TGIF! February 12, 2016

Analyzing the markets is a complex task that takes a team of professionals. Our analysis is a systematic, ongoing process.  It’s repeatable.  There are hundreds of inputs that go into our constant monitoring.  And in this new era it is a constant 24/7 task.  Markets move much quicker and with much larger swings than ever before.

Many clients have asked us how we make sense of markets and come up with investments.  Let us walk through part of a day in the life of our research team:

The S&P 500 or the equity markets are made up of 500 individual stocks.  The other commonly followed benchmark indexes: The Dow 30, Nasdaq 100, Russell 2000 and Mid-cap 400 are made up of another 2,530 stocks.  We must have our fundamental and technical work done and an investment thesis on far more stocks than we actually own.  Why?  Because those other stocks ultimately affect what the Market indexes do and give us clues as to where we are in the cycles.  This bottom-up work helps us take advantage of certain areas as stock pickers when strong trends and themes emerge.

Next we look at market sectors like consumer discretionary, technology, healthcare, energy and financials.  Individual stocks in these sectors often move together in correlation but they also have anomalies that act totally different.  Doing this sector work helps us identify places we absolutely must be invested like Healthcare the past few years, but also more importantly when to take chips off the table. Financials and Energy are two good sector examples that have outside factors effecting their valuation, growth and ultimate stock price movement.

That leads us to the Bond Market and the commodity markets.  We must have a feel and idea what commodity prices are doing.  The energy commodity complex not only effects domestic energy stocks, but because of the impact on many countries economic conditions it effects a lot of world economic conditions.  This creates great periods of growth, but like we are seeing today, the negative consequences of slowing growth and negative growth.  This work helped us stay out of emerging market and Non-US investments that have been hit a lot worse than our markets.  Our contrarian view point following the Metal Markets closely, led us to take a long term position in Gold near the lows late last year.

Interest rates and the bond market play as large a role in worldwide markets as anything.  Flow of capital in and out of the Bond market can literally move markets.  Did you know the bond market is the largest market as far as dollars invested?  Thus we better have our best eyes paying attention to what the bond market can be relaying to us.  This year our Analysis suggested we would be seeing lower interest rates on the 10 and 30 year Treasuries.  This was in the face of the Fed rate hike.  Our thoughts were if rates were going to be moving down against what the Fed wanted, there potentially could be a bigger global issue underway.  Again helping us stay out of foreign markets and cautious near-term our markets.  Interest rates also affect banks.  Financials are 16+% of the S&P 500.  We knew if interest rates took our path lower, financials would not be a great short-term place to be invested.

The options market and volatility pricing are smaller in stature but can lend a huge helping hand in our viewpoint not only in timing, but where we potentially are in the greater landscape of the markets such as periods of stress, or periods of healthy bull market behavior.  Higher volatility pricing mathematically means we are in a faster wider swinging and moving market.  Expectations are larger intra-day swings in the Stock market when volatility  goes up.  This often happens when we get a range expansion, meaning price are trying to find a new fair value area where buyers come in.  For example, when we took out the low 2000’s and high 1900’s on the S&P to start January, and Volatility was simultaneously moving strongly higher, we knew we were finding new prices (lower) and were in a range expansion.  The measured average intra-day high to low move on the S&P 500 the month of November was less than 15 points.  That expanded to around 25 points in December…and today so far this year we’ve seen that number average 40!

Why is all this stuff worth a TGIF?  Well when you put it all together these signals indicate us of times to be cautious, times to sit on higher cash, times to hold hedges or take them off.  These market signals help us navigate markets that to the untrained eye seem to move for no rhyme or reason.  When indicators we follow start coming together it gives us confidence to take a stand, conservative and cautious like today, or more aggressive and very optimistic in good times.

This week we are finally seeing some very encouraging signs giving us an indication that we are much closer to the end of this correction than the beginning.  Many stocks are reaching valuation and technical targets we have been watching for quite some time to end those stocks respective corrections.  Another move lower is possible yet, and would satisfy a lot of our target regions but is not necessary.

Interest Rates have come down to our targeted areas, 2.5% – 2.3% on the 30 year and 1.7% – 1.5% on the 10 years.  Those yields reversed sharply back up and out of those areas (today).  That is exactly the action what we want to see when equities are finding their way towards a bottom.  Volatility has hit some important upside levels and now come in quite a bit since the lows in stock prices yesterday.  More action we like to see in a healthier stock market environment.

Our multi-faceted analysis tells us we are getting much closer and as we always say as soon as the facts change so do we.  And those facts are pointing us to a much more constructive view of the markets very shortly.  We will continue to go through our systematic investment process and analysis and keep our levelheaded approach with your portfolios.

Please don’t hesitate with any questions or comments.

Best to your weekends.

By: Mike Harris

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