Weekly Note - November 18, 2020

Last week I discussed options (see Note 1 below for a link) based on whether the market declined last week and the length of your investment horizon. The market did not decline and I list the relevant options and have added notes in italics: 

  1. You have a long investment horizon: Continue using your current model portfolio. An investment horizon of roughly 7 years or more can be considered a long investment horizon. You can disregard the guidance to hold Box #2 Cash – simply keep it at your regular amount (e.g. 3%).
  2. You have an investment horizon shorter than 7 years, and…
    • A) You are currently using one of the Onyx mixes: Continue using your current model portfolio. Follow guidance regarding Box #2 Cash.
    • B) You are NOT currently using an Onyx Mix. Consider switching to an Onyx mix model portfolio, which tend to be less aggressive and are likely to be more tolerant of a quickly weakening economic situation. Follow guidance regarding Box #2 Cash. 

As of this writing, it appears that we will make it through the current period of vulnerability this week and next without declines of more than roughly 15%.  Over the coming week(s), I will review the strength of the growing resilience and may further decrease Box #2 Cash, and, if it makes sense, for those with a short horizon (e.g. less than 7 years) to move into more aggressive model portfolios. We may be entering a period of high resilience lasting several quarters, and many subscribers may want to move to more aggressive portfolios to take advantage of this. 

Please contact me with any questions about these options.

This post covers:
  • Current Outlook Implied by Current MRI Conditions
  • NASDAQ versus DJIA
  • Valuation and Political Concerns 

Outlook Implied by Current MRI Conditions

These views do not affect the target weights of the model portfolio, but they are consistent with a broad range of MRI conditions and economic variables I review each week. When the MRI conditions change, the outlook will change.  

With multiple promising vaccines, investors can begin to focus on economic recovery in greater detail. Prior to the success of a few vaccine trials, the timing of the end of the pandemic and its related economic effects was uncertain. Now, there is increasing clarity. As you may recall from prior notes, in normal times, stock market investors try to anticipate the economic conditions that will exist 6 to 9 months in the future. Near term expected conditions have less importance. This means that the expected near-term difficulty of the pandemic and any lockdowns will have less of an impact on their decisions.

In addition to now having multiple promising vaccines, other factors contribute to optimism for economic growth in 2021. These include government economic stimulus efforts around the world, the US Fed’s promise of low interest rates for the foreseeable future, and pent-up consumer demand from months of reduced spending. 
Last week I mentioned that high current stock valuations are a concern. High current valuations could limit additional price gains. However, I believe the price of the DJIA will be supported over the next several weeks by the following factors:
  • Rotation of the market to industrial company stocks from technology company stocks. Technology stocks that have done well during the pandemic will underperform those that have lagged as the economy reopens. The tech-heavy NASDAQ has done far better these last months than the S&P 500 or the DJIA. The last 52 weeks of price movements is shown in Figure One below, which is discussed later. I believe the DJIA is likely to close the performance gap with the NASDAQ index over the next few months, with the DJIA moving higher.
  • The growing resilience of the DJIA. Several of the MRI for the DJIA are at inflection points and moving to the uplegs of their cycles. In addition, they are doing so at low levels in their cycles, which suggests that these uplegs may last many weeks. The Macro MRI measuring the longest cycle of resilience lasting several quarters or years is at the 29th percentile of levels since 1919 – a relatively low level. And the Exceptional Macro is now present, which is a very positive sign. The Micro MRI, measuring the shortest cycles of resilience, is beginning a transition to the upleg of its cycle at the 20th percentile since 1918. These transitions are taking place now, and, although there can be higher volatility around these inflection points, the upside for prices is greater than the downside based on these readings.
  • Weakening US dollar. In my review of the MRI conditions of 80+ indexes from around the world, the potential for a weakening dollar appears to be most imminent factor producing US stock price gains. Over the next several weeks, the US dollar will be more vulnerable to declines compared to other major currencies. As opposed to companies in the S&P 500, those in the DJIA get more of their earnings from outside the US. When the dollar weakens, the value of those earnings increases in dollar terms, which supports higher prices. This factor is in addition to the benefits of a potential end of the pandemic and the expected strengthening of the economic recovery.
I expect there to be ups and downs around the time the US Congress debates and votes on the next stimulus bill. Barring a complete failure to pass a bill, I expect the market to move higher through this period.

NASDAQ versus the DJIA

The tech-heavy NASDAQ index has returned about 45% over the last 52 weeks. The S&P500 has about 17%. The DJIA has returned just under 8% over the same time period. The pattern, especially between the NASDAQ and the DJIA fit a “K-shaped” market recovery, which I described briefly in (link: https://marketresilience.blogspot.com/2020/08/performance-review-nasdaq-valuation.html).

The forward strokes of the letter “K” can be likened to the performance of the NASDAQ (upper) and the performance of the DJIA (or S&P) (lower). The last 52 weeks of price movements is shown in Figure One below.

Figure One – NASDAQ, S&P500, DJIA – Return over last 52 weeks

The MRI statistics of the NASDAQ and DJIA index suggest that the DJIA may move higher to close the performance gap. I have already described the growing resilience of the DJIA. It is primed to move higher. The NASDAQ has quite different readings:

                                                    DJIA           Leg of cycle       NASDAQ      Leg of cycle

  Macro MRI percentile level      29th               upleg                    65th           downleg

  Exceptional Macro                    Yes (new)                                  Not present

  Micro MRI percentile level       20th              upleg                    26th            downleg

Based on these MRI and other considerations, over the next several weeks, I believe that the most likely movement is for the NASDAQ to decline and the DJIA to move higher. 

Valuation and Political Concerns

I do have concerns about the valuation of the stock market, which I mentioned last week (see Note 1, below). I wonder if investors in general believed over the past 9 months that as long as there was no vaccine, it was more likely that government stimulus would continue to expand. Now, with at least two promising vaccines, investors may be less interested in the work-from-home investment theme that has favored the NASDAQ index, and may therefore start paying more attention to valuation and growth. If this concern is justified, in early 2021 we may see more volatility in the markets as actual company earnings growth is compared with the expectation of high growth post-pandemic. However, based on historical precedents, as long as interest rates stay low the time that investors in general focus on valuation is likely a few months away. 

We also have upcoming political issues and transitions.  Passage of an additional stimulus bill is important to the stronger economic growth expected in 2021.  Should this be derailed or there are unexpected difficulties in the transition to the new US administration, growth may be slowed and be a downward force of stock prices.       



   1) https://marketresilience.blogspot.com/2020/11/weekly-note-november-11-2020.html