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.

October 2014 Investor Letter

Model Portfolio Update

Executive Summary

Without an immediate about turn in the stock market, we will get an "All Market Sell Signal" on Friday for the first time in over a year. Stocks are now trading at their second highest ever reading based on Warren Buffet's favourite valuation tool. Stock market volatility has picked up recently, and in the short-term, equities are oversold and should bounce. In fact, there have been six other times the Vix Index has jumped 60% or more in three days. Every time, stocks rallied over the next two days. In four of the six times, the rally marked the end of the decline. However, in the other two instances, stocks rallied for 5-7 days and then rolled over to new lows. Our best advice is to continue to follow our Active Asset Allocator Model which is defensively positioned 20% equities / 30% 5+ year Eurozone government bonds / 30% absolute return bonds. / 20% gold.

Equity Market Update

This is a big week for the stock market. My Technical Trend Indicator (TTI) will deliver its first "All Market Sell Signal" in well over a year this Friday unless stocks do an immediate about-turn. Risks are running high as equities enter their sixth year of rising prices without a meaningful correction (we typically experience a 20% correction in stocks every 3.8 years on average). Investors must now contend with an overvalued stock market, overly bullish investor sentiment, the end of the Federal Reserve's latest round of money printing (QE3), which has provided $1 trillion of support to the capital markets this past year and a technical trend change in the market.

We have come a long way since the 2008/9 stock market lows and that is now reflected in equity market valuations. A Warren Buffet favourite valuation tool: US corporate equities are now valued at 127% of US nominal GDP, the second highest reading in history.

The S&P 500 has traded for 475 consecutive trading days above its 200 day moving average - the longest stretch in history - but closed below key support on Friday. While the most popular stock market indices (Dow Jones Industrials, S&P 500 and Nasdaq) are holding up reasonably well so far this year, the smaller cap indices in the US and many key European stock markets have been trading much weaker recently.

The character of the market is changing and this can be seen in the spike in volatility measured by the Vix Index (below) that has coincided with the recent decline in the stock market. In the short-term, stocks are oversold and should bounce from here. In fact, there have been six other times the Vix Index has jumped 60% or more in three days (19/10/1987, 13/10/1989, 8/6/1990, 27/2/2007, 6/5/2010 and 8/8/2011). Every time, stocks rallied over the next two days. In four of the six times, the rally marked the end of the decline. However, in the other two instances, stocks rallied for 5-7 days and then rolled over to new lows. If we get a relief rally that fails over the next week, watch out below. We remain defensively positioned in our Active Asset Allocator Model.

 
 

High yield bonds are also signalling renewed stress in the credit markets for the first time in over three years and equity investors definitely don't like it when junk bonds are plunging to new lows as they are today.

 
 

So, what's an investor to do? The technical trend indicator has navigated the market turns like a professional. Our Active Asset Allocator investment strategy has switched to defensive mode ahead of every significant stock market decline and reverted to bullish mode to capture each medium-term rising trend since inception. Note: the Active Asset Allocation Strategy switched to defensive mode in June 2013 due to our concern over the ageing equity bull market and has since benefited from an overweight position in bonds.

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

US and EU government bond yields are turning lower again but have yet to make new all time lows. Even if they do, there is limited room for yields to fall. We will likely stay in this low yielding environment for quite some time, particularly if equity market volatility picks up over the next 12 months. Only a bout of inflation or a currency crisis will cause yields to spike.

High yield bonds also look unattractive for yield seeking investors, particularly following their recent break lower. So, for investors in search of safety in a low yielding fixed income world, we are left with short duration government debt, emerging market debt and/or absolute return bond strategies. We have an allocation to two of these strategies currently in our Active Asset Allocator model and are happy to discuss in more detail.

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

Commodities as an asset class remain totally out of favour. The CRB Index, when measured against the S&P 500, has returned to 15 year lows, quite unbelievable when one considers the trillions of newly printed notes circulating in the system. We could start to see a rotation into this asset class if equities start to turn lower.

 
 

Gold continues to hold up quite well here, particularly gold priced in euros, which is +11% YTD. Despite gold's resilience to hold above $1,200, I am not hugely excited about the triple test of $1,180 by USD gold in recent months. These support zones tend to become targets for active traders and there are probably plenty of stops placed just under those levels. We could head back below $1,180 on the next decline for gold. That said, this bear market in gold is getting long in the tooth. 2015 could be the year for precious metals to shine once again as one of the remaining true safe haven stores of value in a fiat currency world. In the meantime, continued patience is required.

 
 

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