We have no changes to the model portfolio this week.
The S&P hit a new 52-week high this week but fewer than 70% of stocks in the index closed above their 50 day moving average. This has happened 55 other times in the past 15 years. Two months later, the S&P was positive only 24% of the time with an average return of -3.9% (max gain +2.4%, max loss -7.2%).
The rally in stocks was driven by news that the Federal Reserve would begin a modest tapering of their monthly bond purchases starting in January 2014. Instead of printing $1,020BN next year, the Fed will print $900BN. Fewer buyers of US Treasuries will likely result in higher US government bond yields, exactly what the Fed is trying to prevent.
Although the trend remains bullish for stocks in the short-term, stocks remain expensive and trade on a multiple of peak earnings. The S&P 500 for example trades at 25 times the average of the last ten years of earnings, adjusted for inflation (chart below right). We continue to believe that the risks are elevated that a downside break in markets will occur in the not too distant future.
Economic: On the economic front, data releases were generally positive this week in the US. Although the Manufacturing PMI came in behind target (54.4 versus 55.0 expected), industrial production (+1.1% versus +0.4% estimate) and capacity utilisation (+79.0% versus +78.4%) both beat expectations in November. Revised estimates for 3Q GDP growth showed that the US economy grew at an annual rate of 4.1%. Economic growth is expected to pick up in the US in 2014 from +1.5% to +3.0% and in the EU from -0.6% to +0.9%. Ireland is also forecast to growth next year by +1.5%.
Technical: From a technical standpoint, although the trend is still positive, the Advance/Decline Line continues to flatline, unable to keep pace with the recent stock market rally. In the short-term, stocks are drifting as buying power and selling pressure have stalled.
Strategy: The stock market remains overvalued, overbought in the near-term and investor sentiment has reached an optimistic extreme. We therefore maintain our cautious stance with an allocation in the model portfolio of 20% stocks, 50% bonds, 20% gold and 10% cash.
Next update: Friday 10th January 2014.