February 13, 2019 | eFocus @ Legacy
By: Greg Hansen, CFA, Vice President and Senior Portfolio Manager
If you have ever stared at an old-fashioned paper map, trying to figure out exactly where you are so that you can figure out how to get to your destination, you may see some similarities to the recent stock market activity. Often, map readers get hung up on looking for street names or familiar geographic landmarks only to realize they are not even in the right area of the map. Smart phones and GPS devices have simplified a lot of that for travelers. However, finding your way in the markets may not be as easy as using GPS.
Every day, we are bombarded by thousands of data points and news stories trying to tell us what is going to happen to a certain asset class or security. It does not require much effort to find data to support any position you want to take on either side of the argument. Some of these pieces take a very short-term perspective. Others talk about long-term trends which may fly in the face of what you have seen or expect to see in the near term. We see similarities to this discussion in the recent wild moves in the stock markets.
Dating back to the end of the financial crisis in 2009, we have been in a long-term, secular bull market in stocks. Sticking with the map metaphor, we have been on a cross-country road trip from the southwest to the northeast. Sure, there have been a few detours along the way, but the general trend has persisted.
Recently, however, there have been some relatively unexpected detours on this journey. The equity markets peaked in early October of last year. News that Federal Reserve Chairman Jerome Powell expected four rate increases in 2019, coupled with an accelerating trade dispute with China, spooked investors and caused them to take money out of stocks in the fourth quarter of last year. The selling peaked on Christmas eve as portfolio managers rushed to harvest tax losses before the calendar flipped to 2019. Since then, markets have been headed due north.
Like a driver taking a detour in an unfamiliar city, investors are asking “where do we go from here?”. Coming into 2019, we described the risk factors as being relatively balanced and our models had us positioned at the neutral or mid-point of the allowable range of equity exposures for client accounts. There was a case to be made that equities could appreciate after the dramatic selloff we experienced in December, but there were also concerns about softening economic data.
At the beginning of February, our proprietary barometer model gave us a signal to reduce our exposure to equities. Specifically, the rapid change in investor sentiment – going from extreme pessimism at the end of December to extreme optimism at the end of January – and a reduction in the outlook for industrial production were the factors that caused the change.
All things considered, the changes in the model were not that large. What is noteworthy, however, is that our resulting position after these changes left us modestly underweight equities for the first time since the fall of 2015.
If we do, indeed, experience a modest pullback or, even more encouraging, a successful retest of the December lows, our models would likely suggest an increase in equity exposures. Of course, we do not forecast our models and will remain data-dependent. Accordingly, we will remain modestly underweight equities until we get further clarity on the economic picture.
It is important to understand these changes do not represent a bet against stocks. We simply believe this is a time to be somewhat more cautious about their near-term prospects. Longer term, we still expect a resumption of secular bull market that started in 2009 and we should soon find our way back to the route of the long cross-country trip.