To Go Fast, You Need Brakes

To Go Fast, You Need Brakes

Monthly Outlook: August 2018

Summer doldrums are apparently good for markets as most markets floated a little higher in July. U.S. stocks gained a respectable 3.3% while international stocks gained a similar 2.9%. Bonds, on the other hand, were flat, -0.04% to be exact. Although a gain is a gain, we need to point out that U.S. and international stocks trends have diverged and that is a concern. That is, while U.S. stocks continue to trend higher, international stocks tipped to a downtrend last month as we discussed in our last Outlook. And even though both markets enjoyed a robust month, our outlook is based on the prevailing trend. We remain positive for U.S. stocks but have trimmed back our exposure to the down-trending international stocks. For the year to date, U.S. stocks are now up 6.5% while international stocks are down 1.1%. Bonds are down 1.8%, YTD. As a result, balanced accounts are up low single digits held up only by U.S. stocks for now.

FANGs Lose Their Bite

As discussed above, U.S. stocks are the best performing major asset class this year. And within U.S. stocks, it’s really the technology sector that has been producing all the gains. That was the case, at least, until mid-July. The so-called “FANG” stocks (Facebook, Apple & Amazon, Netflix, and Google) have been particularly strong. But with recent earnings announcements and weaker forecasts, they have begun to crack. Facebook plummeted 21% last week. And Netflix is down 20% in the past two weeks. What does it say for the broader market when the mighty FANGs lose their bite? It is too soon to tell if this is a short-term hiccup or the beginning of something more concerning. As always, we’ll watch carefully and trade accordingly. For now, we continue to hold the tech-heavy NASDAQ index fund.

To Go Fast, You Need Brakes

As an avid cyclist, July is always exciting as the Tour de France coverage pushes out Bloomberg on our office TVs for a bit each day. Watching the daredevil riders blast down mountains at 60+ MPH is exciting and nerve wracking at the same time. How can they do that? One answer is that they’re using bigger disc brakes that give them confidence they can slow down in a hurry and avoid a crash. It’s a bit of a stretch, but we see investing in a similar way. You can accept the volatility of stocks for faster growth when you use trend following sell signals as brakes and as an indication to raise cash for protection. Our iFolios 75 model, for example, allows us to invest up to 75% in global stocks when the coast is clear. But if we see downtrends, triggering sell signals, we’ll “hit the brakes” and we might bring our “speed” or stock allocation down to 35% for protection. Having a little cash, sometimes, is better than being in a crash. Imagine that you had to pick one static allocation to global stocks that you could live with through uptrends and downtrends. You might only be able to handle 50% allocation to stocks. With iFolios, you could handle 75% knowing we can sell down to 35%. To go fast, you need brakes, and that’s what we do.

What We’re Watching

Besides a laser focus on long-term price trends for each of the index funds in our portfolios, we’re keeping an eye on several other indicators. The S&P500 has critical support at about 2,700. If we see a break below this, it would be a concern. Today, it’s at 2,816 so it’s 4% away. Another key indicator is the unemployment rate. Long-term trend crossovers of the unemployment rate have been an excellent leading indicator of a recession and of a stock bear market. Such a crossover would occur if the unemployment rate rose to about 4.1%. It’s at 4.0% today and the number is updated on the first Friday of each month. So listen for updates on August 3rd and September 7th. Lastly, we’re watching U.S. interest rates and bond prices. The 10-year U.S. Treasury rate is presently at 2.96%. A move above 3.1% OR a move below 2.75% would both be a concern. Rising rates would hurt the economy. And falling rates (and rising bond prices) would be a sign of a flight to safety amidst concerns over a slowing economy. With less than 100 days until the mid-term elections, there will be a lot to watch on the political front, as well. As always, our primary concern is to make your portfolio grow, and our signals and trends just help to guide us.