The third quarter came in like a lamb and went out like a lion, as the return of volatility hit risk assets hard across the globe. As in previous quarters, emerging market stocks and commodities suffered double digit declines as markets continue to deal with the end of the commodity super-cycle and the mix of structural and cyclical problems reverberating throughout the emerging market complex. But the big news of the quarter was a catch up in developed markets that had previously appeared impervious to the problems that were festering in the developing world.
We’ve recently changed our cyclical view, as we don’t think the recent downdraft we’ve been experiencing is over yet. In fact, while many believe we’re experiencing a ‘garden variety pullback’ that provides us with a buying opportunity, we believe there’s a growing probability that the long running cyclical bull market may be transitioning into a cyclical bear market. We could be wrong—and hope that we are. But hope is not a strategy and we need to align with the evidence that calls for playing defense and protecting against a possible change in the market cycle.
It is hard to believe that in three trading days, the market has penned its first 10% correction in over 900 trading days. This decline may be an unfortunate reminder of the last bear market, and if you are feeling anxious about your portfolio, don’t worry—you have lots of company. In fact, the market has set a new record for the speed and breadth of market volatility.
Not only has the market dropped, but we have also witnessed several areas of the evidence we follow move into bearish territory. Given this recent downgrade, we now believe the probabilities are high that we are transitioning from a bull market to a bear market cycle.
In the remainder of this post, I’ll summarize our response to the recent market events in each of our three Pinnacle strategies.
The headlines out of Greece are coming fast – deal, no deal, default, referendum, etc. It’s enough to make investors’ heads spin trying to keep up with the news flow. Markets have been volatile this week in reaction to the back and forth, and the rising possibility that Greece may leave the Eurozone. Investors are starting to fear that this could potentially be another “Lehman moment” that results in financial contagion across global markets.
“Long ago, Ben Graham taught me that price is what you pay; value is what you get. Whether we are talking about socks or stocks, I like buying quality merchandise when it is marked down” – Warren Buffett
We pointed out in our recent quarterly commentary that a major countertrend movement was brewing in both the dollar and commodity patch. In other words, the primary trends for the dollar (up) and commodities (down) might have hit a point where their respective gains and losses were overdone in the short-term, but we have a firm conviction that the strong dollar and weak commodity thesis should continue to dominate the backdrop in the long-term.
At the beginning of the year, we wrote about an aging bull market that we thought could be ridden, but with the caveat that one wouldn’t want to take too much risk given the magnitude of the move, current valuation levels in the U.S., and an overall evidence profile that was clearly mixed with pockets of both strength and weakness. When weighing the evidence, our dashboards offered no reason to reach for additional risk this late in the cycle, but instead we tried to focus on some big picture themes that could help us find attractive opportunities to position for.
We’ve been looking at transportation stocks as an intra-industrial sector investment, due to a variety of factors: our forecast for a secular bear market in crude oil, sustainable airline profits, and high domestic exposure as compared to multi-national industrials hurt by a strong dollar. Nevertheless, transportation stocks have had a rough start to the year. As a market technician, I look to charts to tell us when we’re wrong.
At the beginning of the year, we identified several themes that might drive investment markets in 2015. Forecasting is a hazardous process, but it’s part of the job for tactical managers who have the freedom to move portfolios according to changes in macro and market conditions.
I recently reviewed our themes for the year (written up in detail in our latest quarterly), and made a few notes regarding how those themes are playing out.