Like an adolescent, we are back to that awkward, in-between phase. The strong upward trend of the stock market that persisted consistently throughout 2017 and January 2018 seems to have stalled out. That’s a fairly long time for a consistent, upward trend. And while we’ve been enjoying the ride, we know it could change directions eventually.
The market, to us, appears to now be trading sideways with higher volatility than we have seen since 2016 (you know, that year with the Brexit vote and the US election). While this can be nerve-wracking, to us, it is not signaling the beginning of a new bear market trend…yet.
Still, with the increased volatility returning last week, we’ve been working to get more defensive in some of our equity models. Don’t be surprised if you see additional allocations to bonds or money market in the coming weeks. More on that later.
Since the beginning of 2017, our investment focus has been on the Large Cap Growth Index. This investment style has been between 50 and 100% of our equity exposure. And while it, too, has also been feeling the recent volatility, we’ve been impressed by its resilience relative to the Large Cap Value Index (see chart below).
One Year comparison of the S&P Growth and Value Indexes (iShares ETFs) – StockCharts.com
Now our V31 Indicator is suggesting we could go to “Protection” mode for Q2 of 2018. This could change if the US stock market is strong for the last week of March, but at this point, it looks doubtful. In the past, when the Protection signal was given, two scenarios most often played out: 1. the market remained volatile and choppy for an extended period of time or 2. it pointed to the early stages of a new bear market. Right now, we’d expect this to be a pause before continuing into final stages of a bull market.
Bonds may be due for a short-term bounce here if the stock market continues its higher than average volatility. We believe it to be completely normal for a market (like the bond market) to take a step back (in this case up) before it continues on its path (in this case down). While we may be turning to bonds to help counteract short-term volatility, we still believe the long-term trend for bonds is down. That’s why we are looking at holding short-term bond durations for the time being.
We know, we know, it sounds like a contradiction not to like the bond market and to be moving into it at the same time. However, keep in mind the time frame being considered for each scenario is different. We believe that using bonds as a hedge or volatility reduction device potentially has the lifespan of a month or two. In contrast, a bond bear market could occur over decades.
Benjamin Graham, the “Dean of Wall Street,” said: “The essence of investment management is the management of risk, not the management of returns.” – (we have this printed on a poster up in our office as a constant reminder). By watching the risk levels of our portfolios, we seek to help investors get out of this trap. Investors tend to start making bad decisions in frustrating sideways markets, and we are here to help and guide them.
