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Market and Selections Update — August 23

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markets123s (2)The Dow just completed its third consecutive down week. The last time that occurred was nine months ago. Whether this action is a precursor to something more serious or not is an unknown we must deal with.

The update to the rankings of the 11 basic asset classes as of August 23 is presented below. It reflects a significant shift in the composition of markets. Also presented are the relative rankings of the top 21 of the ETFs followed in this service. These can provide a basis for those interested in adjusting their portfolios.

Basic Asset Classes

For the first time [level-premium]DBP and DBC, both inflation or safety hedges are at the top of the list. They and EFA, the International proxy, are the only asset classes that rank ahead of SHY, the cash equivalent and cut-off for minimum acceptable asset classes.

Emerging markets continue to rank at the bottom and SPY ranks near it. The Russell 2000 (IWM) and MidCaps (MDY) rank near the middle of the pack, although both are below SHY.

BASIC ASSET CLASSES

basic assets
A large move upward in the rankings for commodities (grey) took place as a result of recent strong performance. Since these rankings began, it is the first time both have been acceptable (above SHY).

In the last 20 trading days DBP rose 7.5%. EFA rose 1.3% and DBO 2.8%. All other classes were negative. SPY was off 1.5% likely a result of actual and expected to continue rising interest rates.

All Covered ETFs

The table below represents the top 21 ETFs ranked in order by the momentum-volatility algorithm. These are the highest ranked from the population of over 100 ETFs followed. The return percentages at the right reflect the last 20 trading day results for these ETFs.

alletfs
A few points should be emphasized:

  • the domestic stock ETFs are led by the Nasdaq index (QQQ). There are only six (dark blue) US ETFs that made the list. None were in the top four. 
  • International (orange and bright blue) hold ten slots, including the first four. 
  • commodities (grey) cracked the list meaningfully for the first time with five entries. 

In the last twenty days, the three top returns were registered by commodities — SLV, 19.8%, PPLT, 7.5% and GLD 4.8%. The volatility and intermediate term performance prevented these metals from ranking hi9her. If positive returns continue, they will move higher in the rankings. That is not a prediction but merely a reflection of how the algorithm would work, should that happen.

Monty’s Comments

Caution

Subscribers know that I have become very cautious regarding markets recently. A June 21 posting (and maybe before that) reflects my concern.

International now ranks ahead of domestic and has for the last month or so. Fundamentals overseas are worse than domestic (and they are not good here). Europe could incur serious policy change after the German elections. Merkel is unlikely to continue to play rich Aunt Angie for the rest of Europe much longer. The German people sacrificed for the unification of Germany with massive wealth transfers from West to East in order to rebuild that broken sector. They are now sacrificing to keep the phony Eurozone together. That is unlikely to continue much longer.

I have little interest in putting money in International at this point. There may be some exceptions but the rankings for International will not be followed aggressively. IDV is a dividend play that may be less risky than other International ETFs. Rising interest rates around the world could damage this ETF, however.

Domestic ETFs look weak on the momentum-volatility rankings. Whatever strength can be found is subject to the weak domestic economic fundamentals and the eventual tapering of Fed QE. Even here, new commitments will be small.

Commodities

In terms of momentum-volatility, inflation-hedge ETFs have ranked too low to have been selected by the algorithm. Recently, that seem to be changing. In the August 1 selection post, I stated:

I have been nibbling around the edges of this category as I continue to believe that inflation will be a serious problem ahead. According to the model, this asset class is gaining in attractiveness, although I don’t believe it is there yet.

At that time, the rankings did not confirm what some other technical indicators were suggesting. As August unfolded and US and International stocks became less attractive, I increased my positions in precious metals. That turned out to be a good move, even though the momentum-volatility signals had not yet turned.

I am currently over-positioned in both GLD and SLV and under-positioned in traditional ETFs. For the last couple of weeks, that has been a profitable imbalance, although it is highly dangerous and could have been costly. These are highly volatile ETFs and the precious metals contained therein are likely government-manipulated. As the dollar continues to weaken, these ETFs will likely benefit although government will likely attempt to smash them again. That makes positions here, in my opinion, necessary but also dangerous.

Rarely do I utilize over-weightings in asset classes. When I do, I have very close stops on the excess portion and move them up regularly, frequently daily. Staying in such positions with this discipline is only possible when markets are running. Otherwise you are quickly stopped out of the excess portion with (hopefully) small losses. The rest of the position, (i.e., the non-overweight portion) has more normal stop levels.

Premium subscribers are not encouraged to rush into commodities. They are volatile. I mention my behavior only because it may convey what I believe is likely to happen. Unless you are sophisticated and able to follow markets closely, do not play my or your own “hunches.” Being wrong can be costly, especially if you are over-weighted. Personally, I believe that commodities have a good run ahead of them. If so, they will continue to strengthen in the rankings, affording a more disciplined entry and exit strategy.

Where To Now?

September and October historically are the two worst performing months of the year for stock markets. That does not mean that these months are always bad nor that they will be this year. However, when coupled with an economic world that continues to languish and foolishly expends dwindling resources in ways that will not produce a recovery, caution is warranted. The algorithm suggests caution. Central banks are likely to be forced to taper sometime soon. Bad economic policies continue to inhibit any recovery.

All of these factors are negative for stock markets around the world.

The world appears to be slouching ever closer to a financial armageddon. Once the supply of smoke and mirrors runs out, that recognition is apt to become reality and a rush for the exits begins. Tere is no way to predict when the event occurs. It could be next week or years from now.

If it is not now (and betting against Armageddon is always a good bet based on history — it can only occur once!), then markets will revive and continue on an upward levitation as a result of government games and manipulations. I think it prudent to remain cautious until danger signs diminish are replaced with more euphoria.

Personally, I have less than half of the funds normally committed to stocks in play. When the momentum-volatility rankings improve, I shall commit more. The acceleration in the rankings of commodities suggest that those who don’t have this kind of protection should consider adding some to their portfolios.

So, what to do now? For those who want updated selections, the table with the twenty-one  ETFs above represents current rankings. If you have existing positions which have not been stopped out, it may be reasonable to hold them. If you have profits on these positions, I would move stops up. That is generally good advice even under more normal circumstances.

Fed influences raised stocks to these levels and the discontinuation of these influences will cause them to fall. Indications that the Fed may taper soon is enough to produce downdrafts. So too are rising interest rates.

I will stay with the positions that I have, but with closer stops. I also intend to stay with my overweights in precious metals, but with very tight stops on the excess portions. As an example, I have stops within 20 cents of the current SLV price. That represents less than a 1% move for what is a very volatile metal. Gold stops are close, but not nearly as tight in percentage terms. I suspect that market movement will reduce my excesses this coming week.

We may be at an inflection point for markets. Standing aside completely or shrinking positions might be prudent if you believe that. You and your financial advisor, taking into account your own expectations, financial condition and risk tolerance are necessary for you to make the proper judgment. These are dangerous markets. There is no economic recovery and the smoke and mirrors are getting old.

Sorry for the pessimism. However, if we err in these markets, it should be on the side of caution. Short-term this appears to be a period for hunkering down rather than trying to grow wealth.

Performance of August Selections

Despite the downdraft in markets, August results thus far have not been bad. International, as was suggested by the August rankings, was expected to outperform US. That turned out to be correct thus far.

All results assume buy and hold for August. Getting stopped out on some positions may have improved or worsened such performance:

  • The International(6) selections are up 2.07% thus far in August which is slightly ahead of its benchmark EFA.
  • US(6) selections are down 0.57%, losing less than SPY which is down 1.24%.
  • Inflation-Hedge(3) are up 0.30%

On a YTD basis, US selections are up 26.2% versus SPY of 18.1%. International still trails its benchmark EFA by about 9 percentage points. Recent changes in the population of the International pool seem to have improved its performance relative to its benchmark. Inflation-hedge(3) is up 0.7% YTD. While it has not been worth following thus far, action in the inflation hedge area may be heating up.

A breakdown in terms of performance for 2007 – end of August 2013 will be forthcoming for each of the three main categories. All significantly outperformed their benchmarks based on backtesting over this period.

As always, good luck and good trading.

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