Market Climate Worsening

CONCLUSION—Market Climate is Worsening

During the first quarter of this year, the average equity exposure in our tactical accounts was 70%, reflecting a moderately bullish outlook.  That has changed significantly in the past four weeks, starting with a SELL signal from one of our longer term models below.  Two other intermediate models for the stock market went negative last week, so at this writing, only 3 of the 10 main models we use are in a bullish mode.  As a result, net equity exposure is now at 30% (50% in our five core funds, and 20% short).

I’d planned to feature the model below, known as Pentad, since it gave its first SELL in over 3 1/2 years a few weeks ago.  It is even more fitting now, as last week, I learned that my friend and colleague, Nelson Freeburg, who developed this model back in 1996, died suddenly at the age of 63 while visiting New York City on a business trip.  May this in some small way honor his life, and the many contributions through his financial market research that Nelson made to our profession.  God bless you, friend.

Pentad was built with just five components, and relies on the theory that in markets, things need to be in sync to be positive.  When markets become fractured, they begin to sputter and struggle, much like a car that doesn’t have enough oil or transmission fluid and is not firing on all cylinders.  If you’ll examine the mode box in the chart, courtesy of Ned Davis Research (as is the one below), you’ll notice that when the model is in SELL mode, since 1985, the S&P 500 on average, has lost money.  As an example of this fracturing, according to analyst Walter Murphy, almost 45% of the companies in the S&P 1500 finished the first six months of the year with a year-to-date loss in their stock price.

Note—Pentad is not perfect.  No model or strategy is.  It really struggled in 2011.  But, it also completely side-stepped the huge decline in 2008.

For stock markets around the world, usually the biggest risks to price damage is during economic recessions.  History shows that price declines are much bigger during recessions than at any other time.  The chart above from Ned Davis Research (NDR) is a Global Recession Probability Model they featured a few weeks ago.  It is now in a zone where in the past (since 1970), a global recession has occurred 88% of the time.

With markets around the world more connected than perhaps ever before, this would seem to be important.  Yet, NDR also maintains a similar model on the U.S., and its present reading is. . . .2%.  In other words, there is very little sign at present that the United States is at risk of a recession.  Will the rest of the world drag down the U.S.?

This weekend, there is a big vote in Greece on whether they are going to accept the credit demands of the International Monetary Fund.  It is not clear which would be better for world markets—a Yes vote or a No vote.  In markets, there is always something to worry about.  This is why we continually emphasize the discipline of following our models, and forgetting about the news.  The bottom line is—we consider risk control to be more important than usual in coming months.

Portfolio Allocations

As noted above, tactical equity allocations are currently at 30%, with a chance to go to 20% in coming days.  In addition to the deterioration in our stock market models, our real estate model based on the Dow Jones Real Estate Index Fund (IYR), gave a SELL last week and those funds were moved to cash.  Within our bond strategies, our model for the Loomis Sayles Bond Fund went negative and these funds were moved to either cash or the Loomis Sayles Limited Term Fund.  This fund, in the top 18% of its peer group the past three years, is having a crappy year, in the bottom 25% of peers.  Our models for high yield corporate funds and PIMCO GNMA remain in bullish mode, but they have weakened and we are on week-to-week watch with them.

Playing Hooky

As many of you may be aware, I am very involved at my alma mater, Cal State Fullerton, within our business school and Finance Department, and with the baseball team, where I got my start in 1977.  On June 13, I flew to Omaha, Nebraska for the College World Series to be with our team, coaches, parents and fellow Titan supporters for the baseball team’s 17th appearance in the CWS, as one of the top 8 teams remaining in the NCAA Tournament.  Below are a couple of pictures from that trip.

This is in front of the famous statue associated with college baseball, at the entrance to TD Ameritrade Park, the successor to Rosenblatt Stadium.  It is a great stadium, located in downtown Omaha.

And, above, I’m with Titans junior First Team All-American RHP Thomas Eshelman, whom I’ve forged a great friendship with during his past three years with the Titans.  The baseball gods didn’t quite finish the Titan Dream this season, as rain and lightning stopped our opening game against defending champion Vanderbilt in the sixth inning, with Eshelman and the Titans leading, 3-0.

The next day, when the game resumed, it was a different story, and Vanderbilt rallied to win in the bottom of the 9th inning, and the Titans were eliminated the following day in a loss to LSU.  Only one team leaves Omaha happy, but it was a great ride and experience for our young men, and I’m quite proud of them.  Their work is not over, either.  Part of the team and several incoming freshman are currently in South Korea, representing the United States in the 2015 World University Games.  Bracket play begins tomorrow, and they started play yesterday with a 5-1 exhibition win over France.

As for Eshelman, Thomas was drafted #46 overall in the 2nd round of the Major League Baseball draft by the Houston Astros, and as far as I know, is still in negotiations with the Astros.  Don’t be surprised if in a couple of years, Thomas is on the mound at Angels Stadium, beating the Angels!  Speaking of the Angels, perhaps the baseball gods could be kinder to them than my Titans?  Right now, the Angels front office is messier than Donald Trump’s Presidential campaign!

Material of a Less Serious Nature

An accountant is walking along the beach and he finds an old lamp.  He picks it up, rubs it, and of course, out pops a genie.  The genie says, “I am the most powerful genie that has ever lived.  I can do great and wonderful things and I can grant you your dearest wish.  But only one.”

Well, this accountant is a deeply caring individual.  He pulls out a map of the Mediterranean area and says, “My dearest wish is that you solve the Arab-Israeli conflict in the Middle East.”

The genie strokes his beard and looks worried.  “Oh, dear,” he says.  “That’s a tough one.  Those people have been fighting for eons.  No one has been able to come up with a successful solution.  I’m not sure if I could do any better.  You should probably come up with another wish.”

The accountant is understanding and says, “All right.  Listen, the IRS has asked me to re-design their 1040 form so that everyone can understand it.  Can you help me with that?”

There’s a long silence and finally, the genie says, “Let’s have another look at that map.”

Here’s hoping you a terrific Fourth of July.

Sincerely,

Bob Kargenian, CMT

President

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