Spring arrived this morning, but it would have been hard to sell that news to the geese on my lake on Saturday. I awoke that morning and found a thin glaze of ice stretching across the lake and 10 or so geese seemingly frozen in place. The ice encircled them and clung to their bodies like Jell-O to a cherry in a fruit salad.
The flock had arrived during the warm weather the previous week. They were no doubt surprised by the change in their fortunes as well as in the weather.
Investors who have been sitting out the current bull market have been similarly frozen in place for the last eight years. Many have no doubt enjoyed the relative lack of volatility and fixed-income returns of their bond investments. But the yield has been historically low. In addition, it probably hurts that they could have seen their investments grow many times since stocks registered their lows in March 2009.
For those investors that retreated to money-market funds at some point during the 50%+ crash of 2007–2008 and who have never returned, the disappointment must have long turned to despair. They earned next to nothing on their investments, albeit with no volatility, while stocks soared over 250%.
Believe me, after more than 40 years as a “market timer,” I know how hard it can be to pull the trigger and either sell out of the market or buy back into it. Emotionally, going against the grain and selling when all are buying, or buying when the reverse is true, is nearly impossible. And to compound things, during those times the economic conditions are either horrible (at bottoms) or roaring higher (at tops), and it’s difficult to find support for a change.
You certainly won’t find that support from the media. They are usually running with the crowd. And so-called market “experts” have a horrible record of prognostication. The lessons of behavioral finance tell us that these are not good sources of information on which to rely.
Instead, behavioral finance research suggests that in the face of uncertainty, you should look to shorter-term predictions based on computer models. It is inherently difficult for people to accurately visualize the future, and human judgment—unlike computer-based modeling approaches—can be emotionally biased.
Last week proved a good indicator of market uncertainty. Stocks here in the U.S. went essentially nowhere. Bonds were down going into the Federal Reserve’s rate-raising meeting on Wednesday (as one would expect), but then rallied on the news, sending bonds higher and interest rates lower. The dollar also rallied on the news (logically), but gold, which often moves in the opposite direction, actually had some of its most positive daily returns of the year.
In the face of such uncertainty, what are our models telling us? Among our more conservative, intermediate equity models, Classic (up more than 20%—after fees—over the last year) remains 100% invested, and Systematic Advantage (up almost as much over that period) is committed more than 120%. The more aggressive strategies (Self-adjusting Trend Following and Volatility Adjusted NASDAQ), which have had stellar year-to-date performance (the former is up more than 20% after fees, and the latter is up nearly as much), continue with a 200% commitment to the NASDAQ 100 Index funds (amounts over 100% are achieved by using funds that by design allow a 1.5 to 2 times exposure to their underlying stock indexes via internal leverage).
With international stocks having a slight advantage over U.S. equities of late this year, it’s not surprising to see our Tactical Emerging Markets strategy, which spent much of last year avoiding such issues, invested 80% in foreign equities and 20% in emerging-market bonds, resulting this year in 20% better performance than the S&P 500 after fees. Our Global Select strategy has about the same equity/bond allocation, although its international selections are not restricted to emerging markets.
At the same time, TVA Gold is also 80% invested in our Gold Bullion Strategy Fund (QGLDX). QGLDX is the only U.S. mutual fund designed to track the daily percent change in the price of gold bullion.
This positive recovery in gold is no doubt a reflection of the heightened fears of inflation. As the chart below illustrates, inflation has recently shot higher. In addition, higher interest rates have historically reflected rising inflation in the early stages of Fed intervention.
One fear, of course, is that rising rates due to Federal Reserve tightening may send stocks tumbling. After all, such a move is what sent our Classic strategy to cash a month and a half ahead of the ’87 market crash. This time appears to be different. Rates are at historically low levels as the tightening begins, and while the following chart shows that they exceeded the inflation rate back in 1987, today’s rates trail core inflation by a substantial margin.
As research by Charlie Bilello of Pension Partners has discovered, such a situation in the past has generated substantial annual stock market returns.
In addition, while the S&P continues to be slightly overbought, it seems frozen into the overbought band. Since the U.S. election last November, every time that it has moved to the bottom of the band, it has rallied. When it does break through the bottom band, a correction seems likely.
But any correction should be mild. At last week’s Rydex Dynamic Advisory Board Meeting, we learned that most early warning indicators suggest that the chances of a recession remain small and likely have pushed back such an event at least into 2018. See, for example, the ratio of leading to coincident economic indicators. A substantial downturn in that ratio has preceded each of the last eight recessions, yet it is currently rallying.
Similarly, measures of manufacturing activity, as is the case for consumer and small-business sentiment, are in an upturn. In fact, the former are at levels more coincident with the periods immediately after a recession than beforehand.
Finally, I would note that at this point, 50 days into the new year, the S&P 500 stands just over 6% higher than it did at the end of December. Such a beginning-of-the-year rally has occurred 22 times since the end of WWII. In 21 of those years, the stock market went on to greater heights (95.5% of the time), gaining on average an additional 12.16% (even more in the first year of the presidential cycle).
By Saturday afternoon, the geese had moved on. Unlike many investors, they realized that the ice had thawed, conditions had changed, and so did they. While subzero temperatures can return at any time, just like a correction can, our market indicators, like the geese, are programmed to change with the times and alert us when it is time to move on. That’s proven to be a much better approach than remaining frozen in place for the last eight years.
Happy 8th birthday to the bull stock market, and welcome to the first day of spring, at last!
All the best,