Tuttle Tactical Management, LLC is an investment adviser registered with the U.S. Securities and Exchange Commission. You should not assume that any discussion or information contained in this letter serves as the receipt of, or as a substitute for, personalized investment advice from Tuttle ...
This has been a rough week for the markets. It started when Bernanke spoke (if this keeps up we will have to buy protection before he speaks the next time) and continued with bad economic news out of China. The selloff after Bernanke’s speech looked like a buy on the rumor, sell on the fact event. The selloff after weak China data came out was a good, old fashioned sell off.
The Fed didn’t tell us anything we didn’t already know but there is still a bunch of uncertainty and about when and how much. Markets don’t like uncertainty.
There was a bunch of bad economic news out of China this week. This could be even worse because China cooks their books anyway. If your data is suspect to begin with and you can’t make it look good then how bad must it really be?
The blood bath in bonds and anything that pays interest also continued this week. Many people, us included, have been predicting a great rotation out of bonds and into stocks, but this was predicated on an orderly selloff in bonds. What we have seen over the past couple of weeks has been anything but orderly and has pushed rates up too far for the market’s liking at this point. The selloff has been particularly gruesome for some asset classes:
1 Month Returns of Selected ETFs as of 6/24/13
REITs (IYR) : -11.55%
Emg Market Bonds (EMB): -11.66%
High Yld Bonds (HYG): -5.5%
Preferred Shares (PFF): -6.2%
30 yr Treasuries (TLT): -6.58%
MLPs (AMJ): -6.78%
What does this all mean going forward? For now, stocks are still the place to be. Money always flows where it is treated best. Would you rather own bonds with limited upside and a lot of downside, or stocks with unlimited upside and a lot of downside? I’ll take the stocks. The economy stinks but it is improving. The wild cards will be how bad things in China gets, how the Fed does tapering, and how long they hold onto their zero interest rate policy.
As far as short term goes, the rally we had yesterday is probably not sustainable as interest rates are still too high. We think that we will see the bottom of this correction once we see a flight back into Treasuries. Basically, correlations between stocks and Treasuries have become unhinged, we need to go back to a more “normal” relationship where stocks go up with good news and Treasuries rally on any flight to safety selling in stocks. Unless we see the 10 year Treasury back below 2.5% we wouldn’t be surprised if we re tested the lows sometime soon.
Last week we sold our counter trend positions in the S&P 500, small cap stocks, and dividend stocks prior to the selloff. Yesterday we bought the small caps back. We also sold momentum positions yesterday in dividend stocks and the S&P 500. This brings our cash positions in the Trend Aggregation Strategies to over 50% and cash positions in the Momentum Strategies over 20%.
Who Is Really Trying to Predict The Market
When I talk to Modern Portfolio Theory (MPT) types about Tactical Asset Allocation (TAA) the objection I normally get is that TAA can’t work because nobody can predict where the market is going. They are right on one point, nobody can predict the market, they are wrong on another key point however—it is not the TAA guys trying to predict the market it is the MPT guys.
The main idea behind MPT is that investors should create a “diversified” portfolio of a number of different asset classes. To come up with allocations they need to put a number of variables into an optimization program that then gives the optimal portfolio mix. These variables are:
1. Future returns of asset classes
2. Future correlation of asset classes
3. Future volatility of asset classes
How do they come up with these inputs? THEY PREDICT. Imagine coming up with an MPT portfolio at the end of 1999, what would you predict future performance to be? Probably pretty high. What would you predict future performance to be if you were putting together an MPT portfolio at the end of 2008? Probably pretty low. They are right when they say nobody can predict the market.
TAA on the other hand doesn’t try to predict anything, instead it moves based on verification, True TAA doesn’t try to get out at market tops and in at market bottoms, it gets out before bad turns into really bad and gets in when a rally has started.
2. S&P 500
3. US Small Cap Stock
4. Large Cap Value Stocks