Archive for category: Investing

It’s the calm before the storm.

That’s what this market feels like to me right now, because the fact is that the events of the next six weeks have the potential to either 1) Ignite an acceleration of the recent rally or 2) Cause a sharp pullback.

While I admit these markets are downright dull at the moment, it’s important for advisors and investors not to get too complacent, because through the end of September we will get three key central bank decisions that will determine whether bond yields keep grinding lower, or finally reverse higher.

That’s going to be critically important for how stocks and bonds perform in Q4, and the potential is there for either a continued melt up (at which point advisors are going to want to be very long) or a potentially violent pullback in both stocks and bonds (at which point advisors are going to want to be very defensive).

The next six weeks will be an especially critical time if you are an advisor or investor who has underperformed markets so far in 2016 (and there are a lot of very good advisors who have underperformed this difficult market) as these events will present an opportunity to close that performance gap… if you know what’s happening and how to be positioned.

We are going to be very focused on making sure our paid subscribers know, immediately, what the implications are for each of these key events, and which sectors will benefit from those events, whether it’s banks, consumer staples, utilities, tech or inverse ETFs.

Look, it’s been a very tough year to beat lazy indexing, but we recognize the chance to make up ground over the coming weeks and into Q4 and we’re going to be focused on helping our advisor subscribers do just that by making sure they have the need to know analysis of all asset classes and global regions, not just US economics or the Fed.

We’re approaching the one-year anniversary of the August 2015 collapse in stocks, and while markets are higher (finally), so is volatility, as international events exert greater influence over the Fed, the US economy, and the US stock market.

We understand that in this market clients’ assets are, to a point, at the mercy of the BOJ, ECB, Italian banks, Chinese policy makers, etc., and that’s why, every day, we make sure our paid subscribers know the key trends in:

• Stocks
• Bonds
• Commodities
• Currencies
• Economic data

It’s only by providing that 360-degree coverage, every day, that advisors and investors can truly have an understanding of the risk and opportunities for their portfolios in this environment.

Earlier this week we outlined the three key central bank decisions that are coming in the next few weeks, and we’ve included an excerpt of that research for you below:

Three Key Events to Watch (Sevens Report Excerpt)

With yesterday’s FOMC minutes and today’s ECB minutes, stocks have now entered a five-week central bank gamut that will ultimately decide whether this market can grind higher
into Q4, or see a potentially violent reversal
of this low-rates-forever rally.

I say that because over the next several weeks, we will hear from

1) Fed Chair Yellen,

2) The ECB (again) and

3) (most importantly) the Bank of Japan.

Key Date #1: September 26. The Bank of Japan’s “General Assessment.” You’re probably not hearing a lot about this given the Olympics and political focus of the media, but this is easily the most important event for markets over the next six weeks.

The reason this is the most important date over the next six weeks is this:

A few weeks ago the BOJ again disappointed markets and announced they would be doing a “Comprehensive Assessment” of policy on Sept. 21. “Comprehensive Assessment” in this instance is central bank code for, “We’re going to change our strategy.”

The reason the BOJ needs to change its strategy is because their QE program has become so big that it’s dominating the Japanese Government Bond market, raising the risk of some sort of market dislocation, and it’s still not stimulating inflation or growth. So, put in plain English, their QE program isn’t working anymore, and making it bigger will only increase the chances that they form another massive bubble.

So, the BOJ needs to come up with a new strategy, and that’s what the “Comprehensive Assessment” is all about.

People think one of two things will happen at this Comprehensive Assessment:

Option 1: The BOJ will change the duration of JGBs it’s buying for QE from the current 7-12 years to something longer dated (beyond 12 years).

Option 2: (This is the potential negative outcome): The BOJ could “abandon” QE and instead just commit to keeping longer-term interest rates low by making targeted purchases on the long end of the yield curve. It’s the second option that scares markets, because while it’s still stimulus, it’s basically a tacit admission that QE has limits and has failed.

Why This Matters to US Investors: If the BOJ takes option 2, it could cause a spike in Japanese bond yields and could be the catalyst for a massive unwind of the global money flows into US Treasuries. That, in turn, will undermine the entire low-rate-forever rally in US stocks, as the most aggressive central bank in the world (the BOJ) waves a white flag. And, in this scenario, conservatively the S&P 500 could trade back to the initial breakout down in the upper 2000s (a 5% – 7% correction).

Key Date #2: September 8
The Next ECB Meeting. This ECB meeting is important because it’s been assumed (and priced in) to markets that the ECB would be more accommodative post Brexit. But, that hasn’t happened yet. If inflation and growth estimates released at this meeting are stronger than expected, then expected ECB policy will be more hawkish than thought.

Why This Matters to US Investors: If the ECB estimates are good and the ECB hawkish, it could cause a spike in German bond yields and could be the another catalyst for a massive unwind of the global money flows into US Treasuries. That, in turn, will undermine the entire low-rate-forever rally in US stocks, as European investors unwind Treasury long positions. And, in this scenario, conservatively the S&P 500 could trade back to the initial breakout down in the upper 2000s
(a 5% – 7% correction).

Key Date #3: August 26. Yellen’s Jackson Hole Address. Yellen won’t be “hawkish” in the commentary but the extreme complacency in Fed expectations does lend itself to a surprise. Despite recent hawkish commentary, there is still less than a 50% chance the Fed hikes rates in December! So, if Yellen implies a December rate hike (December, not September) in her remarks in late August that will cause a serious readjustment to the market’s Fed expectations.

Why This Matters to US Investors: If Yellen points to a December rate hike, that, combined with what could potentially happen in German bunds and Japanese bonds a few weeks later will undermine the entire low-rate-forever rally, as US, European and Japanese investors unwind Treasury long positions. And, in this scenario, conservatively the S&P 500 could trade back to the initial breakout down in the upper 2000’s (a 5% – 7% correction).

Markets Nearing Tipping Point: How these events turn out will create a pretty sustainable glide path for stocks to start Q4.

On one hand, if all of these events turn out benign, that will be bullish for stocks into year end and a very reasonable target will be 2240 in the S&P 500, and perhaps 2340. And, certain specific sectors should handily outperform into year end, offering smart advisors the opportunity to outperform.

On the other hand, if Yellen isn’t dovish and the ECB and BOJ are “hawkish,” that will undermine the entire reason for this 8%, post-Brexit rally, as it will cause bond yields to rise and stocks to fall. Avoiding that potential pullback will give advisors the chance to close a performance gap and redeploy capital at more favorable levels.

So, bottom line, getting these events right will be a big key to outperforming in Q4 and finishing the year with strong numbers, regardless of the environment.

We are going to make sure that our paid subscribers know what each of these events means for the broad market and, more importantly, what tactical sectors we think can outperform the market into year end. We are very focused on helping subscribers be properly positioned for the fourth quarter.

Click this link to begin your quarterly subscription today and make sure you’ve got an analyst team working to help you outperform into year-end.

What We’re Doing Now

We continue to slowly and methodically add tactical bank exposure, as that will be a sector that will handily outperform if bond yields do rise. Now, is that our biggest holding? No, of course not, but it’s a tactical long that has outperformed the broad markets
and will continue to outperform if yields drift gradually higher or any of the above events contain a “hawkish” surprise.

And, with bank stocks still generally down YTD and trading at historically low valuations, it’s not like we’re adding to some high valuation tech name or over-extended, “over-loved” sector.

From a risk/reward standpoint, if you’re looking to add a position or sector that still offers some relative value and the chance to significantly outperform if yields ever do rise, banks remain attractive from a risk/reward standpoint.

And, our preferred bank ETF does not have any European bank exposure, nor does it have any broad-based financial exposure to insurance companies or REITs – two sectors that are not trading at relatively cheap valuations.

Make sure you’ve got an analyst team that’s watching the macro horizon while at the same time focusing on sectors and tactical ideas that can help advisors and investors outperform.

I am continuing to extend a special offer to new subscribers of our full, daily report that we call our “2-week grace period.”

If you subscribe to The Sevens Report today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Click this link to begin your quarterly subscription today.

Make More Money, Save Time, Have More Knowledge

Our job is to provide you the timely, need-to-know, critical information that will demonstrate to your clients:

1) That you are on top of the markets, and

2) That you are in control of their financial situation.

Actual subscribers to The Sevens Report have told me that discussing the information contained in the Report with prospective clients has helped them land accounts as big as $25 Million!

2015 was a volatile year, and things have gotten worse so far in 2016. Subscribe today and give yourself the market intelligence you need to help strengthen relationships with clients, and acquire new ones.

Subscriptions start at just $65 per month, billed quarterly, and with the option to cancel any time prior to the beginning of the next quarter, so there’s simply no reason why you shouldn’t subscribe to The Sevens Report
right now.

If you want to make your business more successful, you have to possess unshakeable confidence in your knowledge, and helping you acquire that knowledge is what The Sevens Report is all about. Begin your subscription to The
Sevens Report right now by simply clicking the button below:

Finally, everything in business is a trade-off between capital and returns.

So, if you commit to an annual subscription, you get one month free, a savings of $65. To sign up for an annual subscription simply click here.

Best,

Tom Essaye

Editor

The Sevens Report

Yesterday, a subscriber called to tell me about a successful meeting he had with a client this week, in which the advisor explained:

• What the Equity Risk Premium was,
  
• Why it was driving stocks higher, and
  
• Why the 10-year yield is now a leading indicator for a potential correction in stocks.
  

The client asked him “How’d you Know That?”
because the advisor sends this client virtually all of compliance approved firm research materials, and they didn’t say anything about the Equity Risk Premium.

The advisor’s answer: “The Sevens Report.”

This advisor went on to tell the client that he uses
the daily publication as an independent research “check” on the firm-provided research to help formulate his overall investment strategy and make sure his clients are protected from macro risks.

Most importantly, the subscriber told me his client left the lunch happy and confident that his account was in capable hands.

So, what information did you have this week to impress clients?

The Sevens Report isn’t just another research tip sheet that’s designed to tell you whether stocks are going to go up or down. Rather, it’s a tool we have created for the purpose of helping advisors:

1.  Attract more clients
2.  Increase assets under management
3.  Improve retention

In fact, The Sevens Report helped thousands of your colleagues and competitors at wire house firms and smaller RIAs be more efficient and more effective in finding and closing new clients since we launched in 2012, and we did it again in 2016.

Affluent clients want communication on the markets that is not just a “boiler plate” strategy update from your broker dealer.  They are expecting you to know what is happening in the markets and how it is affecting their portfolios, especially in this difficult environment. 

We created The Sevens Report, so that advisors can make sure they have an independent analyst that communicates with them every day and quickly identifies for them the risks and opportunities for:

• Stocks
• Bonds
• Currencies
• Commodities, and
• Interprets what economic data means for the market. 

Most of our subscribers are not actively trading clients’ accounts.  However, they can demonstrate to their clients that they weren’t blindsided by the recent volatility
thanks to The Sevens Report.

That’s the kind of analysis that leads to More Clients and ultimately More AUM.

Easily the most important thing that’s happened this week has been that the Bank of England’s QE program basically “failed” on Tuesday, and we’ve included an excerpt of that research for you below:

Implications of a Failed GILT Purchase Program

Most advisors don’t follow global bond markets, but the most important thing that happened this week was in the British bond market and it’s important for your clients because:

1. It’s another sign that global central bank policies around the globe are becoming less and less effective (which is a problem for an equity rally based on central bank help), and
   
2. Further easing by the Bank of England or other central banks will have real world implications on US bonds, including potentially inverting the yield curve
   (which is a historic warning sign for stocks).

What Happened: On Tuesday, the Bank of England became the latest central bank to have egg on its face when, on the second day of its newly expanded QE program, the bank was not able to buy its daily quota of long dated bonds. The BOE sent bids for 1.17 billion pounds worth of 15 year and longer GILTS (British Government Bonds), but it only received offers for 1.118B of GILTS, falling short by over 52 million pounds worth of debt.

Because of how screwed up the global bond markets have become, holders of long term GILTS were literally unwilling to sell to the BOE because they know that 1) There’s nowhere else in the market to generate a decent yield, and 2) These GILTS are just going to keep going up. This is a prime example of where economic theory unfortunately meets market reality.

Why It Matters:

Reason One: Eroding Central Bank Confidence is a Longer-Term Problem for Stocks.

Japan has been ground zero for this eroding confidence as the Bank of Japan, over the first eight months of 2016 has largely admitted that, practically speaking, it is out of bullets to stimulate the economy. And that any further material easing: 1) Can’t be effectively executed because of the size of various markets, or 2) Will cause more harm than good
(like when negative interest rates sent global stocks plunging last week).

Bigger picture, for those investors with larger time horizons, I feel like even lower yields and more and more easing is becoming a virtual pressure cooker, and as yields grind lower the cooker is starting to shake and screws and nuts are starting to fly off as the pressure gets too great.

Perhaps that’s a bit over the top, but there are anecdotal signs that this entire system is starting to show signs of serious stress, and with global bonds, stocks and real estate all at all-time high prices, I honestly fear for the global economy if this thing blows up. I hope I am wrong.

Reason 2: The Yield Curve Might Invert, Signaling a Looming Recession.

We’ve talked for weeks now about the compression of the 10’s -2’s Treasury spread, and that if the yield curve inverts, that’s historically a sign of impending recession—or in this market, something worse.

And, that fear has been elevated after the BOE this week.

That’s because while the BOE was unable to fill its quota of long-term debt, it easily bought more medium-term debt (GILTS that don’t yield as much).

That’s important for three reasons:

First, it’s created more downward pressure on 30 year Treasury yields. BOE QE makes the 30-year Treasury even more attractive because the yield of over 2% is much, much better than anything else out there right now. So, that will keep downward pressure on 30-year yields.

Second, it puts more downward pressure on 10-year Treasury yields. BOE QE will make the US 10 Year Treasuries even more attractive because the yield at 1.5% is much, much higher than anything comparable in the market, so that will keep pressure on the 10-year yield.

Third, it will not put pressure on 2-year Treasury yields. Finally, with economic data consistently coming in better than estimates (including last week’s jobs report), a Fed hike can’t be delayed any further than is currently expected.

So, the likely direction of the 2-year Treasury yield is flat to higher, unless economic data gets worse—and at that point we’ll be facing a recession
(which is obviously bad for stocks).

I realize that most financial advisors didn’t have “Global Sovereign Bond Markets” in their broker training program. But, this is what’s moving markets right now, so you need to be on top of it.

This research was already sent to our paid subscribers at 7 a.m. in the full, paid edition of The Sevens Report, and I’m confident some of them are using this analysis to impress clients and prospects.

Make sure you have a daily research document that gives you peace of mind in volatile markets.

We’ll directly tell you (in plain English) what’s truly important in markets and provide consistent tactical idea generation so you can outperform for your clients, regardless of the environment.

I am continuing to extend a special offer to new subscribers of our full, daily report that we call our “2-week grace period.”

If you subscribe to
The Sevens Report today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Click this link to begin your quarterly subscription today.

Value Added Research That Can Help You Grow Your Business in 2016

Our subscribers have told us how our focus on medium-term, tactical opportunities and risks has helped them outperform for clients and grow their businesses.

We continue to get strong feedback that our report is: Providing value, helping our clients outperform markets, and helping them build their books:

“Thanks for your continued insight; it has saved my clients over $2M USD this year… Keep up the great work!” – Top Producing FA from a National Brokerage Firm.

“Let me know if there is anything else that you need from us. Thanks again for everything. I really enjoy the Report – it is helping me grow my business and stay on top of things.” –  Independent FA.

“Great service from a great company!!” – FA from a National Brokerage Firm.

“Great report. You’ve become invaluable to me, thanks for everything…!  –  FA from a Boutique Investment Management Firm.

Subscriptions start at just $65 per month, billed quarterly, and with the option to cancel any time prior to the beginning of the next quarter, there’s simply no reason why you shouldn’t subscribe to The Sevens Report right now.

Begin your subscription to The Sevens Report right now by clicking this link and being redirected to our secure order form.

Finally, everything in business is a trade-off between capital and returns.

So, if you commit to an annual subscription, you get one month free, a savings of $65. To sign up for an annual subscription simply click here.

Best,
Tom

Tom Essaye
Editor, The Sevens Report

When I think about what’s become of the Fed, it almost makes me sad.

I’m dating myself a bit by saying this, but when I started in this business the Fed was a revered (and sometimes feared) institution.

• In the early 80s, “with a tear” in his eye, Volker rose interest rates and broke inflation.
  
• In the 90s, Greenspan was the “maestro” that helped support the best economic run in decades.
  
• In the late 00s, Bernanke was steadfast through the crisis.
  

So, when I saw the market reaction to yesterday’s “hawkish” statement, it made me a little sad, because the market clearly no longer respects the Fed.

And, that makes me nervous.

I say that because while the Fed has successfully engineered massive rallies in both stocks and bonds (and, to a degree, real estate again), at some point things have to begin to return to normal, otherwise we’re going to get another bubble burst.

Yesterday’s price action was scary because it implied the Fed has potentially lost control of the markets, and if that is the case then we are going to see a bubble further inflate and then burst across all asset classes (stocks, bonds, real estate).

Given how fundamentally overvalued stocks and bonds are right now, it’s not unreasonable to think that we could see a 5%, 10% or even 15% decline in both
stocks and bonds (like last August, but worse) if the Fed does lose control and then tries to rein markets back in through a knee-jerk increase in rates.

Is that going to happen next week, or even next month?

No.

The trend in stocks is still higher, and 2200-2240 in the S&P 500 remains a very reasonable near-term target.

But, most of us aren’t investing for the next few weeks or months, we’re investing for quarters and years, and the bottom line is that yesterday’s reaction in stocks might be good in the short term, but beyond that—and unless something changes—we’ve got two unattractive alternatives:

1. The Fed continues to lose credibility
   and asset prices simply run higher as the bubble expands, only to ultimately pop at some point.
   
2. The Fed realizes it has lost credibility and shocks markets with more rate hikes than expected, potentially undermining the whole catalyst for the stock and bond rally.
   

No one knows how it’ll go, but the important thing is to be reading someone who recognizes these risks, and someone who is watching specific assets and leading indicators that will give us warning when this unsustainable situation comes to a head (and importantly, provides tactical guidance on how to protect client portfolios).

Over the coming weeks and months, we’re going to be doing that for our subscribers because our goal at The Sevens Report is to wake up each day and help our subscribers navigate these complex markets, and provide the best value in market analysis out there today.

I created this report because I know that most financial advisors and professionals are not glued to blinking screens from 9:00 – 4:00 each day.

They are discussing the financial goals of their clients and mapping a financial course to reach those goals. Most of their time is spent building and fostering relationships, not analyzing Fed commentary, studying the yield curve, or digging through an oil inventory report.

The most successful advisors use The Sevens Report
to stay ahead of the markets (stocks, bonds, currencies and commodities) and to make sure their clients are positioned to both outperform while also being protected from any financial “storm” that may blow up.

Specifically, we take complex macro-economic concepts (like FOMC Policy, Brexit, Jobs Report, Italian Bank Risk, etc.) and tell you:

1) What you need to know,

2) What will move markets, and

3) What will make those events positive or negative for stocks and other asset classes.

Every morning at 7 a.m. we deliver this information, so you can show your clients you’re on top of the markets with a plan to outperform, regardless of the environment.

Yesterday the Fed produced a “hawkish” statement that undoubtedly was designed to get markets to respect the possibility of a rate hike this year, but the effort failed, and while that likely will fuel incremental upside in stocks, it lays the foundation for a potentially violent pullback down the road if the Fed wants to regain the market’s respect.

As a courtesy, we have included both of those pieces of analysis for you today:

Why Was the Fed Hawkish but the Market Dovish?

In a somewhat shocking turn of events, the dollar declined following the Fed statement yesterday and Treasuries (including the Fed-sensitive 2 year) rose, which is the exact opposite of what should have happened based on the FOMC statement.

The reason for this opposite reaction is clear: the market does not believe the Fed anymore.

An old saying on Wall Street is, “Markets always tell the truth.” And the truth is that after a year of policy whipsaws, conflicting statements and consistent dovish excuses, the Fed has lost all hawkish credibility—and with good reason.

First, we’ve seen this act before. The Fed was hawkish last July, but balked at hiking in September. Then they were hawkish in December and said to expect three-to-four rate hikes. Then the entire month of May, various Fed speakers chastised the markets for being too dovish (yes, we’re talking to you Rosengren), only to have the FOMC produce a very dovish statement in June. So, the logical question is… “Why should we believe them now?”

Second, who cares about one 25 bps rate hike? Whether there is a rate hike in September or December, the market doesn’t believe the Fed will hike rates consistently beyond that one hike, regardless of what happens to economic growth or inflation. And frankly, why should markets expect it? It’s taken the Fed nearly a year to hike another 25 basis points, so why should anyone think that will change next year, especially after the Fed keeps talking “gradual rate increases.”

What will change it? It’s going to take Fed Chair Yellen basically saying she is in support of a rate hike sooner than later to re-establish credibility with the market, because at this point the market simply thinks that while there may be a growing number of hawks on the FOMC, Yellen is not one of them, and it’s her Fed.

Market Outlook: What’s Next

Safety vs. Cyclicals Update. The last two days have certainly caught my attention with regard to whether this rotation out of safety and into cyclicals has finally begun in earnest, but it’s still not enough for me to settle on the idea that it has.

There have been many false starts in this rotation over the past few years, and if the market is really skeptical about the Fed hiking rates near term, then defensive sectors are still attractive beyond the very short term.

So, we are not materially reducing our medium- and longer-term holdings of defensive sectors and won’t until we see a material breakout higher in the 10-year Treasury yield (paid subscribers know the levels we are watching).

However, we are thankful we bought a specific bank ETF as a near-term hedge against safety sector underperformance. Since we bought our specific bank ETF two weeks ago, it’s risen 2%,
and we will likely add to it over the next few days if it can make a fresh closing higher above $40.57. This sub-sector of the banks remains one of the few areas of historical value in the markets.

Next Key Event to Watch:
The Jackson Hole Fed conference, which takes place in late August, has now become pretty important.

If Yellen is going to try and regain the market’s respect or prep investors for a potential rate hike in September or December, she will likely do it at her speech at that conference.

So, that’s a day to pencil in for a potential disruption to this rally, and we’ll be watching the Fed speak closely over the next month to discern any hints about what Yellen will say, because if she forecasts a rate hike, this market rally is going to reverse in a hurry.

Bottom line, the stakes in this market game of musical chairs keep rising, and the Fed is the one controlling the music, so it’s critical you’ve got an analyst working for you who is focused on helping you navigate the remainder of the year, regardless of what the Fed does with policy!

Our paid subscribers had this analysis at 7 a.m. this morning, so when their clients called today and asked, “What did they Fed mean for my portfolio?” they could answer quickly, directly, and confidently.

That’s how advisors use The Sevens Report
to strengthen relationships and close prospects.

If your broker or subscription research isn’t providing you this type of analysis on a daily basis and helping you build your business by saving you research time, increasing your knowledge about markets and giving investment ideas that can impress prospects and help client outperform, then please consider a quarterly subscription to The Sevens Report.

At just $65/month (billed quarterly) with no penalty to cancel, we are very confident we offer the best value in the subscription research space.
I am continuing to extend a special offer to new subscribers of our full, daily report that we call our “2-week grace period.”

If you subscribe to The Sevens Report
today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Click this link to begin your quarterly subscription today.

Make More Money, Save Time, Have More Knowledge

Our job is to provide you the timely, need-to-know, critical information that will demonstrate to your clients:

1) That you are on top of the markets, and

2) That you are in control of their financial situation.

Actual subscribers to The Sevens Report have told me that discussing the information contained in the Report with prospective clients has helped them land accounts as big as $25 Million!

To be certain, 2015 was a
volatile year, and things have gotten worse so far in 2016. Subscribe today and give yourself the market intelligence you need to help strengthen relationships with your current clients, and acquire new ones.

Subscriptions start at just $65 per month, billed quarterly, and with the option to cancel any time prior to the beginning of the next quarter, so there’s simply no reason why you shouldn’t subscribe to The Sevens Report right now.

If you want to make your business more successful, you have to possess unshakeable confidence in your knowledge, and helping you acquire that knowledge is what The Sevens Report is all about. Begin your subscription to The
Sevens Report right now by simply clicking the button below:

Finally, everything in business is a trade-off between capital and returns.

So, if you commit to an annual subscription, you get one month free, a savings of $65 dollars.  To sign up for an annual subscription, simply click here.

Best,
Tom

Tom Essaye,
Editor, The Sevens Report

The music is back on.

Several times over the past few years I’ve referred to the markets as a real life game of “musical chairs.”

We all know the children’s game: When the music plays you run around the chairs and you hope that you have a place to sit when the music stops, otherwise you’re out.

It’s the same thing for central-bank-driven stock markets.

When the Fed is ultra-dovish, you have to “Run” (i.e. be in stocks) because stocks tend to go up regardless of economic fundamentals. But, you just have to hope that you have a seat when the music stops (i.e. the Fed actually gets serious about raising rates or the market finally realizes the Fed is out of bullets).

On Friday, following the jobs report, the “music” started again and investors piled back into stocks.

But, contrary to what you may have read in the financial media, Friday’s stock rally was not because of the strong jobs report. Yes, the headline was good, but the trend in job additions has been decidedly lower throughout 2016.

Instead, the reason for this huge rally in stocks is bonds – specifically that Treasuries went UP and yields went DOWN after the jobs report. Additionally, the Dollar was flat despite the strong jobs report.

That told investors that the market is now totally convinced that the Fed won’t raise rates this year, regardless of what happens in the economy, and as a result they piled into stocks.

So, it is the expectation of forever-low interest rates that is driving this stock rally – not any improvement in fundamentals.

Now, do we think this rally is heralding a new bull market in stocks?

No, we don’t.

The risks to this market are generally unchanged from three weeks ago, and we’re continuing to monitor those risks for our subscribers.

But clearly, the near-term trend is higher, and you learn quickly in this business you have to invest in the market you’ve got—and not the one you think you should have!

So, the question now is whether investors need to abandon those defensive equity positions and rotate into higher-growth/higher-beta sectors like tech/consumer discretionary and basic materials?

That’s a pretty important question from a performance standpoint, because defensive sectors have massively outperformed cyclical sectors in 2016 – and if we are going to see a massive rotation back in to cyclicals, then advisors need to know that to maintain outperformance.

We discussed the potential for that rotation in a recent edition of The 7:00’s Report and have included an excerpt for you below.

Are We Going to Witness a Great Rotation?

Most of the free excerpts you receive focus on macro topics, but in the paid edition of The 7:00’s Report
we include a general asset allocation model and list of tactical investment ideas we think can outperform over the medium term.

Throughout 2016, our general equity view has been “Cautious” where we advocate 2/3 allocation to defensive sectors (represented in the Report by SPLV) and 1/3 to higher-beta sectors (represented by SPHV).

Even with the S&P 500 hitting new highs, that allocation has handily outperformed the S&P 500 in 2016, as SPLV has risen 14% year to date, not including dividends, while SPHB has risen 1.4%, giving our “Cautious” allocation a weighed return of 9.6%, doubling the S&P 500’s 4.7% 2016 return.

But, right now, with stocks breaking out and people piling into equities, the question most advisors are asking is whether to rotate into more cyclical/higher-beta sectors.

That’s really important, because anyone who has been in defensive sectors has massively outperformed cyclical sectors year to date and knowing whether to stay in those sectors or rotate into cyclicals will be critical to outperforming for the remainder of 2016.

As we told subscribers earlier this week, we do not think this massive rotation is going to occur and currently we are advocating holding allocations to defensive sectors for anyone other than a short-term investor.

The reasoning behind that conclusion is fairly simple.

This rally is being driven by the idea that interest rates will stay low forever, regardless of the economy. And, as a result, that will continue to favor more income-oriented sectors (beyond the short term).

So, if the main justification for that breakout in stocks was that low interest rates have indeed made it “different this time” from a stock valuation standpoint, and because of record-low Treasury yields and the prospect of no rate hikes in the future, acceptable stock valuations are now higher than previous history.

So, if that is the reason that people are buying stocks, then it negates the “overvalued” argument towards defensive sectors (staples, utilities, REITs).

Yes, those sectors are overvalued compared to historical norms, but now so is the stock market, and if perma-low interest rates justify the valuation extension in the S&P 500, it must also justify the valuation extension in these defensive sectors.

And, so far, the price action has validated our thesis.

Despite the fact that consumer staples, utilities and REITs are basically at all-time highs, the relative underperformance since Friday is not nearly as big as it could have been given how “overbought” most people think utilities/staples and REITs currently are.

In fact, we were actually relatively impressed with the performance of consumer staples (XLP/FXG) on Friday, as given their recent outperformance we could have easily seen outright declines in both those sectors following that strong jobs report.

Getting this potential rotation “right” for subscribers will be very important, and it’s obviously going to be a fluid situation. So, to make sure we get this “right” for subscribers we are watching a single indicator to tell us whether this rotation is gaining steam.

Until we see a material break lower in the belly and long end of the Treasury curve, the income provided by staples, utilities, REITs and other defensive sectors will remain critical to outperforming in this market.

And, we will alert our subscribers to any break that occurs in Treasury yields and analyze the implications for the market in general and for equity asset allocations.

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Best,
Tom

Tom Essaye,
Editor of The 7:00’s Report