Market/Model Commentary

Sentry Page Protection

Market/Model Commentary

"Slow and Steady wins the race"
The Hare and the Tortoise
Aesop (Greek slave & fable author 620 BC - 560 BC)

"Technical Analysis is a windsock, not a crystal ball"
Carl Swenlin (Technical Analyst)

"Investing is the intersection of economics and psychology"
Seth Klarman (Hedge fund Manager, Baupost Group)

Overview

The ECAM Composite 5-Factor model remained RED at the end of the trading week.

There have been substantial negative changes to sub-components within our 5-Factor model over the past several months. This shift has altered the 5-Factor model from GREEN (09 Dec 2016-11 Oct 2018) to YELLOW (12 Oct-25 Oct 2018) to RED (as of 26 Oct 2018). The RED signal puts us on alert for a potential bear market to begin.

There are 2 types of bear markets; non-recessionary and recessionary. The key difference is in the expect losses (losses less than -25% for a non-recessionary bear market vs. losses of 37%+ for a recessionary bear market).

" Technically" U.S. markets (as measured by the S&P 500 index) have not yet experience a bear market (defined as a closing daily price decline -20% or more from its most recent high). The current decline was -19.8% so it is still technically defined as a "correction". This may seem to be "splitting hairs" but it is important to note there have been quite a few "near-bear market" corrections where declines in the S&P 500 were -19%, but less than -20%. Since WW2, there have been five prior "near-bear markets" for the S&P 500, and all but one of them were NOT followed by a recession.

The five prior instances in which the S&P 500 fell 19%+ from a bull market high but never hit the -20% threshold on a closing basis saw the S&P go on to make a new bull market high each time after falling the 19%+. We can't be sure that the recent drop of 19.8% over the last three months won't end up becoming a bear market, but it does show that there's historical precedent for close calls.

Most of the near bear markets did not morph into recessions in that they tended to be quick, and therefore had less of an opportunity to negatively impact consumer sentiment. Therefore, if we have seen the lows, and the S&P can manage to stabilize, any collateral damage on the U.S. economy is likely to be minimized. As the U.S. is the worlds largest economy, it is the key to whether the globe enters recession.

The stock market has historically recovered quite a bit faster from non-recessionary bear markets than from those that are accompanied by a recession. In bear markets accompanied by recessions, the S&P 500 has taken an average of about 34 months to recover its prior peak. In bear markets without recessions, the S&P 500's time to recover its prior peak is shortened to only about 11 months. In the last two bear markets without recessions, the S&P 500 recovered in 3 months.

Equity markets reached oversold conditions rarely seen over the past 20 years on 24 Dec 2018. Typically this would be indicative of a short-term advance (which we have had the past 4 weeks). They have now approached oversold readings and have returned to important price resistance. As such, they have reached a critical decision point.

It is now appropriate to begin to partially de-risk portfolios as a safety measure. While there is no guarantee the recent decline has concluded, continued weakening global macroeconomic conditions have us concerned this may be the "dead-cat bounce" before the beginning of a bear market.

All changes to model portfolios will be emailed directly to subscribers.

ECAM 5-Factor Model

(as of market close 18 January 2019)

Economic Model

Valuation Model

Technical Model

Sentiment Model

Financial Stress Model

YELLOW

RED

RED

YELLOW

GREEN

RED
(as of 26 October 2018)

Weekly Summary

Stocks gained for a fourth straight week as major indexes continue to retrace last month’s steep losses, boosted by bank earnings and late-week developments in the U.S.-China trade narrative. Foreign indexes climbed in the week, but lagged their U.S. counterparts. Further stimulus announcements out of China were offset by a historically bad outcome of the U.K’s Parliamentary Brexit vote.

Global equities staged a late-week rally after the Wall Street Journal reported that Treasury Secretary Steve Mnuchin proposed lowering tariffs as an incentive for the Chinese to make a deal when Beijing’s top negotiator comes to Washington at the end of the month for another round of formal talks. The Trump Administration downplayed the news, but stocks sustained their rally after a second round of headlines on Friday suggested the Chinese would significantly ramp up U.S. imports in an effort to eliminate its trade surplus over the next six years.

Strength in the U.S. was buoyed throughout the week by an undercurrent of generally good earnings reports from a series of large financial institutions that included Citi, JP Morgan, Wells Fargo, and Bank of America. As a result, the financial sector outperformed, while defensives like utilities and consumer staples lagged. The continued shift back into equities pushed Treasury yields up—though the yield curve flattened a bit—and weighed on precious metals like gold and silver. On the other hand, industrial metals, which are more closely tied to economic growth expectations, moved mostly higher. Oil prices hit two-month highs on the heels of an OPEC report showing the group is ahead of schedule on production cuts.

In addition to U.S.-China trade headlines, investors in Europe were focused on the U.K’s parliamentary vote to determine whether the country would have a formal agreement in place when it leaves the European Union at the end of March. Prime Minister Theresa May’s deal was overwhelmingly rejected, though she survived a no-confidence vote thereafter to remain in her position and reassess her options. Market reaction was somewhat muted given the gravity of the situation, but the outcome was never really in doubt.

Globally economic indicators continued to soften with the latest Global Composite PMI data pointing to further deterioration into the end of 2018. The OECD Composite Leading Indicators (CLI) continue to forecast continued deterioration in economic activity globally (with glimpses of strength in EM and Asia Pacific). Global trade continues under pressure as a result of the U.S.-China trade dispute and until a substantial resolution to the issue is reached global equity markets remain under pressure.

The latest comments from IHS Markit reflect this global weakness:

"The danger of a global economic downturn has risen, but the probability of a recession in 2019 is still low. After a brief spurt in 2017 and 2018, growth in the G7 economies is reverting to trend, and emerging markets are unlikely to come to the rescue. This process is likely to be delayed in the US economy because of fiscal stimulus; however, higher tariffs, financial volatility, and the government shutdown will hurt growth - the only question is how much. The good news is that US consumer spending is on solid footing. However, elevated political risks in Europe are beginning to darken the outlook. Moreover, China's growth is proving to be especially fragile, and data for the last seven months show a marked slowing of activity - the industrial sectors are close to recession. Policy mistakes, especially regarding trade, continue to be the biggest threats to global growth. Fiscal and monetary policies have little room to stimulate in the event of a downturn.

United States: Real GDP growth was reported at an annual rate of 3.4% in the third quarter of 2018, and IHS Markit expects fourth-quarter growth of 2.8%. However, recent turbulence in financial markets has softened the outlook for 2019 and beyond. In response, we have removed one Federal Reserve rate increase from our forecast and lowered our projection for US Treasury yields. Combined with other developments, the net effect was to reduce our forecast of real GDP growth by an average of 0.1 percentage point per year from 2019 through 2022. We made no explicit adjustments to the January forecast to reflect the partial government shutdown. Assuming the shutdown lasts three weeks into January, we estimate first-quarter growth will be cut 0.1 percentage point, and losses will be recovered in the second quarter.

Europe: Growth is headed lower in 2019. Eurozone real GDP increased a disappointing 0.2% quarter on quarter (q/q) and 1.6% year on year (y/y) in the third quarter of 2018. Gauging the underlying growth trend has been complicated by a series of distortions, including the emission-test-related slump in automotive output. An expected rebound there, plus the fiscal stimulus coming in Germany, France, and Italy, will lead to a temporary pickup in real GDP growth to 0.5% q/q in the first quarter of 2019. The IHS Markit forecast calls for just 1.4% growth in 2019 and 1.2% in 2020, with risks still to the downside. Meanwhile, recent data and the UK parliament's rejection of the Withdrawal Agreement support our cautious near-term UK growth projections. We expect UK real GDP growth to slow from 1.3% in 2018 to 1.1% in 2019.

Japan: The sales tax hike will cloud the outlook for 2019. Real GDP declined at a 2.5% annual rate in the third quarter. Available data suggest real GDP recovered in the fourth quarter, thanks largely to a rebound in domestic demand. However, net exports were likely a drag on fourth-quarter growth as imports increased more rapidly than exports. Real GDP growth is expected to hold steady at 0.8% in 2019, slip to 0.5% in 2020, and rise to 0.7% in 2021. The scheduled increase in the sales tax from 8% to 10% in October 2019 will contribute to volatility in quarterly growth patterns, as consumers and businesses shift purchases forward.

China: More signs of fragility. Following the trade truce reached by the president of the United States and the president of China, Donald Trump and Xi Jinping, we have assumed that US import tariffs on USD200 billion of Chinese goods will remain at 10% rather than increasing to 25%. Economic growth should stabilize as the government releases additional stimulus, including corporate tax cuts, credit easing, infrastructure investment, and looser real estate rules in lower-tier cities. Meanwhile, exports, industrial production, and retail sales have decelerated, as has factory price inflation. The balance between weak data and expected further stimulus leaves the IHS Markit assessment of China's near-term outlook unchanged.

Other large emerging markets: While currency pressures have eased, the outlook is not that bright. The pressures on emerging-market currencies have eased considerably, compared with the first half of 2018. Further pressure relief can be expected as the Federal Reserve takes an even more cautious approach towards raising interest rates. That said, weakening global growth and more pessimism on commodity prices will do little to boost growth prospects even among the star performers. Growth is expected to be lackluster (or even worse) in other large emerging markets such as Russia, South Africa, Turkey, Brazil, and Mexico. In the latter two countries, uncertainty about the policies of new governments is also giving both domestic and foreign investors pause. All this means emerging markets will not be able to offset the weakness in developed markets.

Bottom line: Growth is slowing everywhere, but it is far too soon to run for the exits. Barring a policy or other type of shock, the world economy is likely to muddle along for at least another year."

Below we show the latest Ned Davis Research Global Recession Probability model which triggered a "high risk" global recession warning recently. This is a seriously negative indication which drastically increases the probability (90.91%) a global recession is either occurring or forthcoming (recessions are officially registered only by assessment of backdated data) .

WEEKLY ASSET CLASS MONITOR

Asset Class

Region

ETF Ticker

Weekly
Return

Year-to-Date
Return

Equities

World
U.S.
Europe
Asia Pacific
Emerging Market

VT
VTI
VGK
VPL
EEM

+2.36%
+2.87%
+1.41%
+2.34%
+2.01%

+6.46%
+7.07%
+5.39%
+6.25%
+6.37%

Bonds

U.S. Bonds
International Bonds

BND
BNDX

-0.23%
+0.30%

-0.08%
+0.22%

Real Estate Equities

U.S. Real Estate
International Real Estate

VNQ
VNQI

+2.16%
+1.13%

+6.52%
+5.48%

Precious Metals Equites

Global Gold Miners
Global Silver Miners
Gold Bullion ETF
Silver Bullion ETF
Platinum Bullion ETF

RING
SIL
GLD
SLV
PPLT

-4.08%
-4.77%
-0.64%
-1.84%
-1.59%

-2.77%
-1.16%
-0.19%
-1.03%
+0.53%

As shown below, global equites had remained range-bound from early-February through mid-December before the recent breakdown. A breakdown of current regional divergences in equity performance is as follows:

Global equites have returned to the consolidation zone they had been trapped within from Oct-early Dec 2018. Price remains below the descending 200 day moving average. (Bearish)
U.S. equities returned to within their consolidation zone. Total U.S. market index closed below the flat 200 day moving average. (Neutral)
European equites returned to their trading range. They remain below the descending 200 day moving average. (Bearish)
Asia Pacific returned to their trading range and remain below the descending 200 day moving average. (Bearish)
Emerging market equities broke above their recent trading range and remain below the descending 200 day moving average. (Neutral)

Below is the percentage returns for each of the monitored equity regions since the U.S. market peak on 21 Sep 2018. The strongest region since this date has surprisingly been Emerging Markets with European equites lagging. All regions have advanced off their 24 Dec 2018 lows with World equities up +9.7%. We still view this as a bounce within a developing bear market.

We continue to monitor the divergence in US equity market performance vs. the rest of the world. This is reflected below in the stark divergence between:

the U.S. Total Market ETF (BLUE)
the MSCI ACWI World (ex-US ) ETF (GREEN)
the MSCI World ETF (RED)

Clearly trade war potentiality has made investors much more U.S. equity oriented since 03 May 2018 and up until the downtrend began it was only the U.S. equity performance that has supported global equity returns for most of 2018.

The End of Global Quantitative Easing

The #1 concern that remains on our mind as we entered 2019 is how equity markets will react to the steady decline in global liquidity associated with Central Bank balance sheet normalization.

As is well documented, since the global financial crisis of 2008 central banks have injected trillions of dollars into the world's financial system by way of an untried/unproven financial engineering experiment known as "Quantitative Easing" (purchase of assets by way of printing money to support the equity/bond markets) . However, central banks are determined to shrink their balance sheets as per the below graph. At the current pace, it is projected in the 1st quarter of 2019 net liquidity will begin to be removed from the global financial system.

Below we have noted the various movements in QE since 2007. Each boxed area shows where central banks expanded their balance sheets and the subsequent global equity market gains. Of particular note is the short period in early 2015 (circled) where central bank liquidity reverted to "Quantitative Tightening" (net balance sheet reduction on a 12 month rate of change). This short period of reduction led to the largest equity market declines (-20%) of the current bull market.

As 2019 proceeds we are mindful a repeat of 2015 (or worse) is highly likely.

Of particular concern at present is the U.S. Federal Reserve and their quantitative tightening program. The FED is attempting to move their interest rate towards "neutral" (an level at which the interest rate is neither stimulative nor restrictive). The "neutral rate" is difficult to estimate but below is the current best-guess shown in RED:

The problem with the above is currently interest rates are being increased towards "neutral" while simultaneously the FED is reducing their balance sheet via quantitative tightening (at $50 billion/month). This is leading to a 2-prong approach never attempted before in economic history.

In order to highlight the true overall tightening (increased interest rates + decreased balance sheet), the Wu-Xia Shadow Rate gives an accurate estimate of the combined effects (RED is the increase in FED interest rates +GREEN the estimated reduction in the FED balance sheet):

The combined effect has now exceeded the level of tightening which led to the last 3 recessions in the U.S. and is a concern we believe very few are monitoring.

Hedgeye Risk Management LLC

As we appear to be approaching a potential turning point in global growth, we continue to utilize global macroeconomic data purchased from Hedgeye Risk Management LLC to supplement our own macroeconomic model. Hedgeye is a U.S. based company which monitors 100's of global macro data points and uses a predictive tracking algorithm to attempt to forecast growth, inflation and policy (GIP) for 50 countries. Using the algorithm, they attempt to "crystal ball" where markets may go up to 4 quarters in advance.

They classify their model using "Quadrants" defined as follows:

Quad 1

rising Growth/falling Inflation (economic recovery phase)
overweight equities/credit
underweight fixed income

Quad 2

rising Growth/rising Inflation (economic boom phase)
overweight equities/credit
underweight fixed income

Quad 3

falling Growth/rising Inflation (economic stagflation phase)
overweight fixed income
underweight equites/credit

Quad 4

falling Growth/falling Inflation (economic deflation phase)
overweight fixed income
underweight equities/credit

Below is their current projections for the top 20 OECD economies (as of 04 January 2019). In general it can said Quads 1 & 2 are bullish for equities (dark/light Green is "good") with Quads 3 & 4 bearish for equities (Yellow and Red are "bad"). Also note as each economic data point is released their algorithm recalculates the projected path so this model needs constant monitoring.

It can be seen their algorithm current projects the U.S. to be within Quad 4 (slowing Growth, falling Inflation) in 4Q18-1Q19 while within Europe (Germany/Spain) Quad 1 conditions (rising Growth/falling Inflation) are forecast to occur. Should their model be correct, it would be expected European equities would begin to outperform U.S. equities in early 2019 with overall global conditions shifting to Quad 1 (bullish global equities) in 1Q19.

Below is their suggest asset exposure for each of Quadrants:

* Retirement Fund Current Model Portfolios *
(click above link to access)

Asset Class Return Monitor
(for week ending 18 January 2019)

Equities Legend:

Vanguard Total World Stock ETF (VT): (Cyan)
Vanguard Total U.S. Stock Market ETF (VTI): (Red)
Vanguard FTSE Europe ETF (VGK): (Lime Green)
Vanguard FTSE Asia Pacific ETF (VPL): (Dark Blue)
Vanguard FTSE Emerging Markets ETF (VWO): (Pink)

Bonds Legend:

Vanguard Total U.S. Bond Market ETF (BND): (Black)
Vanguard Total International ex-U.S. Bond ETF (BNDX): (Green)

Currencies Legend:

U.S. Dollar Index (Cash Settlement EOD) ($USD): (Orange)
Euro (Philadelphia Index) ($XEU): (Maroon)

Commodities Legend:

PowerShares DB Commodity Index Tracking Fund (DBC): (Purple)
SPDR Gold ETF (GLD): (Light Blue)

Past Week Asset Class returns

Over the past week world equites (as measured by the Vanguard Total World Stock ETF (shown in CYAN) gained +2.36%.
U.S. equities were the top performing equity region this past week with European markets lagging.
U.S. bonds (Black) and International bonds (Green) were mixed on the week.
Commodities were moderately higher over the past week with the USD slightly higher on the week.

Year-to-Date (2019) Asset Class returns

Thus far in 2019 global equites (as measured by the Vanguard Total World Stock ETF (shown in CYAN) have gained +6.46%.
U.S. equities have been the top performing equity region thus far in 2019 with European markets lagging.
Bonds have shown mixed returns thus far in 2018 with International Bonds (Green) out-performing U.S. bonds (Black).
Commodities have had positive returns with the USD index flat for 2019.

We remain concerned about excessive equity valuation (especially in the U.S.) relative to historical values. Markets continue to be priced for perfection and and any one of the following events (which we refer to as the 6 Horsemen of the Apocalypse) could quickly bring on a recession and a rapid reduction (40%+) in equity prices:

a central bank policy mistake (excessive balance sheet reduction and/or interest rate increases)
a major disruption to international trade (trade wars or tariffs)
a surge in inflation
a surge in yields (which may be occurring currently)
significant US dollar appreciation
a geopolitical shock (region military conflict, war)

* Note for the 1st time one of our major event triggers (potential trade disruption due to trade tariffs) has triggered with the recent introduction of the US imposing $200B in trade tariffs on China along with steel/aluminum tariffs on Canada and the Eurozone. This has the potential to escalate rapidly into international trade wars which NEVER result in increased equity prices. This is a major concern we continue to monitor over the near term.

Typically bull/bear markets follow a cycle of investor psychology which peaks with euphoria.

In the big picture, it is apparent we saw signs of investor exhilaration/euphoria in early Jan 2018 and have now moved into the back half of the sentiment sin curve.

Typically bull market bubbles end in 3 distinct phases:

a period of exponential rising prices,
a consolidation period, and
a final blow-off phase into extreme over-valuation before a bear market decline.

It must be reemphasized a complete market cycles is composed of 2 distinct cycles/phases: a Bull phase and a Bear phase. We are currently within the the final innings of the "bull 1/2 cycle" and the "bear 1/2 cycle" is oncoming. The key to long term investment success is to protect the majority of those bull 1/2 cycle gains when the bear market comes calling.

We illustrate current market overvaluation via 3 charts produced by Crestmont Research (as of 01 January with data from 1871-to-present). While it is not necessary to understand exactly how the data is plotted, it is important for every investor to realize where current valuations stand relative to this 148 years of history.

In the following graphs note the following:

the Crestmont Price/Earnings (P/E) ratio is at 29.6 and has now begun to decline from the most expensive market valuation in U.S. stock market history (since 1871). It peaked well above both the 2007 peak (24.7) and 1929 peak (26.4) as shown on the 1st chart.

when compared to inflation the current Crestmont P/E remains within the very top region of the bubble zone defining the 1998-2000 bubble peak as shown on the 2nd chart.

the current Crestmont P/E is 122% above its geometric mean; well above the 2007 peak (89%) and 1929 peak (99%) as shown on the 3rd chart. It recently reached the 2000 peak at 153% (the absolute maximum in history).

We remain within the very dangerous period near the end of bull markets where only a minor change in either investor risk appetite or economic performance would be all it takes to "upset the apple cart". Unfortunately valuation measures are a "blunt instrument" when it comes to market timing. Each bull market is different in character and market sentiment can remain bullish long past metrics of reasonable valuation. However, from a risk-reward perspective it is essential to understand risk remains highly elevated and long term equity returns (on a buy-and-hold basis) remain extremely low.

It cannot be overstated how important it is to protect the bulk of one's market gains during the bear market half-cycle. As can be seen below, as the percentage losses increase the required returns to get back to breakeven move in an exponential manner:

a 20% loss requires a 25% gain
a 30% loss requires a 43% gain
a 40% loss requires a 67% gain
a 50% loss requires a 100% gain

This is why it is so important to not let losses continue in the face of a bear market and why we advocate phased movements into cash as our 5-factor model reverts towards Red. The below graphic represents how we move within equity markets through a complete market cycle:

Given current market valuations and our expectation of a -40% or greater decline during the next bear market, "careful and cautious" remains our game plan. When we enter this sort of environment we can play the game on the long side but carefully eye the door for when the music stops. We have no intention in participating in the substantial downside yet to come to complete this current market cycle.

World Regional Equity Monitor

We use the following U.S. exchange traded funds to monitor equity performance for the various world regions:

World Equities: Vanguard Total World ETF (Cyan)
U.S. Equity: Vanguard Total Market ETF (Red)
Pacific Equity: Vanguard FTSE Pacific ETF (Blue)
European Equity: Vanguard FTSE Europe ETF: (Lime Green)
Emerging Market Equity: Vanguard FTSE Emerging Market ETF (Pink)

1 Year Rolling Regional Equity Performance

Over the past 12 month rolling period regional equity performance remains negative for the various equity regions.
The strongest equity region over the past 12 month has been U.S. Markets with Emerging market equities lagging.
Overall world equity performance (as measured by the Vanguard Total World ETF) are negative with a return of -8.20% (including dividends) over the past 12 month rolling period.

3 Month Rolling Regional Equity Performance

Over the past 3 month rolling period the strongest performing world equity region has been Emerging markets with U.S. markets the weakest.
Negative regional equity performance has been evident over most regions over the past quarter (3 months).

1 Month Rolling Regional Equity Performance

Over the past 1 month rolling period the strongest performing world equity region has been Emerging markets with Asia Pacific markets the weakest.
Strong global equity returns are evident over the past month.

Past Week Regional Equity Performance

Over the past week U.S. equities were the strongest performing equity region with European markets lagging.

Latest Global Equity "Big Picture"

World equity market returns are monitored via the following charts:

Dow Jones Global Market Index
(market cap weighted index)

For the week the Dow Jones Global Index had again of +2.08%. As can be seen on the 1st above chart, price remains below the 65 week moving average (for the 1st time in over 2 years) and closed the week above the breakdown point established in Oct 2018 @ 365.85 (now support). The next area of resistance is the early Nov close @ 386-388.

Value Line Geometric Index and Global Dow Index
(equal weighted indexes)

The Value Line Geometric Index ($XVG; top panel) is the median price performance of 1700 U.S. companies equal weighted (as opposed to most indexes which are market cap weighted) into an index. Below that is the Global Dow index ($GDOW; bottom panel). It is a measure of the top 150 international companies equal weighted within the index and represents a good overview of equity performance worldwide.

Both indexes broke key support on the recent market decline and have now rebounded back to this breakdown area. Bearishly both indexes remain below their respective declining 200 day simple moving averages.

Below are weekly charts of the same indexes. As can be seen, the Value Line index has now returned to its breakdown point @ 508-523. A break above this zone would be bullish with a breakdown from this level bearish.

Below is a 38 year daily chart of $XVG which clearly shows the critical price support/resistance @ 508-523. Also shown is the 2 previous corrections within the bull market from 2009 to put the current decline into context. Unless the Value Line Geometric Index can regain its 508-523 price level it must be assumed a bear market is in effect.

iShares MSCI ACWI ETF
(market cap weighted ETF)

The iShares MSCI ACWI (All Country World Index) ETF is used as a benchmark to compare the performance of the various broad-based equity funds available in the Emirates Group Provident Scheme (EGPS) A/B/C accounts. It serves as a benchmark to determine how equity markets are performing on a worldwide basis. This assists in determining 2 parameters; whether to be invested in equities and also which funds within the EGPS offer the best performance relative to the benchmark.

The ETF is composed of the following regional components/weightings:

ACWI Monthly Chart (since 2009)

As shown on the monthly chart above, world equity markets remained range bound for most of 2018 with a breakdown in the month of October. The recent decline has broken the uptrend line from the 2009 market bottoms and the 12 month simple moving average.

For the month of January ACWI has gained +6.34%. Resistance would be expected at the $70 level with support back to the 2015-2016 consolidation zone as shown with the yellow shading.

ACWI Weekly Chart

This past week ACWI gained +2.42%. Price remains below the 65 week simple moving average (which acted as support throughout the 2014-2015 topping process) and remains below the price resistance (69.32-69.87). Support is now the 2015 top @ 59.37.

World Equity Market Regional Relative Rotation Graphs

Below is a graph of 23 major regional equity market ETF's + ACWI (our world equity benchmark) shown on a Relative Rotation chart measured weekly with a 10 week look-back period (which forms the "tail" of the ETF). This graph allows us to observe over time how various regional ETF's are moving relative to both each other and also relative to cash.

Leading (Green): (Momentum Positive + Price Relative Strength Positive)
Weakening (Yellow): (Momentum Negative + Price Relative Strength Positive)
Lagging (Red): (Momentum Negative + Price Relative Strength Negative)
Improving (Blue): (Momentum Positive + Price Relative Strength Negative)

Given the cyclical nature of momentum and price within equity markets, in general the RRG charts will cycle in a clockwise manner (though not necessarily will each pass through all 4 quadrants as it is possible to rotate through an adjacent quadrant only).

Weekly Regional (Country) Relative Rotation Graphs (long term)

As can be seen on the above table, the global RRG quantitative relative scoring peaked on 21 September (+5) and declined to a recent low of -35. This past week it improved from recent lows but remains bearish.

ACWI (our world equity fund benchmark) remained within the RED "Lagging" quadrant this past week (as shown on the below RRG chart with the other countries blanked out to focus upon only ACWI) but has begun to hook upwards over the past week. This remains a negative development until we see ACWI trend upwards and return to the blue "Improving" quadrant.

The RRG trend analysis status is Bearish for world equities:

ACWI price Relative Strength: Negative
ACWI price Momentum: Negative

Coincident Equity Market Indicators

Crude Oil

Crude oil was higher over the past week. It broke out the broad uptrend channel in October and remained above previous support near $50 this week. Firm crude oil prices typically point to increasing demand on the back of world economic growth improvement and the recent large decline over such a short period of time is very concerning as it may be an indication the global economy is slowing substantially.

Gold

Gold was modestly lower over the past week. It was broadly lower through 2018 but began to turn bullish in late October. It appears to want to now target resistance @ $1289-1295.

Since bottoming near $1200 in October the advance in Gold indicates increased concern in equities with a flight to safety. As long as gold continues to advance it remains equity bearish.

Commodities

Commodities were modestly higher over the past week but remain near 2017 lows. Since bottoming in early 2016, commodities had been on a steady (but not overly steep) rise indicating increased demand (and thus increased world growth). This reversed in May 2018 and the recent price break is confirmation world growth is slowing. This remains equity bearish.

U.S. 30 Year Treasury Bond

U.S. 30 year bonds were modestly lower on the week and remain below their 3 year long support (near $146-$148). However, they broke above the downtrend line from their June 2016 peak recently changing their trend to bullish. Rising bond prices indicate a "flight to quality" trade and a break above the resistance would be very equity bearish.

Current 5-Factor Model Indications

The combined 5-Factor quantitative model reverted to RED (26 Oct 2018) with a number of the sub-models now either YELLOW or RED. This indicates a certain level of caution and close monitoring is warranted at present. However, equity markets became drastically oversold in late 2018 and the short term bounce we expected has begun. Reducing equity exposure into market strength appears appropriate.

Click the following link to access current model positioning: "Current Model Portfolio Positions"

The 5-Factor model currently has the following sub-model readings:

Economic Model

The Economic model switched to YELLOW in early August 2018 (GREEN from in May 2016) on the back of subtle but gradually declining world growth. It is unclear if trade tariffs are to blame or something more systemic but it is a growing concern world equities may become vulnerable.

The model is composed of numerous inputs including the following data:

OECD Composite Leading Indicators (CLI)
J.P. Morgan Global Purchasing Managers (PMI) Index
International Monitory Fund (IMF) World Economic Report

OECD Composite Leading Indicators (14 January 2019)

The OECD Composite Leading Indicator is designed to provide a 6-9 month lead time on turns in economic performance. As such, it is a useful "look-forward" tool we use to attempt to predict regional economic weakening/strengthening turn points.

The current report indicates continued declining growth momentum in the OECD area.

Below is a look-back graph of the Composite Leading Indicator for the OECD along with the 4 largest economic regions. All regions are amplitude adjusted to use 100 as their long term growth average. As such, readings less than 100 indicate below average projected growth.

It can be seen the OECD CLI peaked in Nov 2017 and descended below 100 in May 2018. Using a 6-9 month look-forward, this indicates global growth is forecast to have peaked in May-Aug 2018 and will fall below its average historical growth rate in Nov 2018-Feb 2019.

At present the OECD CLI continues to decline indicating no forecast of a change in global growth for the next 6-9 months. The only major region that shows a potential positive growth reversal is China (projected to begin to improve in Oct 2018 - Jan 2019 based upon its Apr 2018 trough). Until the OECD indicator bottoms it is expected global growth will continue to be under pressure.

ECAM Composite Leading Indicator (CLI) Heat Map
6-9 Month Business Cycle Lead Time
(color code shows respective CLI trend)

Below is our latest heat-map of the CLI for various monitored regions. Red/Green boxes indicates CLI rate of change month/month and year/year. Readings < 100 indicate projected below average economic growth. The CLI is designed to predict business cycle changes 6-9 months in advance so the Peak/Trough dates can be used to predict turning point months for the various regions.

As can be seen, the map indicates very few regions/countries with CLI's > 100. This indicates weak world economic growth is projected over the next 6-9 months. Until we see a trough/reversal in the major regional signals, it is premature to anticipate a return to global synchronized growth.

J.P. Morgan Global Composite Purchasing Managers Index (04 January 2019)

The Global Composite PMI Report is based on the results of manufacturing and service sector surveys covering over 18,000 purchasing executives in over 40 countries. Together these countries account for an estimated 89% of global gross domestic product (GDP). Questions are asked about real events and are not opinion based. Data are presented in the form of diffusion indices, where an index reading above 50.0 indicates an increase in the variable since the previous month and below 50.0 a decrease. As such, using the PMI data gives us a real-time look at global growth with readings > 50 indicating economic expansion and readings < 50 indicate economic contraction.

The latest monthly report indicates a continued decline in global growth as of the end of December 2018. While global growth remained expansionary (Global Composite PMI > 50), global growth has now slowed to levels last seen in September 2016

Below is a graph of the J.P. Morgan Global Composite PMI as well as the Manufacturing and Services PMI
sub-components.

It can be seen current global economic growth continues to expand (PMI > 50 indicated economic expansion) but has declined substantially from its Mar 2018 peak. Also it is apparent the weakness is mostly within the Manufacturing sub-component (thin black line) which has fallen dramatically from its Jan 2018 peak (likely due to the current trade/tariff war between the U.S. and China). It is important to note the global economic weakness experienced in mid-2014 to early 2016 was led by the manufacturing sub-component pulling global growth downwards. We are experiencing the same once again.

The Global Composite PMI sub-components are shown below. As of the last reading, every sub-component fell over the past month with several of the sub-components now in contraction (< 50). This is a troubling sign of a pending global recession.

Below is our PMI monitor for selected regions/countries.

values > 50 indicate economic expansion
values < 50 indicating economic contraction
trend GREEN indicates improvement over the past month with RED indicating a decline over the previous month.

G-20 Manufacturing PMI (Dec 2018)

Countries with contracting manufacturing are shown with a RED strikeout
# of G-20 countries with expanding manufacturing PMI: 15
# of G-20 countries with contracting manufacturing PMI: 7

IMF World Economic Report (October 2018)

The International Monitory Fund completes a quarterly Global Economic Review. From their latest report:

"The steady expansion under way since mid-2016 continues, with global growth for 2018–19 projected to remain at its 2017 level. At the same time, however, the expansion has become less balanced and may have peaked in some major economies. Downside risks to global growth have risen in the past six months and the potential for upside surprises has receded".

Executive Summary

Forward

IMF World Economic Outlook

U.S. Economic Growth & Inflation

Year-over-Year GDP growth

The Gross Domestic Product (GDP) in the United States expanded 3 percent in the third quarter of 2018 over the same quarter of the previous year. GDP Annual Growth Rate in the United States averaged 3.20 percent from 1948 until 2018, reaching an all time high of 13.40 percent in the fourth quarter of 1950 and a record low of -3.90 percent in the second quarter of 2009.

Quarter-over-Quarter GDP growth

The US economy advanced an annualized 3.4 percent on quarter in the third quarter of 2018, slightly below earlier estimates of a 3.5 percent growth, final figures showed. It follows a 4.2 percent expansion in the previous period which was the highest since the third quarter of 2014. Personal consumption expenditures (PCE) and exports were revised down, and private inventory investment was revised up. However, the general picture of economic growth remains the same. GDP Growth Rate in the United States averaged 3.22 percent from 1947 until 2018, reaching an all time high of 16.70 percent in the first quarter of 1950 and a record low of -10 percent in the first quarter of 1958.

Annualized Inflation

Annual inflation rate in the United States fell to 1.9 percent in December of 2018 from 2.2 percent in November, matching market expectations. It is the lowest inflation rate since August of 2017, mainly due to a decline in gasoline cost. On a monthly basis, consumer prices edged down 0.1 percent after a flat reading in the previous month and also in line with forecasts. It is the first monthly decrease in consumer prices in nine months, due to a 7.5 percent slump in gasoline prices. Inflation Rate in the United States averaged 3.27 percent from 1914 until 2018, reaching an all time high of 23.70 percent in June of 1920 and a record low of -15.80 percent in June of 1921.

Eurozone Economic Growth & Inflation

Year-over-Year GDP growth

The Euro Area economy grew 1.6 percent year-on-year in the third quarter of 2018, following a 2.2 percent expansion in the previous period, the final estimate showed. GDP Annual Growth Rate in the Euro Area averaged 1.71 percent from 1995 until 2018, reaching an all time high of 5 percent in the first quarter of 1995 and a record low of -5.50 percent in the first quarter of 2009.

Quarter-over-Quarter GDP growth

The Eurozone economy grew 0.2 percent on quarter in the three months to September 2018, unrevised from a second estimate and following a 0.4 percent expansion in the previous period. It was the weakest growth rate since the second quarter of 2014 mainly due to a negative contribution from external demand. Among the bloc's largest economies, Germany and Italy posted contractions, while France's growth picked up and Spain's expansion remained solid. GDP Growth Rate in the Euro Area averaged 0.39 percent from 1995 until 2018, reaching an all time high of 1.30 percent in the second quarter of 1997 and a record low of -3 percent in the first quarter of 2009.

Annualized Inflation

Annual inflation rate in the Euro Area is expected to ease to 1.6 percent in December of 2018 from 1.9 percent in the previous month and below market expectations of 1.8 percent. It was the lowest inflation rate since April mainly due to a slowdown in cost of energy and food, alcohol & tobacco. Inflation Rate in the Euro Area averaged 1.97 percent from 1991 until 2018, reaching an all time high of 5 percent in July of 1991 and a record low of -0.70 percent in July of 2009.

Japan Economic Growth & Inflation

Year-over-Year GDP growth

The Gross Domestic Product (GDP) in Japan stagnated in the third quarter of 2018 over the same quarter of the previous year. GDP Annual Growth Rate in Japan averaged 1.99 percent from 1981 until 2018, reaching an all time high of 9.40 percent in the first quarter of 1988 and a record low of -8.80 percent in the first quarter of 2009.

Quarter-over-Quarter GDP growth

The Japanese economy shrank 0.6 percent on quarter in the third quarter of 2018, faster than a preliminary estimate of a 0.3 percent drop and market expectations of a 0.5 percent decline. It is the steepest contraction since the second quarter of 2014, following a downwardly revised 0.7 percent expansion in the previous period. Natural disasters like flood and earthquake weighed more on personal consumption and capital investment than initially estimated. GDP Growth Rate in Japan averaged 0.49 percent from 1980 until 2018, reaching an all time high of 3.20 percent in the second quarter of 1990 and a record low of -4.80 percent in the first quarter of 2009.

Annualized Inflation

Japan's consumer price inflation eased to 0.3 percent year-on-year in December 2018 from 0.8 percent in the previous month, in line with market expectations. It was the lowest inflation rate since October 2017, mainly due to declines in cost of food, housing and transport. On a monthly basis, consumer prices declined 0.2 percent in December, the same pace as in November. In 2018, the average inflation rate was 1 percent. Inflation Rate in Japan averaged 2.99 percent from 1958 until 2018, reaching an all time high of 24.90 percent in February of 1974 and a record low of -2.50 percent in October of 2009.

China Economic Growth & Inflation

Year-over-Year GDP growth

The Chinese economy advanced 6.5 percent year-on-year in the September quarter of 2018, after a 6.7 percent growth in the previous period and missing market consensus of 6.6 percent. It was the lowest growth rate since the first quarter of 2009 during global financial crisis, amid intense tariff dispute with the US and alarming off-balance-sheet borrowings by local governments. GDP Annual Growth Rate in China averaged 9.58 percent from 1989 until 2018, reaching an all time high of 15.40 percent in the first quarter of 1993 and a record low of 3.80 percent in the fourth quarter of 1990.

Quarter-over-Quarter GDP growth

The Chinese economy grew by 1.6 percent quarter-on-quarter in the three months to September 2018, compared to a 1.8 percent expansion in the previous period and matching market estimates. GDP Growth Rate in China averaged 1.80 percent from 2010 until 2018, reaching an all time high of 2.40 percent in the first quarter of 2011 and a record low of 1.40 percent in the first quarter of 2016.

Annualized Inflation

China's consumer price inflation slowed to a six-month low of 1.9 percent year-on-year in December 2018 from 2.2 percent in the previous month and below market consensus of 2.1 percent. The slowdown in inflation was mainly due to non-food prices, while food inflation remained at its lowest level in three months. Inflation Rate in China averaged 5.19 percent from 1986 until 2018, reaching an all time high of 28.40 percent in February of 1989 and a record low of -2.20 percent in April of 1999.

Valuation Model

The Valuation model remains RED/negative due to overvaluation of equity markets at current prices relative to historical data. We continue to update forecasts from a number of historically reliable sources (see section titled "Market Valuation"). Long term equity returns vary inversely with market valuation and at current price levels forward returns will be much lower than historical average returns (projected to be approximately 2% per year ex-inflation over the next 10 years).

Technical Model

The Technical model remained RED this past week. World Equity markets remain below their recent consolidation zones in established downtrends.

Sentiment Model

The Sentiment model reverted to YELLOW this week on the back of a neutral sentiment among retail and institutional investors (sentiment acts as an inverse trading indicator).

Economic Stress Model

The U.S. Economic Stress model remains GREEN this week with very little U.S. financial stress indicated. Our 1 year forward U.S. recession indicators remained "Low Risk" but our Global ex-U.S. 1 year forward recession indicators recently moved up to "High Risk".

World Bond Asset Class Return Monitor

We use the following U.S. exchange traded funds to monitor bond performance for the various bond asset classes:

Total Market Bond Basket:

U.S. Total Bond Market (BND): (Red)
International (ex-U.S.) Total Bond Market (BNDX): (Blue)

Government Bonds:

U.S. Gov't Bonds (GOVT): (Orange)
Foreign Developed Market Gov't Bonds (BWX): (Pink)

Corporate Bonds:

U.S. Corporate Bond (LQD): (Maroon)
International Corporate Bond (PICB): (Black)

High Yield Bonds:

U.S. High Yield Bond (JNK): (Purple)
International High Yield Bond (IHY): (Green)

Inflation Protected Bonds:

U.S. Gov't Inflation Protected Bonds (TIP): (Lime Green)
International Gov't Inflation-Protected Bond (WIP): (Cyan)

1 Year Rolling Bond Performance

Over the past 12 months rolling period the top performing bond asset class has been U.S. Gov't Bonds with Int'l Corporate Bonds the worst performing.
The U.S. Total Bond Market (RED) and the International (ex-U.S.) Total Bond Market (BLUE) have delivered positive returns over the past year.

3 Month Rolling Bond Performance

Over the past 3 month rolling period the top performing bond asset class has been U.S. Gov't bonds with Int'l Corporate Bonds lagging.
U.S. Total Bond Market (RED) and International (ex-U.S.) Total Bond Market (BLUE) having delivered positive returns over the past quarter (3 months).

1 Month Rolling Bond Performance

Over the past 1 month rolling period the top performing bond asset class has been U.S. High Yield Bonds with U.S. Gov't Bonds lagging.
The U.S. Total Bond Market (RED) and the International (ex-U.S.) Total Bond Market (BLUE) have delivered positive returns over the past month.

Past Week Bond Asset Class Performance

Over the past week U.S. High Yield bonds were the top performing bond class with Int'l Gov't Bonds lagging.
The U.S. Total Bond Market (RED) and the International (ex-U.S.) Total Bond Market (BLUE) delivered mixed returns over the past week.

Commentary:

It has been shown in repeated studies over many years a balanced portfolio consisting of both equities and bonds (with percentage holdings in each adjusted according to personal risk tolerances) remains the best methodology in managing a long term retirement portfolio (due to the independent/low correlated function each takes when navigating though various market cycles and economic conditions).

It is best to think of bonds and equities as 2 independent brains each looking at the market from a different perspective:

Equities: Corporate profits focused.
Bonds: Economic growth and Inflation focused.

As such, both serve a useful purpose in a well balanced portfolio.

Bonds delivered flat returns throughout 2018 as rising inflation and strong growth persisted. We are very cognizant of the fact bond yields are potentially at generational lows (prices overbought and at generational highs) and any significant economic recovery (with associated increases in inflation) has the potential to be very detrimental to bond fund returns.

Rolling 12 month returns for bonds remain positive but recent weakness has been noted and we are monitoring closely US, German & Japanese rates to determine if (when) it may be appropriate to reduce bond positions. Our premise is these 3 bonds tend to be somewhat "tethered" due to capital flows so it would take a breakout in all 3 key Treasuries above their respective price levels (described below) in order to definitively state the bull market in bonds is over.

As of present International bond funds have not been affected by the rise in rates as U.S. bond funds have. We continue to reassessing each of the bond funds within our models to determine their exposure to duration risk should rates outside the U.S. also begin to rapidly rise.

U.S. 10 year Treasury Yield

After rates bottomed in mid-2016 (bond prices peaked as they are inversely correlated), rates rapidly rose to resistance on the perception of future economic growth + inflation. Importantly, price resistance near 2.6% (which had contained yields for almost 4 years) was broken in early 2018. A key resistance level at 3.006% - 3.036% was broken on May 15, 2018 (high 3.115%, daily close 3.109%) but was unable to hold for more than 1 trading day. The same level was broken upward in late Sept but broke down in mid-Dec.

Current support is the 2018 breakout level @ 2.597%-2.648%.

German 10 year Bund Yield

German 10 year treasury yields have remained confined below 0.92% since 2014 with a bottom of -0.19% achieved in June 2016. Since then rates have gradually climbed within a rising channel (until recently) towards 0.92%.

Yields have pulled back since early 2018 and this past week remained below the weekly breakout level of 0.60%. A weekly close above 0.93% and it is likely the bull market in German bonds is over. There is no indication at present to suggest such will occur but we are monitoring for such an event.

Japanese 10 year Treasury Yield

Japan has been fighting deflation for decades and only recent unprecedented monetary policy by the BOJ appears to be having some effect upon deflation (and yields).

After bottoming at near -0.28% yields in mid 2016, a rapid rise to near 0.11% had held as resistance over the past 2 years. Yields have remained range-bound since (indicating deflation remains an ongoing problem in Japan) but a weekly close above 0.12% (which it was unable to hold this week) would likely indicate the bull market in Japanese bonds is probably over.

U.S. 30 year Treasury Yield

An extremely important longer-term chart we continue to watch is the yield on the U.S. 30 year treasury relative to its 100 month exponential moving average (red dotted line on the below chart going back to 1980) as well as the yield on the 10 year treasury with its 115 month EMA. As can be seen below, since the mid 1980's these moving average have acted as a cap on each attempted increase in yields.

Should any given month close with a yield higher than their respective moving average it would be strong confirmation the 35 year bull market in bonds is likely over.

* Note as of the end of Nov 2018 both the 30 year Treasury (top chart) and 10 year yield (bottom chart) closed above its long term moving average but have been unable to hold the breakout. We will continue to monitor this through 2019.

Currencies

Below is a 12 month rolling return for the 6 currencies that make up the U.S. Dollar index. The U.S. Dollar index is a weighted geometric mean of the dollar's value relative to the 6 currencies in the following list:

Euro (EUR), 57.6% weight.
Japanese yen (JPY) 13.6% weight.
U.K. Pound sterling (GBP), 11.9% weight.
Canadian dollar (CAD), 9.1% weight.
Swedish krona (SEK), 4.2% weight.
Swiss franc (CHF) 3.6% weight.

Also shown in the below chart is the following for comparison purposes:

The U.S. Dollar Index to allow comparison to its constituents.
The Australian Dollar (not a part of the USD Index) as it is a popular commodity currency.
Gold (priced in USD) as it typically acts more like a currency void of fiat printing.

1 Year Rolling Currency Performance

Over the past 12 months rolling period the top performing major currency has been the U.S. Dollar with the Swedish Krona the worst performing.

3 Month Rolling Currency Performance

Over the past 3 month rolling period the top performing currency has been Gold with the Canadian dollar lagging.

1 Month Rolling Currency Performance

Over the past 1 month rolling period the top performing currency has been the Japanese Yen with the U.S. Dollar lagging.

Past Week Currency Performance

Over the past week the top performing major currency was the U.S. Dollar with the Japanese Yen lagging.

U.S. Dollar: (Bullish Bias)

Commentary:

The USD index was up +0.76% over the past week. The USD struggled throughout 2017 and into early 2018 as growth indicators had remained stagnant, U.S. officials complained about their "overvalued U.S. dollar", and rate expectation differentials between Central Banks began to narrow on gradual improvements in the Euro area economic data. However, since early 2018 this process has reversed with the USD remaining very bullish as weakening economic data out of the Eurozone have been offset by strengthening data (and rising interest rates) out of the U.S.

Support / Resistance Levels (based upon close):

Weekly: 94.82 / 98.18
Monthly: 94.58 / 98.66

US Dollar Index Daily charts

The 1 year daily chart above shows the bottoming process in the USD since the beginning of 2018. In early 2018 price dropped to a close of 88.51 and retested this level on 3 separate occasions. It remained confined to a trading range for 3 months (shown in the BLUE box) but broke out in late April 2018. Over 2018 it remained very strong but has recently struggled with a double top in Nov + Dec 2018 @ 97.53.

At weeks end the USD remained above short term daily support @ 95.73-95.81.

The 4 year daily chart above clearly shows the important daily close support for the USD over the past 3 years @ 91.88-93.15 with resistance @ 97.21-98.43 (which has stalled the 2018 advance).

Over the past week the USD closed between its short term trend 50 and 200 day moving averages.
(Short Term Neutral)

US Dollar Index Weekly charts

The weekly chart shows the steady -15% decline the USD index experienced from late Dec 2016-early Jan 2018 (from 103.82 to 88.15). It remained in a consolidation zone (88.89-90.33) for 3 months and then in late April 2018 it broke out of its weekly consolidation box.

Price ended the week above the strong support @ 93.03-93.18 and closed the week above the intermediate term trend 20 and 65 week moving averages.
(Intermediate Term Bullish)

A longer term 20 year look-back at the USD shows the 91.66-92.28 weekly close area (thick RED line) has been a very significant bull/bear battle zone over the past 20 years (since 1998). As long as price continues to hold above this significant price level the longer term USD call remains bullish.

It continues to hold the uptrend line from the 2011 bottom and appears to be within a large multi-year bullish ascending price channel.

US Dollar Index Monthly chart

For the month of January the US Dollar index has gained +0.27%.

For all of 2017 the USD had been in a steady decline. It broke its critical support at 92.63-93.03 in late 2017 and rapidly fell to find support at the 86.48-88.01 level. Since the beginning of 2018 it has rebounded back into its previous consolidation zone (shown in AMBER).

Price closed December above the long term trend 10 month moving average maintaining the long term bias to bullish until months end. It remains within the middle of its past 3 year range and is range-bound between the previous monthly support @ 94.58-94.97 and resistance @ 98.66-100.21.
(Long Term Bullish)

Euro (Bearish Bias)

The Euro was up +0.85% over the past week. It had shown remarkable longer-term resilience given European political uncertainty (Brexit, Spain, Germany, Italy) but has weakened since early 2018 due to eroding economic growth metrics out of the EU.

Support / Resistance Levels (based upon close):

Weekly: 107.99 / 114.62
Monthly: 112.12 /114.47

Euro Daily Charts

The Euro had remained above 121.87 until late April 2018 and then began a series of declines on the back of the Italian election and the Turkish debt situation. It touched 2018 lows @ 112.15 in early Nov but has rebounded since.

On the 2nd daily chart price it can be seen how important the yellow band daily resistance zone @ 114.61-116.04 is going back to 2015. It is now back below this key resistance level and closed the week below the short term trend 50 and 200 day moving averages.
(Short Term Bearish)

Euro Weekly Chart

The weekly chart shows the Euro had remained range bound for 2 1/2 years (January 2015-July 2017) between 104.96-105.95 and 114.47-114.62. A significant breakout occurred in the 2nd week of July 2017 when a weekly close above the trading range was established.

This past week the Euro closed below the support @ 114.47-114.62. It closed the week below the intermediate trend 20 week + 65 week moving averages keeping the intermediate term trend bearish.
(Intermediate Term Bearish)

Euro Monthly

For the month of January the Euro has lost -0.88%. On a monthly closing basis it closed the month of December below the long term trend 10 month moving average remaining long term bearish.
(Long Term Bearish)

UK Pound (Bearish Bias)

U.K. Pound Daily Chart

U.K. Pound Weekly Chart

U.K. Pound Monthly Chart

The British Pound gained +0.26% over the past week. Clearly the ongoing Brexit saga will weigh heavily upon cable's performance over the next year.

Critical levels to watch on the Pound remain the respective weekly and monthly reactionary closing prices following the Brexit vote in June 2016:

136.76 weekly close (weekly close 20 June 2016)
133.09 monthly close (monthly close 30 June 2016)

This past week the Pound closed the week between its short term trend daily 50 +200 day moving averages and below the intermediate term trend 20 + 65 week moving averages. For the month of January it has gained +0.94% and closed the month of December below its long term 10 month moving average.

(Short Term Neutral)
(Intermediate Term Bearish)
(Long Term Bearish)

Support / Resistance Levels (based upon close):

Weekly: 127.34 / 129.50
Monthly: 125.09 / 129.79

Australian Dollar (Bearish Bias)

Australian Dollar Daily Chart

Australian Dollar Weekly Chart

Australian Dollar Monthly Chart

The Australian Dollar was down -0.66% over the past week. Price this past week remained on the critical 2 year weekly support @ 71.71-71.87 established as a consequence of the surprise RBA interest rate cut in late April, 2016 which led to a substantial 5 week decline of -8% and a subsequent 18 month consolidation (as shown in the blue box on the weekly chart).

For the month of January the Aussie dollar has gained +1.69%. It closed the week below the short term trend 50 + 200 day moving averages and below the intermediate term trend 20 + 65 week moving averages. It closed the month of December below the long term trend 10 month moving average.

(Short Term Bearish)
(Intermediate Term Bearish)
(Long Term Bearish)

Support / Resistance Levels (based upon close):

Weekly: 71.71 / 73.40
Monthly: 70.17 / 72.32

Canadian Dollar (Bearish Bias)

Canadian Dollar Daily Chart

Canadian Dollar Weekly Chart

Canadian Dollar Monthly Chart

The Canadian dollar was down -0.01% over the past week. After topping in Aug, 2017, the Canadian Dollar has remained within a firmly established downtrend and has gradually returned to price levels last seen in early 2017.

The Loonie closed the week between the short term trend 50 + 200 day moving averages and below the intermediate term trend 20 + 65 week moving averages. It remains confined to a down-sloping weekly price channel from its mid-2017 peak.

For the month of January the Loonie has gained +2.65%. It continues to attempt to consolidate near recent lows and closed the month of December below the long term trend 10 month moving average.

(Short Term Neutral)
(Intermediate Term Bearish)
(Long Term Bearish)

Support / Resistance Levels (based upon close)

Weekly: 73.83 / 76.26
Monthly: 74.42 / 78.49

Key Weekly Returns (week ending 11 January 2019):

Countries/Regions

World Equities

ACWI (iShares MSCI ACWI Index Fund)

North American Equities

SPY (S&P 500 SPDRs)

QQQ (PowerShares QQQ Trust)

IWM (Russell 2000 iShares)

EWC (Canada iShares)

Characteristics

World Equity Fund

U.S. Large Cap S&P 500 Index

U.S. NASDAQ 100 Fund

U.S. Russell 2000 Small Cap Fund

Canada

Week % Change

+2.42%

+2.89%

+2.84%

+2.54%

+2.72%

Non-North America Equities

VGK (Vanguard European VIPERs)

EPP (iShares MSCI Pacific ex-Japan )

EWJ (Japan iShares)

EEM (iShares MSCI Emerging Markets)

ILF (Latin America 40 Index iShares)

Bonds

BND (Vanguard Total U.S. Bond Market)

BNDX (Vanguard International Bond ETF)

TIP (iShares Barclays TIPS Bond Fund)

PCY (PowerShares Emerging Markets Debt Portfolio)

Europe/U.K

Pacific ex-Japan (inc. Australia + NZ)

Japan

Emerging Markets

Latin America

US Total Bond (44% Gov't Tsy, 56%Corp)

World Investment Grade Bonds ex-US

Inflation Protected Gov't Bonds

Emerging Market Sovereign Debt

+1.41%

+1.83%

+2.48%

+2.01%

+1.64%

-0.23%

+0.30%

-0.48%

+0.97%

Commodities

DBC (DB Commodities Tracking Index Fund)

DBA (PowerShares DB Agriculture Fund)

GLD (SPDR Gold Trust Shares)

SLV (iShares Silver Trust)

DBB (PowerShares Metals Fund)

USO (United States Oil Fund)

Commodity Basket

Soft Commodity Basket

Gold Bullion

Silver Bullion

Industrial Metals

Light Crude Oil

+1.57%

+0.23%

-0.64%

-1.84%

+2.26%

+3.76%

Currencies

UUP (PowerShares DB US Dollar Bullish Fund)

FXA (Currency Shares Australian Dollar Trust)

FXB (Currency Shares British Pound Sterling Trust)

FXC (Currency Shares Canadian Dollar Trust)

FXE (Currency Shares Euro Trust)

FXY (Currency Shares Japanese Yen Trust)

U.S. Dollar

Australian Dollar

U.K. Sterling

Canadian Dollar

Euro

Japanese Yen

+0.79%

-0.44%

+0.17%

+0.05%

-0.86%

-1.09%

Charts to Watch

Commodity Basket Index

For the past 4 years the deflationary debt overhang has gripped world economies and equity markets have run up on the "hope" a return to world growth would begin soon. This would typically be reflected in a rise in commodity prices.

Commodities (as measured by the Reuters/Jefferies CRB index) bottomed in early 2016 (along with equities) and have been on a gradual rise. In order to confirm world growth is firming we would like to see commodities moving higher but they have broken down in late 2018.

This past week price closed the week above the strong resistance @ 176.35-179.99 and above the uptrend line from the 2016 lows. This is encouraging as it indicates deflation (decreasing growth + decreasing inflation) may be waning.

Equity Market Volatility

The Volatility Index (VIX) is a measure of expected price fluctuations of options on the S&P 500 index options over the next 30 days (technically the VIX is quoted in percentage points and represents the expected range of movement in the S&P 500 index over the next year, at a 68% confidence level i.e. one standard deviation of the normal probability curve). For example, if the VIX is 15, this represents an expected annualized change, with a 68% probability, of less than 15% up or down.

The VXV uses the same calculation but looks forward 3 months. When the VIX is greater than the VXV ($VIX:$VXV ratio > 1.0) the volatility structure is termed to be in "contango". It indicates traders are much more concerned about short term volatility than they are about longer term volatility and when that ratio returns to "normal" (< 0.93) it is typically a good sign market stress is easing (and a good time to add to equity positions).

As of this weeks market close volatility remained right on the "VIX event" area (VIX:VXV ratio > 0.93). Until the ratio falls to less than 0.93 with a VIX below 16 we would expect equity volatility (large up/down price moves) to continue.

European Equities

Since the 2009 market bottom Europe has been the weakest major equity growth region. As such, we continue to monitor the Euro Stoxx 50 and Stoxx 600 for indications of improving performance out of Europe.

For most of 2015-2016 Europe remained within a deflationary environment with poor stock performance. This changed in late 2016 when both the Stoxx 50 and Stoxx 600 were able to break above their respective trading ranges. These price levels remain important barometers of European equity performance.

This past week the European Stoxx 50 and Stoxx 600 were moderately higher. The Stoxx 50 closed below the important resistance @ 2922-2977 while the Stoxx 600 index closed above the 348-351 price resistance level. As such, the picture remains bearish for European equities.

We remain very concerned about European financial stocks. These are represented below using the iShares MSCI European Financials ETF. As can be seen below, European financial stocks were down over 33% from their January 2018 highs. This is a significant concern as European banks are among the weakest globally and could be a focal point for global systematic risk.

Of particular concern is Deutsche Bank which continues to decline (down over 93% from its 2007 peak!) DB has a massive derivatives exposure (currently estimated at $40T notional with net exposure near $100B) and should they be put forced into a position whereby they need to restructure it will lead to a catastrophic ripple effects worldwide.

Chinese Equities

The Shanghai Composite index was up modestly this past week but continues to remain below key weekly price resistance @ 2715-2820 as shown below. The next target for weekly support is @ 2432-2452.

This is a major concern as Chinese growth is key to both Emerging market performance as well as an indication of Developed markets demand. Since its peak in mid-2015, the Shanghai index has lost more than -50% to its recent lows. We would like to see significant strength return to China further indicating world economic growth continues to increase but currently there is little evidence of a significant change in China's economic performance.

PRECIOUS METALS

Below is a ratio price chart of gold stocks (HUI; the "Gold Bugs" Index) to gold bullion going back to 1996 when the HUI first came into existence. As can be seen, whenever the HUI:GOLD ratio dips to below approximately 0.14 (the GREEN zone on the chart) has been a low-risk opportunity to purchase gold stocks.

This past week gold stocks remained deep into the "low-risk vs. high-reward" range and remain near their cheapest valuations in 22 years. Historically purchases of gold equities when within this range have been a very good long term buying opportunities.

Even more bullish is Silver (chart below) which has entered a price ratio relative to gold (GREEN zone on the chart < .0130) which has historically been a low risk entry point over the past 38 years.

Silver remains near at its "cheapest" price since 2008 and 1995 (chart circles). Both previous moves to this ratio led to large silver price gains.

To put the valuation into a longer term perspective, below is a chart of the Gold/Silver ratio (the opposite ratio to Silver/Gold) going back to 1915. Clearly it can be seen a gold:silver ratio > 80 has historically been an outlier over the past 100+ years:

The current Gold:Silver ratio is 82.36 and it can be seen each instance in the past where the ratio has crossed above 80 (Green line) has resulted in very good gains.

There is no guarantee the ratio will not go higher (allowing for further silver losses or range bound trade as in 1991-1994) but it is now at a level that deserves attention (cautious traders may want to wait for a reversal < 80 to avoid a potential range bound episode as the 1990's)

EVEN MORE BULLISH is the price of Platinum (chart below) which has exceeded the "buy zone" last seen in 1982! Platinum is 15-20 times rarer than gold and has rarely in history traded at a price below the price of gold (only 9.7% of the time going back to 1971). It is now the cheapest it has been GOING BACK TO AUGUST 1971 WHEN THE U.S. LEFT THE GOLD STANDARD on a relative basis:

The current Platinum:Gold ratio is 0.63.
A Platinum/Gold ratio < 0.85 has only occurred 4.7% of the time back to 1971.
Prior to recent lows, the lowest Platinum:Gold ratio since August 1971 (when the USD was removed from the gold standard) was hit on 20 Sept 1982 when it hit a ratio low of 0.689 (Platinum $300.40/Gold $436.00).
If Platinum were to return to its most common ratio relative to Gold (1.0x-1.25x which has been common 35% of the time) it would imply a price rise of approximately 50-90% from recent levels.

Platinum now sits on a price support extending back to 2004 and, combined with its ratio relative to the price of gold, represents a compelling long term buy point.

The following charts and commentary (in italics; bold print is our emphasis) are sourced from Kitco from commentary sourced in Feb 2017 when the ratio was near 0.85 (Platinum has become even cheaper on a relative basis since the data was published):

Platinum to gold ratios show wide variance over the 46 year period ranging from highs above 2.5 before and soon after Nixon began taking the United States off the gold standard to periodic lows below 1.0:

Our data set covers 553 months beginning in January 1971. The distribution of ratios in both tabular and chart format follows:

Platinum/Gold Ratio: % of Months

< 0.85: 4.7%
.85-1.01: 5.0%
1.0-1.25: 34.7%
1.25-1.5: 19.3%
1.5-2.0: 15.4%
2.0-2.5: 8.9%
> 2.5: 2.0%

From our data set and the distributions of monthly average platinum-gold ratios from January 1971 thru January 2017, I glean the following:

A ratio of less than 0.75 is a single outlier that occurred once during the second half of 1982 when overall ratios averaged 0.81.
Ratios <0.85 are quite unusual at 4.7%. They occurred for two months in the first quarter of 1975, the aforementioned six months in 1982, in June-July of 1985, and for an ongoing run of 16 months that commenced in October 2015.
Ratios from 0.85 to 1.0 constitute 15.0% of the record.
Pt:Au from 1.0 to 1.25 is the most common range and comprises 34.7% of ratios since 1971.
The ratios between 1.25 and 1.5 occur 19.3% of the time.
Ratios from 1.5 to 2.0 make up 15.4% of the record.
The 2.0-2.5 interval covers 8.9% of the months in our compendium.
The 11 monthly outliers at >2.5 comprise 2.0% of the total record and have not occurred since 1971.

From a compendium of sources, the average crustal abundance of both metals is around 4 ppb. Based solely on this fact, platinum and gold should trade at about the same price.

And indeed, our compilation shows that for nearly 50% of the time since gold was decoupled from the world’s reserve currency and allowed to trade freely on exchanges, the price ratio has ranged from 0.85 to 1.25. That said, since January 1971, the average price of platinum has been $637/oz and gold has been $518/oz for an overall ratio of 1.23:1. Clearly there are other factors other than the nearly equal crustal abundances that account for this historic price relationship.

A variety of supply and demand factors cause platinum to trade at a premium to gold:

Platinum is a much smaller market. Cumulative world production of platinum is estimated to be about 5% of gold (9400 tonnes versus 182,000 tonnes). From 1994-2014, 3700 tonnes of platinum were mined versus 52,600 tonnes of gold or about 7% (source: USGS).
Platinum is largely an industrial metal. Catalytic converters, electronics, petroleum and chemical catalysts, medical technologies, and many minor uses constitute over 60% of its annual demand. Around 30% is used in jewelry and 10% for investment demand. Also, 30% of the annual platinum supply now comes from recycling, mostly from catalytic converters. Some demand is consumed and lost to the marketplace.
Gold is overwhelmingly a precious metal; 90% is used in jewelry and investments and only 10% in industrial applications. An estimated 98% of all the gold ever mined in the world remains available and held in jewelry, by central banks, in private hoards, and as fabricated products (source: USGS).
About 70% of yearly platinum mine supply comes from South Africa, a geopolitically risky country. Much new platinum is a by-product of nickel-copper mining and smelting; therefore, annual platinum production is dependent on the supply-demand fundamentals and prices of these primary metals.

Fluctuations in the relative prices of platinum and gold are largely driven by:

the overall growth and health of the world’s economy and in the case of platinum, the automotive industry;
labor, power, currency, and political issues in South Africa that cause major perturbations in the platinum supply;
safe haven hoarding of gold and to a much lesser extent, platinum, in times of economic uncertainty and major geopolitical events; speculators moving in and out of paper markets of both metals (bullion exchanges, ETFs, and derivatives) and to a lesser extent, central bank trading of physical gold.

Platinum functions both as a precious and industrial metal. It is usually tied to the price of gold in both short- and long-term trading patterns. In times of financial distress and economic turmoil, platinum tends to behave more like gold with widespread hoarding.

The platinum-gold ratio can be used to ascertain whether one metal is over- or undervalued with respect to the other. The current monthly average ratio below 0.85 is unusual and indicates that platinum is severely undervalued with respect to gold *

* The ratio recently hit 0.63 and remains near a record low.

Elliott Wave

We use Elliott Wave theory in conjunction with cycle analysis to attempt to "crystal ball" what to expect going forward. We have included some basic information below for those who might be interested followed by our current interpretation/analysis.

The Elliott wave principle is a form of technical analysis that some traders use to analyze financial market cycles and forecast market trends by identifying extremes in investor psychology, highs and lows in prices, and other collective factors. Ralph Nelson Elliott (1871–1948), a professional accountant, discovered the underlying social principles and developed the analytical tools in the 1930s. He proposed that market prices unfold in specific patterns, which practitioners today call Elliott waves, or simply waves. Elliott published his theory of market behavior in the book The Wave Principle in 1938, summarized it in a series of articles inFinancial World magazine in 1939, and covered it most comprehensively in his final major work, Nature’s Laws: The Secret of the Universe in 1946. Elliott stated that "because man is subject to rhythmical procedure, calculations having to do with his activities can be projected far into the future with a justification and certainty heretofore unattainable."

The Elliott Wave Principle posits that collective investor psychology, or crowd psychology, moves between optimism and pessimism in natural sequences. These mood swings create patterns evidenced in the price movements of markets at every degree of trend or time scale.

In Elliott's model, market prices alternate between an impulsive, or motive phase, and a corrective phase on all time scales of trend, as the illustration shows. Impulses are always subdivided into a set of 5 lower-degree waves, alternating again between motive and corrective character, so that waves 1, 3, and 5 are impulses, and waves 2 and 4 are smaller retraces of waves 1 and 3. Corrective waves subdivide into 3 smaller-degree waves starting with a five-wave counter-trend impulse, a retrace, and another impulse.

In a bear market the dominant trend is downward, so the pattern is reversed—five waves down and three up. Motive waves always move with the trend, while corrective waves move against it.

Wave 1 (I): Wave one is rarely obvious at its inception. When the first wave of a new bull market begins, the fundamental news is almost universally negative. The previous trend is considered still strongly in force. Fundamental analysts continue to revise their earnings estimates lower; the economy probably does not look strong. Sentiment surveys are decidedly bearish, put options are in vogue, and implied volatility in the options market is high. Volume might increase a bit as prices rise, but not by enough to alert many technical analysts.

Wave 2 (II): Wave two corrects wave one, but can never extend beyond the starting point of wave one. Typically, the news is still bad. As prices retest the prior low, bearish sentiment quickly builds, and "the crowd" haughtily reminds all that the bear market is still deeply ensconced. Still, some positive signs appear for those who are looking: volume should be lower during wave two than during wave one, prices usually do not retrace more than 61.8% (see Fibonacci section below) of the wave one gains, and prices should fall in a three wave pattern.

Wave 3 (III): Wave three is usually the largest and most powerful wave in a trend (although some research suggests that in commodity markets, wave five is the largest). The news is now positive and fundamental analysts start to raise earnings estimates. Prices rise quickly, corrections are short-lived and shallow. Anyone looking to "get in on a pullback" will likely miss the boat. As wave three starts, the news is probably still bearish, and most market players remain negative; but by wave three's midpoint, "the crowd" will often join the new bullish trend. Wave three often extends wave one by a ratio of 1.618:1.

Wave 4 (IV): Wave four is typically clearly corrective. Prices may meander sideways for an extended period, and wave four typically retraces less than 38.2% of wave three (see Fibonacci relationships below). Volume is well below than that of wave three. This is a good place to buy a pull back if you understand the potential ahead for wave 5. Still, fourth waves are often frustrating because of their lack of progress in the larger trend.

Wave 5 (V): Wave five is the final leg in the direction of the dominant trend. The news is almost universally positive and everyone is bullish. Unfortunately, this is when many average investors finally buy in, right before the top. Volume is often lower in wave five than in wave three, and many momentum indicators start to show divergences (prices reach a new high but the indicators do not reach a new peak). At the end of a major bull market, bears may very well be ridiculed (recall how forecasts for a top in the stock market during 2000 were received).

Wave A: Corrections are typically harder to identify than impulse moves. In wave A of a bear market, the fundamental news is usually still positive. Most analysts see the drop as a correction in a still-active bull market. Some technical indicators that accompany wave A include increased volume, rising implied volatility in the options markets and possibly a turn higher in open interest in related futures markets.

Wave B: Prices reverse higher, which many see as a resumption of the now long-gone bull market. Those familiar with classical technical analysis may see the peak as the right shoulder of a head and shoulders reversal pattern. The volume during wave B should be lower than in wave A. By this point, fundamentals are probably no longer improving, but they most likely have not yet turned negative.

Wave C: Prices move impulsively lower in five waves. Volume picks up, and by the third leg of wave C, almost everyone realizes that a bear market is firmly entrenched. Wave C is typically at least as large as wave A and often extends to 1.618 times wave A or beyond.

S&P 500 Weekly Elliott Wave Chart

For those who are new to Elliott wave, it is essential to understand as market participant psychology changes (and, as a consequence, the various waves unfold in specific patterns) objective analysis requires readjustment of counts as the waves unfold. Elliott wave is not a "crystal ball" but more a quantitative tool to analyze changes in market psychology as market conditions evolve. Elliott wave analysis can be quite confusing and intricate but in our experience we find it is best used as a "road map" towards the bigger picture.

Below is the current long term view of the equity market from 1929-Present. Clearly the 2008-2009 market decline was of such stature as to be historic. Given such, we have begun to think out of the box with respect to Elliott Wave as it has recently progressed.

In broadest terms markets cycle through 65-80 year "Grand Super-Cycles" (generally coinciding with generational demographic expansion/contraction). If one were to use the end of the 1929-1932 market crash/depression as the beginning point for a new Grand Super-Cycle, it could be argued a complete 77 year Grand Super-Cycle began in 1932 and ended in 2009. A 5 wave Super-Cycle advance (SC-1, SC-2, SC-3, SC-4, SC-5) occurred between 1932 and 2000 (68 years in length) followed by a 9 year Super-Cycle decline (SC-A, SC-B, SC-C) from 2000-2009 (culminating in the 2007-2009 market decline; the worst since the great depression). If this is the case we would have completed a full 77 year Elliott Wave Grand Super-Cycle pattern from 1932-2009 (5 wave Super-Cycle advance with a 3 wave Super-Cycle decline) and have embarked on a new 65-80 year Grand Super-Cycle beginning in March 2009.

We have marked this Grand Super-Cycle on the below chart with the 68 year SC-1 through to the SC-5 advance (1932-2000) followed by the 9 year SC-A, SC-B, and SC-C decline (2000-2009). If this is the case, an argument can be made the period from 2009-to-Present is unfolding as follows:

The market is currently within the early stages of Primary Wave III implying a long-term upwards trend for many more years.
The market is currently within Major Wave ((2)) projecting downwards as a shallow bear market decline.
Intermediate wave (C) wave projecting downwards to end the Major Wave ((2)) bear market @ 2240-2374.

Alternately, our original EWT weekly chart we have been following since 2009 is shown below with "classic" Elliott Wave indications projecting we are within the ending stages of the 2009-present bull market (with projected Fibonacci Primary Wave decline levels as shown):

At present we remained torn between 2 possible Elliott Wave counts:

If the market is within Major Wave 2 as per the 1st chart, we would expect a fairly shallow Major Wave (((2)) decline composed of an Intermediate Wave (A)-(B)-(C) bear market decline followed by another full bull market Major Wave 3 advance. This would project much higher equity prices into the future.

Alternately, if the have completed Primary Wave 5 up of the entire bull market advance from 2009-2018, a Primary Wave A-B-C bear market has just begun with a projected decline to 1535-1803.

The difference between the 2 counts is either a 19-24% pullback (in the 1st case of the Major Wave ((2)) decline) or a > 40% bear market decline (in the case of the Primary Wave A-B-C decline). Only once the decline has been established will we be able decipher which count is potentially correct but in both cases it indicates we are either at the top or very near the top.

Market Valuation

U.S. (NYSE) Margin Debt

We have been studying with interest the current margin debt on US markets. For those who are unfamiliar, margin debt is the amount of "loans" taken out by market speculators to leverage up their equity positions. During normal bull markets margin debt will increase as the market continues to climb. This increased margin debt amplifies equity market prices. However, at some point speculators become nervous and begin to reduce their margin positions. This reduction in margin is like letting the air out of a balloon and deflates equity asset prices.

As can be seen on the below graphic, both the 2000 and 2007 market tops were signaled in advance by tops in margin debt (margin debt not inflation adjusted on this chart):

The following chart (source: Doug Short) shows US equity margin debt adjusted for inflation. As can be seen, in both 2000 and 2007 inflation-adjusted margin debt peaked and then began to decline leading to the tops in the S&P 500 index. As such, margin debt rollovers acts as a good lead indicator of possible future market weakness.

As of the end of October U.S. margin debt has shown a significant decline from its summertime peak. A similar decline occurred in 2015 (and did not derail the bull market) but the recent decline is a concern given how late we are in the market cycle combined with the extreme levels of margin debt relative to past market cycles.

U.S. Equity market Valuation Models (data as of 31 December 2018)
(Source: D. Short)

Below is a graph representing 4 different long-term valuation measures plotted back to 1900 (118 years):

The Crestmont Research P/E Ratio
The cyclical P/E ratio using the trailing 10-year earnings as the divisor
The Q Ratio, which is the total price of the market divided by its replacement cost
The relationship of the S&P Composite price to a regression trendline

As of 31 December 2018 the average of these 4 measures places the U.S. stock market (S&P 500 index) as being 93% overvalued relative to its long term geometric mean. This remains the 2nd highest valuation in the history of the stock market going back to 1900. This level is well over 2 standard deviations above the mean and above the market peaks in both 2007 and 1929. It is only surpassed by the 2000 dotcom bubble peak.

Another popular valuation metric is know as the "Buffett Indicator". In an interview with Fortune magazine back in 2001 Warren Buffett remarked "it is probably the best single measure of where valuations stand at any given moment."

The indicator measures the price of Corporate Equities (Mkt Cap) to Gross Domestic Product (GDP) as a ratio going back to the 1950's. As can be seen below, the ratio of equity prices relative to GDP currently stands at 151.0%. It has exceeded the recent 2015 peak of 128.9% and is second only to the 2000 equity peak of 161.1% in terms of equity overvaluation relative to economic output.

The de-trended graph indicates it would take a 48% market decline to return valuations back to the long term detrended regression line (shown in red on the 1st chart). This would be our minimum expected decline when the next bear market begins.

7-Year Asset Class Real Return Forecast (as of 30 November 2018)
(Source: GMO LLC)

Each month GMO (Grantham, Mayo, Van Otterloo & Co.) publishes a forward forecast for expected annual real rates of return (i.e. inflation adjusted) for a number of different asset classes with a 7 year forward outlook. They have historically had a very good track record (0.97 correlation) of estimating forward 7 year asset class returns based primarily upon current valuations combined with mean reversion. Charts are published following analysis of the previous months data.

I have followed GMO's methodology with interest for many years. In my experience I have found them to be conservative over the shorter term with a tenancy to make calls too early. HOWEVER, similar to Dr. John Hussman of Hussman Funds, they also tend to be right over the longer term. As such, I use their outlook as part of the valuation model within the ECAM 5 Factor model.

Above is their current forecast of expected real returns (after inflation) for the next 7 years broken down by asset class. It is clear based upon current market valuations GMO forecasts well below average annual investment returns in all asset classes with a 7 year forward time horizon (the dotted line is the historical real return of U.S. equities of +6.5% per year). This is important for those who may be soon retiring and expecting "average" returns on their equity and bond investments over the next 7 years. Current high market valuations make it a certainty forward returns over the next 7-10 years will be well below historical averages.

12-Year US Equity Real Return Forecast
(Source: Hussman Funds)

S&P 500 12 year forward projected annual returns (Mkt Cap-GVA)

S&P 500 12 year forward projected annual returns (margin-adjusted CAPE)

Balanced Portfolio 12 year forward projected annual returns
(60% in the S&P 500, 30% in Treasury bonds, and 10% in Treasury bills)

Dr. John Hussman uses a unique measure of estimating future equity returns over a 12 year period based upon market capitalization relative to gross corporate value added. He claims the measure has a 91.9% correlation to actual S&P 500 future returns over a 12 year horizon. As per his previous explanations:

"Across the scores of measures I’ve evaluated or created over three decades of research, the ratio of non-financial market capitalization to corporate gross value added (essentially corporate revenues, including estimated foreign revenues, excluding double-counting of intermediate inputs) is best correlated to actual subsequent market returns over a 10-12 year horizon".

As can be seen on the above chart, since 1950 his approach has correlated quite closely with future returns (blue line is his estimates and the red line the subsequent returns 12 years later). Currently his calculations project a "buy and hold" rate of return on the S&P 500 index of -0.6% nominal per year out to 2028 should one employ a "buy and hold" strategy. Clearly tactical asset allocation will be required as we transition to the back half of the current market cycle.

His recent conclusion:

" At present, the valuation measures that we find best correlated with actual subsequent S&P 500 total returns are at the most offensive levels in history, matching or eclipsing the 1929 and 2000 extremes. Even considering the level of interest rates, economic growth, and other factors, the S&P 500 currently stands about 2.8 times the level that we believe the index will revisit over the completion of the current market cycle, implying an interim market loss something on the order of -64%. Moreover, the most reliable valuation measures uniformly imply the likelihood of negative total returns in the S&P 500 over the coming 10-12 year period."

Clearly the high level of current market valuations does not bode well for the "buy and hope" investor.

Global Asset Class 10-year Expected Return Forecast
(as of 31 December 2018)
(Source: Research Affiliates)

Cycle Commentary

At left is a 20 year chart of the seasonal monthly performance of the Dow Jones Global Index.

The number at the top of the column is the percentage of time the month is positive and at the bottom is the average % gain/loss for the month.

As can be seen, over the past 20 years the period October-April yearly offers the highest potential global equity market returns (cumulative +6.3% average return) while the period May-September offers little in total return (-1.9% cumulative average return).

In the interest of moving more towards more recent market action broken down by region, below is the past 10 years seasonal returns for our selected benchmark ETF's:

Global Equities (VT)
U.S. Equities (VTI)
European Equities (VGK)
Asia Pacific Equities (VPL)
Emerging Market Equities (VWO)

It is interesting to note over the past 10 years the month of September has begun to perform better than it has in the past. Also it is interesting to note the exceptionally poor equity returns in Europe during the month of June with very strong returns in July. This is an interesting phenomenon that can be used to potentially time regional equity exposure.

S&P 500 Seasonality (historical 50 year look-back annual seasonality)

"Turning to the months ahead, the performance for January and February is rather lacklustre compared to the months that bookend this start of year period. The S&P 500 Index has gained an average of 0.8% and 0.2%, respectively in the first two months of the year, based on the past 50 periods. These months are easily the weakest of the best six month trend for stocks. The large-cap benchmark has closed positive just over half of the time (56%) in January and February, making this winter lull little better than a flip of a coin in terms of the frequency of success.. Returns for January have ranged from a loss of 8.6% in 2009 to a gain of 13.2% in 1987. Performance tends to gyrate in the middle of January with the majority of the strength achieved in the first few days and last few days of the period".

Ned Davis Research 2018 Composite Model

Composite directional model forecast for the S&P 500 index based upon the following parameters equal weighted:

10 year Decennial Market Cycle (Year 7)
4 year Presidential Market Cycle (Year 2)
1 year Annual Seasonal Market Cycle

U.S. 4 Year Presidential Election Cycle

2018 is Year 2 (post-election year)

As can be seen on the chart above, historically since 1928 the 2nd year of the 4 year Presidential Cycle tends to provide the worst returns of the 4 year cycle.

While we do not make investment decisions strictly based upon cycle analysis, we are cognizant of the historical nature of these cycles and tend to be a bit more wary as they approach.

Presidential Cycle S&P 500 returns (inc. dividends):

1988-Year 4: +12.40%
1989-Year1: +27.25%
1990-Year 2: -6.56%
1991-Year 3: +26.31%
1992-Year 4: +4.46%
1993-Year 1: +7.06%
1994-Year 2: -1.54%
1995-Year 3: +34.11%
1996-Year 4: +20.26%
1997-Year 1: +31.01%
1998-Year 2: +26.67%
1999-Year 3: +19.53%
2000-Year 4: -10.14%

2001-Year 1: -13.04%
2002-Year 2: -23.37%
2003-Year 3: +26.38%
2004-Year 4: +8.99%
2005-Year 1: +3.00%
2006-Year 2: +13.62%
2007-Year 3: +3.53%
2008-Year 4: -38.49%
2009-Year 1: +23.45%
2010-Year 2: +12.78%
2011-Year 3: +0.00%
2012-Year 4: +13.41%
2013-Year 1: +29.60%

2014-Year 2: +11.39%
2015-Year 3: -0.73%
2016-Year 4: +11.96%
2017-Year 1: +21.83%
2018-Year 2: TBD