Why I’m Worried

Over the last week I have done a major revamp of our managed portfolios. In our ETF Seasonal Growth Strategy I’ve rotated into low beta and low volatility ETF’s. In our Dividend Income strategies I’ve replaced several higher beta holdings with lower beta, lower P/E, and unfortunately lower yielding stocks and ETF’s. Our models also signaled a sell of JNK, the SPDR High Yield Bond Index ETF, which increased our cash position by 20%. Here’s what I’m looking at:

  1. Seasonality. Any fundamental investor, and probably most technical investors seem to minimize the history of “Sell in May, and buy in November” as a legit trading strategy despite historical evidence showing significant risk reduction by following the strategy. While results are not consistent, what the data does show is that most of histories large drops have come between May and November. I don’t like big drops, so I’m cautious, and nervous.
  2. The Chicago Federal Reserve’s National Activity Index (CFNAI) has had a large downturn since February. While the St. Louis Financial Stress Index (STLFSI) continues to show an improving trend (downward sloping line means less stress), the level is still well above levels that have historically started recessions. Apparently from the graph below, STLFSI is just not improving fast enough to keep the CFNAI above a zero reading

Year to date the Standard and Poors High Beta ETF (SPHB) has outperformed the Standard and Poors Low Volatility ETF (SPLV) and the index itself (SPY) which is what you would expect in a rising/bull market. See Figure 2 below: Blue line – SPHB, yellow line – SPLV, and the red and green candle sticks – SPY.

Chart 2. Year to Date: SPY, SPLV, and SPHB

Source: freestockcharts.com

However, if you look at the same chart below, but change the time frame to the past month you can clearly see the market has rotated to lower volatility (risk off) stocks vs. higher beta (risk on) stocks as represented by the SPLV and SPHB ETF’s.

Chart 3 One Month: SPY, SPLV, and SPHB

Source: freestockcharts.com

But the big worry comes down to Spain. Chart 4 shows the past two years of SPY and I’ve highlighted the highly volatile breaks in between a couple of nice runs. Pretty much each period of high volatility has come about from concerns over Greece and the Greek debt crisis. While out of the headlines, Greece has not been solved. Only the can has been kicked down the road. Last December the EU implemented LTRO, Long Term Refinancing Operation. Which basically has given European Banks free money. The thinking was that this would kick the can into 2012. Wrong. We are barely past a quarter into the year, and Spain’s financial difficulties have started to hit the news. Particularly troubling because here in the U. S. corporate earnings have beaten estimates thus far. The expectation, (hope) was that with good earnings, reasonable valuations, and continued ZIRP, earnings would kick off another leg of the bull market. Instead the market has been shrugging off the good news (earnings) and moving on the bad news (Spain).

By summer Greece should be back in the news, and Italy and Portugal should be attracting their fair share of attention as well.

Chart 4. SPY, 2 Years

Source: freestockcharts.com

Bottom Line is summed up nicely in this headline from marketwatch.com on Monday the 23rd:     INVESTOR ALERT Stocks slide as volatility leaps

 Volatility is not good for stocks. While there is still time for President Obama to work some election year magic, and keep the economic expansion going through the fall elections, the markets seem to be betting against him, for now.

But I would recommend being alert, and don’t forget, “Don’t fight the Fed.” If the Fed comes up with a new money producing stimulus, the market could bounce back quickly and it will be “Risk On!” again.

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bill@401advisor.com • 937.434.1790

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Charles H. Dow Award Winner 2008. The papers honored with this award have represented the richness and depth of technical analysis.

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