Week 42 Sitrep

Although the ultimate stock index returns for the week were not significant, the S&P 500 Index finished up 0.66%, the relief that came from good news of a trade deal between the U.S. and China made us feel better. The news on Friday sent the index up 1.09% for the day culminating another volatile week for U.S. stocks when there was little in the way of earnings or economic news. The trade headlines, once again, drove stock prices in both directions.

Source: J.P. Morgan Asset Management, Weekly Market Recap, 10/14/19

 

The largest companies with growth characteristics performed the best in the U.S., however the real relief was felt in non-U.S. stocks as the U.S. dollar fell in value relative to other foreign countries.1 To be fair, the headlines that drove higher stock prices were not limited to U.S. trade with China. News broke on Friday that a “peaceful” Brexit deal may be possible, and the British currency saw that as very good news. The news sent the broader MSCI EAFE International Index up 2.31% for the week. Emerging markets fared well also, finishing the week up 1.53%.2

Source: J.P. Morgan Asset Management, Weekly Market Recap, 10/14/19

 

Stock investors clearly interpreted the comments on Thursday and Friday to be clear sailing for those sectors hit hardest by trade news over the past year. Materials and industrials soared nearly 2% for the week, while the lower risk sectors like utilities and consumer staples were down for the week.3 Time will tell if this is a fundamental shift in thinking for the stock market.

Source: Bespoke Investment Group, The Bespoke Report, 10/11/19

 

Retail investors continue to lose confidence in stocks as the news headlines have convinced many that recession is on our doorstep. Although the economic data does not currently support recession in the near future, retail investors have reduced their stock holdings in favor of higher-priced fixed income investments. Despite an uptick in flows to equity funds after the election in 2016, optimism regarding the stock market has waned.4

Source: Bespoke Investment Group, Fund Flows Favor Fixed Income, 10/11/19

 

Jeffrey Saut recently quoted Jason Goepfert of Sentimentrader, who notes that investment sentiment has dropped to the 2nd lowest level since the financial crisis in 2008.5 Despite healthy corporate earnings and economic news, investors continue to heed the non-stop rhetoric of cable news that the end is near, causing many investors to miss out on one of the best performing U.S. stock markets in years.

Source: Jeffrey Saut, Saut Strategy quoting Sentimentrader.com, 10/14/19

 

If you are a client at Engrave Wealth or have attended one of our educational retirement seminars, you have heard us talk about the importance of investor demand. Our investment committee recognizes the importance of healthy corporate earnings growth and signs of a growing economy. But we also know that investors can invest in that growth or choose not to invest at all. There are many signs in the stock market that we follow to determine if stocks are in demand (more importantly, which kinds of stocks) and how we should invest in those areas to manage risk appropriately. We have seen many indicators over the years reporting that “stock fundamentals” are very attractive. If, however, investors are not interested in those stocks then even the best fundamentals can mean nothing. We are curious as to whether the recent news of weaker equity fund flows and investor skepticism are indicative of a weaker stock market outlook.

 

Our investment committee follows a strict discipline that identifies market indicators over three different time frames. The goal of these indicators is to help us know when various parts of the market are in higher demand than others. There are numerous ways of tracking demand in the stock market. The more obvious would include recording the number of stocks hitting new 52-week highs versus stocks hitting 52-week lows. We also look at how many stocks advanced in the last 10 days to the number of stocks that declined in the last 10 days. These are widely followed market statistics that help analysts to know where investors are placing their money.

Above is the data as reported for Monday, October 14, 2019. This measurement is for broad market indexes and it shows the indicator geared to measure long-term trends. The current status is a summary of many statistics measuring demand. The “indicator value” on the far right is our way of tracking trends. The indicator value is measured between 0-100 and a rising indicator value would suggest strengthening demand. The absolute indicator value of 52.66 means little unless you know that we began the year at 45.88 before rising to the mid-60’s in July 2019. If the indicator value closes a week below 45 then we would expect a change in status reflecting weaker demand for stocks. In other words, that would be a good time to reduce equity risk in the portfolio.

We also track the broad markets in shorter time frames as seen above. The shorter indicators point to some intermediate term weakness as shown in the quarterly indicator value as the U.S. and International markets have “down” indicators (shown under “Today’s Indicator Value”). The intermediate outlook, however, does remain positive. The short-term indicator tracks demand characteristics from all 36 sectors and subsectors of the U.S. stock market. Currently, the indicator shows a positive status as 17 out of 36 sectors show strengthening demand. Again, the absolute number (17) does not matter as much as the trend of that number in recent weeks.

The significance of the short-term indicator in our portfolio management is to look for opportunities when adding new money to stock positions would be most advantageous. If the short-term indicator were negative, we would likely look at pausing new investments into the market until the indicator changed to positive or instead seek to spread new investments out over time in smaller increments (dollar cost averaging).

Finally, we also look beyond the broader market index to determine the same demand trends for individual asset classes and sectors. The same methodology is quite useful for seeing which asset classes are strengthening. We like to invest new money in asset classes that are showing signs of increasing demand. It does not always mean that we eliminate asset classes that are weak in demand if the positions have been held for lengthy periods and we have taxable gains to consider.

This data is tracked daily and it is interesting to note that changes are usually very moderate and slow-moving. Therefore, we do not have to adjust portfolio’s every day, week or month. Evidence has shown that demand trends for individual asset classes change slowly.

The primary purpose of this discipline is to help our investment committee see evidence of changing risk levels in the investment markets. Our goal is to justify every investment we make by the standard of how much return can we obtain for the risk that we’re taking. If there is an investment that has a given amount of risk that does not offer enough potential return, that is an investment that will not be made. This process is one tool of many that our investment committee uses to determine when to adjust risk in a portfolio. The process has an excellent history of reducing risk at appropriate times and offering a better “risk-adjusted return” experience for our clients. We will be including updates on the risk metrics in our weekly sitreps.

If you’d like to schedule a time to discuss your portfolio or the markets in detail, please feel free to call our office at (281) 616-5935. We welcome the opportunity to sit down with you and learn more about your situation so we can help you optimize your portfolio to meet your financial goals for years to come.

Engrave Wealth Partners Investment Committee

Bill Day, CFP®, CIMA

Taylor Parker, CFP®

Greg Parker


Footnotes:
1. J.P. Morgan Asset Management, Weekly Economic Update, 10/14/19
2. J.P. Morgan Asset Management, Weekly Economic Update, 10/14/19
3. J.P. Morgan Asset Management, Weekly Economic Update, 10/14/19
4. Bespoke Investment Group, Fund Flows Favor Fixed Income, 10/11/19
5. Saut Strategy, Jeffrey Saut, “Contrarian Investing”, 10/14/19

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