April 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 just 1.5% each time and has a win rate in excess of 70%.

Executive Summary

Following the worst start to the year for equities in recorded history, we have just experienced one of the sharpest recoveries off the lows since records began. This rally has been so strong in fact that my technical studies have just triggered a buy signal for the stock market for the first time since September 2013. This month, I review the recent improvement in the stock market's technical setup and outline my plan of attack for the weeks ahead. For now, the Active Asset Allocator remains defensively positioned, 20% equities / 30% bonds / 30% PM's / 20% cash.

This month I also explain why I remain bullish on bonds and expect an additional 15-20% upside for the 10 year duration bond ETF I hold in the Active Asset Allocator and provide a brief update on the ongoing bullish developments in the precious metals sector as this bull market shifts into gear.

Stock Market Update

My technical studies have just triggered a buy signal for the stock market for the first time since September 2013. Equity valuations today are approaching an extreme only witnessed near prior stock market peaks and US corporate earnings are now in a declining trend. Despite these cautionary flags, continuous central bank intervention has created the perception that stock market investing is a low risk endeavor and a buy-the-dip mentality on every correction has taken hold. This will not end well. In the interim, price trumps opinion. My Technical Trend Indicator (TTI) is smarter than I am and keeps me on the right side of the prevailing stock market trend. In this monthly update, I consider my plan of attack for the weeks ahead.

 
 
Based on valuation measures having the strongest correlation with actual subsequent market returns across history, equity valuations have approached present levels in only a handful of instances: 1901 (followed by a -46% market retreat over the following 3-year period), 1906 (followed by a -45% retreat over the following year), 1929 (followed by a -89% collapse over the following 3 years), 1937 (followed by a -48% loss over the following year), 2000 (followed by a -49% market loss over the following 2 years), and 2007 (followed by a -57% market loss over the following 2 years). A few lesser extremes occurred in the 1960’s and 1970’s, followed by market losses in the -35% to -48% range.
— John Hussman, Hussman Funds, 18th April 2016.

In this long-term chart of the S&P 500, I have highlighted the prior instances in 2000 and 2007 when the stock market topped and rolled over, followed shortly thereafter by a bearish cross of the 50WMA below the 100WMA. This coincided with the onset of a bear market in equities and a declining trend in US corporate earnings. In 2016 YTD, we have already experienced a sharp -14% drop in stocks followed by an equally sharp +16% rally. However, there has been no bearish cross yet of the 50WMA below the 100WMA and the S&P 500 currently trades above both trend lines. Meanwhile, US corporate earnings have begun to slide, highlighted in the lower section of the chart below. This should be expected and is consistent with the maturing phase of an ageing equity bull market, which is now over seven years old.

 
 

Margin debt, a measure of the degree of speculation evident in the stock market, also appears to have peaked and rolled over. Prior peaks in margin debt have coincided with past peaks in the stock market. So today, we have a combination of stocks that are trading at expensive valuations, a weakening trend in US corporate earnings and a declining trend in margin debt. That's the bad news.

 
 

Despite this backdrop, equities have powered ahead in recent weeks. In February 2016, only 15% of stocks on the NYSE were trading above their 200DMA. Today, this figure has jumped to a much healthier 69%. If stock markets can consolidate their recent gains over the next couple of weeks while a majority of stocks continue to trade above the 200DMA, the bulls will remain in control.

 
 

In another positive development, the NYSE Advance/Decline Line (lower left chart), which captures the trend of rising stocks versus declining stocks over time, has recently broken out to new all time highs. This suggests that price should follow suit shortly. Volume flowing into advancing versus declining stocks is lagging however and has yet to break out (lower right chart) to new highs. So, we still have some mixed signals here (click on charts to enlarge).

As markets have rallied, stocks making new lows have also all but disappeared, which is another requirement before a bull market can resume.

So from a technical perspective, the outlook for equities has improved, but there are still many reasons for caution. Remember, 2016 started with the worst negative stock market performance in history, so it's only natural that the first rally following this correction should be powerful. The markets are overbought in the short-term and a correction of some degree should now be expected. The extent of the correction will determine when and by how much I will increase the equity allocation in the Active Asset Allocator. Stay tuned, we should find out soon enough.

 
 

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

 
 

The ECB is attempting to stimulate economic growth and generate inflation in the order of 2% annually by printing money, buying bonds, funding some EU country deficits and potentially using some form of "helicopter money" for EU citizens. The road ahead is concerning but we have not yet reached an inflection point where ECB policies trigger an acceleration in the rate of inflation and a path towards higher government bond yields. Draghi has committed to doing "whatever it takes" which means he is willing to drive 10-year EU government bond yields into negative territory. 

 
 

The Active Asset Allocator currently holds a 20% allocation in EU government bonds (IEGZ). The regional split of this bond fund is 32% France, 27% Italy, 19% Germany, 17% Spain, 5% Netherlands. The fund has a yield of 1.4% and a duration of 10 years. If ECB policies are successful, the yield on IEGZ should reach zero or negative implying 15-20% upside return potential from here. I plan to increase the allocation to inflation linked bonds (IBCI) and reduce the allocation to fixed interest rate bonds (IEGZ) later in 2016. Of course, the overall allocation to bonds will reduce if/when I increase the allocation to equities in the weeks ahead. Stay tuned.

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

Gold Market Update

Gold closed above the 20-month moving average (20MMA) in February 2016, confirming a new bull market had begun. As long as gold continues to trade above the 20MMA, bull market rules will apply - we buy and hold and do not get shaken out of our position. The 20MMA closed on Friday at $1,170 and should start trending higher shortly.

 
 

Silver's bull market kicked off a month later, as this more volatile precious metal closed above its 20MMA in March 2016. Silver's 20MMA closed on Friday at $15.60, so above this price, bull market rules should also apply. 

 
 

The one fly in the ointment for both precious metals (silver in particular) is the extent of the speculative long position that has been accumulated by hedge funds and those betting on higher prices for the precious metals. The latest Commitment of Traders report shows an all time record net long position by speculators in the silver market.

 
 

Commercial traders (the mining companies and bullion banks) take the opposite side to the speculators and are always net short the metals to varying degrees, depending on price, to hedge their production. The Commercials are often referred to as the "smart money" as they are able to manage the gold and silver price in the short-term, knocking down the price and covering their short trades when the speculators get overly stretched on the long side. We are potentially at this point now, particularly in the silver market. The Commercials do not always win and have been forced to cover at much higher prices in the past. As always, I will be guided by the price action as it unfolds. Above the 20MMA, it's a bull market.

I expect the precious metals bull  market to benefit from an overall declining trend in the US dollar over the next 3-5 years. The USD has been perceived as a safe haven currency since the 2008 financial crisis and has benefited handsomely from significant inflows into various US growth assets, driving price and valuation to extreme levels. As valuations normalize, I expect the USD to decline on a trade weighted basis.

 
 

Confirming the bull market in precious metals, the gold and silver miners are rocketing higher. The gold and silver mining index is already +111% from their recent lows. The miners are notoriously volatile. However, for those willing to close their eyes and hold on, I expect BIG rewards here. The miners are too volatile for the Active Asset Allocator but are confirming my bullish view on the sector.

 
 

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