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Weekly Market Update 02/09/2020

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Weekly Market Update 02/09/2020

The S&P 500 surged 3.17% this week with Friday's close at 3,227.71.  The index came out of the gate strong on Monday and never looked back.  Monday's open ultimately recorded as our weekly low.  The S&P 500 erased everything it lost the last two weeks and recorded fresh all-time highs this week, both on an intraday (3,347.96) and closing basis (3,345.78).  In last week's Update we wrote that we'd "be shocked if the S&P 500 didn't trade down below the 50MA next week, perhaps even on Monday."  Consider us shocked. 

So, is that it?  Is the breather over?  On the surface, it's easy to believe the answer is yes.  Beneath the surface, we understand that one week does not a trend make.  Just like the S&P 500's -2.12% weekly decline the week prior didn't see any follow-through this week, we can't make any guarantees that this week's 3.17% advance will show any follow-through over the week ahead.  A breather often takes the shape of a rectangular chart pattern, a period of sideways trading or price consolidation.  This week's reversal only confirms the establishment of the range.  It will take follow- through to the upside next week for the index to "breakout" above January's high, and thus strengthen the idea that the breather is truly behind us.

 

 

While the coronavirus is still front and center, and the news flow isn't overly optimistic, we saw relatively strong economic data come forward this week.  The ISM Manufacturing Index came in better than expected on Monday (click here), factory orders came in better than expected on Tuesday (click here), ADP's employment report came in better than expected on Wednesday (click here), and the jobs report came in better than expected on Friday (click here).  It's through these lenses where this week's sharp upside reversal makes a bit more sense.  The forward-looking expectations regarding the health of the consumer, and thus the state of the economy and corporate profitability, remain the primary driver of stock prices via the collective actions of market participants in the present - not the fear of the coronavirus.

As for the week ahead, the S&P 500 is sitting at "resistance" from January's highs, so a pivotal week awaits.  Ironically, there are plenty of market-moving catalysts on the agenda.  We'll hear from Federal Reserve Chairman Jerome Powell.  Collectively, participants still believe the Fed's next move with the federal funds rate is lower, not higher, even in spite of the economic data from this week.  We'll get inflation data on Thursday, and retail sales on Friday. 

Sustained upward extension above January's highs would be confirmation that the breather is behind us, and help clear the internal and momentum divergences that presently exist.  A move lower would reinforce "resistance" in the ~3,340 price region, and morph the breather into a sideways trading range.  After the curveballs of the last two weeks we won't pretend to know what pitch the S&P 500 is going to throw next, but we're always excited to stand in the batter's box.

 

S&P 500 Primary Trend - Up, Bullish

We continue to label the S&P 500's primary trend as up or "bullish".  During uptrends, long-term investors are generally best served with an equity overweight across their portfolio's asset allocation and relying mostly on passive, or strategic, asset allocation methodologies.  The degree of equity overweight a long-term investor chooses to implement is a derivative of individual investor attributes such as one's time frame, financial objectives, volatility preferences, and current savings rate. 

It isn't until the primary trend can be labeled as down, or "bearish", that long-term investors need to consider treading more carefully via an equity underweight across their portfolio's asset allocation.  We're not there yet, but we'll get there one day.  It's imperative long-term investors have a plan to manage equity market risk before we're actually staring the risk right in the face - otherwise that's generally when panic ensues, and panic is rarely profitable.

 

 

The S&P 500 accomplished something rare this week: it traded up to a fresh all-time high for the fifth consecutive calendar month.  This has only happened 11 prior times since 1980, and just 3 prior times since the year 2000.  The last 6 times it's occurred, dating back to 1995, the S&P 500 has absolutely boomed higher over the forward 1 year.  The 5 times it occurred prior to that, spanning from 1980-1995, the index closed lower one year later 4 out of 5 times. 

There's nothing we can ever truly glean from something that's occurred just 11 times over the last ~40 years, but we find it ironic that this type of upward momentum has ultimately recorded as a coin flip.  We certainly prefer the parallels from the most recent 6 samples.

 

 

Finally, large cap domestic equities (i.e., the S&P 500) remain the cleanest shirt in a basket of dirty laundry.  Collectively, market participants prefer large cap domestic equities over any other asset class at the moment.  No matter whether this is a derivative of "TINA" (the acronym for "there is no alternative"), or because of the passive investing "bubble", or simply the momentum aspects associated with the greater fool theory, it doesn't change the fact that those overweighting large cap domestic equities are essentially outperforming everyone else.  This is as certain to change as death and taxes, but nobody knows when. 

We've watched analyst after analyst talk about overweighting the international equity markets for years, and for years it's done nothing but exacerbate opportunity loss for long-term investors.  It isn't until market participants, collectively, prefer something other than large cap domestic equities that long-term investors should be underweighting large cap domestic equities.  The last five-plus years teach us all that it is never best to fight the money, it's more equitable to follow the money.

 

Interest Rates Bounce At Support

The yield on a 10-year United States Treasury (UST10y) gained 5.30% this week with Friday's close at 1.59%.  UST10y has been trendless for nearly a decade, oscillating between ~1.5% (yellow shaded region) and ~3% (red shaded region).  This week's move to the upside, which is a derivative of market participants being eager sellers of 10-year Treasury bonds, comes from a level where market participants have always been eager sellers of 10-year Treasury bonds.  It begs the question of what lies ahead for UST10y: a rotation back toward the ~3% price region, or a decisive breakdown to fresh all-time lows?

 

 

The answer to the above question is impactful for long-term investors.  UST10y heading back toward 3% is a result of falling bond prices.  This would leave most fixed income allocations across long-term investors' portfolios underperforming, similar to 2018. 

Alternatively, a breakdown to fresh all-time lows for UST10y is a derivative of bond prices rising to new all-time highs.  This would help fixed income allocations across long-term investors' portfolios outperform return expectations, similar to 2019. 

The conundrum for long-term investors is that neither of the above scenarios is ideal.  Underperforming bonds, the result of UST10y heading back toward 3%, brings about portfolio lag and opportunity loss.  Outperforming bonds, the result of UST10y heading down to levels we've never seen before, doesn't make long-term investors that much money given where UST10y is in the present.  Additionally, fresh all-time lows for UST10y probably serves to spur buying interest in the S&P 500, making bonds a relative laggard across a long-term investor's portfolio. 

So, what's the average long-term investor to do?  We think the answer is to assess and analyze the role the bond market plays in your asset allocation.  For all the attention stocks get on the valuation front, it's valuations across the bond market (i.e., interest rates) that are far more egregious in our opinion. 

There are a variety of ways for long-term investors to generate competitive yields from relatively safe fixed income-like investments; they're simply not found in a traditional basket of publicly traded bonds held in your local bond mutual fund or exchange-traded fund.  Alternative investment strategies, such as private credit, long/short fixed income, merger arbitrage, and private real estate can help "diversify" a long-term investor's portfolio away from the perils currently present in traditional fixed income.  These alternative investment strategies provide nearly the same exact broad diversification benefits of traditional fixed income investments, except long-term investors can actually generate competitive yields from them!  That's a win-win. 

 

Happy Sunday!

Steve, Rick, and the AlphaCore team

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