March 2015 Investor Letter

Model Portfolio Update

Executive Summary

Currency swings are getting more violent, a clear sign of stress in financial markets, as central banks step up their efforts to intervene, all in the name of price stability. Of course, increased currency volatility has been a direct result of central bank intervention. With the Euro -25% in 12 months, systemic risks are rising and a market dislocation cannot be ruled out. Despite the escalating risks, equities continue to trade in bullish mode. In this month's Investor Letter we examine some potential chinks in the armor of the stock market.

The Active Asset Allocator is currently defensively positioned 20% equities / 30% bonds* / 30% gold / 20% cash. (Bonds now include euro government, corporate, inflation linked and absolute return bonds). We increased the allocation to gold in December 2014 from 20% to 30% and gold rallied +20% the following month in euro terms.

Stock Market Update

While stock markets were surging higher back in 2007, three technical indicators were diverging and signalling potential trouble ahead. The Relative Strength Indicator (RSI) and Moving Average Convergence Divergence (MACD) Indicator shown at the top and bottom of the following chart were both losing momentum, making lower highs and lower lows for much of 2007 despite rallying stock prices, suggesting that the underlying trend of the market was weakening. (The third indicator of course is our own Technical Trend Indicator, which forms the basis of the decisions we take in our Active Asset Allocator investment strategy). Both indicators of course proved prescient as stock prices tumbled in 2008.

 
 

Roll forward to today and we may have a similar set up. Global stock markets, measured by the FTSE All World Index above, peaked at 286.09 in September 2014, declined in October 2014 and then made a slightly higher high in February 2015 at 286.34. Today, FTSE All World Index trades at 282. Note however, that the technical indicators, the RSI and MACD, are diverging again. Both have been unable to confirm the recent highs in the stock market. If this internal market weakness persists for much longer, we could experience an acceleration in selling in the stock market. Our own technical trend indicator is also only a couple of days away from delivering another "All Market Sell Signal". We therefore remain defensively positioned in the Active Asset Allocator, holding 20% equities, 30% bonds, 30% precious metals and 20% cash.

 
 

On a regional basis, stock market performance has varied widely, depending on which currency is used as the denominator. Currency swings are getting more violent, a clear sign of stress in financial markets, as central banks step up their efforts to intervene, all in the name of price stability. Of course, increased currency volatility has been a direct result of central bank intervention. With the Euro -25% in 12 months, systemic risks are rising and a market dislocation cannot be ruled out. Despite the escalating risks, equities continue to trade in bullish mode

Since January 2014, the clear stock market winner has been the United States, where the S&P 500 (below left) has rallied +15% while the USD has also gained +26%, providing a double win for non-US investors. The S&P 500 chart in euros now looks parabolic in its rise (below right). Currency volatility is distorting the investor decision-making process and leading to mis-allocations of capital. This will not end well. 

In addition to the overvalued and overbought nature of the US stock market, long USD is now also a very crowded trade. At some point soon, US equities and the USD will both turn lower and non-US investors will suffer a double hit. We continue to advise caution for now.

 
 

Closer to home, the Euro has lost a full -25% of its value in a little over a year, a staggering move (Thank you Mr. Draghi). EU stocks have so far been able to offset those currency losses, albeit to differing degrees. Since January 2014, the Eurostoxx Index has returned +24%, Germany +26%,  France +20%, Italy +12% and Spain +12%. If you are a non-Euro investor however, and you have not hedged your currency exposure, your net return from investing in the EU stock market has been, at best, zero.

The rally in the USD (and plunge in the EUR) has been relentless without any kind of correction in over twelve months. I am expecting a "sell the news" event that puts at least a short-term top in the USD (and bottom in the EUR) as Fed Chair Janet Yellen steps up to the microphone and once again announces she will think about raising rates from zero to 0.25%. When stock, bond and currency markets catch on to the fact that the Federal Reserve is trapped there will be hell to pay, but that is tomorrow's news. Today, investors appear unconcerned.

It is interesting to note that, while US and EU stock markets have been ripping higher, emerging market equities have not participated in the cyclical bull market in stocks over the past five years. Emerging markets have been consolidating in a relatively tight range over that time. A break higher would be a bullish development and likely cause us to add an allocation to EM in our Active Asset Allocator investment strategy. For now, we watch and wait.

 
 

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

We continue to operate in an environment of low inflation and modest economic growth in the Eurozone, which supports our continued positive outlook for Eurozone government bonds. The ECB is also helping our cause, printing €60BN / month and buying bonds of EU member states in an effort to fulfill their price stability mandate.

Yields on AAA and AA EU government bonds have reached record low levels and have moved below zero for 2 and 5 year bonds in Germany, Netherlands and Austria. We believe there is still scope for peripheral EU bond yields to fall and prices to rise. The performance and asset distribution of the iShares Euro Government Bond Fund ETF in our Active Asset Allocator strategy is summarised below.

Our smaller allocation to EU corporates and inflation linked bonds offer some additional protection in the form of a higher yield for corporates and inflation protection in the index-linked fund. However, these holdings are more short-term tactical positions rather than long-term holdings, as we continue to wait for a lower-risk entry to the stock market.

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

Gold Market Update

The USD surge (and EUR plunge) has been one of the most violent on record since the Euro started trading on world financial markets on 1st January 1999 (at €1.00 / $1.1743). The Euro is now approaching oversold levels on a technical basis (MACD and RSI) and we should expect a rally in the EUR from here.

 
 

Commodities have borne the brunt of the USD rally over the past 18 months but are now trading at long-term support. The CRB (Commodities Research Bureau) Index for example is priced at a -20% discount today to the price it reached all the way back in 1996. Despite the US central bank printing trillions of USD in the intervening period, investors continue to focus on deflation as their main concern.

 
 

We are getting close to the inflection point when inflation rather than deflation becomes the key focus for investors. This is why we own gold in the Active Asset Allocator. Despite the correction in 2013, gold (priced in euros) continues to be the stand out performer relative to equities and bonds since 2007. Gold also provides an excellent hedge during difficult, volatile markets. 

We increased our allocation to gold in the Active Asset Allocator in December 2014 and caught the +20% surge in Euro gold in December and January. Now that the USD has potentially topped, we are looking for gold to make its move. If we don't get what we are looking for, we cut back our allocation to precious metals accordingly, but for now, we are happy with our positioning and remain patient for gold to show its hand.

 
 

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

February 2015 Investor Letter

Model Portfolio Update

Executive Summary

The Active Asset Allocator was handsomely rewarded with an overweight position in bonds in 2014. This year, we are diversifying into corporate and inflation linked bonds while we wait for a compelling entry point into the stock market. In the meantime, our overweight gold position is working well. Our overweight position in equities worked in 2012 and 1H2013 and our overweight position in bonds worked in 2014. Gold is shaping up to be the trade of the year in 2015 and we fully intend to participate. Why don't you join us? We are not fussy where the returns come from, only that they do come in some form.

Equity Market Update

We start this month's update with a recap of the current positioning of the Active Asset Allocator investment strategy. As a reminder, the Active Asset Allocator invests in a mix of global equities, bonds and precious metals, the allocation of which is actively managed and determined by each market's primary trend. One of our tools, the technical trend indicator, delivered a 'sell' signal in October 2014 and has remained in defensive mode ever since. As a result, the Active Asset Allocator remains defensively positioned today with an allocation of 20% global equities / 30% bonds / 30% gold / 20% cash.

 
 

While European stock markets have started 2015 on a firm footing, US equities have traded in a weaker fashion, chopping sideways in the first six weeks of the year. US equities now account for 57% of the typical investment manager global equity benchmark and this is why we focus so much of our time and research on this region. A break below support will have us sitting tight in defensive mode and focusing on a low risk place to rebuild our equity exposure. If we get a sustained break in the S&P 500 above resistance and out to new all time highs, we will increase our equity allocation, despite current expensive equity valuations. If we increase our equity exposure, we will have a clearly defined exit strategy in place in the event that the market turns lower later in the year.

 
 

We have come a very long way from the March 2009 stock market lows - over 200% in fact if the S&P 500 is your benchmark. In that time, the VIX (FEAR) Index, a key measure of stock market volatility (blue dotted line below) has returned to pre-crisis lows, falling from a crisis peak of almost 80 in 2008 back to 12 in December 2014, an -85% drop. The Vix Index rises on fear and falls on greed. It reached multi-decade lows in December 2014. However, in the first six weeks of 2015, we have seen a +45% jump in the Vix, our stock market volatility barometer, from 12 to 17.5. Investor complacency has given way to a small degree of investor angst. It is too early to tell just yet if this is an emerging trend, but our interest is piqued.

 
 

This next chart should give the equity market bulls something to think about. Here we see real NYSE margin debt growth - basically investors borrowing to invest in the stock market - at a new all time high, above both prior peaks in 2000 and 2007. Amazing. If/when margin debt peaks and starts to turn lower, the stock market will be in trouble. Margin debt growth may have peaked in February 2014. We will have to wait and see. 

 
 

Let's end the equity market update on a positive note. Healthy bull markets require a majority of stocks to participate in the uptrend. The Advance/Decline Line - a key input into our Technical Trend Indicator - captures this trend and so far, the trend continues in a bullish fashion. The A/D Line hit a new all time high just last week, tipping the scales once again in favour of the bulls. Other inputs into our trend indicator are more cautious but the A/D Line is signalling that new highs lie ahead. 

Typically, the A/D Line tops out weeks or months before the stock market as you can see in the following chart. We wait patiently for the market's next signal.

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

US real GDP has grown by 2.2% per annum for the past four years, accelerating to over 4.0% in the last six months, with no real sign of inflation or deflation. US 30 year treasuries are currently yielding 2.6%. In the Eurozone, real GDP growth has grown by +0.3% pa over the same period, nudging higher to +0.4% in recent months, while deflation remains the prevailing threat. German 30 year bunds currently yield 0.9%. Neither bond market offers compelling value, while both appear to be discounting a slower growth and/or recessionary environment in the not-too-distant future. However, capital has been treated well in the fixed income markets and as long as that trend continues, the bond bull market won't die.

The Active Asset Allocator currently holds a 30% allocation to Eurozone government bonds (1.3% yield, 10 year duration), a 5% allocation to Euro aggregate bonds (0.7% yield, 6 year duration) and a 5% allocation to Euro inflation-linked bonds.

The Active Asset Allocator was handsomely rewarded in 2014 with an overweight position in Eurozone government bonds. This year, we are diversifying into corporate and inflation linked bonds, while we wait for a compelling entry point into the stock market. In the meantime, we continue to benefit from our overweight position in gold. Our overweight position in equities worked well in 2012 and 1H2013; our overweight position in bonds worked well in 2014; our overweight position in gold is working well so far in 2015. We are not fussy where the returns come from, only that they do come in some form!

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

Gold Market Update

We increased the allocation to gold in the Active Asset Allocator from 20% to 30% in December 2014. Shortly afterwards gold took off, rallying +20% in euro terms before giving some of that back in the last week. We will likely cut back the allocation to precious metals in the Active Asset Allocator shortly and wait patiently for the next safe entry point, likely to come in April or May. Gold is gearing up to potentially be the trade of the year for 2015 and we fully anticipate being on board along with our clients. For any prospects reading this evening, please do get in touch and we can show you how to implement the Active Asset Allocator in a very cost effective way.

 
 

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

January 2015 Investor Letter

Model Portfolio Update

Executive Summary

Despite being defensively positioned for much of the year, the Active Asset Allocator delivered a strong performance in 2014, +15.6%, outperforming the average multi-asset fund by +3.1%. Buy-and-hold equity investors have been spoiled in recent years as all news has been treated favourably. That trend is about to change and many will be caught wrong-footed. We anticipate another strong year for the Active Asset Allocator in 2015 as we navigate what we expect will be increasingly turbulent waters.

The Active Asset Allocator is defensively positioned today 20% equities / 50% bonds* / 30% gold. (Bonds now include euro government, corporate, inflation linked and absolute return bonds). We increased the allocation to gold in December 2014 from 20% to 30% and gold has since rallied +9% in euro terms.  

Equity Market Update

Is history about to repeat? January 2015 has started out in quite a volatile fashion with government bond yields falling (and bond prices rising), crude oil prices tumbling, high yield bonds topping out and the US dollar rallying sharply. The same trends occurred in 2008 before the stock market fell out of bed. 

In our December 2014 Investor Letter, we began with a 6 month chart of the S&P 500, questioning the sustainability of the recent break out to new all time highs, given the many risks that we see on the horizon. Our cautious stance has so far been proven correct. Shortly after breaking out to new 52-week highs, the S&P 500 rolled over and plunged -10%. We then witnessed a sharp bounce in what we noted at the time had all the hallmarks of a short-covering rally, followed by more selling in the first week of January 2015, which is where we find ourselves today. Heightened stock market volatility will be a prevailing theme this year. Be prepared.

 
 

Last month, we also discussed the plunging price of crude oil, which we expect will drive many financial trends all over the world in 2015. We highlighted the strong positive correlation between European equities and Brent crude and noted that crude oil was either about to have a snap back rally (unlikely) or European equities were in trouble. Let's take a look at the updated chart today.

 
 

In a little over a month, Brent crude has fallen another -30% or $21/barrel, while the German Dax Index has dropped -5% or almost 500 points. This divergence has a long way to run before it resolves itself either by crude oil rallying sharply or European equities entering a bear market. For now, we continue to be positioned defensively in the Active Asset Allocator.

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

Bond Market Update

Following the strong performance by government bonds in 2014, we have begun to shorten the duration of the bonds we hold in the Active Asset Allocator, making the portfolio less sensitive to changes in interest rates. We also started to increase the allocation to inflation-linked bonds and corporate bonds. We will likely keep the allocation to corporate bonds relatively low as they are positively correlated to risk assets. 

Government bond yields around the world continue to decline and credit spreads (the difference between risky high yield bonds and lower risk government bonds) continue to widen. We witnessed the same phenomenon in early 2008 as investors started pricing in the increased global macro risks at that time. The credit spread ratio on the chart below has not yet reached 2011 or 2008 levels, but it is still rising and the slope is getting steeper. We are watching this chart closely, particularly now that the down-sloping trend line from 2009 - 2014 has been broken.

 
 

High yield bonds have not confirmed the recent highs in the S&P 500, which is another red flag we are monitoring closely for now. Should equities and junk bonds rally to new highs together, we will move back to a more constructive asset allocation, but for now, continued caution is warranted in our view.

 
 

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

Gold has historically performed best during periods of US dollar weakness relative to other currencies. What we can see clearly in the following chart is that since 2011, gold has struggled while the USD Index (faded blue line), a proxy for the US dollar, has rallied sharply. Gold got ahead of itself in 2011 and too many bulls crowded the long side of the precious metals market. Those late to the party have now been well and truly shaken out of their positions. Sentiment has reached a negative extreme and it is our view that the three year bear market in gold may have ended in December 2014.

Look closely at the chart below. You will see that the US dollar has rocketed higher over the last few months but gold has refused to decline. This is quite a change in behaviour for the precious metal and a clear signal that the gold bull may be about to return. We recently increased the allocation to gold in the Active Asset Allocator from 20% to 30% to capture what we expect will be rising gold prices in the months ahead.

 
 

When gold recaptures the longer-term 20 month moving average, we will become more confident that the gold bull market is back. Capital should come flooding back into the precious metals sector when the trend higher resumes.

 
 

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

December 2014 Investor Letter

Model Portfolio Update

Executive Summary

2014 is shaping up to be another good year for our Active Asset Allocator investment strategy. We have been able to maintain our 12% annual return since inception and are on target to beat our benchmark despite our strategy's lower risk profile. Stock markets have been strong all year and have returned 15%-18% YTD. However, bonds have done even better +19%, justifying our overweight position. Long duration bonds are +25% this year, an incredible performance. We are making a number of changes now to the bond allocation in our AAA model to reduce the interest rate sensitivity of the bonds we own, including:

  • Reducing the allocation to 5+ Year EU government bonds from 30% to 20%
  • Adding 5% allocation to EU aggregate bonds
  • Adding 5% allocation to EU inflation linked bonds
  • Reducing the allocation to absolute return bonds from 30% to 20%
  • Adding 10% allocation to gold

We are increasing the allocation to gold from 20% to 30% ahead of what we expect will be a strong period for precious metals in the months ahead. Our Active Asset Allocator is now positioned 20% equities / 50% bonds* / 30% gold. (Bonds now include euro government, corporate, inflation linked and absolute return bonds).

Equity Market Update

The S&P 500 has put in a powerful rally to recover from the sharp -10% correction in October. The move so far has been straight up without correction. In fact, coming off a six month low, for only the second time since 1928, the S&P 500 traded above its 5-day moving average for 30 consecutive days, before ending that streak on 1st December. That is an impressive move and has all the hallmarks of a short covering rally. The bulls appear to have regained the upper hand for now. However, if the majority holding a short position against the S&P 500 have been carried out, we may have a vacuum below current price. Short sellers are a necessary part of any functioning market and have the effect of slowing down a stock market in decline, as the shorts must always buy to cover their initial sale. When the stock market trades like it has done for the past few weeks and the shorts get run over, often the real move (lower in this case) only occurs afterwards. It doesn't always have to happen this way of course, but we are not out of the woods yet. Let's take a look at some charts to see how stock markets around the world are setting up today.

 
 

It has been a roller coaster year for US equity investors. The S&P 500 returned +9% through September before falling out of bed in October and giving up all the gains for the year. Stocks then rocketed out of those October lows and the S&P 500 is now back to +10% YTD. A strong US dollar versus the Euro has added another +10% for unhedged Euro investors. If you have been able to withstand the volatility, 2014 is turning out quite well. However, the US stock market has used up a lot of energy to get to where it is today. The bulls are now fully committed, the bears have covered and the Fed has pulled $1 trillion of financial support. So, who is left to buy? We should find out shortly.

While US large cap stocks continue to make new highs, albeit on declining volume, European markets are lagging. The Eurostoxx 600 Index (above left) and the German Dax Index (above right) have failed so far to make new highs along with the S&P 500. It is the same story for the small cap sector with the Russell 2000 in the US making a series of lower highs and lower lows in 2014. These divergences could be signalling that equity markets are running out of steam and due for a pause/consolidation. Also, Brent crude has historically had a strong positive correlation with European equities and Brent crude is now plummeting. Either crude oil is about to have a snap back rally or equities are about to roll over.

 
 

Spain and Italy have traded in a wide range since the 2008 financial crisis. While stock markets in the US and many across Asia have tripled or more since the 2009 lows, Spain and Italy trade at less than half their prior peaks today... six years into the current equity bull market.

The outlook for Europe is challenging as we head into 2015. The region is forecast to grow by only 1%, versus 2.5%-3.0% for the US, and deflationary risks are rising. We expect EU equity markets to struggle next year. However, the Euro has fallen by -10% versus the US dollar in 2014, which should benefit export-oriented companies in the region and further Euro weakness in 2015 could prove a catalyst for EU stocks. Much will depend on the ECB.  

There is precedent here. The set up across many EU stock markets today looks similar to that of Japan in late-2012. The Nikkei had traded in a wide range between 7,000 and 11,000 from 2009-2012 but then broke higher in November 2012. The catalyst was Japanese central bank money printing. The Nikkei went on to double in JPY terms over the next 24 months while the Japanese Yen collapsed by -40% versus the USD. While we don't expect a similar outcome for Eurozone stocks this time, it cannot be ruled out. We are watching the EU currency and stock markets closely for clues.

 
 

For now, we remain defensively positioned in our Active Asset Allocator investment strategy.

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

Bond Market Update

 
 

Our Active Asset Allocator investment strategy has been overweight bonds all year and while equities have returned 15%-18% so far in 2014, the bonds we hold are +19% YTD, while longer duration bonds are +25% over the same period. Today, a passive 5+ year EU government bond fund - a good proxy for our model portfolio bonds - has a duration of 10 years and a yield of 1.5%. While yields can fall further, there really is limited room left for yields to decline (and bond prices to rise). We do not expect a dramatic rise in interest rates for the foreseeable future, particularly as deflation grips the Eurozone, but believe it is prudent to start reducing the interest rate sensitivity of our bonds now. As a result, we are making the following changes to the model portfolio:

  • Reducing the allocation to 5+ Year EU government bonds from 30% to 20%
  • Adding 5% allocation to EU aggregate bonds
  • Adding 5% allocation to EU inflation linked bonds

We are also reducing the allocation to  absolute return bonds from 30% to 20% and increasing the allocation to gold from 20% to 30% ahead of what we expect will be a strong period for precious metals in the months ahead.

We would like to include an allocation to emerging market debt in our AAA model but today is not the time, as emerging market debt has already rallied sharply over the past 18 months and offers no real margin of safety.

 
 

The same is true for high-yield (a.k.a. junk) bonds. Investors are reaching for yield in a zero interest rate world and will pay a heavy price when the market turns. It could in fact be turning now. The Barclays High Yield Bond Index below is rolling over and has not confirmed the recent highs in the S&P 500. Risks are rising, buyer beware.

 
 

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

The volatility in precious metals has picked up sharply in recent weeks. Buyers and sellers are battling it out, which is often a signal that an intermediate-term trend change is at hand. Last Friday, gold fell $36 from $1,200 to $1,164. Then, following the Swiss referendum over the weekend, where the Swiss voted against a proposal to back the Swiss Franc with gold, on Monday morning gold fell another $22 to $1,142. The gold bears were sure gold would fall sharply following news from Switzerland, but the reverse happened. We experienced a dramatic $80 rise in the gold price back above $1,200, which is where we find ourselves today. Too many bears were crowding the short side of the market and were forced to cover.

 
 

An interesting set up is now occurring in the gold market. The USD gold price has made a series of lower lows over the past three years, but selling pressure is easing, as can be seen in the chart above (RSI and MACD indicators). The public today still believes it makes little sense to invest in gold at exactly the time when it is needed most. Sentiment will turn and when it does, gold prices will move substantially higher. 

For brave souls, the gold miners have enormous potential. Gold mining companies today trade at the same price relative to gold as they did when the gold bull market began over a decade ago. Mining is a notoriously difficult business but with crude oil prices falling - a major input cost in the mining business - and gold prices set to rise, certain gold miners offer incredible value today.

 
 

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