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When Everything Looks Like a Nail

| June 11, 2019

There’s the old saying, that when the only tool you have is a hammer, everything looks like a nail. In this case when the only tool that you have is ‘tariff,’ that’s what you use, even if the problem is completely unrelated. Unfortunately, in this case it worked. Trump threatened a tariff on Mexico unless they helped stem the flow of illegal immigration across the US-Mexico border – and it looks like it worked. I think you call that a negative feedback loop. It worked once, now it will work every time. Fortunately for Trump, we are the biggest consumers in the world and that is a big hammer to use.

Ok, enough with that. The market seems to have quickly put that issue in its rearview mirror (wise or not, that’s another question), so let’s also turn our attention elsewhere by looking at what else the market is telling us. We continue to get many different signals depending on what we are looking at. If you remember last week’s note, I said the market was oversold and was due for a rally. Well, fast-forward a week and that’s exactly what we got, with the S&P 500 climbing 4.46% last week. That key index is closing in on fresh highs, but many other market indices are still well below their recent highs. Below is a weekly survey by AAII (American Assoc of Individual Investors). This is a contrarian indicator, meaning when the bullish numbers are high, it’s best to take less risk and when the bullish number is low, you are better off taking more risk. Investors tend to be very emotional and it’s those emotions that lead them to do the wrong thing at the wrong time, i.e.. buy when they should be selling and sell when they should be buying.

Contrast that with consumer sentiment. You can see from the chart below that in general people are feeling as good as they’ve felt before the end of most cycles. On the face it looks good but look at the red circles compared to the gray lines (recessions).

Finally, after seeing global interest rates move higher over the last couple years, we are now seeing 29% of all government bonds in the world yielding negative returns. I’m not that smart, but it seems difficult to make any money when the yields are negative. I guess you hope that they get more negative? You can see why US Treasuries have been in such high demand around the globe. They seem like a great deal when earning about 2% for risk free rates (better than negative).

We’ve worked off some of the oversold position in the market, but our money flows still seem to be saying that a new high is around the corner.

While we continue to be cautiously optimistic, we realize that we are getting closer to the end of the cycle, and while we can make the case that the market is high risk, we can just as easily make the case for new highs. When conditions like this present themselves, we go with two rules of thumb:

  1. Continue in the trend that’s been established (in this case upward) and;
  2. When in doubt, the markets go up over time.

In your portfolios, we continue to remain biased towards the equity markets – particularly US equities, but with a higher-than-normal cash position to help play defense in these late stages of the cycle.  We will continue to stay vigilant and if we need to, we will take further protective measures.