Davos as Contra-Indicator

Davos as Contra-Indicator

Euphoria at Davos may be a sign that the market melt up may soon begin to cool.

By Scott Minerd, Global CIO

Two years ago, when I last attended the World Economic Forum in Davos, a growing consensus saw the global economy at the brink of recession. The spread between credit securities such as bank loans and high-yield bonds had dramatically increased relative to lower-risk assets like U.S. Treasury securities. Stocks had sold off, and many pundits predicted that we were at the brink of a new bear market. Oil was collapsing toward our earlier established target price of $25 per barrel for West Texas Intermediate. Declining asset prices were offered up as full evidence that the U.S. and probably the entire global economy was at the precipice of recession.

At the time, we argued that correlation was not causality and that oil, stocks, and high-yield bonds were approaching a bottom. In our clients’ accounts we were increasing exposures to high beta asset classes such as mezzanine collateralized loan obligations (CLOs), bank loans, and high-yield bonds. While we stayed the course with our client portfolios, the consensus at Davos led me to conform by allowing for further price erosion when I should have pounded the table that it was time to buy. Fortunately, my words did not exactly match our actions. I remember explaining on a CNBC appearance that no one can time the bottom, and despite any comments to the contrary it was time to start buying on weakness. The good news is our investments performed well as we continued to load up on energy exposures and leveraged credit risk in the form of mezzanine CLO securities.

As things kick off here in Davos, the sentiment could not be more radically different from January 2016. Global growth is accelerating and risk assets are soaring. Sentiment is so positive, it feels like the discussion will focus on “How high is up?” This is occurring in the face of U.S. tariffs on solar panels and washing machines, while CNN and the BBC run documentaries on a rising tide of nationalism, and against a backdrop of discussions on restricting immigration just when healthy Western economies are starting to experience labor shortages in certain key industries.

While I am still a Davos neophyte—it is only my fifth visit to Davos—I am starting to consider that Davos may be a valuable contra-indicator. A few years back the big story here was about the emergence of Africa onto the global scene as an important component of future global growth. While I think that view is ultimately correct, the immediate experience proved very disappointing for investors. Rather than a buying opportunity, investors would have done better to go short for the near term.

While I am hesitant to jump to a conclusion, I am troubled by the euphoria undergirding the gathering here. I will be listening closely and speaking occasionally, most likely asking more questions than providing opinion. I have seen bull market tsunamis before. They can be both rewarding and destructive. The key is to know when to get out.

 

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This article was originally published in https://www.guggenheiminvestments.com/perspectives/global-cio-outlook/davos-as-contra-indicator

 

Why Sector Rotation Makes So Much Sense

Two Methods of Investing

While there are many ways to invest, there are two general approaches to investment strategies.  The first approach is called buy and hold investing and is also known as passive investing.  An investor with this type of strategy buys certain stocks, bonds, ETFs, mutual funds etc. and holds them long term without changing their allocation.  This style can be modified to allow for long-term periodic adjustments.

The second style is called active investment management and utilizes more frequent changes in allocations.  Its goal is to optimize upside performance while lowering downside stock market risk.

What is Sector Rotation?

Sector rotation is a specific methodology within the active management style.  There are 10 broad sectors within the US economy.  On rare occasions, these sectors are correlated and move in the same direction.  However, those times are rare.  Most frequently, some sectors in the economy have gains while others have losses.  While there are no guarantees, these sectors seem to rotate in and out of favorable and unfavorable gain/loss positions.

According to portfolio manager, Matt Erickson, in his Seeking Alpha article, How to Beat the Market with Sector Rotation, those sectors with the most gains seemed to lose ground during the subsequent time period – and those with the most losses, tended to recover.  This assessment needs a couple of caveats; while this pattern does not always hold true, it does TEND to be the case.  Based on my research, some sectors, such as those tied to oil, commodities and interest rates are an exception to this pattern.  Generally speaking, sectors pertaining to consumer and consumer behavior trend in an upward direction after a fallback. The pattern is known as mean reversion or sector rotation.  I observed that this pattern tends to occur whether considering a daily, weekly or monthly perspective.

In my opinion, mean reversion is more predictive for sector indexes than for individual stocks.

My own investing strategy applies mean reversion to the “buy side” for sector funds or sector ETFs and does not utilize short selling.  The primary method of this strategy is to buy sectors that have had a short term correction.  With this strategy in mind, an investor or investment professional must choose the timeframe and sectors which suit their individual investing style.

Practical Steps

Take the following steps to test the validity of this concept (particularly in those sectors tied to consumer behavior):

  1. Determine the timeframe to measure – daily, weekly or monthly.
  2. Observe gains or losses for the time period measured and observe whether these tend to “change places” from one period to the next.
  3. Do those sectors at the “bottom” tend to move up? Are those at the “top” tending to fall back?

Follow your time of observation by asking this question:  Does this pattern suggest a way to improve rate of return and minimize downside market risk?

 

Ben Reppond is CEO and Investment Manager of Reppond Investments. Reppond Investments, Inc. is a registered investment adviser in the States of Washington and Montana. We may not transact business in any state where we are not appropriately registered, excluded or exempted from registration. Individual responses to persons that involve either the effecting of transactions in securities or the rendering of personalized investment advice for compensation will not be made without registration or exemption.

Investment Advisory Services offered through Reppond Investments, Inc. 

Please click on the embedded links for specific details related to sources and comments cited in this article.

 

A More Scientific Approach to Investing

A More Scientific Approach to Investing

Scientific Approach to InvestingHow do you lower your investing risk from a more scientific and strategic perspective? At Reppond Investments, Inc., these questions are the focal point of what we do. We believe wealth preservation is possible with investment strategies that carry a goal of producing consistent and positive growth. By conducting true analysis and doing our own research, we place our clients in investments that are in their best interest, not ours or someone else’s. Everything we do is based on hard research.

We would like to offer you a resource that may help you in your investments.

Here’s a complimentary download of “Forecasting the Next Recession”. It’s a Predictive Model that forecasts a recession in late 2019 or 2020 – and what that likely means for the stock market in the next 24 months.

Scientific Approach to Investing
Download here:

https://www.reppondinvestments.com/forecasting-the-next-recession/

Please don’t hesitate to reach out to us if you have any questions!

Best regards,

Ben Reppond

Ben Reppond is CEO and Investment Manager of Reppond Investments. Reppond Investments, Inc. is a registered investment adviser in the States of Washington and Montana. We may not transact business in any state where we are not appropriately registered, excluded or exempted from registration. Individual responses to persons that involve either the effecting of transactions in securities or the rendering of personalized investment advice for compensation will not be made without registration or exemption.

Investment Advisory Services offered through Reppond Investments, Inc.

[i] S&P 500 Index as of November 28, 2017, CNBC.com.