May 2017 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 focuses on capturing the strongest and weakest parts of gold's daily cycle, buying daily cycle lows, selling daily cycle highs and holding for 10-20 trading days, depending on the cycle count. This approach allows me to effectively manage risk. The strategy aims to capture +5%-6% profit per trade while risking 2%-3% each time and has a win rate in excess of 70%.

Executive Summary

Over the last couple of months, Facebook, Apple, Amazon, Netflix and Google together have added $260 billion in market capitalisation. Meanwhile, the other 495 companies in the S&P 500 have lost a similar amount. Market leadership is narrowing to just a handful of names, a trend that often occurs at the tail end of a bull market. Smart investors are taking note. Paul Singer recently raised $5 billion to take advantage of opportunities when investor confidence becomes impaired and volatility spikes. Warren Buffett is sitting on 22% cash in his investment company Berkshire Hathaway. We are getting close.

Bonds have had a quiet couple of months but as long as 3% on the 10-year US Treasury and 1% on the 10-year German Bund hold, I continue to believe that the final low in yields of this multi-decade bull market lies somewhere in our future. The price action in gold could provide the clue to the timing of the turn (lower in stocks, higher in bonds and gold). Gold Trader is looking to catch the top of gold's fourth daily cycle before the final descent into a medium-term low in June. Once next month's low is in place, I expect a powerful move higher over the Summer, possibly to $1,500, as the stock market finally rolls over.

Stock Market Update

Paul Singer's hedge fund Elliott Management raised $5 billion in 24 hours last week to take advantage of a potential major investment opportunity set that could emerge "when investor confidence is impaired, recent correlations and assumptions don't work and prices are changing rapidly". Singer, one of the most successful hedge fund managers of all time, is expecting a sharp rise in volatility and some unpleasant consequences for investors in the not too distant future. He is not the only one. Warren Buffett is currently holding 22% cash - nearly $100 billion - in his investment company Berkshire Hathaway. Two titans of the investment industry are on edge and concerned about the outlook for global markets.

Back in May 2013, Paul Singer penned an excellent article describing the moral hazard that has been created by the Federal Reserve. (The full article is available in the Research section of my website at the following link: In the Wilderness). In the article, Singer lambastes the Federal Reserve for the dangerous policies they have pursued and the unintended consequences that have yet to be felt from their reckless and irresponsible actions.

“If you look at the history of Fed policy from Greenspan to Bernanke, you see two broad and destructive paths quite clearly. One path is the cult of central banking, in which the central bank gradually acquired the mantle of all-knowing guru and maestro, capable of fine-tuning the global economy and financial system, despite their infinite complexity. On this path traveled arrogance, carelessness and a rigid and narrow orthodoxy substituting for an open-minded quest to understand exactly what the modern financial system actually is and how it really works. The second path is one of lower and lower discipline, less and less conservative stewardship of the precious confidence that is all that stands between fiat currency and monetary ruin. Monetary debasement in its chronic form erodes people’s savings. In its acute and later stages, it can destroy the social cohesion of a society as wealth is stolen and/or created not by ideas, effort and leadership, but rather by the wild swings of asset prices engendered by the loss of any anchor to enduring value. In that phase, wealth and credit assets (debt) are confiscated or devalued by various means, including inflation and taxation, or by changes to laws relating to the rights of asset holders. Speculators win, savers are destroyed, and the ties that bind either fray or rip. We see no signs that our leaders possess the understanding, courage or discipline to avoid this.”

— Paul Singer, Elliott Management, May 2013.

One of the consequences of continuous central bank intervention in capital markets has been the emergence of the short volatility trade as investor confidence levels ratchet up once again. A tremendous amount of capital has been placed on bets that volatility will remain suppressed for the foreseeable future. This, at a time when the Vix Index (below) is trading at multi-decade lows. Over the past 13 trading days, the S&P 500 has traded within a range of 1.01%, the least volatile 13 days in history! Volatility spikes and rapid changes in price are what Paul Singer is preparing for.

The Vix Index is a measure of the volatility of S&P 500 index options and is considered a prescient gauge of investor confidence (when the Vix is low) and fear (when the Vix spikes higher).

Another direct consequence of continuous central bank intervention has been the reach for yield as investors are forced out of low risk cash and into higher risk investments in the search for income and a reasonable investment return. Total assets in Rydex Money Market Funds have now also fallen to multi-decade lows.....

.... at a time when stock market valuations and margin debt as a percentage of nominal GDP have rarely been higher.

There is also a potential negative divergence now appearing in the S&P 500 where price is breaking out to new all-time highs but relative strength and momentum indicators are failing to confirm the move. This signals that the rally could be nearing its final stages.

In his 1st May Weekly Market Comment, John Hussman showed a simple chart of the S&P 500, marking all days since 1960 where the opening level of the Index was 0.5% above the prior day's closing price and the Index was within 2% of an all-time high. On some occasions, these conditions occurred shortly before the final bull market high, while on others (August 1987 and October 2007), they occurred just a few days before or after the final market top. Food for thought.

Stock markets have enjoyed a very strong multi-year rally since 2009, and since bottoming versus gold in 2011. The S&P has handily outperformed precious metals over the last six years, following gold's strong relative performance versus US equities from 2000 until 2011.  I believe the trend is now turning once again in favour of gold. I think gold will put in a meaningful low over the next 4-6 weeks (see Gold Market Update for more information), which I expect will coincide with a top in the stock market. After that, things should start to get interesting.

European stocks (lower left chart) trade at a valuation discount relative to US stocks and the market is pricing in quite a depressed level of earnings growth for EU companies. So, there is a margin of safety priced in to EU stock markets. Chinese stocks (lower right chart) continue to face significant headwinds and the chart of the Shanghai Stock Exchange Composite Index suggests that the downward trend will persist for some time yet. I will be tilting the regional equity bias in the Active Asset Allocator towards Europe following the next meaningful correction, but for now, I continue to recommend caution and maintain a defensive position in the Active Asset Allocator of 20% equities / 40% 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

The trend remains down for government bond yields across the world. Inflationary pressures are probably greatest in the United States and eventually that will be reflected in the US Treasury market. However, as long as the US 10-year yield remains below 3.0%, I think the final low in yields of this multi-decade bull market lies somewhere in our future. 

Debt, demographics and delusional central banks are combining to perpetuate this bull market in bonds. Despite the recent rise in yields, Eurozone government bond yields also remain in a multi-year downward trend. As long as 10-year German bund yields remain below 1.0%, the bond bull market remains intact.

It has been a quiet couple of months for inflation-linked bonds but the longer-term trend remains up for this under-owned asset class. Inflation-linked bonds offer attractive diversification benefits for multi-asset portfolios and perform well at times when equities and fixed interest rate bonds are struggling. I will likely increase the allocation to ILB's in the Active Asset Allocator over the course of the next 12 months.

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

I closed Trade 12 of the Gold Trader strategy last week for a 2% gain (+4.4%YTD). I am looking to place another short position for Gold Trader to catch the top of gold's fourth daily cycle before the final descent into a medium-term low in June. Once next month's low is in place, I am expecting a powerful move higher over the Summer, coinciding with a top and decline in the stock market.

I am pretty excited about the prospects for Gold Trader. The strategy looks to capture 5-6% per trade while risking just 2-3% each time and has a win rate in excess of 70% based on over 10 years of data. Profits are tax-free to the client and fees are performance based. No gain, no fee. Please get in touch if you are interested in learning more.

I expect gold to bottom next month near $1,170. The possibility remains for a fast and sharp drop below the December 2016 low of $1,124 to shake out the bulls, which would provide the fuel for the next rally. Either way, once gold gets going, I expect a strong move higher towards $1,500. Gold Trader will be searching for a long position next month to get on board the move. 

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.

February 2017 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

Wishing all Secure Investments readers a healthy and prosperous 2017! The Active Asset Allocator returned +8.9% in 2016. A full two thirds of this performance came at the start of the year during a period of heightened volatility and declining stock prices. By the end of February 2016, the 30% allocation to bonds had contributed +1% to the strategy's performance while the 30% allocation to precious metals had contributed +5%. The 20% allocation to global equities impacted performance by -1%. So, the AAA was +5% by the end of February versus -4% for the average multi-asset fund.

From March through October 2016, the AAA added another +5% with +2% coming from the allocation to global equities and +3% from precious metals. By the end of October, the AAA was +10% YTD versus +2% YTD for the average multi-asset fund. Following Trump's election victory on 8th November, money flowed out of safe haven assets and into stocks, leading to a run higher in equities in the last two months of the year and a selloff in bonds,  gold and the Euro. All in all, I am satisfied with the performance of the strategy in what was quite a difficult year to navigate. Many hedge funds delivered negative or very modest positive returns in 2016.

For Gold Trader followers, the December 2016 low marked the end of the last Investor Cycle (IC) with a new IC starting on 16th December. The first daily cycle (DC1) of this new IC peaked at $1,219 on 17th January and then dropped into a low (DCL1) on 27th January 2017 at $1,190. DC2 is now underway and I think it could be quite powerful; a $50-$100 move could be on the cards over the next four weeks. Gold Trader entered a long position yesterday (1st February 2017) at $1,204 with a stop on a close below the recent low of $1,190.

Stock Market Update

2016 began with an -16% plunge in global equities. Over the course of the year, stocks recovered so that by the time the US Election rolled around, the FTSE All World Index had crept back into positive territory. Then along came the Donald.... Following Trump's election victory, money flowed out of safe haven assets and into stocks, leading to a run higher in equities in the last two months of 2016. The US dollar also rallied sharply versus the Euro (the euro fell from $1.12 to $1.04), thereby putting quite a gloss on global stock market returns for the year in euro terms.

Historically, post-election years have not been as kind to investors and I expect 2017 will be no different. The current bull market, 8 years old in March 2017, is already the third longest in history and twice as long as the average of the last 100 years. Still holding on to second place for now is the 1921-1929 stock market bubble, which ran a few days over 8 years; while in first position is the nine year and five month run from October 1990 to March 2000, culminating in the epic internet bubble. We are getting close to the apex of this multi-year run and I believe the next bear market is just around the corner. Stock valuations have returned to prior peaks, investor confidence is back, while short interest - those betting on falling stock prices - has fallen sharply. One of the most successful hedge funds in recent years, Horseman Capital, recently scaled back their significant short position on equities after losing -24% in 2016. The bears are throwing in the towel, potentially, just at the wrong time. When investors take short positions on the stock market, they become natural buyers during stock market declines (as they cover their positions). However, when short sellers cover their trades during a rising market, there are fewer buyers around when stocks eventually turn lower and the declines can become bumpier and much more violent.

An interesting development that has occurred since the US election is the jump in confidence among CEO's and consumers, which hasn't yet, but may flow through to rising retail sales and economic growth in the months ahead. However, the key problem that trumps all others is that stocks are trading at 25 times reported earnings (which peaked in 2015) versus a long-term average of just 17 times. Stocks have traded at single digit P/E multiples in the 1940's, 1950's, 1970's and 1980's and could do so again when the next bear market arrives. In the meantime, stocks have only been this expensive on two occasions previously since 1860: the last few months of the roaring 1920's just prior to the Great Depression and at the tail end of the internet bubble in the late 1990's!

As frustrating as it has been to sit with a 20% allocation to cash (and as much as 30% for new Secure Investments clients), I continue to advise caution for now. The stock market has run 11 months without any meaningful pullback, which is very unusual. A 5% correction typically occurs every 7 months during a bull market. In the next few weeks I will outline some of the areas where I see opportunity in 2017 across equities, bonds and precious metals. 

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

I think the rise in global government bond yields has just about run its course for now. I am looking for a rally in Eurozone government bonds, which coincides with a decline in global stock markets over the next three to six months. German 10 year government bond yields have rallied 0.50% over the last 7 months and have now reached short-term overbought levels but remain in a multi-year downward trend. Technical indicators suggest that the rally is losing strength. 

More broadly, Eurozone government bonds have rallied over 60% in recent years, so a -21% pullback is healthy. The next chart suggests that the Euro bonds are now oversold and the next move higher is just around the corner. I will be paying close attention whether bonds can break out to new highs later this year (bullish) or not.

US 20-year Treasuries have also corrected sharply, falling -18% and have now also reached an extreme oversold position. The longer-term uptrend is still in place for US Treasuries.

Inflation-linked bonds continue to hold up better than fixed interest rate bonds and I expect ILB's to continue to price in a gradual increase in inflation expectations over the next couple of years. 

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

Gold is at quite an interesting juncture. For the first time in five years, gold has broken the trend of lower highs and lower lows. Gold bottomed at $1,045 in December 2015 and then rallied over $300 to a new 52-week high of $1,378 just seven months later. A sharp correction followed but gold managed to dig in and make a higher low in December 2016 at $1,124. 

For Gold Trader followers, the December 2016 low marked the end of the last Investor Cycle (IC) with a new IC starting on 16th December. The first daily cycle (DC1) of this new IC peaked at $1,219 on 17th January and then dropped into a low (DCL1) on 27th January 2017 at $1,190. DC2 is now underway and I think it could be quite powerful; a $50-$100 move could be on the cards over the next four weeks. Gold Trader entered a long position yesterday (1st February 2017) at $1,204 with a stop on a close below the recent low of $1,190.

Gold priced in euros has held up much better than USD gold, providing a natural hedge for euro-based investors. I expect USD will play catch up now so we could see gold and the US dollar rally together this Spring, which would be great news for our Active Asset Allocator strategy. There is not much to do for now but wait and see how this plays out. Sitting through a bull market is tough to do but I expect our patience will be handsomely rewarded over the next three years. 

Gold spent the majority of the time above the long-term 20-month moving average (20MMA) during the last major bull market (2001 to 2011). Gold broke below the 20MMA in 2012 and remained in a downtrend for the next four years but then turned higher once again in 2016. Gold closed below the 20MMA briefly on the recent correction but has now regained this bull market trend line. I am looking for an acceleration higher as this bull market gathers steam and broadens in popularity.

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.

April 2015 Investor Letter

Active Asset Allocator Performance

Executive Summary

Market anomalies exist everywhere we look. Today, US stocks trade at two standard deviations above their long-term average valuation, while European stocks have now closed their valuation gap versus US equities on a price/free cash flow basis. We are in the third longest streak in history since the last 10% correction in the stock market and 40-60% of core Eurozone government debt now trades with a negative yield. Meanwhile, central banks are stepping up their gold purchases and have increased their buying from 409 tonnes in 2013 to 477 tonnes last year. Amidst all the noise, the Active Asset Allocator continues to perform +10% YTD, despite being defensively positioned 20% equities / 30% bonds / 30% gold / 20% cash.

Stock Market Update

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. The market capitalization of US corporate equities relative to US GDP tells a similar tale. US equities remain approximately 2 standard deviations above their long-term average valuation. 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.

European stock markets are off to a strong start in 2015 with many regions posting double-digit gains YTD, assisted by central bank money printing on a record scale and the subsequent and linked plunge in the euro.  Is the rally justified? There are some reasons for cautious optimism. For example, we continue to see a steady improvement in new car registrations and solid retail sales growth ex autos +3.7% year/year in January 2015 across the EU. 

Credit demand is also picking up with capital becoming more easily accessible as bank lending standards loosen. The ECB of course is playing a key role as liquidity provider of last resort and assisting in the slow but steady repair of European bank balance sheets.

However, stock market valuations have already discounted much of this improvement in our view. A cursory glance at price/earnings multiples in both the US and European markets suggests stocks are trading at rich multiples today.

If we take a closer look at the valuation differential between US and EU stocks in the following table, we can see that US stocks were valued on a price to free cash flow of 11.4 times in December 2014 versus just 8.7 times for the EU stock market, so EU stocks appeared cheap on a relative basis. However, when examining the make up of each regional stock market index on a sectoral basis, we note that EU stock indices have a higher allocation to the cheaper sectors of the market including automotive, telecom, utility and financial stocks.  If US sector weightings are applied instead to the EU stock market, the valuation discount closes.

Roll forward to today, and the relative valuation discount has disappeared. Banking, financial services and insurance sectors in Europe look cheap versus their US peers but probably for good reason, while active stock pickers may still find some opportunity in the automotive, oil and gas, construction, machinery and retail sectors. However, European stocks are now trading at 11 times free cash flow or 13 times when US sector weightings are applied to the EU Index. These are premium valuations to pay for long-term investments.

In addition to stretched valuations,  we are also on day 1,292 since the last 10% stock market correction. This is the third longest streak in history (data from Stock Traders Almanac). Now is not the time to be swinging for the fences.

 We remain defensively positioned for now in the Active Asset Allocator, holding 20% equities, 30% bonds, 30% precious metals and 20% cash.

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

Bond Market Update

Government bonds re-priced in 2014 to reflect a broader reluctance from global central bankers to tighten monetary policy. This trend has continued in 2015 to such an extent that between 40% and 60% of core Eurozone government debt now trades with negative yields. 

Despite negative yields, central banks, insurance companies, pension funds and passive fixed income funds could potentially continue buying bonds with a negative yield in the future as a combination of QE, regulation, mandate guidelines and liability management force their hands. The ECB for example is mandated to buy €1 trillion in bonds over the next 12 months, which is significantly more than the annual supply of new issuance in the region and 50% of the global net issuance of all debt in 2015. Also, if the Eurozone experiences a prolonged period of deflation, bond investors could experience a positive real yield. 

However, this trend towards negative long-term yields is not sustainable over time. At some point, valuation concerns should deter investment flows into bonds. We continue to assess our bond allocation in the Active Asset Allocator and will likely make some changes in the months ahead if the trend towards negative yields (and continued rising bond prices) persists. For now, we continue to be happy with the performance and allocation of our various bond investments.

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

Gold Market Update

Gold in euros has gained +15% YTD and +20% since we increased our allocation in the Active Asset Allocator from 20% to 30%. Gold has done a great job protecting Euroland investors from the recent -25% drop in the EUR versus the USD. We can see on the following chart that a gap has opened for the first time in almost a decade between the EUR and USD gold price, indicating we are either about to experience a rally in EUR or the USD gold price in the near future, or potentially a combination of both.

The Euro certainly has room to appreciate and is oversold on just about every indicator we follow. A relief rally may be just around the corner. 

We continue to monitor our overweight position in gold in the Active Asset Allocator and will hold it as long as the position continues to work. Longer-term, we need to see gold trade back above its 20 month moving average to have confidence that the secular bull market has returned. An analysis of the various components of the demand for gold each quarter may provide some clues. 

According to data from the World Gold Council, ETF investors, concerned about the first significant price decline in gold in over a decade, sold 880 tonnes of the metal in 2013, while central banks purchased 409 tonnes. ETF selling moderated in 2014 to just 159 tonnes , while central banks stepped up their purchases buying 477 tonnes of gold. 

So, according to the World Gold Council, investment demand is potentially stabilizing around 900 tonnes pa and $1,200/oz. Gold ETF selling declined significantly last year and central banks are becoming more active in the market. Central bank actions speak louder than words and central bankers are well aware that printing money in the trillions of euros and dollars and yen each year is not a risk free solution to our problems. At some stage, investors are going to connect the dots and then the price of gold will trade substantially higher than where it is today. Until then, we have to be patient.

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

May 2013 Investor Letter

Model Portfolio Update

Past performance figures are estimates only and may not be a reliable guide to future returns.

Executive Summary

The Active Asset Allocator Model remains fully invested with 60% equities, 20% bonds and 20% gold, a position that has been maintained since June 2012. All the action in April took place in the precious metals market as gold broke long-term support ($1,523) triggering significant selling by over-leveraged investors and late-comers to the gold bull market. An important low may have been set on 16th April at $1,322, which should mark the end of the 2-year correction in precious metals. Meanwhile, equities continue their impressive run but should be in the process of forming an important high later this year. Investor sentiment is at an optimistic extreme, aggregate corporate earnings are 30% above the long-term trend, company valuations are expensive relative to their 10-year average and margin debt has returned to levels last seen in 2007. While we have yet to receive a sell signal to move to a defensive position, now is a time to be cautious and not increase exposure to stocks.

Equity Market Update

Equity market cycle count

The S&P 500 peaked on 24th March 2000 at 1,527. At the time, investors valued the US stock market at a forward price/earnings multiple of 23 times. A severe bear market followed and stocks fell by -47% by October 2002. With assistance from the Federal Reserve, the US economy recovered and another cyclical equity bull market began. By October 2007, the S&P 500 reached 1,565 and this time traded at a more reasonable forward P/E multiple of 15 times. However, despite the improved valuation, analysts' earnings estimates proved overly optimistic. The global property and equity bubbles popped shortly thereafter and stock prices crashed again, this time by -55% in seventeen months. Central banks intervened once more, cutting interest rates to zero and firing up the printing presses. Yet again, stock markets responded. Today, as we break above 1,600 on the S&P 500 again, investors are valuing US stock prices at close to 14 times next year's net earnings. Investor sentiment has turned full circle. Institutional fund managers have not been this positive on their outlook for US stocks in over 20 years. I expect the boom-bust cycle to repeat once the momentum move currently underway exhausts itself.

S&P 500 has made no progress now for 13 years.

Another gauge of bullish sentiment is clear from the front cover of a recent edition of Barron's, a weekly-published New York financial newspaper and must-read for many on Wall Street. Barron's pictured a bull on a pogo stick bouncing over a bear on their front cover last month, as they advertised the results of their semi-annual Big Money poll of professional investors. In that survey, 74% of respondents were either bullish or very bullish on the prospect for US stocks. As a comparison, 54% were bullish in 1999 and 46% were bullish in 2006 at the prior two stock market peaks. Only 7% are pessimistic today. The timing or prior Barron's surveys was prescient, but for reasons that will not excite the bulls.

Barron's Big Money poll says 74% of professional investors are bullish or very bullish on the prospect for US stocks. (54% were bullish in 1999 and 46% in 2006).

Equity investors take note. Stock markets continue to rally and the Active Asset Allocator model continues to hold a 60% position in stocks for now. However, the risk of at least a medium-term correction is now quite high. Smart money is selling into this momentum move. Leon Black for example, owner of one of the most successful private equity firms in the world, The Apollo Group, reported last week that the current environment represented a fantastic opportunity in which to sell into and he was "selling everything that is not nailed down". Apollo has sold $13 billion worth of businesses in the last 15 months. Black noted that "the market is pricey.... priced for perfection."

Seth Klarman, founder of The Baupost Group, is another world class investor who operates under the radar. Klarman summed it up very well in a recent investment update to clients:

"While economist David Rosenberg at Gluskin Sheff believes government actions could be directly or indirectly responsible for as many as 500 points in the S&P 500, or 30% of its current valuation, traders have confidence in Ben Bernanke because betting that his policies will drive equities higher bas been a profitable wager. Bernanke, likewise, is undoubtedly pleased with these speculators for abetting his goal of asset price inflation, though we all know that he will not call them first when he decides to reverse direction on QE. Then, the rush for the exits will be madness, as today's "clarity" will have dissolved, leaving only great uncertainty and probably significant losses. Investing, when it looks the easiest, is at its hardest. When just about everyone heavily invested is doing well, it is hard for others to resist jumping in. But a market relentlessly rising in the face of challenging fundamentals – recession in Europe and Japan, slowdown in China, fiscal stalemate and high unemployment in the U.S. – is the riskiest environment of all."

Seth Klarman – Founder, The Baupost Group

Next, I want to highlight an interesting study from US-based investment manager Sitka Pacific that examined historic valuation contractions in the S&P 500 and corresponding inflation changes in the United States during all of the previous bear markets since 1900. They identified a consistent pattern in the way valuations have tended to decline during long-term equity bear markets. The chart below shows how the market’s P/E ratio, based on the last 10 years of average earnings, has declined during previous bear market cycles (light blue line) and during the current bear market (dark blue line). If the current long-term bear market in equities runs true to course, we could have another 60 months or 5 years of P/E contraction before we reach the final bottom.

The green lines on the chart measure the change in the Consumer Price Index (CPI) from the beginning of past long-term bear markets, and during the current one. Price inflation has tended to be relatively modest during the first half of long-term bear markets, only to accelerate during the second half. We could be at an inflection point in the current cycle where the inflation curve is about to accelerate higher. I have found this framework of past cycles of falling valuations and rising inflation quite useful when framing my overall market views. It has defined the second half of every long-term bear market since 1900 and I expect it to define the second half of the current bear market (although it doesn't feel like a bear market just now), once this momentum move higher in stocks runs its course.

Is the outlook for inflation set to accelerate?

The cyclically adjusted Shiller P/E (CAPE) for the S&P 500 (price divided by ten-year average inflation-adjusted earnings) continues to show that stocks are quite expensive relative to the past 100 years of data. The CAPE currently trades at a lofty 22.3 times historical earnings, a level similar to previous valuation peaks in 1901 and 1966. For comparison purposes, historical troughs in the CAPE came in 1920 at 4.8 times, 1932 at 5.6 times, 1942 at 8.5 times, 1949 at 9.1 times and 1982 at 6.6 times. We are obviously a long way from trough valuations levels today which makes investing in the stock market such a difficult proposition.

Cyclically adjusted P/E ratio still trades at 23 times.

Finally, a note on the technical trend indicator (TTI). I developed the TTI, a market trend indicator, a few years ago to help investors stay on the right side of long-term trends in the equity market. I use the TTI as one of the bases for the asset allocation changes I make in the Active Asset Allocator model and it has worked out quite well to date. For example, despite my scepticism of the sustainability of the current global stock market rally, the Active Asset Allocator Model continues to hold a fully invested position of 60% stocks, and that is thanks to the TTI. The indicator comprises eight sub-components of price, volume and breadth that capture the overall health of the stock market. Equities cannot rally or decline in a meaningful way without the TTI following suit. It is not a perfect timing tool but quite effective for capitalising on the meat of long trending moves. Certainly if the stock market was to break lower and not look back, it would take a week or two for the TTI to catch up. However, market top formations usually take many weeks or months to complete, which makes the TTI so useful.

Stock markets… and the TTI… are accelerating higher right now. Accelerations in either direction are typically ending patterns in markets. When bull and bear markets accelerate higher or lower, retail (dumb) money is chasing the move and typically arriving late to the party. Once the latecomers are 'in', it usually marks the top, as there are no buyers left. Then bids suddenly dry up and the market rolls over and does not look back. That is the way markets tend to work. The TTI should protect you from getting caught up in any long protracted declines. 

The Technical Trend still favours a fully invested position of 60% stocks.

As noted earlier in this report, stock market sentiment remains sky high. The Hulbert Stock Sentiment Index (below left) shows an overbought equity market. The Intermediate Term Indicator Score (below right) suggests there may still be room for stocks to rise, confirming the current bullish stance of my technical trend indicator.

Equity markets accelerating higher now.... Accelerations tend to be ending patterns.

Bond Market Update

You get paid one basis point per annum to lend money to Angela Merkel for two years.

 

You only get paid one basis point – one hundredth of one percent – per annum to lend money to Angela Merkel for two years. Last month, you had to pay her 5 basis points/year just to take your money! There is something very wrong with that situation. Ten year yields on government bonds across the world are at generational lows. A quick scan of numerous fixed income charts reveals that an important low (in yields) may be in the process of being made in the many of the government bond markets of the developed world. You will shortly be able to check out these charts for yourselves and much more on my new website, which I hope to launch next month..... Stay tuned. Bull markets have to end some time and yields can't go down forever. Nominal government bond yields are already well below the rate of inflation today. If a rising trend in inflation is on the cards over the next few years, then long-term government bonds could be quite a poor investment. Investors should only choose bonds with a short term to maturity, as they are less sensitive to interest rate movements. Bonds should only be used as a tactical investment; somewhere to shelter during periods of turmoil in stock markets.

Sentiment on bonds today remains mixed. US Treasuries appear to be making a long-term top. It will be interesting to see how they trade on the next market decline. If treasuries fail to make new highs on the next sharp move lower in the stock market, the bond bull may have cast his last breath.

US Treasuries are in the process of forming a long-term top.

Gold Market Update

Gold bull market wounded but still intact.

First, some perspective. The gold debate is a rather emotive one with quite a diverse range of opinion. The bears will say that gold is just a 'barbarous relic' with little use in today's world. Gold pays no coupon or dividend and earns no income. It is just a price, which rises based on the greater fool theory. It is a peculiar market. One group of folks spend a fortune trying to find it and dig it out of the ground only to sell it on to another group who want to bury it again, paying storage costs and insurance to protect against theft. What on earth is all the fuss about? The bulls will counter that gold provides an effective hedge against central bank profligacy and the risk of financial contagion as well as its more traditional function as an inflation hedge.

When gold began its secular bull market in 2001 at $250, the bears hardly noticed. The run to $1,000 left them perplexed but disinterested. Gold then corrected in 2008 from just above $1,000 to $770 and the bears cheered; their consensus views finally vindicated that the gold bull market was over; but of course, it was not. When gold started rising again in 2009, disinterest turned to irritation and confusion for those of a bearish viewpoint. Why was gold rising in such a consistent pattern? Jim Grant of Grant's Interest Rate Observer provided the best answer in April 2011 when he said: "to me, the gold price takes the form of a very uncomplicated formula. All you have to do is divide one by 'n' and 'n' I'm glad you ask, is the world's trust in the institution of paper money and in the capacity of people like Ben Bernanke to manage it. So, the smaller 'n', the bigger the price. One divided by a receding number is the definition of a bull market."

Nothing has changed regarding the institution of paper money. In fact, the situation has deteriorated since 2011. More and more central banks are deciding to follow the lead of the Federal Reserve, turning to the printing press to weaken their currencies and stimulate their economies. They see no downside to their actions. Central banks are sowing the seeds of inflation and the next significant move higher in precious metals. So, the gold bull market is not over despite many (who did not participate at all in the 12 year run to date) now calling time on the most precious of metals. A good deal of technical damage was done in April and it will take some time to repair, but repair it will and gold will trade at new all time highs in the not too distant future.

Let's look back for a moment at what happened last month. On the evening of Friday 12th April in a thin (low volume) market, an enormous 400 tonnes of 'paper gold' was sold in the futures market in the space of 90 minutes, driving the spot price of gold down sharply. More aggressive selling occurred on Monday and long-term support levels at $1,520 gave way. Plenty of stops were triggered and gold plunged to a low of $1,322. I will leave it to the conspiracy theorists as to who placed those big orders in the derivatives market. I will just say that someone or some bank wanted to drive the gold price lower and they succeeded in the short-term.

Gold has now recovered approximately $150 but may re-test April's lows in the next 2-3 weeks; re-tests often occur in markets at major turning points. Alternatively, gold could just take off from here, keeping many who were shaken out during the recent decline from re-establishing a position. I feel strongly that we are now very close to the start of the next major move higher, which will mark the transition to the start of the bubble phase in the gold bull market. Sentiment in the gold sector is at the most lopsidedly bearish level as I have ever seen it. Gold bears are vitriolic in their commentary, partly because a bet on gold is a bet against the financial system and that does not sit well with many investors.

In terms of target prices in the short-term, step one on the road to recovery will be a close back above $1,620; step two will be a close above $1,800; and the third and final step will be a close above the current all time high of $1,923. Once gold breaks through $1,923, the sky's the limit. We will get there; it will just take some time. My final target for gold is much higher than today's price and I will reveal it in good time, but for now, we need to stay focused on the price action in the shorter-term so we can identify with some confidence when the current bout of selling has ended. In sentiment terms, we are still at all time lows since the bull market began in 2001. The Hulbert Gold Sentiment Index shows that newsletter writers continue to recommend a net short position in precious metals and public opinion on gold is at a bearish extreme. Patience will be rewarded.

Gold sentiment at a bearish extreme; at the lowest level since the bull market began in 2001.

To learn more about the full range of investment services available at Secure Investments, please contact us by email at brian.delaney@secureinvest.ie. 

April 2013 Investor Letter

Model Portfolio Update

Past performance figures are estimates only and may not be a reliable guide to future returns.

Executive Summary

The Active Asset Allocator Model remains fully invested with 60% equities, 20% bonds and 20% gold, a position that has been maintained since June 2012. The risk of a medium-term peak in equities is increasing. The S&P 500 is close to setting new all-time highs (above 1,576), last seen in October 2007. We should get there shortly and the smart money may use it as an opportunity to unload their shares to optimistic retail investors who are always too bullish at market tops and too bearish at market bottoms. This time should be no different. Investor sentiment is frothy. Confidence is high. There is still no technical evidence yet to warrant moving to a more defensive position but I remain on alert for clues of a trend reversal.

Equity Market Update

We are on week 19 of the current investor cycle. Investor cycles typically last 20 weeks on average, rising for a minimum of 10 weeks during bull markets but less than 10 weeks during bear markets. So, the current cycle has been quite powerful but is now stretched and likely close to correcting. As noted last month, stock markets have been rallying since March 2009, so the current bull market is four years old. Bull markets on average last 3.8 years. Equities have been propelled higher by record levels of liquidity supplied by central banks to the financial system. However, a significant amount of 'quantitative easing' has now been priced in to global stock markets.

The recent news from Cyprus that depositors will lose up to 10% of their savings as part of a troika-led bailout of their insolvent banking sector is a game changer. So far, equity markets have shrugged at this news. However, in time, we will look back and view the events unfolding in Cyprus as a turning point in the Eurozone financial crisis. Until now, depositor savings have always been sacrosanct. (Cyprus has a €100,000 bank guarantee scheme but no funds to back it up). Depositors want no risk and typically lend to banks in return for a low, risk-free rate of interest. This relationship is based on a level of trust; a trust that has now been broken. Perception is that Cyprus is a unique, self-contained event. Reality, once it sets in, will be quite different.

Changes to investor psychology take time to have an impact. Once confidence in the banking sector is lost, it is very difficult to restore. The case for owning gold has just become stronger. Hedge fund manager and mentor Bill Fleckenstein put it very well recently when he said:

"Oftentimes, events come along that change the psychology, the fabric of trust, or affect the business cycle and go unrecognised simply because such things take time to play out, or one event impacts another and then another…. Just because there was no 'implosion' yesterday when the markets got a chance to react to the Cyprus bank plan does not mean that it will not have many more consequences down the road. Psychology is an extremely important component of the whole investment landscape. The willingness to suspend disbelief regarding inflation and the monetization of debt here, in Europe, and everywhere else for that matter is a big reason stocks and bonds are where they are. When one considers what people have been willing to look past (or disregard), it is clear that it wouldn't take much sobering up to cause a whole litany of problems."

The EU and ECB have sent a strong signal to Eurozone depositors that can now not be retracted. Deposits held in Eurozone banks should no longer be considered as riskless investments. If there is so much trouble over Cyprus, what will happen when Spain has to deal fully with the losses in its banking sector? Contagion risks to peripheral Eurozone countries have just stepped up a notch. These risks have yet to be discounted by a remarkably confident contingent of equity investors. Margin debt is now close to its prior 2007 peak. Investors are borrowing to invest in stocks at a rate not seen since 2007. Are memories really that short? Leveraged equity investors have been right with their positions so far, but there is an eerie similarity to prior periods of irrational exuberance. Corporate margins also appear to be peaking just as investor sentiment becomes overtly bullish. Market commentators continue to call for higher stock prices in the months ahead. Stocks look cheap because the next twelve months earnings are at record levels. Corporate margins always mean-revert over time. The best time to buy stocks is when profit margins are turning up from depressed levels, not when they are turning down from record highs.

Newsletter writers have rarely been more bullish in their outlook for stocks than at the present time. John Hussman of the Hussman Funds recently made the following observation:

"Last week Investors Intelligence reported that the percentage of bearish investment advisors has declined to just 18.8%. The last time bearish sentiment was below 20%, at a 4-year market high and a Shiller P/E above 18, was for two weeks in May 2007…. The next instance before that was two weeks in August 1987…. The next instance before that was for three weeks in December 1972, which was immediately followed by a 50% market plunge… The instance before that was in February 1966, which was promptly followed by a bear market decline over the following year. You get the picture."

The cyclically adjusted Shiller P/E (CAPE) for the S&P 500 (price divided by ten-year average inflation-adjusted earnings) shows that stocks are not priced for long-term gains and are, in fact, quite expensive relative to the past 100 years of data. The CAPE is currently 22.8 times, a level similar to previous valuation peaks not troughs. 

Investor sentiment can and often does remain elevated for lengthy periods of time, particularly with such significant central bank support. This is why technical market timing tools are so useful. The technical set up for stocks remains positive as captured by my technical trend indicator. This indicator comprises a mix of market sensitive data that work together to keep investors on the right side of major market moves. The rising trend will likely break over the next few months and this will result in a recommendation to move to a more defensive position. I am on watch for warning signs of a trend change and will advise accordingly.

Technical Trend

In sentiment terms, the four-year equity bull market has had its effect. Investors are once again optimistic in their stock market outlook and only see blue skies ahead. The Hulbert Stock Sentiment Index (below left) suggests the rally is due to at least pause and consolidate. The Intermediate Term Indicator Score (below right) suggests there may still be room for stocks to rise, confirming the current bullish stance of my technical trend indicator.

Bullish equity sentiment is reaching extreme levels.

Bond Market Update

Record low government bond yields unsustainable.

With 10-year government bond yields for Germany, US, UK and Japan all now trading below 2.0%, it is very difficult to make a long-term bullish case for buying bonds. After all, when inflation is taken into account, real yields are negative across the board. A 1.0% increase in 10-year yields will result in an 8-10% capital loss on your 10-year fixed income investment. Investors should favour bonds with a shorter term to maturity, as they are less sensitive to interest rate movements. Bonds should now only be used as a tactical safe haven investment; somewhere to shelter during periods of turmoil in stock markets.

Sentiment today is neutral on government bonds following last month's rally. Bonds may catch a bid during the second half of 2013 if equity markets begin a multi-month decline, but the long-term case for owning government bonds, particularly long duration bonds remains rather weak.

Sentiment neutral

Gold Market Update

Gold has started to act better in recent weeks following a long and difficult 19 month decline from all-time highs. Sellers now appear to be exhausted. However, we have yet to experience a sustained period of buying pressure. That will come in time but first we need to see gold break and hold above the $1,650-$1,700 range. Buyers should step in once they become more confident that the almost 2-year decline is at an end. Odds are high that gold has made a significant low in the $1550-$1,590 range. I believe we are close to the next major move higher in this bull market that should take gold over $2,500 in the next 18-24 months.

Sentiment remains at levels similar to previous investor cycle lows. The Hulbert Gold Sentiment Index reflects newsletter writers' continued contempt for the sector as they recommend investors take a net short position in precious metals. Public opinion on gold is flat as a pancake. This should be music to the ears of gold bulls. After twelve consecutive years of rising prices, one would think that there should be a reasonable level of excitement and expectation for the sector but in fact the opposite is the case. Long-term gold holders will once again be rewarded for their patience as rising precious metals prices lift sentiment later this year.

Record low sentiment reached on gold

An interesting divergence is appearing in the gold mining sector. Despite gold mining stocks making lower lows recently, fewer stocks are falling this time around, a common occurrence near major trend changes. This non-confirmation is evident in the following chart. The McClellan Summation Index, which measures the number of stocks declining versus advancing, has not confirmed the recent price lows set by the mining sector. Also at the bottom of the chart, fewer stocks are closing below their long-term 250 day moving average. This also signifies that the record decline may be nearing an end. If this turns out to be the case, the entire gold mining sector may be indicating that a major turn is at hand.

Are we there yet?

We are at a defining moment in this bull market for precious metals. After rallying for 12 straight years, gold has started 2013 by declining -5% in euro terms. If the bull market is still intact, which I believe is the case, then the next significant rally should be around the corner. A close below $1,520 for gold will postpone the next major move higher for another while. We will know soon enough.

To learn more about the full range of investment services available at Secure Investments, please contact us by email at info@secureinvest.ie.  Please feel free to pass this report along to anyone who you believe may have an interest in the services on offer.