Re-balance Cycle Reminder All MyPlanIQ’s newsletters are archived here.

Regular AAC (Asset Allocation Composite), SAA and TAA portfolios are always rebalanced on the first trading day of a month. the next re-balance will be on Thursday September 1, 2022. 

As a reminder to expert users: advanced portfolios are still re-balanced based on their original re-balance schedules and they are not the same as those used in Strategic and Tactical Asset Allocation (SAA and TAA) portfolios of a plan.

Asset Trends Review

Recently, we are finding ourselves spending more time to analyze trends and the economy. This is somewhat annoying as we really would like to focus on long term portfolio management and personal finance. Unfortunately, we have been inundated with quite a few users’ questions. This is understandable as markets have rapidly moved recently. We are in an unusual time. 

Recent Asset Trends

Stocks started their rapid ascend 30 days ago:

As of last Friday, US stocks and US REITs now have positive trend scores: 

Description Symbol 4 Weeks 52 Weeks Trend Score
Commodities DBC 4.07% 36.81% 10.33%
US Equity REITs VNQ 10.82% -0.92% 4.34%
US Stocks VTI 11.65% -4.93% 3.11%
International Developed Stks VEA 9.35% -11.38% -0.87%
Total US Bonds BND 1.32% -8.08% -1.85%
Emerging Market Stks VWO 6.06% -14.76% -3.19%
10-20 Year Treasury TLH 0.33% -16.75% -5.55%

Unfortunately, the other three major assets: international stocks, emerging market stocks and US bonds still have negative trend scores. What’s noticeable is that bond prices barely budged in the recent stock rally. Fixed income hasn’t recovered much at all from its low in June. The important 10-20 Year Treasury Bond (TLH) has the worst 52-Week return and ranked the worst in the above trend score ranking table. Long time readers know that we pay attention to long term bonds as they show fixed income investors’ assessment on future economy growth. Long term bond interest rates also greatly affect housing market (mortgage rates) and corporate capital expenditure. 

However, the recent stock rally indeed is ‘real’: at the moment, all US styles and sectors (other than Telecom that one probably can safely ignore for now) all recovered and have positive trend scores. See 360° Market Overview for more details. 

Meanwhile, market internals have markedly improved. The percent of stocks in S&P 500 above their 200 day moving averages reached 48.8%, just about the same as its 200 day moving average. It recovered back to the level before the Russia-Ukraine war in March:

Similar conclusions can be drawn for stocks in NYSE and Nasdaq indexes. At any rate, it does seem at the moment, investors are now back to full risk on mode and are chasing stocks higher. 

Economic indicators

Moving to economic data, however, we are seeing a more pessimistic but still mixed picture. So far, we are seeing

  • Retail sales: as what we stated before, the US retail sales have been down year over year for the past several months now. This is an important barometer as US economy is mostly driven by consumer’s consumption. 
  • Manufacturing: so far, the general Industrial Production indicator is still growing (we are still waiting for the latest July number that will be released tomorrow). However, the latest NY state Empire State Manufacturing index is down big time in the last month and is in contractionary territory: 

  • Housing: with a rising interest rate, mortgage rates have risen much. It’s no surprise that homebuilders are feeling the heat. The latest homebuilder sentiment index fell to 49 from 55 in prior month, worse than 54 estimated:

Housing started continued to decelerate: 

  • Real personal income growth has been negative since last year. See the above chart. 
  • On a positive side, unemployment rate actually declined last month from 3.6% back to the low 3.5% reached in February 2020, just before the pandemic:

What the above shown is that the US economy is probably still in some transitory stage, not necessarily in a recession yet. However, subjectively, we believe with a Federal Reserve whose only option is to raise interest rates and tighten financial conditions to control inflation, the likely path is still down. 

Inflation data are still sticky: Don’t fight the Fed(eral Reserve) Bank

Though last month’s CPI came down a little bit (from 9.1% to 8.5%), the decline was mostly due to lower energy prices and retailers’ overbuilt inventory liquidation. The sticky CPI, i.e. the core CPI that only consists of those whose prices are more sticky (such as rents and medical service costs) is still rising faster: from previous month’s 5.4% to 5.6%:

Service cost and rents are sticky since once they are raised, providers will be slow and very reluctant to bring them down. Unlike food and energy prices (and other physical goods that have inventory and transportation cost), services and rents are less affected by speculation and have less penalty to maintain price levels for a while. 

Recent market rally was mainly ignited by investors’ interpretation/belief that the Fed is likely to pivot or start to lessen or even stop interest rate hikes. The Fed Chairman Jay Powell made some surprising ‘dovish’ comments in the last month’s FOMC press: he indicated that the current interest rate might be in its neutral zone. However, since then, various Fed officers have tried hard to walk back or tame down this ‘dovish’ comment. 

Given the above inflation data, the ultra low unemployment rate, the tight labor market, and the recent market strength, the Fed is likely to be forced to keep raising rates. Interested readers can look at this Tweet for more information: 

The other headwind for stocks and risk assets is that recent corporate earnings growth has stalled at best. As stock prices have risen again, this means that Price/Earnings (PE) ratios are rising again while in the meantime, the alternative fixed income (bonds) is yielding higher. if stocks rose in the past decade mostly because the Fed’s ultra loose monetary policies were creating TINA (There Is No Alternative) for stocks, the current situation is completely opposite. If ‘Don’t fight the Fed’ worked in the past, it would be wise this time around to stick to this. As the main purpose of the Fed’s raising interest rates is to tighten financial conditions, part of which are controlling elevated stock and other asset prices, at best, stock prices will stagnate. Subjectively, given the current ultra high stock valuation, stock prices will probably come down fast again when the rising rate effect fully manifests deeper to various economic segments. Subjectively, we lean to a continuing bear market at the moment. However, as always, objectively, we will let future development guide us. 

What to do

At the moment, US stocks are posed to be in an up trend. Whether this up trend can sustain for long is still very questionable. We will have a better picture by the end of this month. At the moment, we call for patience and stay the course. Our strategies will respond to market and economic conditions as time goes:

  • For strategic allocation (buy and hold) investors, ignore the current market behavior. Remember, as what we have emphasized numerous times, when you choose and commit to a strategic portfolio, you essentially know and commit that your investment horizon (or the time you need to utilize this capital) is 20 years or preferably much longer given the current high valuation. As we pointed out, if your investments are those diversified (index) funds such as an S&P 500 index fund (VFINX, for example), you know your money is in some solid ‘business’ that eventually (20 years later and preferably many more years later) will deliver some reasonable returns. As long as you are comfortable with this thesis, you should sit tight and forget about the current gyration.
  • For tactical investors, again, you have to ignore the current market noise. Furthermore, you should follow your strategy rigorously, especially in a time like this. Human emotion, both optimistic and pessimistic, and human desire, both greedy and fearful, are your worst enemies. This has been shown to be true time and time again.

Stock valuation has dropped. However, it is still high by historical standard. For the moment, we believe it’s prudent to be extra cautious. However how serious a correction might be, we have confidence in the US economy in the long term and thus in the stocks in aggregate. We just need to manage through interim losses carefully.  

We again would like to emphasize that for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot.

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