September 2015 Investor Letter

Active Asset Allocator Performance

Investment Philosophy and Approach

The Active Asset Allocator investment strategy is designed to deliver a consistent level of positive returns  over time with a strong focus on capital preservation. We follow a multi-asset investment approach, actively allocating between global equities, bonds, precious metals, currencies and cash. We always invest with the primary trend of the market and do not follow a benchmark. Instead, we manage the market risk for our clients. Our strategy has returned 12% per annum net of fees since inception. Our active asset allocation approach is best illustrated in the following chart.

 
 

Executive Summary

Stocks tumbled in August, the first real -10% decline since 2011 and the bounce out of the August lows has been mediocre so far. Our studies confirm the continued deterioration in the internal structure of the stock market. The recent rally barely registers on the charts. The Large Cap Breadth Index (LCBI) for example (below left) has been steadily declining since peaking in September 2014. The recent performance of the FTSE All World Index also reinforces our defensive position. Bonds,  gold and cash, which together account for 80% of the  Active Asset Allocator investment portfolio, have provided some shelter from the storm. 

Stock Market Update

All eyes are on the Federal Reserve this afternoon as the US Central Bank decides whether to increase interest rates from 0.0% to 0.25%. The magnitude of the potential rate hike is small but market reaction to the news over the next few weeks could be significant.

We experienced a sharp correction in stocks in August, the first real -10% decline since 2011. The bounce out of the August lows has been mediocre so far. Our studies confirm the continued deterioration in the internal structure of the stock market. The recent rally barely registers on the charts. The Large Cap Breadth Index (LCBI) for example (below left) has been steadily declining since peaking in September 2014. This Index captures the underlying trend of the largest companies that trade on the NYSE and is a very useful tool in that it shows where the major players in the investment management sector are placing their trades. Most large portfolio managers need to own the largest market cap stocks for liquidity purposes, as they have multiple billions to invest on a regular basis. The LCBI is highlighting that the big institutional players have yet to step back into the market in any meaningful way.

The advance/decline line (above right) also shows that the majority of stocks have been trending lower for much of 2015. The A/D Line is a composite of over 3,000 stocks trading on the NYSE, so it is a broad measure of market breadth and an excellent barometer of the overall health of the stock market. Both of the above indicators suggest the trend remains down and lower stock prices lie ahead.

We continue to follow the path of the FTSE All World Equity Index with interest. As noted in last month's update,  this Index is the benchmark for global equity fund managers and includes stocks from North America (54%), Europe (23%) and Asia (23%). Similar to the 2007-2008 stock market top, the FAW Index:

  1. made an initial break lower in October 2014 (I);
  2. rallied to new market highs in early 2015 but on weaker momentum (II);
  3. declined to lower lows below (I) in August 2015 (III); and
  4. is currently attempting to rally back to the now declining 50 week moving average.

As long as this pattern continues in a similar fashion to 2007/8, we will continue to recommend a defensive position in the Active Asset Allocator.

 
 

The stock market in the United States looks to have formed a medium-term top. Following a 15% decline in August, the NYSE Index of 3,000+ stocks has managed a weak +6% rally. We need to see a sustained break above the upper resistance trend line before turning bullish again on US equities.

 
 

There have only been four occasions over the last 20 years when the S&P 500 traded below its long-term 100 week moving average. In 2000 and 2007, it preceded a severe multi-year bear market. In 2011, we experienced a -20% stock market correction before the uptrend resumed. In 2015, the Index is once again testing the 100WMA. We closed below the 100WMA for 9 trading sessions before the current rally took us back above this key support level. Correction or bear market pending?  We will find out shortly.

 
 

Turning to Europe, we can see a similar trend unfolding. The Eurostoxx 600 Index, comprising 600 of the largest companies from European developed countries, has fallen -20% since peaking in April 2015 and is currently +6% off those August lows. It is very likely we revisit those lows at some stage over the next 1-3 months. A successful re-test will likely have us turning more positive on equities. However, should we break the August lows, we expect to see an acceleration in selling pressure for stocks. We are at a critical juncture now for the stock market.

 
 

Emerging markets have fared worst of all. Peak to trough, the MSCI Emerging Markets Index (below) has fallen -32% from the highs earlier this year in local currency terms. Many emerging market currencies (ex China) have also experienced punishing declines over the last 12 months. China accounts for 23% of the index, followed by South Korea (15%), Taiwan (13%), India (8%), South Africa (8%), Brazil (6%), Mexico (5%) and Russia (4%).

 
 

The Chinese stock market has already corrected -45% from the top in June and there is no evidence yet that this correction is over. The Latin American region is another basket case and is already fast approaching the 2009 lows experienced during the last financial crisis.

We continue to recommend a defensive position in the Active Asset Allocator of 20% equities / 30% bonds / 30% precious metals / 20% cash as we navigate an increasingly volatile market environment. 

For more information on our stock market analysis, please get in touch. You can reach Brian Delaney at brian.delaney@secureinvest.ie or 086 821 5911.

Bond Market Update

 
 

We initiated a 5% position to inflation linked bonds in the Active Asset Allocator at the start of the year and will likely add to this position once it starts working for us. While deflationary fears persist in the marketplace, we believe they are already discounted in security prices. It therefore makes sense to us to begin to diversify our bond holdings ahead of the more inflationary future we anticipate. So long as inflation rises faster than nominal interest rates (thus causing real yields to fall), our inflation linked bonds will perform well for our clients.

 

 
 

We also bought a 5% allocation to Euro aggregate bonds, a mix of short duration government and corporate bonds, at the same time as we started our inflation linked bond position. The rationale is similar in that we want to diversify our bond holdings and reduce our interest rate exposure. We do not anticipate a significant rise in interest rates or bond yields in the years ahead but expect volatility to pick up, so we think it makes sense to reduce risk a little.

For more information on our bond market analysis, please get in touch. You can reach Brian Delaney at brian.delaney@secureinvest.ie or 086 821 5911.

Gold Market Update

Gold priced in euros had a great start to 2015 rallying over +25% shortly after we increased our allocation from 20% to 30% in the Active Asset Allocator. The last few months however have been disappointing and Euro gold has given back a lot of its 2015 gain so far, but is still +5% since we took our overweight position.

 
 

We are now entering the most seasonally positive time of year for gold and expect to see higher prices over the next 4-6 weeks. If we do not get what we are looking for, we will be quick to cut back our allocation to our longer-term strategic weight of 20%. We are paying very close attention to the market action in the precious metals sector.

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