Moment of Truth

The moment of truth has arrived for the stock market. Either the top is in and this bear-market rally is about to roll over, or the past 10 months have been nothing more than a sharp correction in an ongoing bull market. We should find out soon enough. The Active Asset Allocator remains defensively positioned for now with an asset mix of 20% equities, 30% bonds, 30% gold, 20% cash.

 
 

We began 2016 with a waterfall decline in the stock market, the worst start to the year in recorded history. At the January 2016 low, stocks had declined -21% from their May 2015 peak. The market has experienced a powerful and impressive rally over the last 4 weeks, back to the now down-sloping 50-week moving average (50WMA). The FTSE All World Index, the global stock market barometer, closed the week just 6 points below the 50WMA. I am expecting stock markets to turn lower shortly but remain flexible to both bullish and bearish views. Stay tuned.

Path of Least Resistance

Regular readers will recognise the following chart, the FTSE All World Index, a market-cap weighted Index that captures the aggregate performance of stock markets around the world. I have been tracking the potentially bearish pattern labelled on the chart for months now and remain concerned about the unfolding downward trend. Market breadth and relative strength continue to weaken and the path of least resistance remains lower for the vast majority of global stock markets.

 
 

The United States accounts for over 50% of the global equity benchmark, which is why I pay so much attention to the region. For a different perspective, I also monitor the Value Line Geometric Index, an equally weighted index of 1,700 US companies. Here, no single  stock dominates the Index, which has fallen -21% since peaking in mid-summer 2015. The deterioration in relative strength since 2014 is very similar to that which occurred just prior to the 2008 financial crisis.

 
 

The NYSE Primary Exchange Index captures the 3,000+ companies trading on the NYSE. This market-cap weighted index tells a similar story. Same pattern, same deterioration in the technical picture.

 
 

This analysis reinforces my current defensive positioning in the Active Asset Allocator. Opportunities will arise in 2016 and I expect to take advantage of them as they occur but for now, continued caution is advised.

AAA Defensive Mode Paying Dividends

I designed my Active Asset Allocator investment strategy to deliver a consistent level of positive returns over time with a strong focus on capital preservation. It has required significant patience to remain defensively positioned throughout 2015 but that decision is starting to pay dividends now. The Sell signal generated in October 2014 is still active. A break in the S&P 500 below 1,867 (3% below today's level of 1,922) will likely trigger an increase in selling pressure. We remain in full defensive mode for now, 20% equities / 30% bonds / 30% gold / 20% cash.

 
 

Stock Market Crystal Ball

Stock Market Crystal Ball

Regular readers will know that we are watching the performance and chart pattern of the FTSE All World Equity Index with interest. This global equity benchmark for fund managers around the world continues to track the 2007/8 stock market top in an eerily similar fashion. We have experienced a sharp selloff in the stock market and are now rallying off the August lows. The bulls will argue we have had our -10% correction and have come through October relatively unscathed, so it's off to the races for the rest of the year. We take a more sanguine view. Given that the global economy is slowing and corporate earnings have been relatively disappointing, there is quite a disconnect in the market today between expectations and reality. 

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Crocodile Jaws Are Closing

Crocodile Jaws Are Closing

Volatility spikes as stock markets decline. Investors scramble to buy insurance (put options)  to protect their stock portfolios and insurance premiums rise rapidly as a result. The Vix Index captures this phenomenon. Options are cheap (low Vix) when investor confidence is high and stocks are in a bull market. Options become quite expensive as the bull turns to bear.

Up until a week ago, the Vix was trading at multi-decade lows. That all changed late last week. The Vix is now spiking as the stock market tumbles. There is potentially a lot of room for the S&P 500 to drop from here (and for the Vix to rise). More concerning, the Federal Reserve has already cut interest rates to zero and has no room left to cushion the next decline. 

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The Most Important Chart in the World

The Most Important Chart in the World

The FTSE All World Index, the benchmark for active global equity fund managers, includes stocks from North America (54%), Europe (23%) and Asia (23%) and provides an excellent read of the overall health of the stock market. The recent deterioration in the trend has us concerned. The stock market today is showing signs of weakness similar to the 2007-2008 experience just prior to the wheels coming off and stocks in aggregate are more expensive today than they were in 2007. 

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USD Index Peaks and Troughs

USD Index Peaks and Troughs

How much gas has the USD left in the tank? The following chart may provide a clue. The USD Index has a tendency to peak every 15-16 years. It happened in 1985 at the Plaza Accord and again in 2001 at the top of the tech/telecom stock market bubble. This coincided with the start of the gold bull market. Roll forward another 15 years and you get to 2016. This is what makes the recent USD surge all the more interesting. We could be fast approaching a major peak in the USD that also coincides with the 6-year cyclical bull run in stocks (and maybe bonds too) and bottom in commodities and precious metals. The next major top in the USD and bonds and bottom in gold could be very significant turning points.

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Stock Market Valuations Stretching...

Stock Market Valuations Stretching...

The equity bull market rumbles on, now in its seventh year, and stock market valuations are stretching once again. As investors reach for yield, they are bidding up stock prices and valuations above pre-2007 levels. When you compare the value of US equities to corporate net worth, for example, the ratio (Tobin's Q) indicates US stocks are more expensive today than at any other time in history with the exception of 2000. Valuation alone is not a timing tool but we continue to advise caution and do not recommend carrying an overweight position in stocks at the present time.

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Swiss Franc Volatility

Swiss Franc Volatility

As you will no doubt know by now, the currency markets went into turmoil yesterday as a result of the dramatic Swiss Franc revaluation following the Swiss central bank's decision to "un-peg" its currency from the Euro. The news was not lost on gold, the only currency with no central bank to meddle in its affairs. Gold spiked +3% yesterday, is now +13% in euro terms in the first two weeks of the year and +18% since we upped our allocation from 20% to 30% in our Active Asset Allocator Model. Our Active Asset Allocator is starting 2015 on a strong footing +4.4% YTD.

Now, let's take a look at what happened yesterday. Following the Swiss central bank's decision to remove the CHF 1.20 peg to the euro, the Swiss currency exploded higher by +40% in about 2 minutes, blowing up a number of hedge funds and currency exchange providers in the process. The fallout will take a few weeks before the true extent of the carnage becomes evident. The following chart is a US quoted ETF of the Swiss Franc so it doesn't capture the massive 40% spike yesterday morning, as it happened before US markets opened. It does however show the +20% move in the Swiss Franc which has taken place as of today's post. Those planning a ski trip to Zermatt this season may want to re-consider and head to St. Anton or Val d'Isere instead!

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GMO 7 Year Real Return Forecasts - 21st October 2014

GMO 7 Year Real Return Forecasts - 21st October 2014

The investment manager GMO has published its 7-year asset class real return forecasts for 30th September 2014 and they sync very well with our current market views. Based on current stock market valuations, GMO is forecasting negative real returns each year for the next 7 years for US equities of between -1.5% (US large cap stocks) and -4.1% (US small cap stocks). Their expected real return forecast for European stocks is little better at +1.8%, while emerging market equities appears to be the only real bright spot with an expected annual real return of +3.7%.

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Trend Change: 15th October 2014

Trend Change: 15th October 2014

Our Technical Trend Indicator has triggered its first sell signal in over a year and right on queue, stock market volatility has picked up dramatically. Our model portfolio is already defensively positioned due to our concerns about the this ageing equity bull market. Now is not a time to swing for the fences. Capital preservation is always our primary goal.

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Gold Update: 26th September 2014

Gold Update: 26th September 2014

You would never guess that gold, measured in euros, is +9% YTD, given the extent of the bearish sentiment on the precious metal today. Of course, many folks focus on the USD price of gold, which is only +1% YTD but for euro investors, it is the euro price of gold that is relevant. The USD has appreciated strongly versus the euro in 2014 and USD denominated assets have benefited. You can see the difference in euro gold (black line) and USD gold (grey line) in the chart below. Of course, after 13 straight years of price appreciation, gold was hit in 2013 by -30%, which has put investors on edge.

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Technical Trend Indicator: 24th September 2014

Technical Trend Indicator: 24th September 2014

How useful has the Technical Trend Indicator (TTI) been as a market timing tool? Very useful it turns out; the TTI has proven to be an excellent barometer of the overall market trend and has caught many of the large inflection points in the stock market over the last seven years as shown in the chart below. The TTI drives the asset allocation decisions taken in Active Asset Allocator Model, which has delivered a 12% per annum return since inception with less risk than the average multi-asset fund.

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Silver Update: 11th June 2014

Silver Update: 11th June 2014

Silver went on an epic run from October 2008 to April 2011, rallying nearly 500% over a short 2 and 1/2 years. The move certainly got the attention of the speculators and many bought aggressively as silver prices surged higher. As with all great speculative advances, the buy-side eventually got overcrowded and folks got greedy as hot money piled into what is quite a small and volatile asset. Trouble soon arrived. Silver topped for the move in May 2011 at just under $50, and then spent the next three years in free-fall, declining by -63% in total to $19. Today, the silver chart is starting to look interesting once again. Silver is stabilizing around $19/oz and the propensity by speculators to drive the price lower looks like it is coming to an end. 

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Gold Update: 19th May 2014

Gold Update: 19th May 2014

There aren't many asset classes that offer solid long term return potential in the current climate. Equities have doubled over the past five years and are now expensive relative to historic norms; bonds have been in a 30+ year bull market and yields are trading at multi-decade lows; property has been quite a volatile asset class in recent times but has also recovered during the most recent economic cycle. Gold is one of the few asset classes today that remains attractively priced. 

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Euro Equities: 14 February 2014

Euro Equities: 14 February 2014

European stock markets delivered very solid gains in 2013. The top 600 stocks across the Euro zone rallied +15% in aggregate. The Dow Jones Europe Equity Index gained +18%, while Germany, Italy, Spain and Denmark were all up in excess of 20%. Investor risk appetite has returned as the 2008 collapse fades from memory. In the shorter-term, we have started 2014 on a softer note. Following declines of -5% or more in January, stock markets are now in the process of re-testing their prior December peaks. If those highs are exceeded, this long-in-the-tooth rally should extend for another couple of months. However, if we fail to make new highs in February, selling pressure should increase.

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Gold Update: 14 February 2014

Gold Update: 14 February 2014

Gold investors are getting a nice Valentine's Day gift today, as the precious metal continues to act like the 2.5 year bear market is now in the past. Gold successfully re-tested the $1,180 June 2013 lows in December 2013, and hasn't looked back since. Today gold is trading at $1,315, over $100 off those bear market lows. Recent market action is significant. If the bear market in precious metals is over, then the bull market is back and gold should move to recapture the all time highs in the not too distant future. However, there is still work to do. We first need to see a weekly close above $1,525 to confirm the bull trend. After that, $2,000 should fall quite quickly. Patience will be rewarded. 

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Emerging Markets: 7 February 2014

Emerging Markets: 7 February 2014

When measured in US dollars, the stock market performance of the emerging markets has suffered a lot over the past 12 months (top half of the chart below). Asian stock markets have fallen -15.6% in that time, while the Middle East has declined -17.2%. The weakest performing countries have been Indonesia (-32%), Turkey (-23%), South Africa (-20%) and Brazil (-16%). A significant portion of the decline has been currency related. As you can see, the stock market performance in local currency terms (bottom half of the chart below) has been far less dramatic. 

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US Equities: 7 February 2014

US Equities: 7 February 2014

Following a very consistent rally in global stock markets since the March 2009 lows, the uptrend has accelerated higher over the past 12 months and is now starting to break down. Accelerations higher in stock markets are typically ending patterns, suggesting that the consistent uptrend is now at risk of breaking lower. Those that are following our model portfolio are well positioned with an allocation of 20% stocks, 50% bonds, 20% gold and 10% cash.

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