This note has three parts:
The short summary is of our market view and intended allocation actions for discretionary accounts, and recommended actions for coaching or “prior approval” accounts
For those of you who want a feel for why we have our market view and why we believe the allocation changes are appropriate; the bullet points will help.
If you want to see what data is behind most of the bullet points, you will want to look at the 24 supporting graphics.
There is an unfortunate need to use some jargon in the bullet points and graphics which may be unfamiliar to some of you, so please call or write in to have any of them explained; and to discuss their significance to portfolio decisions.
THE SHORT SUMMARY…
Major world equity markets are in up trends — but there is mounting evidence that the US markets are over-extended and significantly vulnerable to a meaningful downward adjustment based on a combination of valuation, breadth, possible turmoil from key elections in Europe; and as Goldman Sachs puts it “rhetoric meets reality” in Washington.
Downside risk exists, but while the trend remains upward, we are remaining invested. However, we are not committing additional assets from cash positions to US equity risk positions at this time (except for dollar-cost-averaging programs) due to the elevated vulnerability of the US stocks market. We will be transferring some of the US equity risk assets in portfolios to some international markets that are in intermediate-term up trends that offer better valuation opportunities.
Portfolio changes or recommendations will be framed within the strategic allocation policy level of each client which varies based on individual needs, goals, stage of financial life, preferences, risk tolerance, and other limits or factors.
Based on valuation and long-term forecasted returns, US stocks exposures will transition from the higher end of individual portfolio policy allocations to the long-term strategic objective levels, or a bit below. We are currently underweighted non-US developed markets and emerging markets allocations, which we will gradually raise to the long-term strategic allocations levels of each individual portfolio’s allocation policy.
Emerging markets have a more attractive valuation level than other non-US international stock markets (although they pose significantly more volatility), and allocation to them may be raised somewhat above strategic target levels within individual permitted allocation ranges.
For determination of intermediate trend status, we relay on our monthly 4-factor indicator. For more information about our trend following indicator and its performance implications, click here to see our descriptive video.
THE BULLET POINTS …………
- United States – UP
- Non-US Developed Markets – UP
- Emerging Markets – UP
- United States – Expensive on Price-to-Book and Price-to-10yrAvEarnings and not expensive when earnings yield is compared to Treasury yields. However, when rates rise the comparison will worsen, making stocks more expensive.
- Non-US Developed Markets – Moderately expensive on Price-to-Book and moderately inexpensive on Price-to-10yrAvEarnings
- Emerging Markets – Significantly Inexpensive on Price-to-Book and Price-to-10yrAvEarnings
- Institutional Investors – are reducing equity allocations (a Bearish indication)
- Investment Newsletter Writers – Bullish at record high levels (a Bearish contra indication)
- Individual Retail Investors – strongly Bearish this week but neutral last week
- Options Market – complacent to mixed (jargon terms defined below):
- Volatility Index – below 200-day and long-term average (complacent, expects smooth ride next 30 days)
- Skew Index – above 200 day average and long-term trend line (nervous about possible large downside move, next 30 days)
- Individual Equities PUT/CALL ratio – is 9% above its 200-day and its 10-year average (more cautious that institutional investors)
- Index PUT/CALL ratio – is 7 % above 200-day average and 4% below its 10-year average (cautious but mixed signal)
- Percent of S&P 1500 stocks in Correction, Bear or Severe Bear have decidedly turned up (Bearish)
- Percent of S&P 1500 stocks within 2% of their 12-month highs have decidedly turned down (Bearish)
- The net flow of money is into S&P 1500 stocks over 3 month, 6 months and 1 years, but the leading edge of those flow has turned down
- The net flow is explained by the net Buying Pressure declining substantially more than the Selling Pressure; and both measures are at levels below the 12-month average indicating reduced overall force driving the market
- “Street” consensus 2017 S&P 500 earnings growth 8.9% on revenue growth of 7.2%
- “Street” consensus 2018 S&P 500 earnings growth of 12.0& on revenue growth of 5.1%
- Consensus 3-5 year earnings growth for S&P 500 is 8.89%
- Consensus 3-5 year earnings growth for MSCI non-US developed markets stocks index is 8.76%
- Consensus 3-5 year earnings growth for MSCI emerging markets stocks index is 10.37%
- Consensus 3-5 year earnings growth for MSCI core Europe stocks is 8.11%
- Consensus 3-5 year earnings growth for MSCI Japan stocks is 9.43%
- Consensus 3-5 year earnings growth for MSCI China stocks is 7.13%
- Bank of America/Merrill Lynch just raised its 2017 S&P 500 price target from 2300 to 2450
- Research Affiliates (leading factor based investor) forecasts 10-year real (after inflation) returns:
- US large-cap stocks 0.7% (with 14.4% volatility)
- US small-cap stocks 0.5% (with 19.6% volatility)
- Non-US Developed Markets stocks 5.4% (with 17.0% volatility)
- Emerging Markets stocks 7.0% (with 23.3% volatility)
- GMO Bearish Mgr (lowest min fund investment $10 million available) forecasts 7-year real returns
- US large-cap stocks – negative 3.4%
- US small-cap stocks – negative 2.7%
- Large International stocks – positive 0.2%
- Emerging Market stocks – positive 4.1%
- BlackRock (fund manager in the world) forecasts 5-year nominal returns
- Large US stocks 4.1% (with 15.5% volatility)
- Small US stocks 4.1% (with 18.7% volatility)
- Large International stocks 5.5% (with 18.5% volatility)
- Emerging Markets stocks 5.5% (with 23.3% volatility)
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