Loyal Dissenter

I love to play the 10th man. It gets me in trouble a lot though. It comes across as argumentative or combative if you forget about the key word in the job, “loyal”. As humans one of our biggest flaws when it comes to making the best decisions is our default response to anchor only on our beliefs or the consensus. Of course, the best decisions are those that are made by looking at every solution, including those that present the other side of our beliefs.  If we remember the goal is to make the best decision and not about our ego and being right, we stand a much better chance, over the long run, of being better off. This is especially important when it comes to investment/financial decisions and money is on the line.

With that in mind, the “end of the worlders” are out in force. They make a case for this being the end of this economic expansion (the longest in history), bringing in politics, war, negative rates, fake meat etc, etc. and therefore why investors should be de-risking portfolios. Playing the 10th man here and presenting the other side, while it’s not my analysis, the historical technical study done by Tom Bowley below presents a very strong case and why it may be too early to write off bulls just yet. If you are a doom and gloomer, I just ask you keep an open mind and read …

 “I've been adamant that we remain in a secular bull market, and I'm sticking to it. Yes, September scares me. The Fed petrifies me. And no more tweets, please! Oh, and let's not forget about the inverted yield curve (which isn't inverted any longer, by the way). But, despite all of that, here we sit on the brink of yet another record all-time high on the Dow Jones, S&P 500 and NASDAQ. It's going to happen.

Over the past week, we saw new leadership emerge. Financials (XLF) did very well, as did industrials (XLI). It's easy to forget, but these two sectors were our leaders from 2016 through early 2018, when we raced to new record highs with only the slightest hint of volatility. The small-cap Russell 2000's ETF (IWM) is comprised nearly one-third of financials and industrials. These two sectors are very important to the performance of this closely-watched small-cap index/ETF.

One thing we need to keep in mind is that when transports ($TRAN) and small caps ($RUT) perform well, it generally translates into huge S&P 500 gains. Let's use the 10+ years of this bull market to illustrate:

I think this chart is very clear. When the downtrends and/or consolidation periods in both transports and small caps break to the upside, the S&P 500 is likely poised for a major, explosive rally. While we might be premature, an argument could certainly be made that both the TRAN and the RUT broke their downtrends this week. The next few weeks will likely either refute or confirm that statement, but, if it's the latter, prepare for a launch higher in Q4.”

Epic Shift or Normal Rotation?

If you weren’t looking, you wouldn’t know last week was a disaster for a part of the market that has been a leader for years. Momentum stocks got absolutely pummeled at a time when the overall market was rising. It wasn’t the Nasdaq, which most think of when momentum is mentions, but just the Nasdaq leaders that were creamed. Some lost as much as 20% in 4 days. The momentum ETF basket lost a much more tolerable under 2% while the broader market, SP500, climbed more than 1%.

What is just even more interesting is where that money shifted into. If you have been in the game long enough it shouldn’t surprise you the benefactors were the past laggards, value and small caps. As you can see in the chart below, from left to right, is last week’s return on the SP500 (light blue), followed by momentum (magenta), small caps (green), value (blue) and the Nasdaq (red). It may not seem like much but a difference between the winners and losers of more than 6% in just one week is huge and should not be ignored.

Rotation is normal and how the market continues to ramp higher over time so it could be I am making a mountain out of a mole hill here. On the other hand, if this is the start of a new trend, investors would want to know this because what has worked for the past 3-5 years may no longer. The market is sending a message here and it’s up to us to figure out just what it means.

Value is Dead, Long Live Value

There have been many investment strategies written around value investing and how it has outperformed growth. The debate that rages on between the two camps is fun to listen to because they both have strong cases and are right. How they both can be right is because depending upon the time frame the answer change. As with all things investing, identifying your time frame is the most important thing to know.

The reason for bringing up the topic was as I looked at the past 12-month performance its clear to see value (gold) has substantially under-performed (~20% less) growth. As you can see the under-performance really took hold after the market bottomed last December from its 20% decline. The months prior to that were pretty even. Does this mean you should be ignoring value stocks? Au contraire, divergences such as this can present very compelling investment opportunities. The operative word is can.

From a strength standpoint, as of right now, there is no reason to be buying value …. Just yet. But, when these situations arise, I would (and am) actively looking for a reversal in this divergence. Finding a bottoming pattern on a ratio chart of the two investments is the best way I know of identifying a way to capitalize on this divergence and a potential reversion to mean value run.

The Real Deal

The Brazilian Real has lost more than 60% of its value against the US Dollar since peaking in July of 2011. A combination of a weak Real and very strong Dollar has pummeled Brazil’s currency. Unfortunately for those who continue to hold the currency, it looks as if the pain may not be over. And maybe, by a long shot.

Looking at the ratio of the Dollar to the Real in the chart below, you can see it sits at an important level that has provided resistance many times in the past. Each and every attempt to move higher has been rejected. Those pattern geeks will appreciate the smaller (blue) cup and handle pattern is the handle of the much, much bigger red, cup and handle. A pattern within a pattern. Something that occurs quite often and provides a higher probability outcome.

If the dollar continues to rise, like I believe it will, and eventually breaks above the important horizontal resistance, the Real is in real trouble. The first target would be another 13% decline, the second target would be double that and the third? Let’s not go there because I don’t want to talk about low probability events especially considering the potential disastrous affects it could trigger. The bottom line is those that anyone in the US holding Brazilian Real should expect a loss in their purchasing power. Those in Brazil, should expect to see the cost of imported items (particularly those denominated in US dollars) rise dramatically. Those that are looking to travel to Brazil from the US should find some huge bargains ahead.

The Worst

As you can see in the chart below that looks back over the past 69 years at the US stock market major sectors (SP500, small caps, technology and industrials), September has been the only month, “on average”, that every one of those sectors closed lower than where it opened. In other words, lost money.

While this data might trigger a negative emotional response like Sell! Sell! Or even Sell!  Before succumbing to the fear, check what the data’s message is after September. The total “average” gains made in Oct-Dec for all major sectors well exceed the “average” losses in September. Your response to these questions tells a lot about you as an investor.

What this tells me is that the higher probability is to expect more choppy action this month and there is no reason, yet, to add risk to portfolio’s in anticipation of Q4’s “average” rise.