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Stock Investors Bask In The Economic Slowdown’s Glow

Once more, the U.S. economy is flirting with trouble. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. The financial markets will only support extreme overvaluation if the Fed is in “stimulus” mode, as opposed to “de facto” tightening. By July of 2012, a wide range of indicators suggested that the U.S. economy was flirting with trouble. Job growth was decelerating. Business investment was deteriorating. Meanwhile, manufacturing via the ISM Manufacturing Survey (PMI) was flirting with contraction. Up until that moment in time, the Federal Reserve had already left rates at zero percent for three-and-a-half years. What’s more, they had already created trillions of electronic dollars to acquire government debts and push borrowing costs to unfathomable lows to ward off a double-dip recession (i.e., “QE1,” “QE2,” “Operation Twist”). However, the end of those programs seemed to show that the U.S.economy was still too fragile to stand on its own. Not surprisingly, leaked rumors about a more awe-inspiring economic jolt began taking over the July 2012 business headlines. Terms like “QE3, “QE Forever,” and “QE Infinity” had been making the rounds. Indeed, by September of 2012, The Fed had unleashed an open-ended bond buying program that rivaled anything investors had seen previously. Fast forward three years. Once more, the U.S. economy is flirting with trouble. The percentage of 25-54 year-olds (19.5%) that are out of work has risen sharply. (Retirees? College students?) Median household income is sagging. Business investment in research, plants, equipment and human resources development is virtually non-existent, with virtually all after-tax profits going to share buybacks and shareholder dividends. Non-revolving consumer credit has grown from 14.6 percent of after-tax income at the end of the recession (6/2009) to 18.7 percent (6/2015). And manufacturing via PMI? Falling throughout 2015 and hanging on by a thread (50.2), we’re right back to the type of environment that prompted previous calls for more quantitative easing (QE) “cowbell .” From an investment standpoint, the demand for U.S. treasury bonds in recent government auctions still points to risk aversion. Recall Monday’s 3-month T-Bill auction (10/5) where $21 billion had been acquired at 0%. Zero percent! It was the lowest yield for the 3-month T-bill on record . On Wednesday (10/7), another $21 billion went to auction on 10-year Treasury bonds. The high yield of 2.066% was the lowest since April. Equally worthy of note (no pun intended), the indirect bidding component that includes significant central banks acquired $13.1 billion (62.2%) – the second highest percentage on the record books. On the other hand, euphoria on the high probability that the Fed will abstain from 2015 rate hikes has given hope that a 4th quarter rally may materialize. For instance, the New York Stock Exchange (A/D) Line shows September’s successful retest of the August lows. Remember, it was the A/D Line that foreshadowed the dramatic sell-off in the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ) before its mid-August arrival. Higher lows and higher highs on the A/D Line from here forward would likely signal a shift in attitude toward greater risk taking. Another trend that is worth watching? Consider the relationship between U.S. treasuries and crossover corporates – U.S. company bonds that straddle the line between low-end investment grade (Baa) and higher-rated “junk” (Ba). A rising price ratio for iShares 7-10 Year Treasury Bond ETF (NYSEARCA: IEF ) : iShares Baa-Ba Rated Corporate Bond ETF (BATS: QLTB ) is a sign a of risk aversion. Granted, IEF:QLTB is still rising alongside its 50-day trendline. On the other hand, the fact that IEF:QLTB is lower than it was in August may be a sign that risk taking is on its way back. Put another way, a tightening in spreads between treasuries and crossover corporates would be a sign that investors might be looking for a return on capital again, rather than a return if capital alone. Indeed, the battle between risk-on and risk-off has reached a crossroad. Many of the significant stock ETF proxies – the SPDR S&P 500 Trust ETF ( SPY ), the iShares Russell 2000 ETF (NYSEARCA: IWM ), the V anguard FTSE All-World ex-U.S. ETF (NYSEARCA: VEU ), Vanguard FTSE Developed Markets ETF (NYSEARCA: VEA ) rest near resistance levels of 50-day moving averages. Similarly, the S&P 500 itself fights to reclaim the psychological level of 2000, while the Dow Industrials toils to climb back above a psychological level of 17,000. Keep in mind, though, analysts widely anticipate earnings and revenue declines for the third consecutive quarter . If investors push prices much higher from existing levels, they’d be back to exorbitant P/E and P/S multiples. And if recent history is any guide on investor comfort will overvalued equity valuations, investors would not take kindly to a 4th quarter rate hike campaign; that is, the financial markets tens to support extreme overvaluation when the Fed is in “stimulus” mode. A three-month stock celebration (Oct-Dec) may come down to these factors: (1) the Fed stays at the zero-bound, (2) the 10-year stays at 2%-2.25% to keep the credit bubble blowing, and (3) the earnings and revenue picture surprises at the flat-line, as opposed to disappointing with sharper than projected deterioration. In the meantime, pay attention to the market internals via the A/D Line as well as the spreads between treasuries and corporates. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

What The 3rd Quarter Tells Us About The Stock Market In October

As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Three months ago to the day (6/30), I served up a list of reasons for lowering one’s exposure to riskier assets . I discussed weakness in market internals where fewer and fewer corporate components of the Dow and S&P 500 had been propping up the popular U.S. benchmarks. I talked about the faster rate of deterioration in foreign stocks over domestic stocks via the Vanguard FTSE All-World ex-US ETF (NYSEARCA: VEU ):S PDR S&P 500 Trust ETF (NYSEARCA: SPY ) price ratio. Additionally, I highlighted exorbitant U.S. stock valuations, the Federal Reserve’s rate hike quagmire and the ominous risk aversion in credit spreads. Three months later (9/30), a wide variety of risk assets are trading near 52-week lows or near year-to-date lows. Higher yielding bonds via the PIMCO 0-5 Year High Yield Corporate Bond Index ETF (NYSEARCA: HYS ) as well as the iShares iBoxx $ High Yield Corporate Bond ETF (NYSEARCA: HYG ) are floundering in the basement. Energy via the Guggenheim S&P Equal Weight Energy ETF (NYSEARCA: RYE ) has broken down below the S&P 500’s correction lows of August 24, suggesting that a bounce in oil and gas may be premature. Even former leadership in the beloved biotech sector via the SPDR Biotech ETF (NYSEARCA: XBI ) reminds us that bearish drops of 33% can destroy wealth as quickly as it is accumulated. Is it true that, historically speaking, bull market rallies typically fend off 10%-19% pullbacks? Absolutely. Yet there is nothing typical about zero percent rate policy for roughly seven years. For that matter, there was nothing normal about the U.S. Federal Reserve’s quantitative easing experiment – an emergency endeavor where $3.75 trillion in electronic dollar credits were used to acquire government debt and mortgage-backed debt. And ever since its 3rd iteration came to an end eleven months ago, broad market index investments like the Vanguard Total Stock Market ETF (NYSEARCA: VTI ) have lost ground. The same thing happened in 2010 during “QE1.” Once it ended, risk assets had lost their mojo. Then in September of 2010, rumors swirled about the Fed engaging in a second round of quantitative easing (a.k.a. “QE2″). And then the bull rally was back in business. As things currently stand, investments that are more likely to benefit from lower borrowing costs rather than higher ones have been winners. Utilities and REITs are up over the last three months; in contrast, industrials, financials and retail have been battered. The demand for higher yielding stocks contradicts the idea that the Federal Reserve can demonstrate any genuine conviction when attempting to move the overnight lending rate higher. (Some seem to believe that the next significant move might even be to ease.) Relative strength for utilities and REITs in the stock world, as well as relative strength for investment grade debt in the bond universe, suggest that the Fed will barely bump overnight lending rates, if at all. Granted, the Federal Reserve would like to tell you the job growth is solid, even as chairwoman Yellen and her colleagues ignore the disappearance of high-paying manufacturing jobs on a daily basis. It has gotten so bad that, according to ADP, the manufacturing sector has experienced a net LOSS for 2015. Is it any wonder that the extraordinary growth of part-time service workers alongside the loss of full-time manufacturing positions have contributed to significant declines in median household income? Should we ignore the reality that 19.5% of the 25-54 year-old, working-aged population is not participating in the labor force (a.k.a. unemployed) – a percentage that has increased every year from 16.5% in the Great Recession to 19.5% today? These are not “retirees” that we’re talking about here. We are maintaining our lower-than-normal asset allocation for our moderate growth and income clients at Pacific Park Financial, Inc. During June-July, our equity exposure moved down from 65%-70% stock (e.g., growth, value, large, small, foreign, etc.), down to 50% (mostly large-cap domestic). Our income exposure moved down from 30%-35% (e.g., short, long, investment grade, high yield, etc.) down to 25% (almost exclusively investment grade). The 25% cash component that we’ve been holding? We would need to see a desire for greater risk through greater pursuit of high yield bonds at the expense of treasuries. We would want to see a pursuit of capital gains over safety in a rising price ratio for the PowerShares S&P 500 High Beta Portfolio ETF (NYSEARCA: SPHB ):iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ). The fact that the SPHB:USMV price ratio is near its lows for the year tells me that it is still better to be safe than sorrowful. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Dual Momentum Model Recommends Move To Bonds Or Cash

The Dual Momentum model recommended selling equities as far back as August 10th. A slight modification of the Dual Momentum model recommends holding Cash or SHY. Look-back periods make a difference in recommendations. Three metrics, as described in the second table, improve returns and reduce annual draw-downs. Momentum investors following the Dual Momentum model are currently invested in either bonds or cash depending on how strict they follow the DM guidelines. In the following table the look-back period is one year or 365 days as recommended in Gary Antonacci’s book, Dual Momentum Investing . Exchange Traded Funds representing U.S. and International Equities markets are substituted for those securities suggested in Antonacci’s book. These ETFs are commission free securities available through several discount brokerage houses. VTI covers U.S. Equities while VEU represents International Equities. If neither VTI or VEU outperforms SHY , our cutoff ETF, we move to bonds. In this momentum model an intermediate bond BIV is selected as an obvious choice. One could also use BND as the bond representative. Using the 365-Day look-back period, the current recommendation is to invest 100% in bonds. Investors may wish to wait until after the FEDs settle on an interest rate rise before making this move. (click to enlarge) An alternative model to the above DM is shown in the following screen shot. After hours of research using a Monte Carlo model, a different look-back emerges. In the following model a 30% weight is assigned to the performance over the most recent 87 calendar days while a 50% weight is assigned to the most recent 145 calendar days. To hold down portfolio volatility and reduce risk, a 20% weight is assigned to a 14 calendar day mean-variance. Following these three metrics improves performance while reducing draw-down with respect to either the S&P 500 or VTSMX benchmarks. This can also be demonstrated using out-of-sample data. Numerous portfolios are now undergoing additional testing of this three-metric model. Using these three metrics, the recommendation varies slightly from the above DM model as investors are now advised to invest 100% in SHY, the “circuit breaker” ETF. Moving to SHY or Cash was recommended as far back as August 10th . One adjustment is advised when both VTI and VEA are out of favor as is now the situation. Instead of maintaining the 30% – 50% weights assigned to the 87- and 145-day periods, reverse those percentages. The reason is to place more weight on the most recent period so as to catch the upward swing when the market begins to rebound. As for the current situation, the Dual Momentum model recommends holding 100% in bonds while the revised DM model recommends holding 100% in Cash or SHY. Both are conservative portfolio positions. (click to enlarge) Disclosure: I am/we are long SHY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Share this article with a colleague