Weekly Note - March 18, 2020

Revised 11:50 am 3/18/2020

The stock market decline has been startling.  If you are uncomfortable with the level of aggressiveness of your current model portfolio, I believe it is reasonable to consider shifting near-term to a model portfolio that has a lower maximum exposure to ETFs linked to the DJIA.  These ETFs include DIA, DDM, and UDOW.  The rest of this note describes changes to the Diamond publication and my communication that will make shifts in aggressiveness easier. Again, these changes affect the Diamond publication. For now, the publications other than Diamond have not changed - please contact me with questions about the other publications.  

If you are comfortable with your model portfolio's the level of variability, you need not change.   

I think everyone is now fully aware of the coronavirus crisis.  The economic impact of fighting the virus is just beginning. The extent and duration of stock price declines, layoffs and rising unemployment are likely to reverberate through the economy for some time. I believe the likelihood of a near-term, price rebound has diminished. At the end of this note, I discuss the current MRI conditions, which drive my belief that the likelihood of a rapid increase in stock prices (the key reason one would maintain the current level of aggressiveness) is diminishing. 

As economic and market conditions stabilize, we can shift to model portfolios that have higher maximum exposures to these DJIA-linked ETFs. We do not want to miss price appreciation when it does occur.  I have laid out a framework below for doing this.  The framework has three phases and makes wider use of the Onyx sleeve of low volatility sectors, which is designed to do well in challenging market environments, as I describe below. 

Three Phases and an Expanded Set of Diamond-Onyx Mixes

Considering recent events and the ambiguity around us, we need to shift our goals. At this time, they are to be able to sleep at night, to recoup losses rapidly in a methodical and low risk manner, and to shift back to a model portfolio that is a good long-term fit when doing so is prudent. Ultimately, we want to take full advantage of the once in a generation investment opportunities that this crisis will present. I see three likely phases over the next several months:

  1. High Uncertainty and Market Volatility – We are here now and can expect high uncertainty about the markets’ reaction to the government measures and the real virus situation. Generally speaking, few asset classes are performing as expected. During this phase, I suggest that subscribers who have found the recent losses intolerable consider a model portfolio with lower risk than the one they currently use.  One can select a model portfolio to the left (i.e., lower variability) of the one they currently use on the scatter chart provided on the first page of the weekly publication.  Patient subscribers with longer investment horizons (say, more than five-years) time horizon can probably stay with their current portfolio. This phase may last a few weeks or more.  
  2. Greater Clarity on the Path the Markets Take – During this phase, I expect the various stock and bond markets to perform more consistent with expectations in terms of magnitude of ups and downs and in relationship to other asset classes. Based on historical precedent, there are two major paths the markets can take after significant declines such as those we have experienced (and may still be experiencing) and formed a bottom:  A) the stock market moves higher at a moderate pace for an extended period (as in 1987), or B) the stock market move higher more aggressively (a relief rally) followed by declines in a few months (as in 2008).  During this phase, I will alert you when I believe that you should consider having more exposure to the stock market by shifting to a model portfolio to right on the scatter chart.   
  3. Transitioning to the Desired Model Portfolio – One would transition (as needed) to a model portfolio that is a good long-term fit. I suspect this would take place in roughly early summer. Obviously, potentially unknown factors may affect timing.  

Because we are now in phase 1, part of our focus is on looking for the time to move to portfolios that have higher allocations to DJIA-linked ETFs. The price declines we are experiencing will ultimately create very attractive opportunities. When the economy and markets settle, prices are very likely to move quite a bit higher than they are now.  The MRI provide reliable signals for the long-term market bottoms. 

To provide greater flexibility in carrying out the framework’s phases, I have adjusted the line-up of model portfolios on the weekly publication.  Specifically, I have added additional Diamond-Onyx Mixes. each has a different maximum allocation to the D5 signal set using DDM. The D5 signal set was caught off-guard by the virus but provides very strong signals in many market environments.  The Onyx segment (or sleeve) of the model portfolios rotates among four low volatility sectors that tend to perform well in bad markets for the DJIA. Onyx rotates among these four sectors based on their resilience and vulnerability:

1. Consumer staples company stocks in ETF “XLP.” These are food companies, drug stores, and grocery stores. When the economy is bad, people still need food, toothpaste, and toilet paper.

2. Utility company stocks in “XLU.” In many economic downturns utility stocks do well because they benefit from lower interest rates and lower energy costs.

3. US 7-10 Year Treasury bonds in “UST.” This ETF provides two times the return of the 7-10 year index and tends to move higher as interest rates decline.

4. US 1-3 Treasury bonds. This is the lowest volatility ETF and essentially cash.  

This link shows the holdings of our most important ETFs, including those listed above.  Scroll down to see XLP and XLU.  https://marketresilience.blogspot.com/p/etf-holdings.html 

The family of Diamond-Onyx Mixes are variations of the Diamond-Onyx Mix (sg218) that has been on the Diamond publication.  Together they cover a range of maximums allocations to the D5 signal set using the ETF DDM (DJIA x2).  Use of the term “Diamond” in the portfolio name indicates that it relies on the D5 signal set using DDM.  Members include:

   Diamond-Onyx 50-50 Mix (sg118)* A maximum of 50% to the D5 signal set using DDM
   Diamond-Onyx 35-65 Mix (sg218)  A maximum of 35%
   Diamond-Onyx 18-82 Mix (sg318)  A maximum of 17.5%
   Diamond-Onyx 10-90 Mix (sg418)  A maximum of 10%
   Diamond-Onyx 5-95 Mix (sg518)  A maximum of 5%. 

* This line was added at 11:50 am 3/18/2020.  This model portfolio has a 50% maximum exposure to the D5 signal set using DDM.  Diamond (sg131) has a 70% maximum.  Sg 118 represents a less dramatic change in exposure than does the Diamond-Onyx Mix (sg218). 

As of last Friday (3/13/2020), the Diamond-Onyx 5-95 Mix (sg518) does not have losses for the year.  The Diamond-Onyx 35-65 Mix (sg218) is down 8%.

I have removed model portfolios Zircon (sg206), which appears in the Zircon publication.  I have also removed sg249 and sg289 – if you are using one of these please consider using one listed above.  Please contact me with any concerns about the removal of these model portfolios. 

It is useful to have some allocation to the D5 signal set and the DJIA-linked ETFs (i.e., DIA, DDM, or UDOW). We want to watch it and be ready to move up to a more aggressive portfolio as the market recovers. In Diamond-Onyx 5-95 Mix (sg518), the 5% maximum allocation to the D5 signal set using DDM will have very little impact on portfolio returns - this is a good model portfolio for those just starting out with the Diamond Onyx Mixes. One can get a feel for the variability of DDM; it is high. 

An advantage of organizing the model portfolios in this way is that once you set up your Shares-to-Trade worksheet for one of the Diamond-Onyx model portfolios, you can shift to one of the other model portfolios without altering that sheet.  In fact, all the model portfolios on Diamond can use the same sheet.  A very slightly revised worksheet can be found here: https://focused15.net/training-level-2-1. The new sheet has names of the ETFs for the Onyx Mixes in the fields. 

As market conditions improve, I will indicate when it is appropriate to move to a more aggressive (higher maximum exposures for D5 signal set and the DJIA) in the weekly publications or by special e-mail. Using this approach, we have a better way responding more rapidly to crises and opportunities. 

Of course, you are free to move up or down this list as you want to change your maximum exposure to the DJIA. Also, you can reduce the aggressiveness of any one of them by holding more cash (adjust the cash level in Box #2 in the Share-to-Trade worksheet), and this approach may be more suited to those using Diamond (sg131) and Zircon (sg206) - they hold just three ETFs and focus on the D5 signal set.

MRI Conditions

We will be looking for evidence of inflection points in the market dynamics to determine when it is wise to consider increasing one’s maximum exposure to the DJIA.  At the moment, none of the MRI are providing resilience.  I consider the stock market to be at its most vulnerable.  The market has shifted from “somewhat resilient” to “most vulnerable” in just a few weeks.  This happened in the 1987 crash and the economy was not significantly harmed by that crash.  Prices recovered slowly but steadily from the bottom of that crash. 

At present, the Micro MRI has been poised to move higher for a week or so but has not yet moved higher. When it does move higher, that will signal greater short-term resilience and a likely move higher in prices.  The D5 signal set will respond to that change and increase the target weights of the DJIA-linked ETFs.  The upleg of the Micro MRI will identify when to participate in that rally.  However, unless the other MRI become positive and provide resilience, the price increase is likely to be temporary – a bear market rally.  Bear market rallies are traumatic – investors pile into stocks quickly on expectations that there is relief from the crisis, only to experience further declines when the short-term resilience ends the upleg of its cycle.

Currently, neither the Macro nor the Exceptional Macro are close to providing support.  At this moment, it seems mathematically unlikely that the Macro or Exceptional Macro will provide support over the next several weeks.  This reinforces my view that the next rally could easily be, sadly, temporary and end tragically for those who over-allocate to the stock market (through DJIA-linked ETFs or other means).  Also, generally speaking (based on 100 years of history), when a Micro MRI cycle takes longer then normal to complete, an adjoining one is cut short (as opposed to being simply delayed). This could mean that any bear market rally is cut short simply because it was delayed - in addition to any bad news that comes into play. We may need to be more nimble than we are in less turbulent times. This situation causes me to believe that shifting to a lower risk portfolio AFTER the recent big declines can be acceptable. 

As you know, the MRI dynamics are evaluated each week and my views will likely evolve. I understand the economic situation is difficult and the economic woes are likely to expand from here. The government responses around the world are huge. This is good, but the massive government stimulus may also raise the risk for inflation.  Also, we may be positively surprised by the effectiveness of the drastic measures being undertaken or an effective vaccine.

In summary, if you are comfortable with your current model portfolio no change is needed.  But if you are concerned and losing sleep at night, the framework above can help us navigate this challenging time more effectively and still have a very good chance of achieving your investment objectives. 


Here is a link to the note I sent out what seems like a year ago - it was last Sunday.  https://marketresilience.blogspot.com/2020/03/update-as-of-march-15-2020-this-note.html