer.  After trimming its financial unit and selling the home appliance division the company aims to leverage its massive industrial knowledge based by becoming an Industrial Internet Powerhouse, a new direction with potential promise.  Investor’s Business Daily details more here.  General Electric is not currently included in my favorite dividend stock investments but that may change if the new initiatives improve the company’s rank relative to other dividend paying stocks.  The real takeaway is this, despite all the challenges faced 124-year old companies like G.E., companies are finding ways to position their businesses for future growth opportunities.

Stocks had a great start to the week.  My favorite growth investment closed up 1.25% Monday.  This performance is so ironic.  Just this past Friday I was contemplating a short position for the Adaptive Growth strategy based on the ongoing deterioration of my second trigger measurement.  Just when you think it is about to get a lot worse it gets better which is typical in this market.  I have found this particular market environment requires a little more patience then usual.  Everything could change in the near future and I admit there are a lot of reasons to suggest markets are going to go through another correction.  However, markets have a tendency to do their own thing so a summer rally is not out of the question either.

NOBODY knows what tomorrow will bring and with stakes potentially higher than usual, based on risks that may have been introduced to the market by Central Bank intervention, using multiple strategies I believe is an effective approach for navigating the current uncertainty while positing for potential opportunities.

Have a great week!

Are Negative Interest Rates Coming To The U.S.?

You may have heard the central banks in Japan and several countries in Europe have implemented negative interest rates.  They are hoping the banks that deposit funds with the central bank will be incented to loan the money out versus receive less when they make a withdrawal.

Central Banks with Negative Interest Rates

There have been some reports negative rates have made their way into consumer products in Europe, specifically mortgages.  At least one bank in Spain, Bankinter, with mortgage rates tied to Swiss Libor which is now approaching minus 1%, sold mortgages that it could not charge interest on so it reduced principle for some of its customers.  For the most part, negative interest rates are a policy tool between central banks and those banks the deposit funds with them.

Here in the U.S. rates are still positive but barely.  The Federal Reserve started the process of raising rates at the end of 2015 but they have been on hold since.  Economic data, while not deteriorating, is not improving either.  The U.S. economy appears to be stuck in a slow growth mode.

Eventually this could turn into a big problem because a lot of debt has been accumulated trying to stimulate the U.S. economy.  This is why policy makers are so desperate to see economic activity pickup.

It would be quite a turn of events if the U.S. switched form raising rates to negative rates after holding ultra-low rates for such an extended period of time.  It could happen and if the 10-year Treasury yield falls below 1.5% we may see it happen.  However, helicopter money may become the policy tool of choice going forward.  I’ll have some more to say about that in the future.

Panama Papers…Confirming What We Already Knew

If you haven’t heard, Panamanian law firm Mossack Fonseca, suffered a data breach of more than 11 million documents dating back four decades.  The firm is well known for establishing secret shell companies for offshore accounts used by world leaders and politicians.  So far 140 or so names have been referenced; we are not just talking about corrupt leaders from 3rd world countries.

It appears much of the work Mossack Fonseca conducts is perfectly legal.  That is not the problem.  It is the money that finds its way into these secret accounts that is troubling.  Wide spread fleecing of tax payers and ordinary citizens is so ridiculously obvious by politicians and their close contacts I don’t know how you could deny it.  I am not saying every politician’s fortune was ill gotten, but statistically how this group of individuals becomes so filthy rich with a salaried job and doing the “people’s work” doesn’t add up.

Corruption

The potential fallout from this story could be huge as the world treads water in a sea of debt some of the people mentioned in these documents may have helped create.

Then again, we may be just one Kardashian distraction away from forgetting about the whole thing.

From an investment stand point, I have felt there are some companies that may do a better job of working with government officials than others and as a result may benefit more from policy decisions than their competition.  I view it as another form of competition in the area of formulation and execution of government engagement.  I believe I have identified such group of companies and they serve as a core investment in some of my strategies.  Let me know if you are interested in learning more about these companies.

Pro Forma & Reported Earnings Spread

The Wall Street Journal recently published an article suggesting earnings are far worse than reported based on a widening gap between Pro Forma and Reported (GAAP) earnings.  Pro Forma earnings exclude certain items like restructuring charges and stock based compensation and shows U.S. companies earning 0.4% more in 2015 then 2014 – the weakest growth since 2009.  When you look at earnings based on GAAP reporting EPS actually fell by 12.7%, the sharpest decline since 2008.

There is also concern about “one-time events” taking place every quarter.  One-time events allow a company to clean up their books by writing off bad investments, accounting for the cost of a layoff or other infrequent business expenses.  It sounds like bad things are happening in corporate America on a more frequent basis.

Investors continue to plug their nose in hopes this is a short-term development with sales and profits to recover later in the year.  It could happen, often during a earnings decline the market will anticipate the earnings recovery sending stocks higher.  This late in the credit cycle risks are higher earnings will contracting further before making a recovery.

Q1 earnings have been adjusted down by analysis, probably too low, which allows companies to “beat” their estimates sending the stock higher.  Just another reason for investors to be very selective and careful regarding their exposure to stock investments.

4.5.16 Q1 Earnings Growth

On Alert, Not Alarm

Apparently central banks and politicians have not done enough to help the global economy recover according to, Christine Lagarde, IMF Managing Director, in a speech at Frankfurt’s Goethe University where she called for stronger action by the world’s economies, suggesting downside risks were increasing.

“Let me be clear: we are on alert, not alarm. There has been a loss of growth momentum”.
Ms. Lagarde’s concern helps explain the shift by some central banks to negative interest rate policy (NIRP) and more recently talk of “helicopter money”.  (Seeking Alpha, April 5, 2016)

Remember the 2008 tax rebate checks? That is an example of helicopter money, money that bypasses the banks and lands directly in consumers’ pockets.  The path is set.  This is where we should expect to be headed.

Meanwhile, apparently the best case we have for a stronger recovery according to Bob Doll, Chief Equity Strategist at Nuveen Asset Management, are summed up with his positives outweigh the negatives summary (Financial Advisor April 5th, 2016):

• Dovish comments from Janet Yellen suggested a slow pace of interest rate increases and helped push stock prices higher.
• We expect relatively weak first quarter corporate earnings results, but believe conditions should improve later this year.
• Despite some near-term risks, we have a positive long-term view toward equities.

Sorry, but those are pretty lame and generic reasons to be bullish.  Yes, the Fed continues to be able to inflate the market with policy speak.  True, earnings may be in contraction so stocks could rally on an expected recovery during the second half of 2016 but what is the catalyst?  And who on Wall Street doesn’t have a positive LONG-TERM view of stocks?

Meanwhile U.S. Treasury Bonds rally which is why they can be a great tool for managing portfolio risk and provides a real assessment of what the market thinks about the current situation.

Bonds Continue To Outperform

It has been around 9 months since the current market selloff began during the summer of 2015.  U.S. stocks have been on a bit of a roller coaster ride since then with several sharp declines and snap-back rallies.  While U.S. stocks have shown some improvement recently, U.S. bonds still hold the top performance slots and stocks remain quite a bit below 10-year Treasuries.  Do you need any Treasury Bonds in your portfolio?

BondsOutperform

Performance data calculated by ETFReplay.com.  Performance data is based on Total Return calculations but does not include other potential costs.

Performance results are hypothetical.  Investments and the income derived from them fluctuate both up and down.  This presentation is for informational purposes only and is neither an offer to sell or buy any securities.  Benchmarks or other measures of relative market performance over a specified time period are provided for informational purposes only.  The material provided herein is for informational purposes only and is not an offer to buy or sell any security.

No investment recommendations have been made in this article. Investing involves risk including the loss of capital. Conduct your own research before making any investment decision.

 

How Real are Current S&P 500 Earnings?

Aggregate corporate earnings are the primary driver of stock market valuations and are communicated as “Reported Earnings” based on GAAP (generally accepted accounting principles) and “Pro-Forma” which exclude certain on-time or extraordinary items.  The problem is corporations are reporting these “special, one-time” items excluded from pro-forma earnings quarter after quarter leaving investors with an unclear picture of what the company is really earning.  This has led 90% of current earnings reports to be based on “pro-form” earnings with GAAP based earnings reported in the back of the quarterly report.  A couple decades ago it was the opposite, the majority of earnings reports were based on GAAP.  It is starting to sound like corporate America has taken a cue from the political class where manipulation, deceit and obfuscation rule the day.

Eventually the accounting trickery reach their effective limit and that point may have arrived.  2015 “pro-forma” earnings rose 0.4% over the prior year marking the weakest growth since 2009.  This is based on pro-forma figures.  GAAP earnings fell by 12.7% and the spread between GAAP versus pro-forma earnings is wider than anytime since 2009.

SP-500-Earnings-WorseThanRealized-022416

Another factor to take into consideration as the market tries to climb out of what has been a mild correction so far.

 

An Upside Trigger for Stocks may be Approaching

If stocks continue to rally they won’t have to move much higher to trigger a signal for my Adaptive Growth strategy.  This is a strategy that uses a timing base mechanism to determine whether the strategy should own stocks or cash.

Here is a picture of the current state of the trigger.

StockTrigger22616

If he black line moves above the blue line it is usually a good indication stocks are about to resume a long-term uptrend.  There is always a chance during a transition period (where lines have recently crossed) the indicator will reverse course after crossing . We saw that happen back in the fall.  The first dip below the blue line was based on the mid-summer selloff.  The August Flash-Crash sent the black line much lower but stocks quickly recovered for a short time only to fall below it again at the end of 2015.  Aside from the reverses that can happen around an initial trigger this has been a very reliable indicator for both avoiding sustained declines and staying invested during more mild corrections.

Here is what the indicator looked like back in 2007-08.

StockTrigger2007-09

I have to apply a bit of discernment when a trigger arrives.  Currently this recovery rally is not all that convincing so I am willing to be a little patient if the black line does move above the blue line in the near future.  Even getting back into the market a couple points past where the lines cross I should be able to enter below the highs back in mid-2015 if the current uptrend continues its course.

Past Commentary

Due to an abrupt service change by my website hosting company, I had to move my website and blog during the month of February.  The website transition went very smoothly but porting over years of blog posts is a different matter altogether.  Although I have provided a lot of market and investment commentary over the years I have decide that I am going to start a new blog and not bring over the old content.  I have access to the old content and at some point I might change my mind and decide to bring some over but at this point there is no plan to do so.

Welcome To Market Insights

The purpose of Market Insights is for Dightman Capital to be able to share more information about the state of investment markets through the results of various portfolio strategies.  We hope this will introduce some helpful concepts around investment growth and risk management.

Occasionally we might dig into the “why”, but most of the time we will be content to deliver the what.  As in, what is the current state of different investment strategies and what part of the investment mix can be attributed to current performance.

The biggest point we hope to drive hope is, a traditional mix of stocks and bonds may only be appropriate for part of an investors portfolio.  Incorporating a simple timing based system along with a unique mix of traditional stocks and bonds may provide a more complete solution for those investors looking for potentially superior risk adjusted returns.