Weekly Market Update 12/8/2019Posted Dec 08, 2019
Steve here. Before we get into the markets this week, I'd like to share some huge personal news for a family member of mine. Over the last 15 years, I've spent more time with Rick Nerad than anyone else. He's become far more than a friend, he's a brother. He's one of the most kind, caring, considerate, and reliable human beings I've ever met, and I'm positive these attributes have shined brightly for our clients who've gotten to know him over the years. He's been there for me, and he's probably been there for you, whenever we need him.
So, since he doesn't like to talk about himself, and since I like to talk too much, it's my great pleasure to announce that he recently got engaged to his girlfriend of the last ~4 years! Patty shares all of the same qualities as Rick, and we all think they're a perfect match. So, an early "mazel tov" to you Rick, and if anyone wants to email him you can send him a note at email@example.com. Their "bull market" is only getting started!
The S&P 500 gained 0.16% this week with Friday's close at 3,145.91. Friday's close is a new all-time high weekly close. The index started the week on a sour note, trading all the way down to 3,070.33 at Tuesday's low, a decline of -2.25% from last week's close at 3,140.98. It felt like the inevitable pullback was finally here, with uncertainty on the trade front seemingly being the narrative, but market participants once again had other ideas. Participants began to "accumulate" into Tuesday's lows, with Tuesday's session closing well off its daily low. Friday's better than expected jobs report then jolted the S&P 500 into the green for the week.
The index has now increased 8 of the last 9 weeks, and this week's upside reversal would seem to suggest there's further drawup over the week ahead. Everyone has 3,154.26 (our current all-time high) and 3.070.33 (this week's swing low) on their radar. The chart below is a bit messy, but the interpretation is clean: As long as the S&P 500 can sustain above the red shaded region, we can expect the S&P 500 to trade higher over time through a series of higher highs, higher lows, and higher closes over all measurable time frames. From a behavioral perspective, the red shaded region represents the only known area of "resistance" on the chart, thus it's imperative it behaves as "support" in the event the price of the S&P 500 revisits the scene of past crimes. And since there's no known "resistance" presently above Friday's closing price for the S&P 500, there's no telling just how high the S&P 500 can climb.
However, as we wrote last week, prices don't move linearly forever. There will be a pullback, the S&P 500 will take a seat to catch its breath, and the next eight weeks probably won't look anything like the last eight weeks. We often find ourselves thinking like contrarians, and right now it feels as if the S&P 500 can't go down, it can only move higher. Naturally, we quantified this week's upside reversal and were surprised with the results.
Since 1950, there are only 10 prior trading weeks that traded -2% or more below the prior week's close, yet managed to finish the week in positive territory and record a new all-time high. It sounds like accumulation, it sounds like it should precede a continued advance for the S&P 500, but in these 10 prior instances it hasn't far more often than it has. The S&P 500 has closed lower two weeks later 8 out of 10 instances, for average declines of -1.15%. The index has also closed lower twelve weeks later 5 of 10 times for average returns of -0.88%. Ironically, the last time we saw a calendar week like the one we just recorded was December of 1999, a time period where it also felt like stocks couldn't go down.
As always, the study above is a crime of small numbers and the view through the rearview mirror. What lies ahead for the remainder of 2019 is anyone's guess. On one hand, there's tremendous momentum and buying interest across the collective actions of market participants; on the other hand, strong returns in the present always have to be paid back to some degree into the future. We'd love it if this week's low is truly the low for the month of December, but we remain skeptical and uncertain for now.
S&P 500 Primary Trend - Up
Our quantitative work continues to label the primary trend for the S&P 500 as up or "bullish". During uptrends, most long-term investors are best served including the equity asset class in their portfolio's asset allocation and relying mostly on passive investing strategies. Primary uptrends are analogous to sunny skies; you can play outside and enjoy the weather. It's not until the primary trend can be labeled as down, or "bearish", that most long-term investors are best served underweighting the equity asset class, analogous to the weather transitioning from sunny skies to rainy days. And while we're on the subject, would you believe it if we told you that San Diego had more rain in the month of November than Seattle? (click here)
While it's hard to believe that San Diego got more rain in a month than Seattle did, it serves as a great reminder to expect the unexpected. When it comes to the future price of the S&P 500, it's prudent to expect that it will trade beyond the limits of anything we can imagine as of today.
Referencing back to the chart above, there wasn't a person who thought the S&P 500 would close a month at 735.09 in 2009 when the index closed a month at 1,549.38 in 2007. And after closing at 735.09 in 2009, there probably wasn't anyone who thought we'd close a month at 2,107.39 a mere ~6 years later. Using the trailing one year as an example, the S&P 500 traded down to 2,346.58 on December 26th of 2018. Here we are, a little less than one year later, and we're higher by ~34.06%. And while 99.99% of the population was in a panic on December 26th of 2018, virtually nobody saw a rally of this magnitude unfolding here in 2019.
The main point here is that when we look forward, there is an unbelievably wide range of outcomes that lie ahead, outcomes that exceed the limits of our imagination in the present. There's a compelling case that we're headed much, much higher, and a compelling case that we're headed much, much lower. On a long enough time line, it's easy to predict both, and that wel'll move much, much higher, and much, much lower than Friday's close for the S&P 500. It's then the sequence of events that's incredibly influential in whether or not someone can achieve their financial goals, whether it's the best of times, or the worst of times, that lie ahead. And since the sequence of these events are entirely unknown, and all we have is an educated guess, it forms the basis for diversification as a staple in the ongoing portfolio management process.
A prudent portfolio is one that's designed and built to generate the minimum annual return that's necessary to achieve stated financial objectives. The minimum annual return that's necessary is a derivative of individual investor attributes, as everyone's current financial position is unique. However, there's a common objective all prudently designed portfolios share: they lean on diversification at the asset class level to hedge against sequence risk in an attempt to respect uncertainty. But "diversification" is a word that's often said and rarely understood. Truly understanding diversification is to understand cross-asset class correlations, and understand that there are a plethora of asset classes beyond just stocks and bonds. It's also to understand that "timing is everything", and there's a time for portfolios to be more, or less, diversified. Diversifying for the sake of diversifying lacks a sound premise, and it's important long-term investors incorporate smart, meaningful, and impactful diversification.
So, as we look forward and think about the years ahead, we can't help but think long-term investors are best served in the present truly examining, exploring, and understanding the diverse world of asset classes, from traditional asset classes to the world of alternative asset classes, and investment strategies, from the factors affecting their portfolio to the pros and cons of strategic vs. tactical asset allocation. The more tools a long-term investor, or an investment manager, has in their toolbox that they truly know how to use, the more prepared they are to tackle any and all uncertain jobs into the future. That's sound financial planning.
So, here SPF is, face-to-face with a breakout to fresh, new, all-time highs. As we've mentioned previously, we'd love to see SPF breakout to the upside. SPF is the third largest sector within the S&P 500, and a breakout to all-time highs would be a vote of forward-looking confidence in the Federal Reserve's mid-cycle adjustment.
SPF's lag the last decade is undoubtedly attributable to the world's evaporation in interest rates, thus collapsing net interest margins across the constituents within SPF. However, if the collective expectations across market participants believe in the idea of a steepening yield curve, then SPF can breath in a nice deep breath of fresh air. The forward-looking outlook for corporate profits will ascend, and that's generally the primary driver of stock prices.
2019, The Year *Almost* Everything Went Up
2018 was the year where *almost* everything went down, courtesy of a December to never remember. Naturally, 2019 is the year where *almost* everything went up. Who imagined that a year ago? Nobody we talked to.
The table below illustrates the year-to-date returns of a variety of futures contracts. The biggest winner is palladium, with a 2019 return of 54.69% thus far. The biggest loser is volatility, which is down -40.23% through this past Friday's close. Nearly all traditional investments held by the average long-term investor have appreciated in value thus far in 2019. The only red on the table below is attributable to currencies, commodities, and volatility.
So, what's in store for 2020? We have no idea, but we'll be analyzing and considering almost everything that's on the above table, since only focusing on stocks and bonds is like a handyman packing nothing but a hammer and screwdriver - it's just not enough to truly get the job done.
Steve, Rick, and the AlphaCore team
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