September 2014 Investor Letter

Model Portfolio Update

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Executive Summary

Our model portfolio overweight position in bonds has worked well this year but the time has come to bank some profits and shorten the duration of the bonds we hold. The end of this multi-decade bull market in bonds is finally coming into view. German 10 year yields have reached 0.89%, while Dutch 10-year yields are trading at 500 year lows. There simply is little room left for yields to fall and therefore limited upside for bond prices. As a result, we are making the first change to our model portfolio in quite some time, introducing a 30% allocation to absolute return bonds. To fund this position, we are reducing our existing bond allocation by 20% and also investing 10% from cash. The model portfolio is now invested 20% equities / 30% 5+ year Eurozone government bonds / 30% absolute return bonds. / 20% gold.

Equity Market Update

Equities continue to trade in almost bullet proof fashion, ignoring all negative news, from QE tapering in the US to increasing political instability across much of Europe. The US stock market is leading the charge and the S&P 500 today is making new all time highs. Investor complacency is running high. Despite an ageing bull market, there are some short-term reasons for optimism, albeit largely technical in nature. For example, our Technical Trend Indicator continues to give the all-clear for stocks. Every touch of long-term support has been met with more investor buying. As long as this trend continues, equity investors should reap the rewards. However, with equity market valuations running high and investor sentiment quite frothy, equity investors should remain on red alert for any sign of deterioration in the technical trend of the market. 

 

In another positive development, our Most Active Stocks Index Advance/Decline Line remains firmly in bull mode and our Large Cap Breadth Index Advance/Decline Line could be breaking out to the upside again, reaffirming the recent strong trend higher for stocks.

 

However, despite the above short-term positive developments, we remain defensively positioned and patiently await the next correction in risk assets to take effect. While timing the next market decline is always difficult, a study of market history suggests that we may not have too long to wait.

  • Historically, 5% corrections happen in stock markets every 7 months. The last one happened in January 2014, 8 months ago.

  • Historically, 10% corrections occur every 26 months. We witnessed the last 10% correction in April 2012, 29 months ago.

  • Historically, 20% corrections occur every 45 months. The last 20% correction ended in March 2009, 66 months ago.

The latest Investors Intelligence Sentiment Index is also revealing in that it has reported the lowest percentage of investment strategists with a bearish outlook since 1987, with a reading of just 13.3% bears. Investor sentiment readings also reinforce our defensive position for now.

 

As we enter third quarter earnings season in the United States, companies reporting earnings will also have to contend with a strongly appreciating US dollar, which will negatively impact profits earned abroad, when translated back to the domestic currency. The US dollar has rallied +6% versus the euro in the last three months and has experienced a similar sharp appreciation versus the Japanese Yen and Australian dollar. For now, we are happy with our current allocation in the model portfolio.

For more information on our equity market analysis, please contact Brian Delaney at 086 821 5911 or by email at brian.delaney@secureinvest.ie.

Bond Market Update

Our overweight Euro zone government bond position in the model portfolio has worked out very well this year. With no growth or inflation in sight, EU bonds have rallied sharply in 2014, driven higher by defined benefit pension schemes across the continent seeking to buy long duration bonds to match their ever-growing pensioner liabilities and also by EU banks leveraging up customer deposits and buying bonds in a reach for yield. 

However, the time has come to cut this position and shorten the duration of the bonds we hold. We don't want to outstay our welcome. The end of this multi-decade bull market in bonds is finally coming into view. German 10 year yields have reached 0.89%, while Dutch 10-year yields are trading at 500 year lows. There simply is little room left for yields to fall and therefore limited upside for bond prices. As a result, we are making the first change to our model portfolio in quite some time, introducing a 30% allocation to absolute return bonds.

For more information on our bond market analysis, please contact Brian Delaney at 086 821 5911 or by email at brian.delaney@secureinvest.ie.

Gold Market Update

As long as equities continue their cyclical bull market, there will likely be little interest in or demand for insurance in the form of gold. That has been the case since late 2011 and gold delivered its first negative return last year for euro investors in thirteen years! Gold's time has not yet come but it will and when it does I expect fireworks in this sector. Until then, we must remain patient.

In the short-term, euro investors in gold are getting some reprieve from the strong rally in the US dollar versus the euro, as year to date, euro gold (black and red line on chart below) is +9% while gold in USD is just +1% higher (grey line on chart below). 

 

For more information on our gold market analysis, please contact Brian Delaney at 086 821 5911 or by email at brian.delaney@secureinvest.ie.