“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.
Over the last couple of months, we have been preparing to expand our product offering by launching two new sets of strategies, called the Market series and the Quant series. They are offered as alternatives to our traditional strategies, now referred to as the Prime series, for a chance to help our current and future clients achieve their financial goals. While the Market series and the Quant series are different under many aspects, they share one important feature: under both strategies, a portion of the client’s portfolio is managed according to a rules-based, quantitative model developed in house at Pinnacle. Diversification has always been a core tenet of Pinnacle’s investment process and the way we manage risk. However, with this move, Pinnacle has now further expanded the diversification it offers to clients to a new dimension of risk: decision risk. While the Pinnacle traditional (now Prime) strategies rely primarily on the time-proven judgment, experience, and intuition of the members of the Investment Team, the new strategies are based on a rules- based decision-making process that is more objective and unemotional. In Pinnacle jargon, we say the Prime strategies are subject to manager risk, while the new strategies are subject to model risk. Modern Portfolio Theory tells us that by combining different sources of uncorrelated risks, we can move our portfolio farther out in the efficient frontier and achieve a better expected return-to-risk ratio.
The MACD (Moving Average Convergence Divergence) Indicator is one of many tools in a market technician’s toolbox. The indicator takes two moving averages (usually the 12 period and the 26 period exponential moving averages) and converts them into a momentum oscillator by subtracting the longer period from the shorter period. There are a variety of ways to interpret the MACD indicator, but for right now we are focusing on signal crossovers. To do that we also create a 9 period exponential moving average of the MACD for use as a signal line.
The year has begun in roller coaster fashion, and our team has been busy reading and digesting the many 2015 outlooks that come across our desks. But reading is the easy part, and now it’s our turn to distill the many facets of our process into a workable thesis that allows us to generate attractive risk-adjusted returns in this maturing market cycle. As tactical managers, we’re well aware that forecasts are always fraught with risk, but we also realize that in order to look forward, we need to have views that set the tone for the portfolio in the coming year. Below is our best articulation of how we see the investing world shaping up over the next year or two. Our aim is to inform you of our views, and to explain how they affect current asset allocation decisions.
Next Thursday (January 22), the European Central Bank will be hosting an important meeting. Last year, Europe experienced a setback in their recovery from the debt crisis as growth ground to a halt. As a result, the ECB took a series of actions over the past several months in an attempt to support the recovery. Their efforts thus far have been considered lackluster by financial markets, which has led to growing speculation that ECB President Mario Draghi will resort to a large-scale asset purchase program (otherwise known as quantitative easing) in hopes of achieving the desired impact. Indeed, he has stated on more than one occasion that the ECB intends to restore the balance sheet back to its 2012 level, which translates into an expansion of nearly one trillion euros from its current size.