By Frank Barbera CMT. June 2, 2009
I am ‘on the road’ for a few days this week, attending some investment meetings, so I thought I’d pass along a few observations on the current markets, along with some (hopefully) helpful tips on navigating these difficult markets. Over the last few weeks the Foreign Currencies, Commodities, and Equities markets have behaved once again as ‘all one market’ -- just the kind of behavior as was seen between much of the time period 2003 to 2007.
Above: Silver (bold) & Crude Oil; Aussie Dollar (bold) and Crude
Above: S&P 500 (bold) and Crude Oil
This is a potential alert to investors, that when markets do correct to the downside, the likelihood is that like 2007 and 2008, hiding places will be difficult to come by. To a very large degree, the animal spirits of speculation, driven by the all powerful investment performance gods have linked markets in a manner never really seen in years gone by. Today, the investment markets are almost uniformly aloft on the sea of investment liquidity, and for smaller investors, understanding when that sea of liquidity is rolling in versus when it is about to roll out is the overwhelming name of the game. The idea of markets ‘decoupling’ proved to be a huge fiction in 2008, and over the last few days we hear the same kind of discussions taking place as were making the rounds in July 2008 when Crude Oil was over $140. Speaking of Crude Oil, anyone notice the new VIX Index for Oil and Gold? In both cases, the recent rally has caused the VIX Index to plunge, with the VIX Index for Oil all the way back down right now to where it was when Oil was trading above $100 last August with the new Gold VIX also back down to the lows.
Above: Crude Oil and VIX Index
Above: Gold and the VIX Index – again, near the lows.
One thing investors can consider and manage is their own risk profile. Are you concerned that your equity portfolio has had a huge run, and could end up giving back a large portion of the recent gains but still want some upside exposure? If so, consider dialing down some of the portfolio risk by swapping out some of the equity funds for a position in high grade corporate bonds. Now, when stocks go down, high-grade corporate bonds also tend to decline as their yields back up. However, the trends in high-grade corporate bonds are far more benign than what would generally unfold in the stock market. While they are no substitute for money market or cash, they can help a portfolio retain some potential participation in continued upside (if that upside develops) while dialing down the overall portfolio risk if something more unpleasant begins to develop. In the chart below, I show the long-term return of PIMCO Total Return, one of the world's largest bond funds rebased to the same starting point as the S&P 500 going back to 1999. Which one of these investment markets would you have rather owned? Pretty easy choice now, isn’t it? More to the point, which of these two curves produced the best return with the least degree of negative volatility? Again, the wiggles in the bond fund, while not always immaterial, have been a whole lot more manageable than the violent wiggles seen in the equity market.
Above: PIMCO Total Return rebased to same starting point as SPX, better return and a lot less bad volatility.
Above: Pimco Total Return tends to move in tandem with the trend of the stock market, but with a whole lot less negative beta. Want more of a sleep well at night feeling? Maybe a high grade corporate bond fund can do the trick at the right time, dialing down the risk in your portfolio.
Want to go one step further? An investor who is willing to put in some real homework can actually research any category of mutual fund and then find funds which have more manageable trading restrictions. While some funds have stiff early redemption penalties, (so-called STR fee’s or Short Term Redemption fees) many others do not. Among many funds that are NTF, or No-Transaction-Fee Funds, the cost of getting in and getting out may be as simple as a round-trip commission. In some cases this means that moving average “timing” (defensive timing, as opposed to any other kind of ‘illegal’ timing, which we are NOT advocating) can be employed. Take a fund like Pimco Total Return, which just as an example, would have generated an equity curve as shown in the bottom clip if an investor could have employed a simple 200 day moving average. This technique reduces the negative volatility in a fund and gives the investor a higher confidence and a substantial “sleep well at night” factor. In the case of the Pimco Funds, there are in many cases, early redemption fees, and in some funds, like Total Return, the investment minimum is huge, of the sort suited only for institutional investors. Thus, fund investors need to seek out other similar kinds of funds which would be more suitable. The point here is that a little basic timing can often go a long way in reducing levels of investor stress. As a source of searching for No Load, No Fee funds, both the Morningstar.com, and the Schwab.com websites have extensive information on finding no load, low fee equivalent funds. In the case of high grade corporate bond funds, for example, the Janus Flexible Bond Fund (JAFIX) has done every bit as well as Pimco in recent years, is also five stars, and is far more readily available to the retail investor. Morning Star: JAFIX
Above: top clip – Pimco Total Return with 200 day moving average, and lower clip, Pimco Total Return with 200 day moving average.
Of course, in addition to the realm of 40 ACT Funds, major growth has taken place in recent years with ETF’s. One pair that we like to monitor is the High Yield Bond ETF versus the Corporate Bond ETF, symbols HYG and LQD respectively. Simply put, when the equity markets begin to decline HYG usually falls pretty hard in response, while LQD will either go down more slowly or could even stay neutral or rise. Thus, there is the potential here for a solid long/short strategy if and when markets reverse and breakdown.
Above: top clip HYG – High Yield Bond ETF, middle clip, LQD Corporate Bond ETF, and bottom Ratio of HYG to LQD.
Above: SPX and R/S Ratio High Yield vs. Corporate Bonds. In down markets High Yield underperforms, while in up markets High Yield overperforms.
Yet another area we have taken an interest in during the last few months is the action of so-called “Back to School” stocks, the education services group. In this sector, there are many names, some of which are more recent IPO’s. As a group they seem to do fairly well when the stock market declines and the herd frets to a greater degree about the downside of recession. Seems only a few months ago the word ‘recession’ was everywhere on the news and in the headlines with one negative media article after another. Many stocks in this sector did well as people realized that fewer job availabilities imply more people going back to school. Now, with 90% of economists boldly predicting an end to the recession between now and year-end, like Wal-Mart and some of the other recession retailers (see last week's article), the Education stocks have fallen off and been left behind.
Above: GST Education Services Group with MACD.
Some of the ticker symbols in the Education Services sector include: APOL, CECO, DV, COCO, ESI, STRA, APEI, EDU, CPLA, LTRE, LINC, UTI, and LOPE. In the chart below we show the close up view of the Education Services group in the top clip, the S&P 500 in the middle clip and the Relative Strength Ratio in the lower clip of Education Services versus the S&P.
Above: long term view of Education Services Relative Strength versus S&P 500.
Above: close up view, Relative Strength Ratio Education Services vs. SPX with 14 day RSI.
As always investors need to do their own homework, and all of these ideas require constant vigilance, but with the abundance of new funds and ETF’s coming out almost daily, there are today more tools available to investors than ever before. In an economic climate that is generating such high volatility, the advent of more trading vehicles is always a good thing. On the recession front, we disagree with 90% of economists who are forecasting an ‘end’ to the recession in the sense that we expect that after going ‘positive’ for a quarter or two the economy will relapse into a second contraction phase, forming a ‘double dip’ recession as was seen in the 1979-1981 time period. I have been on record with this forecast in this column for several months, and that’s still the way I see things developing. The only twist I see morphing on this theme is that the second ‘recession’ could be far deeper and more painful than the first dip just seen. If this was the ‘great recession’, I already wonder what tag line will be attached to the second dip when interest rates are surging and the Dollar is in free fall. One hundred dollar Oil, I believe in the three to four year future, but we may have some real downside pain in Crude before those triple digit readings return. That’s all for now,
© 2009 Frank Barbera