Based
on prices as of December 9, 2016; views effective December 19, 2016
The most recent rally began (using our methodology) on
November 7, one day before the election. Our report was published November 1, at a time when many thought
that Clinton would surely win the Electoral College tally. I believe we would be
having a rally now if Clinton had won. The Focused 15 Investing approach
emphasizes anticipating the direction and timing of market moves based on market
resilience. We do not try to anticipate magnitude, except to suggest that moves
will be either small (and maybe not worth trying to catch) or large. The
magnitude of this rally has been large, but we don’t know what it would have
been if the election had a different outcome.
We are just over one month into this rally, and the question
is: Are we closer to its beginning, its middle, or its end?
Let’s first look at the magnitude of the returns. The chart
below shows the price moves of the DJIA since 2000. The recent pop in prices is
seen at the far right. It looks large compared to what has happened since 2000,
but not completely unprecedented. There was a roughly 10% increase in prices
from November 4th through December 9th.
Yes, prices have increased dramatically over the last month,
and they are at an all-time high, but those reasons alone are not sufficient
cause to take money out of the stock market. The chart below is also for the
DJIA and covers the same time period. However, it is on a log scale, which means that a move up or down of a given length
(visually on the chart) equals the same percentage point shift regardless of the
starting point of the move. This has the effect of reducing the apparent size
of the recent run up compared to prior price movements. The recent shift is
dramatic, but not unusual in percentage point terms.
As prices move higher, greater price moves are needed to
achieve the same percentage point move. This is why Focused 15 Investing
publications favor using a log scale over multi-year periods.
Thus, the recent price movement is not unusual in percentage
terms. Prices being at an all time high should also be ruled out as a reason to
get out of the market. Economic growth continues (even if the rate is slow) and
inflation boosts price levels over time. These forces have been present for
decades and continue to push market price levels higher.
Focus on Resilience
At the moment, the US stock market is resilient and likely to remain so for the foreseeable future. It is rated 2 out of a possible 3. This means that two of the three Market Resilience Indexes (MRI) are positive. While the next 4 to 5 weeks may not be like the last (returning about 10% on the DJIA), resilience is sufficient to limit the likelihood of a deep and/or protracted decline over the next several weeks.
After the first of the year, we may see larger declines that
could alarm some market observers. It appears, however, that any decline will
be short-lived given the strength of current resilience. The Focused 15
Investing model portfolios may become more defensive just prior to that time,
but for now, the model portfolios are fully invested. Our assessment for
January will take place at the end of December.
As my regular readers know, we invest on the basis of market
resilience – not forecasting future events. When negative events happen in a
resilient market, losses may occur, but they tend to be recovered quickly.
Negative events happening in a vulnerable market tend to result in longer-lasting
declines, which may induce panic selling leading to greater losses. For now,
the US stock market appears to be resilient and able to recover from negative
news and events. Stay invested for now.
Bonds
The US 10y Bond continues to be vulnerable to declines. Going
forward (over the next roughly 6 weeks), declines are likely to be less severe
than the recent drop. However, this is now an inherently vulnerable market and
should be avoided. Focused 15 Investing model portfolios have little or no
exposure to US 10y bonds. The US 30y is also vulnerable overall but is now
developing some resilience, at least over the short term.
Commodities
Oil and copper have been resilient for several weeks, and
this condition is likely to continue for at least a few more weeks. Gold has
been vulnerable since October 7, 2016, and this condition is likely to continue
for several weeks.
Currencies
The Dollar (DXY) shifted from vulnerable to resilient on December
12th. Strength in the dollar
could undercut the rally in US stocks; the greater resilience of the dollar
could be foreshadowing an erosion of resilience in the US stock market.
2015/6 Phantom Bear Market
Recent market action reinforces my view that in March 2016
we bounced off the trough of a phantom bear market that took place largely in
2015. It was clear that resilience levels experienced a bear market. However,
probably because of monetary policies, US stock prices did not.
The bounce after the phantom market trough was anemic.
During this period, we had rally-like MRI levels but not rally-like price
behavior. I described those months in a commentary as a mid-2016 malaise.
The dramatic returns over the last month may simply be the
market catching up to roughly where it might have been
based on its own inherent resilience, regardless of whether Trump or Clinton
won.
Somewhere Between the
Beginning and Middle
It could be that we are in a bull market that is almost a
year old. Based on 100 years of market history, we can see that bull markets
don’t live indefinitely, but they can last several years. If we indeed
experienced a phantom bear market, we are now in the early years of a new bull
market. Given the phantom bear market and the mid-2016 malaise, this bull
market could be shorter than usual. We will only know for sure after the fact,
and as long as the current MRI ratings register “resilient,” we would invest
that way.
Presidents and Market
Impact; Remain Dispassionate
Of course, who the president is and what they accomplish does
have an impact on economic growth and stock market performance. Also, markets
anticipate possible events well into the future. Perhaps the pro-business
policies of a Trump administration will boost corporate earnings.
Nevertheless, it is important to be dispassionate about
politics. If resilience levels change, we will change portfolio exposures
regardless of views we might hold about current political circumstances.
Jeff Hansen
For more information about Focused 15 Investing and the performance
of the approach, please see the website Home Page tab above.
