Monthly Outlook: September 2019
August was a dizzying month for stocks with plenty of 1%+ daily moves in both directions. One tweet would drive algorithms to pump the market up 1%+ only to be followed by another tweet that would drive the market down 1%+. In total, the S&P500 oscillated over 700 points in August, or a total of 24%. But, at month end, the cumulative effect was just down -1.8%. International stock markets followed a similar pattern, down -2.4% for the month. Bonds were, again, the best performing asset class, gaining +2.7% in August as interest rates continue to fall. The 10-year US Treasury, for example, fell from 2.02% to 1.51% in August and we see further cuts in the months ahead. Tweets are surely not the best way to manage trade policies and other political matters but that’s where we are. The stock market is just trying to keep up and appears equally indecisive. Although the daily volatility has risen, the long-term trends are, luckily, not quite as volatile. And that’s what we follow to manage portfolios and asset allocations.
What the Trends are Telling Us
Our iFolios strategy is designed to grow your wealth – and keep it. We do that by investing in growth and income-producing assets (stock and bond index funds) so long as they are rising above their long-term trendline. We define that trendline based on each index fund’s 200-day moving average. It’s not uncommon for an index fund to stay above or below this trendline for a year or more. During these sustainable trends, we stay fully-invested (if up-trending) or under-invested (if down-trending). But sometimes, at turning points, we can experience some back and forth trend changes that forces us to buy/sell faster than normal. That’s where we find ourselves today. We’ve made more trades in 2019 than normal, but we’re dedicated to keeping you on the right side of the trends.
Today, up-trending markets are: All bonds, gold, cash & T-bills, US large growth, and NASDAQ stocks. On the other hand, down-trending markets are: US large value and dividend stocks, US small company stocks, European, Asian, and emerging market stocks, and commodities. It’s a mixed bag. Of the total world stock market, about 55% are down-trending, or below their 200-day moving average trendline. You can see, then, why our iFolios strategy has us holding quite a bit of cash, T-bills, and bonds, and why we’re underweighted stocks. We’re not guessing; we’re following the trends and investing accordingly. It’s the logical way to invest.
Economy and Valuation will Drive the Trends
Over the long-term, as in 7–10 years, valuation and economic factors drive stock prices. But over the short-term, risk-seeking or risk-aversion psychology is more important. Valuation and economic data are actually easier to read than psychology. For example, it’s clear that the stock market is highly valued, most likely over-valued, today. Indicators like TMC/GDP, PE10, and Margin Debt are all at peak levels only seen in 2007, 2000, and other tops. We can also read economic reports that PMI is below 50, the yield curve is inverted, factory orders are slowing, house prices are softening, and corporate earnings growth is slowing. On Friday, we’ll get another monthly jobs report and a rise in unemployment above 3.7% will be further evidence that employment is softening, too. All the data, both valuation and economic, suggest that over the next 10 years, stock returns are likely to be significantly below average. But, how do we get there? Does the market stay flat for 10 years? That’s highly unlikely and historically unprecedented. Does the market go up, then down? Or down, then up? To answer this short-term question, we use our trend-following signals that we discussed earlier. Changes in price trends are an indication of a change in psychology. And as we noted, bonds are up-trending while some stock markets are starting to down-trend. The trends are showing us that investors are oscillating between risk-seeking and risk-aversion. Given the valuation and economic peak levels, we have to take these trend changes seriously and invest cautiously (and so we are!). What no one can know is how long a downtrend would last and how low it could take stocks. We’d be taking an educated guess, but a guess nonetheless, if we suggested a forecast. Instead, we’ll watch the trends every day, monitor any changes, and invest accordingly. Growth of wealth is important. So is keeping it.