Monthly Outlook: August 2017
We’re starting to sound like a broken record: Last month was yet again another good month for markets and our iFolios’ returns. But that’s a tune we never get tired of hearing! Let’s get right to the numbers. For the month of July, U.S. stocks (Russell 3000) gained 1.9%, international stocks (FTSE All‐world ex‐USA) soared 3.3% higher, and bonds (Barclays Aggregate) plodded 0.4% higher. The trends continue to be “up” for all markets so we remain fully invested. We will point out that markets are fairly extended within their trends, however. For example, the S&P500 is 6.2% above its 200‐day moving average trend line and the NASDAQ is 9.5% above its 200‐day moving average trend line. What that tells us is that the up‐trends are strong and that maybe, just maybe, markets could pause or even pullback a bit over the near term. And by “a bit”, we mean 3% to 6%, let’s say. But until the long‐term uptrends are broken (and we’re a long way from that) we do not see significant downside risk.
Many Gurus are Calling the Top
You may have noticed lately that some pretty well‐ known gurus are cautioning investors that markets are risky and that we’re likely at “the top.” Analysts and managers love to call the tops (and bottoms for that matter) because it makes them look smart when they’re right. And, of course, when they’re wrong (which is most of the time) they just hope you forget about the call. Predictions are famously wrong most of the time. We know from history that tops and bottoms rarely occur when everybody calls for one. If this does prove to be the top of this nine‐year stock rally, it will be one of the most telegraphed tops in history. Our guess is that yes, we’re all justified in being concerned, but we’re at least several months away from any long‐term trend changes (to down).
As readers are aware, we’ve routinely discussed the valuation metrics of the stock markets and have acknowledged that this market is over‐valued. In fact, it’s as over‐valued as any previous peaks including 2007, 2000, and even 1929. But frankly, these high valuations have been around for a year and we would have missed out on about 10% of continued gains if we had sold stocks a year ago. But sure, we have to be concerned and watchful given these record‐high valuation levels. Extreme valuations (both high and low) tell us a lot about the potential of price movements once the momentum (or trend) changes. We know that high valuations like the ones that are in place today, can result in losses of 40%‐plus once the trend is broken. But until that happens, it’s also entirely possible that markets just trend higher. Make sense? So obviously, our job is stay invested but on high alert for any trend change in any asset that we hold. And that’s what we do. We look at every asset, every day. We’ll let you know when anything changes but for now let’s enjoy the gains.
Predicting Black Swans
In “investment‐speak” a black swan is a very rare event, that is near‐impossible to predict, that can have catastrophic results for investors. It’s understandable, then, why analysts love to ponder about potential black swans and to identify the next one before everybody else. Today, people point to North Korea and their increasing use of ICBMs, the dysfunction of the Trump presidency, his cabinet, and his communications staff, the huge expansion of global debt amongst governments, businesses, and individuals, the potential involvement of Russia in U.S. politics, and on‐and‐on. But the point is that all of these widely‐identified issues are therefore unlikely to be the next “black swan.” They’re too well known and already factored in. Only in hindsight will we look back at a black swan event and wonder how we didn’t see it coming.
Calling tops and predicting black swans are probably necessary functions for investment analysts but there is a better way to manage portfolios without guessing. Our iFolios strategy is to build well‐diversified global portfolios with low‐cost index funds. Then we use fact‐based trend‐following to know when to be fully invested for growth and when to be under‐invested for protection. It’s a strategy you can count on.