December 2016 Investor Letter

Strategy 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. I follow a multi-asset investment approach, actively allocating between global equities, bonds, precious metals, currencies and cash. I always invest with the primary trend of the market and do not follow a benchmark. Instead, I manage the market risk for clients. This strategy has returned +11% per annum net of fees since inception with a lower level of risk than the average multi-asset fund. My active asset allocation approach is best illustrated in the following chart.

 
 

Gold Trader and Gold PowerTrader focus on capturing the strongest and weakest parts of gold's daily cycles, buying daily cycle lows, selling daily cycle highs and holding for 10-15 trading days, depending on the cycle count. This approach allows me to effectively manage risk. The strategy aims to capture +5% to 6% profit per trade while risking 2% each time and has a win rate in excess of 70%.

Executive Summary

Stock markets are back in rally mode following the US and Italian election results. I believe this is the final "blow off" phase to a market top which could peak at any stage between now and March 2017. Stock market valuations have once again reached an extreme only experienced in 1929, 1972, 1987, 2000 and 2007. Donald Trump's election success has been compared to that of Ronald Reagan who won the race to the White House in November 1980. Following Reagan's win, the S&P 500 rallied +14% in just a few weeks but topped out in November 1980 and then tumbled -22% over the next year. That was when stocks were trading at single digit P/E multiples. Today, they are four times more expensive.

Government bond yields are rising, particularly in the US where Trump's policies will be viewed as potentially quite inflationary. US Treasuries have declined -8% since the US election result. Eurozone government bonds have held up better, falling just -4% during the recent Trump-inspired inflation scare (but -7% since August). Euro government bonds have now reached an oversold extreme and I expect a rally in EU government bond markets to get underway shortly, likely coinciding with a top in equity markets. While the Federal Reserve has backed away from its position as lender of last resort, the ECB continues to buy everything not nailed down and has recently extended its QE programme to December 2017. 

Gold has also declined recently in tandem with other safe haven assets. Despite the recent correction however, gold priced in euros has still rallied +12% year-to-date. Based on my reading of the gold cycles, we are getting very close to the end of the current investor cycle for gold and I expect a turn higher shortly, possibly coinciding with an interest rate hike by the Federal Reserve on December 14th.  I remain defensively positioned for now with 20% equities / 40% bonds / 30% precious metals / 10% cash.

Stock Market Update

Trump's election victory has led to an +4% rally in the USD, an +8% rally in US stocks and an -8% drop in 30-year US Treasuries. 30-year Treasury yields jumped 50 basis points from 2.6% to 3.1% over the last four weeks. More broadly, global stock markets have added +5% in Euros, Eurozone government bonds have declined -4% and gold in euros has fallen -5%. What was initially considered bad news for investors ahead of the US election transformed into good news, literally overnight. The Active Asset Allocator lost -2.2% in November but has returned +8.4% year-to-date. In this Investor Update, I review the short-term impact of the Trump effect on equities, bonds, currencies and precious metals and examine what may be in store for investors in 2017. 

Will a Trump presidency make America great again? He has promised tax cuts, infrastructure spending and regulatory reform, all of which could boost US GDP over the next two years, but at a significant cost of ballooning government debts and budget deficits. His protectionist policies on trade and immigration will negate the aforementioned positives to a certain degree. Of course this is all speculation for now as Trump and his team have yet to execute on their plan. Let's take a closer look at some of Trump's proposed policies and their likely potential impact.

The headline rate of corporation tax in the US is 35%. However, the average tax rate of the largest 50 companies in the S&P 500 is just 24%. So, stock markets may be overestimating the positive impact of Trump's tax reform plan. On infrastructure spending, Trump is planning to spend $100 billion/year on much-needed repairs to America's transportation network. Spending billions of dollars on America's rail infrastructure, roads, bridges and tunnels makes sense and should provide a timely boost to US GDP growth. However, the Trump team must execute. The Obama administration attempted a similar strategy in 2009 in the midst of the Great Financial Crisis. "The American Recovery and Reinvestment Act of 2009" was put in place at a cost of $800 billion to save and create jobs and invest in infrastructure, education, health, and renewable energy. The impact on job creation and GDP growth was considered relatively modest in the following years. Asset prices benefitted handsomely of course but this was largely a result of four rounds of quantitative easing rather than Obama's fiscal policy decisions.

Many are comparing Trump's recent victory to that of Ronald Reagan who won the race to the White House in November 1980. Reagan beat incumbent President Jimmy Carter on a platform of policies quite similar to those now being proposed by Donald Trump. Following Reagan's election victory,  the S&P 500 took off (see chart below) rallying +14% in just a few weeks (compared to just +8% so far since Trump's win). However, that was it for the stock market rally back then. Stocks topped in November 1980 and then dropped -22% over the next 12 months. That was when stock market valuations were trading at single digit P/E multiples. Today, stocks are four times more expensive. 

 
 

Back in 1980, the US national debt amounted to $908 billion and US GDP was $2.86 trillion (32% debt/GDP). Today, the US national debt is $19.6 trillion while US GDP is only $18.7 trillion (105% debt/GDP). It is going to be much more difficult for the Trump administration to grow the US economy by more than 2%/year during his time in Office. So far, the stock market has given Trump the benefit of the doubt, but I can't help but feel that 2017 is shaping up to be quite a different proposition, for reasons I will explain next.

The Dow Jones Industrials Average is a price-weighted index of 30 of America's largest publicly quoted companies including many household names like Disney, JP Morgan, Caterpillar, MacDonalds, Proctor & Gamble, Exxon Mobil and Goldman Sachs. Following the Great Financial Crisis of 2008, the Dow kicked off a new bull market, fueled to a large degree by central bank money printing on a scale never before witnessed. The rise over the next 9 years has been a sight to behold - a triple from those March 2009 lows. Times have changed however. QE has ended in the US, bond yields have rallied 100 basis points and the USD has added +10% versus the Euro since May 2016. US corporations are facing multiple headwinds at a time when corporate earnings are declining.

From a technical perspective, we are now at an interesting juncture. Take a look at the chart below. Multi-year support broke for the first time in 2015 but stocks recovered strongly for the remainder of the year. 2016 started with another sharp 15-20% correction before the bulls regained control once again. The DJIA has now rallied all the way back to the major multi-year support trend line and has broken out to new all time highs this week. Is this the start of a new multi-month rally or a bull trap? Chartists and traders around the world are watching this setup very closely. We should find out shortly.

 
 

A similar pattern is unfolding on a shorter time-frame in the S&P 500 - a break of support in October 2016 followed by a sharp rally that has just broken out to new all-time highs. In a world dominated by computer-driven algorithmic trading, these chart patterns matter. 

 
 

When the S&P 500 is trading at a P/E multiple of 25 times earnings and those earnings peaked in 2015 and have been declining ever since, the chart patterns matter even more. The last time US corporate earnings were at current levels was almost 10 years ago, back in 2007 when the S&P 500 was trading at 1,500, -32% lower than today's level.

 
 

Margin debt, which measures the extent to which investors borrow to invest in the stock market, also looks like it may have peaked. Notice that margin debt as a percentage of GDP peaked at similar levels in 2000 and 2007 coincident with the previous two stock market bubbles.

 
 

The recent break higher in the stock market has looked convincing and has reversed the sell signal in my technical studies, which triggered in October. Portfolio managers under performance pressure are chasing this move in fear of underperforming benchmarks as we approach the end of the year. I believe the recent breakout will not be sustained and, similar to last year, we will get a sharp reversal at some point between now and March 2017. So I continue to recommend a defensive position in the Active Asset Allocator with an asset mix of 20% global equities / 40% EU bonds / 30% precious metals / 10% cash.

For more information on my stock market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.

Bond Market Update

 
 

US Treasuries have been hit hardest during the recent correction in government bonds. The 10-year Treasury yield rallied 110 basis points from 1.4% in August to 2.5% today, sending Treasury prices falling over -10%. 30-year Treasury yields increased 1% from 2.1% to 3.1%, resulting in a capital decline of -15%. (the Active Asset Allocator strategy has no exposure to US Treasuries).

Eurozone government bonds held up better, falling just -4% during the recent Trump-inspired inflation scare (but -7% since August). Euro government bonds have now reached an oversold extreme and I expect a rally in EU government bond markets to get underway shortly, likely coinciding with a top in equity markets. While the Federal Reserve has backed away from its position as lender of last resort, the ECB continues to buy everything not nailed down and has recently extended its QE programme to December 2017.

Government debt in the Eurozone continues to grow at a faster rate than GDP. The ECB must hold interest rates below the rate of inflation so that these debts can be serviced and inflated away over time. While EU fixed interest rate bonds are approaching the end of their multi-decade bull market, the outlook for Inflation linked bonds (and gold) is brighter. Although fears of deflation continue to reverberate around the world, the echo is starting to fade. We are moving towards an environment of rising inflation. The Active Asset Allocator will continue to transition from fixed interest rate bonds to inflation-linked in 2017.

 
 

For more information on my bond market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.

Gold Market Update

Despite the recent correction, gold priced in euros has still rallied +12% year-to-date. Based on my reading of the gold cycles, we are now getting very close to the end of the current investor cycle for gold and I expect a turn higher shortly, possibly coinciding with an interest rate hike by the Federal Reserve on December 14th. 

 
 

The Federal Reserve last raised interest rates a year ago on December 16th 2015. Gold closed at $1,071 that day. In a shakeout move, gold dropped $20 the following day before then shooting higher by +30% over the next 6 months. I expect something similar this time round. Also, inflation wasn't a concern for the Fed last year but with Trump in the White House in January 2017, the narrative is changing.

 
 

Another difference between then and now is that USD gold looks to be making a higher low for the first time since 2011. A higher low is bull market action and will confirm a change of character for the gold market. If gold can form a low in the $1,100's, the next target will be a higher high in 2017 above $1,378. I think we will get it. A higher low followed by a higher high will get more involved in the precious metals market, a necessary development to drive gold prices higher.

 
 

Gold priced in euros has been holding up reasonably well since June 2016. Euro gold has not made a lower low despite the +7% rally in the USD over the same period. 

 
 

The time has come for gold to show its hand. If the bull market is back, gold should rally sharply over the next 6 months. If gold disappoints, something else is at hand and I will cut back exposure in the Active Asset Allocator

For more information on my gold market analysis, please get in touch. You can reach me at brian@secureinvestments.ie or at 086 821 5911.