Managing the Turn – The Experts Have Spoken!

It appears there is currently some rhyme in the markets as to when the end of the bull market will begin. The consensus survey says it should be sometime in 2020! The reasons for the timing are all well documented from the fading effects of the Trump tax cuts to asset valuations to the length of the economic expansion. Be assured that no one person knows for sure.

The larger challenge lies in managing the turn over a period of time and conveying this process as the change is occurring. This is where we stand today. The starting point can’t seem to get any better.

The small business optimism index is at an all-time high. The chart below shows 50 years of data. Gravity and optimism will at some point turn to reality and pessimism.

Source: VIP Wealth Solutions and Bloomberg

It seems to make sense to be somewhat prudent or to be a little cautious when things look so great. Can optimism go on forever? So far, history has suggested that pots of gold at the end of rainbows and unicorns are somewhat mythical.

BUT wait the bull market is in full swing. The long-term trend line of the S&P 500 continues to march to its own beat and the analysts suggest we remain in a longer-term bull market trend.

Source: VIP Wealth Solutions and Bloomberg

This is where we see the risk in that the world has become somewhat less concerned about the obvious. We picked up this analogy in one of our recent readings and thought it was appropriate for the current environment:

It is worth remembering that portfolios, like a garden, must be carefully tended to otherwise the bounty will be reclaimed by nature itself.

  • If fruits are not harvested (profit taking) they ‘rot on the vine.’
  • If weeds are not pulled (sell losers), they will choke out the garden.
  • If the soil is not fertilized (savings), then the garden will fail to produce as successfully as it could.

So, as a reminder, and considering where the markets are currently, here are the rules for managing your garden:

  1. HARVEST: Reduce “winners” back to original portfolio weights. This does NOT mean sell the whole position. You pluck the tomatoes off the vine, not yank the whole plant from the ground.
  2. WEED: Sell losers and laggards and remove them from the garden. If you do not sell losers and laggards, they reduce the performance of the portfolio over time by absorbing “nutrients” that could be used for more productive plants. The first rule of thumb in investing “sell losers quickly.”
  3. FERTILIZE AND WATER: Add savings on a regular basis. A garden cannot grow if the soil is depleted of nutrients or lost to erosion. Likewise, a portfolio cannot grow if capital is not contributed regularly to replace capital lost due to erosion and loss. If you think you will never lose money investing in the markets…then you shouldn’t be investing, to begin with.
  4. WATCH THE WEATHER: Pay attention to markets. A garden can quickly be destroyed by a winter freeze or drought. Not paying attention to the major market trends can have devastating effects on your portfolio if you fail to see the turn for the worse. As with a garden, it has never been harmful to put protections in place for expected bad weather that didn’t occur. Likewise, a portfolio protected against ‘risk’ in the short-term, never harmed investors in the long-term.

There are plenty of warning signs the ‘good times’ are nearing their end, which will likely surprise most everyone.

Maybe it is time to remind ourselves of the noise and what might happen. Here is a list of the biggest threats that may come into play in the coming quarters.  We are watching the data closely as it could come from multiple directions:

  • Technical deviations
  • Emerging market debt and economic stabilities
  • U.S. dollar strength
  • Oil prices (below $60)
  • Interest rates (Fed)
  • Economic strength
  • Earnings
  • Leverage (Margin)

It is not necessarily one event but the linkages that may impose an overall effect:

  • Continued moves higher in the dollar impacts exporters, reduces profitability and drags on earnings.
  • A rising dollar also weighs on oil prices which are highly correlated to the economic growth and inflationary pressures. Just ask Alberta!
  • As the Fed continues to hike rates into a slowing economic growth rate (think housing), the downward pressure is exacerbated as higher rates reduce capital expenditures and consumption.
  • As the emerging market rout intensifies, debt related issues become much more prevalent and the Fed’s rate hikes eventually trigger a credit-related event. This would be bad.
  • The combination of these events weighs on asset prices which trigger an “algorithmic” sell-off and sparks a broad-based sell-off leading to margin calls. There is a lot of money in ETF strategies and when they sell – well… they sell
  • As the sell-off intensifies, and margin liquidation causes a liquidity issue in the ETF complex, investors eventually “panic sell” the next low.

Okay, that was gloomy!

SO back to managing the turn. This is a bit more complex, but the all-stock complex is not the answer. Diversified strategies and ultimately cash, hedging and some good old fashion quality will prevail as noted by the gardener above.
We have started to be more cautious and recognize that we may not be at the end of the bull market. We are also confident enough to realize that risk reduction happens before the event not during the event. No one likes the feeling of everyone trying to get out the door at one time.

 

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