Be Wary. And, Be Flexible

A lot has happened in the five weeks since our last update. There were two themes that we presented in that summary. First, long term charts suggested the bear market was not likely over. Yet, short term indicators indicated one of the most attractive buying opportunities in nearly 11 years.

It’s possible that both are (and were) true. From its low on March 23 at 2237, the S&P 500 advanced over 31% in just 26 trading days. Nearly 30% of that gain took place on the first day after the low, when the index surged over 9%. At last week’s peak value of 2954, the index had retraced 62% of its losses. Similar retracements of both greater and lesser degree have taken place in the NDX and the Russell 2000 Index of small companies.

What’s all this mean? Is the worst over? Clear sailing ahead? Don’t worry, be happy? Not according to our technical models, almost all of which remain negative. We’ll get right to the point, inside, along with touches on refinancing, CARES Act provisions and the challenges that money fund yields present (no thank you to Jerome Powell of the Fed).

Portfolio Positioning

Despite the massive rally described above, only one of our stock market risk models turned positive in the last several weeks, and we used that to increase tactical equity allocations to about 22%.  We think there is a message in that perhaps the most sensitive of the models we’re using has refused to turn bullish (at least yet).  That same model went positive after a 20.7% gain from the March 2009 low, and after a 13.7% rally subsequent to the December 2018 low in the S&P 500.  Here, stocks rallied over 30%, and no BUY signal.  Hmm.  

Market history suggests that significant retracements, or countertrend rallies, are common following significant market peaks, including those of 1929, 1937, 1966, 1973, 2000 and 2007.  Given the lack of volume on the rally and the absence of significant breadth thrusts, the evidence we have at present suggests the past several weeks have simply represented a bear market rally that may be completely erased in coming weeks.  Bear markets normally have three phases, and it’s hard to fathom that the excesses of an 11-year bull market were corrected in a mere 5 weeks.  At the lows on March 23, valuations by the median P/E ratio had reached “fair value,” but the rally returned this measure to spitting distance of “overvalued.”

One other development did take place shortly after our last update.  Our risk model for high yield corporate bond funds flipped positive on March 30.  Given that daily volatility in this area was at times running twice the level of our weekly risk controls, we made the conservative management decision to take the trade with only 50% of our normal capital.  After two weeks, the trade was running break even, and then the Fed stepped in with an announcement that they’d created a special entity to purchase the ETFs of high yield bonds.  Never mind that what they did is illegal, but the Fed always finds ways to get around their charter.  And, investors have to deal with it.  So, on that day, the ETFs of the two largest high yield bond funds, JNK and HYG, surged over 6.5%.  

In one day, our trade turned profitable, but our model went negative last week, and we sold all the positions on April 27 for gains mostly ranging from 3.5% to 4%.  Perhaps that will be a reminder to keep things simple and take our indicators at face value, and not worry about risk?  I think it’s telling that HYG and JNK have never closed higher than on the day of the Fed announcement, and are in fact down about -4.5% from that day’s close.

What gives us pause here is many things are lining up together.  Though it is true that all sell signals from our high yield model do not result in lower prices, it is also true that all significant declines take place AFTER sell signals.  Below is a daily chart of the SPX, courtesy of www.stockcharts.com.  

A close below the mid-April lows in the range of 2720-2736 would likely confirm the peak of the rally is behind us.  We’ll be watching this week if the decline picks up further downside momentum, coupled with expanding downside volume.  Though Warren Buffett is not perfect, I think it was telling that as a value-oriented investor with a splendid history, he did no buying during the decline in March, but rather raised additional cash of around $10 billion by eliminating all his positions in airlines.  

Recently, I was reviewing our Disclosure Brochure, which needs to be updated for any changes every year by March 31, and is part of our required filings with the SEC (Securities & Exchange Commission) as being a RIA (Registered Investment Advisor).  In the brochure, there is a section on Methods of Analysis, Investment Strategies and Risk of Loss.  Several of the paragraphs really stood out, and are worth repeating here.

“TABR’s research demonstrates that some environments are particularly hostile to stocks and other asset classes, while others have been historically friendly.  The reality is that one cannot avoid risk.  TABR utilizes its models in an attempt to minimize the downside during particularly unfriendly market environments.

“TABR’s approach to the market can be summed up in three words:  Disciplined Risk Management.  In fact, TABR is an acronym for ‘Technical Analysis Based Risk-Management.’  TABR believes that avoiding significant losses is as important to investment success and financial security as is generating big returns.  For clients who are drawing an income (whether retired or not), this is even more important, as it has been demonstrated that the sequence of investment returns really does matter in determining outcomes when a withdrawal strategy is in place.”

Perhaps the most valuable aspect of our investment discipline is BEING FLEXIBLE.  Though we certainly have opinions, they don’t get in the way of our process.  In mid-February, our tactical equity allocations were 85% and we had heavy exposure to high yield bond funds.  Barely 20 days later, equity allocations were around 20% and nearly all high yield positions had been eliminated.  It’s our willingness to respond to changes in market conditions, and therefore our models, which makes us different.  There’s no need to worry about forecasts, price targets, or how this current virus pandemic will turn out.  We don’t know, and importantly, no one else does either.  

Right now, the overall message of our work is negative.  When more positive conditions emerge, we’ll begin to add exposure, whether that is three weeks from now, or six months from now.  Remember—it only takes one bear market to wipe out several years of gains, and it’s entirely plausible that buy and hold passive investors are once again going to discover this the hard way.

Money Fund Yields—The Road To Zero

In the past six weeks, the Federal Reserve Board has cut the Fed Funds rate from a range of 1.50%-1.75% to effectively zero, at 0-0.25%.  I’m at a loss just as to how this is exactly “helping” the economy.  I’m afraid we are back to the days of 2008 and 2009, when the Fed also cut rates to zero, and kept them at that level for nearly six years.  Based on comments from Jerome Powell, the Chairman of the Federal Reserve Board, one can expect to see rates remain at zero for quite some time.  Like several years.  Below is what has taken place with money fund yields since last summer.

The top two funds listed above are the core cash funds that clients use at Fidelity Investments.  Core cash is the portion of an account where we leave anywhere from 1% of the account value in place to cover fees, to as much as 5% or more of the account to cover regular monthly income.  Just 10 months ago, clients were able to earn over 2% risk-free.  That number is now zero.  That is a big drag on returns.  The fund listed at the bottom, Fidelity Money Market, is a prime money fund which we use to hold cash as part of our equity allocations.  With our stock risk models only at 22% invested, we currently have 78% in cash.  By virtue of this process, the Fed once again is forcing investors to take risk, in order to reap returns.  It’s important to be very careful about chasing returns in a zero yield environment.  There is no law that stocks cannot go down just because interest rates on Fed Funds are at zero.  

Some other tidbits in this area.  What I am citing above cuts across the entire industry.  The major banks never increased savings rates (Bank of America, Wells Fargo, Chase, etc), and their bank savings and money funds will remain at the 0.05% range.  Please note that Fidelity and other sponsors of money funds will have to resort once again to waiving management fees on their funds to avoid yields going below zero.  The average management fee on Fidelity’s money funds is about 0.34% annually.  

For those of you with significant cash sitting in banks, we would once again encourage you to look at the likes of Ally Bank and their competitors.  At this writing, Ally’s online savings account is still paying a yield of 1.50%.  I cannot imagine how long that will last, and expect them to cut their rate to at least 1% in coming weeks.  For reference, one should note that since the beginning of the year, the yield on the 30-year Treasury Bond has plummeted from 2.38% to 1.29%, and the 10-year Treasury Yield has dropped from 1.91% to 0.63%.  Ally Bank cannot continue to pay depositors 1.50% on liquid funds, when you cannot even earn 0.75% by purchasing 10-year paper.  If you do invest in Ally Bank’s products, or any other online bank such as Barclays, Synchrony or American Express, DO NOT go over the FDIC insured limits.  Ally Bank’s stock has dropped more than 50% in the past two months.  If they continue to pay depositor’s yields which are double the market, they will eventually go out of business, just like Washington Mutual did back in 2008.  And, if you have more money with them that is not insured, you will likely lose it all, so don’t go and chase yields unless you stay within the confines of protection.

Refinancing Home Mortgages

Since we’re on the topic of lower interest rates, the recent plunge in Treasury yields has once again opened up the opportunity for certain homeowners to refinance their mortgage.  Lowering a payment by even a few hundred dollars a month can make a positive impact on anyone’s monthly expenses, whether retired or not.  Several clients are either in process, or have just finished refinancing (and that includes my wife and I on a small loan on our new home in Yorba Linda).  Currently, rates on conventional 30-year fixed rate loans are running in the 3.25% to 3.50% range.  Your individual rate will weigh heavily on your balance sheet, your sources of income, and your credit score.  The better all of that is, the lower the rate.  

Despite the deflationary forces that seem to be in place for the bond market, one should not assume that rates will go lower from here.  Underwriting standards have tightened considerably in the past 5 weeks, and one should not assume that everything would happen quickly.  Mortgage lenders are overwhelmed with demand, and one can’t even think about locking in an interest rate until all your documentation has been submitted for review and is approved.  Steve Medland and myself are identifying opportunities with clients as we come across them in our database with clients, but if we’ve overlooked you, don’t hesitate to contact us.  We’ve got a terrific independent mortgage broker we’ve been working with for a few years, and his customer service team is unmatched.    

Key Provisions Of The CARES Act

Due to the global coronavirus pandemic and national health emergency in the U.S., a new bill was passed in March 2020 to provide relief to Americans impacted by the virus.  It’s called the Coronavirus Aid, Relief and Economic Security (CARES) Act.  Three major retirement planning changes were enacted for 2020 to provide temporary relief.  They are not permanent.

First, the CARES Act suspended all required minimum distributions (RMDs) for 2020.  If you needed to take an RMD from your IRA or an inherited IRA account, you can skip the payout for 2020 and you won’t have to double up in 2021.  

Second, if you are under 59 1/2 and you or your spouse have been diagnosed with the virus or you’ve suffered financial implications due to a loss of employment, you may withdraw up to $100,000 from your retirement plan account in 2020 and not pay the normal 10% penalty tax.

Finally, the CARES Act extends the time you have to repay 401 (k) loans and increases the amount you could withdraw as a loan during 2020.  Typically, 401 (k) loans are to be repaid in five years, but the ACT extends that to six years.  It also increases the maximum borrowing amount from $50,000 to $100,000.  

So What, I Missed The Best 40 Days.  Big Deal.

Over the nearly 40 years I’ve been a subscriber to Barron’s, the weekly financial newspaper which is the sister publication of the Wall Street Journal, I’ve had many a letter to the editor published in their Mailbag column.  But, my writing has never made the print edition.  Technically, that is still the case, but last Thursday, my submission of a piece that I felt worthy of their Other Voices section was published on Barrons.com, the digital complement to the print edition.  It’s a technical article on the virtues of market timing and debunks the half stories that virtually the entire financial industry continues to reproduce, implying that investors will be much worse off if they are out of the market during its “best” days.

Below is the link to the article:

https://www.barrons.com/articles/timing-the-market-pays-off-buy-and-hold-51588186928

Please note the article is behind the Barron’s paywall, so if you’re not a subscriber, you won’t have access to it.  Should you have an interest in reading the piece, feel free to contact me.

Material Of A Less Serious Nature

We are 11 days into self-isolation and it is really upsetting me to witness my wife standing at the living room window gazing aimlessly into space with tears running down her cheeks.

It breaks my heart to see her like this.  I have thought very hard about how I can cheer her up.

I have even considered letting her in. . . .but rules are rules.

Don’t worry, ladies, I have one for next month to make fun of the guys.  

Is there any other advice to offer in this difficult time?  I’ve been having some good conversations the past couple of weeks with some of our baseball players from Cal State Fullerton.  Normally playing baseball at full tilt right now, they, along with thousands of other students, have been reduced to finishing their classes online, and keeping their bodies in shape for what we all hope is a “normal” fall schedule of practice, and hopefully, a “normal” slate of games beginning next February, with real people in the stands.  One of the most important things I’ve emphasized to them is to stay on their mental game, and stay in a routine.  Don’t slough off.  The mental edge in baseball is huge, and for all of us, our mental attitude in how we cope with what is going on will go a long way in determining outcomes.

Leave it to us to worry over and monitor your financial situation.  And know we don’t take that responsibility lightly.  This is a time when strength and courage and emotional maturity are incredibly valuable to our social order.  We are all, every one of us, an important part of the daily struggle of people we are care about—and let that be motivation as we all slog through this pandemic one day at a time, together.

Let us offer you our blessings and our hope—and most of all our support through this difficult time.

Sincerely,

Bob Kargenian, CMT

President

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