Weekly Note - February 24, 2021

I discuss in this post the MRI conditions of the sleeves used in the various model portfolios. I believe that the current target weights adequately reflect the MRI conditions described.

The algorithms for the DJIA and also the MRI conditions for a number of markets in general indicate it is time to reduce Box #2 Cash for the model portfolios. Please note the new suggested amount on the detail page for each model portfolio in the attached pdf.

See this link for a reminder of the language we use to discuss MRI conditions: https://focused15investing.com/language

The Onyx Sleeve

The Onyx sleeve is a major component of many portfolios. It consists of four low-variability ETFs (consumer staples stocks, utility stocks, US 7-10-year bonds, and US 1-3-year bonds). Each of these ETFs is at the lower end of its Micro MRI cycle and continued to move lower as of last Friday. The Micro MRI levels of these ETFs range from the 15th to the 28th percentiles. These ETFs could easily reach the troughs in their Micro MRI cycles in the next week or so. They will then move to the upleg of their Micro MRI cycles and experience higher resilience and support higher prices.

The DJIA-Focused Loss-Avoiding Sleeve

The DJIA-focused loss-avoiding sleeves are important sleeves in many model portfolios. Model portfolios using these sleeves are listed first in the weekly publications.

As of last Friday, the Micro MRI for the DJIA was at the 40th percentile and still moving lower. At the moment, it looks like it may reach its low point over the next few weeks. After reaching its low point, the Micro MRI will enter its upleg, and thus we can expect the DJIA to be more resilient over the short term, which will support higher prices.

Accordingly, the algorithms have set higher target weights for the DJIA for this Friday. Thus, despite stock prices being at all-time highs and stock valuations being high as well, support for higher prices is likely to increase.

I would feel better about the stock markets globally if there had been large price declines during the current downleg in the Micro MRI cycle. Yet the current economic stimulus intended to overcome the negative effects of the pandemic are massive by historical standards, and a significant price drop has not yet materialized. The time for significant declines rooted in a lack of short-term resilience is passing.

The Exceptional Macro is again present for the DJIA. My guidance for holding extra Box #2 Cash for people sensitive to losses has been driven by the off-and-on nature of the Exceptional Macro over the last several weeks. This pattern is highly unusual by historical standards—but it is understandable, considering high stock valuations and the market’s dependence on the government’s life-support measures.

An important condition to keep in mind is that the Macro MRI for the DJIA is moving higher (i.e., it is in the upleg of its cycle), indicating that the current longer-term trend for DJIA prices is positive. The Macro has declined from an extremely high level at the beginning of 2018 to a low point in late-2020. It is now at the 43rd percentile of levels since 1918 and moving higher, which suggests there is ample room to accommodate further price increases. The returns of the stock market since 2018 have been remarkably good considering the headwind introduced by the negative Macro trend. This condition has been psychologically challenging – at least for me – because we were investing in a stock market that lacks a key component of resilience, its long-term or “Macro” resilience. Because the Macro MRI is now in its upleg (which it has been since December 2020), we are no longer in that situation.

As additional background, while stocks moving higher in a negative Macro MRI environment seems counterintuitive, it has happened before. In the late 1990s, the Macro MRI peaked in early 1997 and declined in an almost uninterrupted fashion until late 1999. However, DJIA prices continued to move higher despite the negative Macro trend and peaked two-and-a-half years later, at the beginning of 2000.

The late 1990s had similar features to what has occurred since 2018. In the late 1990s and now, government stimulus has been an important factor. In the late 1990s, governments made rescue efforts to support the markets and economy related to the Asian and Russian debt crises and the Long-Term Capital Management implosion. The rescue efforts created a benevolent environment for stocks, especially high-tech stocks. The pandemic and residual issues from the 2008 Global Financial Crisis and trade tensions are currently driving even larger rescue efforts.

If we continue with the same pattern of the late 1990s and early 2000s, the NASDAQ might experience losses (after its large gains in both periods) while the DJIA continues to make gains. This potential decline in the NASDAQ (based on this historical precedent) is a key reason that the NASDAQ is not a permanent part of the main model portfolios at this time.

2020 Recovery and Emerald Sleeves

The important ETFs in these sleeves have been moving lower in their Micro MRI cycles for several weeks and are nearing the lower ends of their normal ranges. Specifically, as of last Friday:

      PBD Green Energy was at the 11th percentile in the downleg of its Micro MRI cycle
      ARKK: was at the 30th percentile in the downleg of its Micro MRI cycle.

The Micro MRIs for both are close to their troughs and can be expected to move to the upleg of their cycles over the coming weeks, a move which will provide greater resilience and support for higher prices.

Focusing on the longer price trend for these two ETFs, the Macro MRI (indicating the long-term trends for prices) continues to be in the upleg of its cycle. Thus, it appears that these ETFs will experience support for higher prices for the time being.

In contrast, the NASDAQ’s Micro MRI is at a higher level in its Micro (shorter-term) cycle. Its Micro MRI is at the 64th percentile and continues to move lower. While currently positive and providing resilience, the Macro MRI and Exceptional Macro are historically less reliable for the NASDAQ than they are for the DJIA. The algorithms currently call for a less-than-maximum weight for the NASDAQ ETFs in the sleeves.

Final Comment

There are two potentially related aspects of current market conditions that cause me to be cautious over the mid-term horizon (beginning in roughly May). First, stock valuations are still high by historical standards. I expect that investor concerns about valuations will be first indicated by a deterioration in the Macro MRI, which has not taken place yet. I infer from the current status that government stimulus and a low interest rate environment currently overwhelm investor concerns about valuation. Second, is the on-and-off behavior of the Exceptional Macro. This behavior over the last few months is not typical and may reflect concerns about valuations or other factors. I believe the upcoming period of resilience from the Micro MRI will temporarily reduce these concerns.

Despite these concerns, I believe the major market indexes like the DJIA are performing as expected given their MRI conditions. I also believe that the algorithms are adjusting the target weights in an appropriate manner.