The risk budget this month is unchanged. For the moderate risk investor, the allocation between risk assets and bonds remains at a defensive 40/60 versus the benchmark of 60/40.

  • HY credit spreads continued to widen on the month indicating continuing stress in that market. Spreads did not widen sufficiently to generate an additional sell signal.
  • Valuations are still near recent highs and earnings for the third quarter are likely to shrink.
  • Despite a furious rally off the lows, momentum in the S&P 500 is still negative for intermediate and long term time frames. Short term momentum indicators are positive but now quite overbought.
  • The yield curve was essentially unchanged for the 10/2 and 10/5 spreads.

risk budget

Credit spreads continued to widen over the last month in High Yield as well as investment grade credits. Spreads did narrow somewhat as stocks rose out of the correction in late September/early October but the change over the last month is still wider. The change for the month was not sufficient to further reduce our equity exposure. Baa spreads (low end of investment grade) also continued to widen on the month and are now wider than at the start of each of the last two recession. High grade (AAA) spreads were basically unchanged over the last month.

baa spreads

hy spreads

The yield curve isn’t telling us a lot right now, still sitting in the middle of its historic range. With Fed rate hikes looking less likely I would have expected the curve to actually steepen but instead we got a minor flattening. That seems to me an indication that the market’s faith in central bank magic is waning but that’s probably my own bias showing through. In any case, I don’t think much can be gleaned from the yield curve with short rates stuck at zero.

10:2 spread

With stocks down slightly from their highs, valuations have been reduced but only slightly. All the reliable measures of valuation remain in the upper quartile of historic values. I’ve seen a lot of commentary recently intimating that with it looking more likely the Fed will stay on hold that stocks can be pushed higher. The idea that stock valuations can be pushed to extremes due to low interest rates is a popular notion that is belied by history. Bear markets are associated with recessions which also happen to coincide with periods of falling interest rates. There is little the Fed can do in normal times to prevent a recession and in any case they tend to follow the market not lead. At the onset of each of the last two bear markets, the Fed was cutting interest rates furiously to no avail. To believe that they can prevent the next one, with interest rates already pegged at zero, is frankly absurd. Valuations remain a risk factor for long term investors and it will take either a long period of sideways market action – and earnings growth – or a large selloff to change that.

Momentum readings for intermediate and long term are still negative although short term measures did turn higher. Unfortunately for the bulls, the short term measures are also very overbought after the big rally off the lows and markets are at resistance levels.

s&p 500 daily

s&p 500 monthly

Long term momentum continues to favor bonds (Treasuries) over stocks:

ief spy

Long term momentum is also still shifting to gold over stocks:

gld spy

It should be noted, however, that we do not have a long term momentum buy signal for gold as yet. Short and intermediate term momentum has turned higher but we’ll need a good month from gold to get a long term signal.

gld

EAFE continues to try and make a relative performance shift versus the S&P 500 and is still outperforming – barely – year to date. I am maintaining the overweight to see how this is resolved.

efa spy

General commodities still show no sign of reversing the performance trend against stocks and do not yet warrant an allocation. If the dollar continues to fall that might change but it appears to be showing up in gold first.

gsg spy

We continue to hear about a strong dollar and no doubt it has been fairly strong against emerging market currencies. But the dollar index most widely followed peaked months ago and is threatening to break down. However, while short and intermediate term momentum has turned negative, long term measure remain on a buy signal.

us dollar

us dollar monthly

The overall asset allocation for our moderate asset allocation overlay is unchanged on the month:

MODERATE ALLOCATION

If you’d like to see allocations for other risk profiles, contact me.

Momentum Asset Allocation

I also run two asset allocation models (one aggressive, one more moderate) based on momentum. These models ignore all fundamental and economic information in favor of just allocating to the asset classes that are exhibiting momentum. Here’s where those models stand as of today (rebalancing is monthly):

Aggressive Version:

50% TLT

50% IYR

Moderate Version:

25% TLT

25% TLH

25% IYR

25% IEF

As you can see, both of these models are very conservative right now. IYR was added to the portfolio in the most recent update as interest sensitive assets are starting to outperform as Fed rate hiking gets delayed.

More information on these momentum models can be found here.

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“Wealth preservation and accumulation through thoughtful investing.”

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@4kb.d43.myftpupload.com or   786-249-3773. You can also book an appointment using our contact form.

 

This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any particular security, strategy, or investment product. Investments involve risk and you can lose money. Past investing and economic performance is not indicative of future performance. Alhambra Investment Partners, LLC expressly disclaims all liability in respect to actions taken based on all of the information in this writing. If an investor does not understand the risks associated with certain securities, he/she should seek the advice of an independent adviser.