Market Update

HAPPY NEW YEAR

Wowzers! We thought November was a crazy month until we witnessed the past four weeks. We felt the best place to start this month off is right where we left off last month.

The technical indicators that we drew attention to that occurred on December 3rd proved to be very important after all !

Once again, please refer to the charts above.

The first is an updated daily chart of the S&P 500 over the past year.

In last month's Market Update we noted that on December 3rd the level of the index had once again closed BELOW its 200-day moving average; a bearish indicator telling us that more losses may be coming. The previous 2 occurrences were short lived as the market turned back to positive shortly after. This time was different. Here's why...

Last month we mentioned that often what happens next depends on whether another supporting technical indicator triggers to support and strengthen the warning suggested by the original indicator.  We asked you to look at the chart and find the blue line; the 50-day moving average.  At the time, the 50-day line (blue) looked to be on a crash course to cross the 200-day line (red). Guess that happened on December 11th? The dreaded "Death Cross"; a chart pattern indicating the potential for a major selloff. See the area highlighted in yellow.  The market proceeded to drop another 11% from December 11th to the bottom reached on Christmas Eve.  When we saw the Death Cross occur we took action and reduced risk in our equity investments by selling more aggressive momentum stocks and buying higher quality and dividend paying stocks.

We have also updated the second chart; the price of the 10-year US Treasury bond. Remember...as prices of bonds go up, yields go down.  Also remember that US treasury bonds are a safe haven when uncertainty is in the air.

Last month, we made note of the sharp reversal in interest rates that occurred during the first two trading days of December. We also cited that the price rose above the 200-day moving average...seen as a potential positive for a price rally (yields dropping). Lastly, we mentioned that we felt the move in bond prices may only be a correction because the 50-day average (blue line) was nowhere near crossing the red line (200-day). As you can see on the updated chart, the blue line is making a move for the red line (highlighted in yellow). It will be important to continue to watch the narrowing of these two lines. However, we do not believe that we will see a Death Cross in long term treasury bonds. The top of the chart shows RSI (Relative Strength Index). As indicated by the area we highlighted, treasury bonds appear to be "overbought". That typically means that we have seen the top (low in yields) unless we get a significant catalyst. That being said, considering all the craziness we have seen lately, almost anything is possible.

Stay tuned !

Overall, we are still cautious but think we may have seen a bottom in both the stock market and long-term treasury yields that may hold unless we see Q4 earnings fall short of expectations and/or further evidence that the economy is slowing. All eyes and ears are still on the Fed as well. 

One last lesson in technical analysis...one of our favorites. It is:  "What Once Was Support, Now is Resistance". So, what does that mean?  The red line that shows us the 200-day moving average used to act as a potential area of support (where a price trend may slow, stop or reverse when decreasing).  Now that price has crossed significantly below the line, we now should treat the line as a potential area of resistance (where a price trend may slow, stop or reverse while increasing).  In other words, we would not be surprised to see the S&P 500 have a hard time getting back above 2,713 unless we get some really good news.  That news could be in the form of positive corporate earnings, strong economic data, indication that the Fed will cease interest rate increases or an effective resolution to the Trade Wars with China.

Let's Talk About Risk AGAIN

Last month we talked about your "Risk Number".  This month we want to talk in more realistic and tangible terms. 

First, we would like to review the results of our poll question.  Thank you all for your responses.

Which investment strategy would you prefer?

A. 50% of the upside and 0% of the downside of the S&P 500. for example, if the S&P is up 10% you get 5%. If the S&P is down 10% you get 0%

B. 100% of both the upside and downside of the S&P 500. for example, if the S&P is up 10% you get 10%. If the S&P is down 10% you lose 10%.

The overwhelming majority (100% to be precise) of your responses were for choice B.

We have to admit, we were hoping that would be the case because it fits our investment style and philosophy...especially for those approaching retirement

Each month, we like to share with you the core facets of our investment strategies.  We believe in erring on the side of caution and looking for a margin of safety.  December was no different.  Once again, our Spidey senses began to tingle, and we responded.  We reduced our stock exposure in favor of some investment opportunities that we have not seen in a long time.  

As a result, we made some investments in an effort to increase portfolio diversification and reduce investment risk; something we felt good about in the current market conditions.  At the same time, we improved the yield of our portfolio.

We will discuss what we purchased in more detail below.

The point to make here is that we are active in our approach and not afraid to adapt and take advantage of anomalies when it can make a positive impact on risk management and overall portfolio performance.  We believe that it is very important to have conviction when making investments.  We pride ourselves on being able to confidently convey our investment thesis to you in our communications. 

Financial Planning Tip of the Month

This month we are going to talk to you about a couple of investment strategies that we have been employing off and on for several years.  We saw some opportunities present themselves recently and we have taken advantage of them.

The strategies are as follows:

The first is what we like to call "Buying Assets at a Discount". 

The second is "Getting Paid While You Wait".

Let me share some details in an attempt to help you understand these strategies.

First, "Buying Assets at a Discount".

Here is an example:

If I wanted to buy 100 shares of an XYZ exchange traded fund (ETF), I would place a trade and buy the shares at the next available Market Price available on a stock exchange.  The Market Price is determined by supply and demand and the underlying fundamentals of whatever the ETF invests in. 

If I wanted to buy $5,000 of my favorite mutual fund, I would place a trade and get the number of shares equal my investment amount divided by the next available Net Asset Value (NAV).  If the NAV was $100, I would get 50 shares.  Net Asset Value is simply the total of the values of all the investments in the fund divided by the total number of shares outstanding.

Now, let me introduce you to Closed End Funds (CEFs).

CEFs throw another wrinkle into the mix...CEFs have both a Market Price and a NAV. 

If you pull up a quote on a CEF, what you are seeing is the Market Price.  You need to dig a bit further and do some research to find the NAV.  The important thing to understand here is that when you buy a CEF, you are buying at the Market Price NOT the NAV...much like the ETF example above.  Now, here's the part we really like.  If you carefully track the CEF market (as we do), you can find times when Market Prices fall significantly below the NAVs.  This occurred from October into December when the stock market completely fell out of bed.

We found 2 CEFs that we have been following for years that hit historically high discounts to NAV and added then to our portfolios.

Since purchase in December, both have performed well. 

Our strategy is to hold the funds until a reversion back to the NAV occurs (already starting) and then reassess.  Once the discounts are reduced or eliminated, we typically will consider selling.

Please note: Most CEFs employ financial leverage.  Leverage is borrowing for the purpose of additional investments and does have risks involved.  Therefore, one must use caution when investing in CEFs.  However, when used appropriately and at the right times, leverage can have a significant impact on the total return of a portfolio.  

Next, we want to tell you "Getting Paid While You Wait".

We have seen ample opportunities to employ this strategy lately as well.  Generally speaking, we have moved to a more defensive stance within our equity allocation focusing on dividends and income.  This sort of falls into this category but we want to share a much better example. 

Months ago, we exited almost all direct exposure to energy and fortunately missed a tremendous fall in the price of both oil and oil stocks.

We have been watching very closely for opportunities to present themselves. 

Well, one did a couple of weeks ago and we jumped on it.

Master Limited Partnerships (MLPs) got absolutely hammered from September to December, losing anywhere from 25-40% of their value.  Without getting into specifics and lots of legalese, we just need you to know that many oil and gas companies issue MLPs instead of corporate stock.  MLPs are known for offering income-oriented investments related to oil and gas pipelines.  Because they earn an income that is often based on long-term service contracts, MLPs are conducive to offering steady cash flows, which lead to consistent cash distributions. This enables MLPs to offer attractive income yields (often higher than the average dividend yield of equities). 

When market prices fall, the income distributions do not necessarily follow; creating another anomaly that we like to call "Getting Paid While You Wait".  

Here is an example to better explain:

As part of the major selloff in energy, MLPs dropped significantly in the fourth quarter of last year.  Before the drop, the average MLP had a yield of approximately 6%.  As an example, let's say the price of ABC MLP was $100 before the drop.  A 6% yield would be $6 in annual income.  Make sense?  Now let's say this particular MLP dropped in price to $60 in the steep decline that occurred.  Just because the price dropped does not mean the $6 in annual income changed (it is important to do research to gain confidence that the income will continue).  So now our $60 ABC MLP is paying $6 equaling a 10% yield.  You gotta love math tricks!

We felt the worst was likely over with the slide in energy prices.  We felt comfortable knowing that even if there was a bit more downside, we were content to "GET PAID WHILE WE WAIT" for energy prices to recover.  In other words, we will get a 10% yield as we own the MLP and wait for it to go back up to a price that we would consider selling at.  Truth be told, we sold the exact MLP at $26.05 on October 12th and bought it back on December 20th at $19.28.  It closed today at $23.69 and we will get a $0.655 quarterly dividend in February.  

Please let us know if you have any feedback or questions. 

We would love to hear from you !

We are looking forward to working with you to make 2019 a wonderful year.