Update for Portfolio Positioning and Management as of 8/23/18

My last update was published on 7/27/18.

Vix Asset Allocation Model: Stable Vix Pattern 

Vix Asset Allocation Model Explained Simply With as Few Words as Possible

This model was developed in the Spring of 2007 as one among many timing devices. The first signal given by the model was a Trigger Event in August 2007 that terminated a Stable VIX Pattern and ushered into existence the Unstable VIX Pattern. VIX Chart from 2007: Alerts and Triggers Major Disruption of Cyclical Stable Bull VIX Pattern; Vix Charts from 2004 2005 2006 Stable VIX Patterns Phase 1 and Phase 2; Trading Strategy Under The Vix Asset Allocation Model: Part 1 - South Gent | Seeking Alpha

There has been much celebration about the S & P 500 breaking its longest bull winning streak last Wednesday. The dramatic wall of worry that stocks scaled to become the longest bull market, in one chart - MarketWatch; Bull run

This calculation starts with the low point in the last bear market cycle, which occurred on March 9, 2009 and continues the count until there is a 20% decline from the high.

There are problems and issues problem with the count. In 2011 summer, the S & P 500 came very close to declining 20%. Another bad day or two before the market started its upswing could have restarted the count then, and this move would not be the longest. 

Another issue is that the count started after a major bear smashup. 

The S & P 500 index did not surpass its October 2007 high point until 2013. 

The total annual average return of the SPDR S&P 500 ETF (SPY), which includes reinvesting the dividends, starting on 10/10/07 through 8/23/18, was 7.87%. DRIP Returns Calculator | Dividend Channel 

That return is below the long term average. 

And, if I go back to March 31/2000 as my start date, SPY's annual average total return unadjusted for inflation was 5.39% through last Thursday. The period covered by that calculation was 18.5 years. 

So there is a problem when there is this much chop. In retrospect, an investor needed only to make a few correct timing calls to produce far superior total returns. 

The first and second decisions would be to sell in the 2000 Spring when investors had obviously lost their marbles and to buy five year treasury notes. 

Then the third and fourth decisions would be to sell the treasury notes and buy back stocks sometime in 2002. 

The next two decisions would be to sell the stocks in the late summer or early fall 2007 and use the proceeds to buy the 5 year treasury note again. 

Then the last two decisions would need to occur the Spring or early summer of 2009, where the investor sells the 5 year treasury notes and buys back stocks when it became obvious that financial armageddon was not going to happen. 

While the VIX Asset Allocation Model was still in an Unstable VIX Pattern then, the VIX was coming down and the S & P 500 pierced its 200 day SMA line to the upside in June 2009.   

So that is 8 decisions over 18.5 years. 

I could cut it to 4 correct decisions give or take a few months by eliminating the five year treasury buys and just allow the stock proceeds to fall into a sweep account until redirected back into stocks.  

One thing about those decisions is that many of them were in plain sight at the time. 

The 2000 valuations were off the charts and became reasonable only after a 50% haircut. The economy was fine in 2002-2003 so the haircut was primarily a market reset to correct excessive valuations. 

The rot in the housing market was in the news throughout 2007 as the market moved to new highs. Then I also had the Trigger Event sell signal in August 2007. 

The decision in March 2009 to reallocate into stocks was not that hard given the almost 60% decline top to bottom and the then obvious fact that a financial collapse was not going to happen with governments and central banks doing what was necessary to keep the world from sliding into another long term Great Depression.  

At the moment, my two most important indicators, both technical and related to market dynamics, are still flashing green. The VIX is in a Stable Vix Pattern that can only be terminated by a Trigger Event and the S & P 500 is trading above its 200 days SMA line. 

I am ignoring that green light since I can. 

I do not need to stay invested in stocks to meet my financial goals, so I have substantially dialed back my risk. I would not be anxious to have another buying opportunity after another 50%+ collapse in the S & P 500 holding a meaningfully large stock position for me. 

My dollar allocation to long term and high quality Tennessee Municipal bonds is close to my total stock exposure including mutual funds. The stock exposure may be around 10% of investable assets and monetary exposure to all individual stocks in isolation is meaningless to me. I am trying to generate additional income and some trading profits, but the overall amounts are not that important to me in their totality. 

I am using a small ball buying approach using commission free trades to buy most common stocks. This is my current list with the lowest price in the chain shown for each stock: 

The count that led to the recent longest record is to be distinguished from a long term bull market in stocks that can be interrupted by a cyclical bear markets (usually no more than 1). The prior long term secular bull stock market started in August 1982 and lasted until the Spring of 2000. There was a one day bear market in October 1987 that interrupted the count. 

The Bull Market Is Really Old. Does That Mean It’s at Death's Door?

The foundation for a long term stock bull market includes low interest rates and low inflation. Interest rates remain abnormally low in the U.S. 

Inflation is benign for stocks, even though it has recently ticked up due in large part to an increase in energy prices. 

The S & P 500 is valued well above historical norms using traditional valuation metrics other than the estimated forward 12 month non-GAAP E.P.S. and the FED Model. Those traditional valuation metrics flashing caution are the Schiller and the TTM P/E ratios, the price to sales ratio, market cap to GDP, and Tobin's Q.  Three Metrics Of Stock Market Overvaluation; Market Cap to GDP: An Updated Look at the Buffett Valuation Indicator - dshort; What are valuation indicators and which indicators are the best – Bull Markets (has several helpful charts on the various indicators) 

Longer term bonds are a bit dicey now too which is why my weighting is substantially into short term maturities and the low end of my intermediate term bond ladder. 

A graph of the entire bond/CD ladder would have a huge bump to account for the 2018-2020 maturities and then a  slide starting in 2021 which picks up steam in 2024-2026, followed by another surge up with the Tennessee municipal bonds. 

The bond market was in a long term secular bull market starting in 1981-1982 and probably ending in July 2012. This may become evident in future years, looking back at the past. 

The ten year treasury closed on 7/25/12 with a 1.43% yield that this long term secular bull market in U.S. bonds ended in July 2012, with the ten year TIP trading well into negative yield territory that month. 

The fact that there have been bond rallies since that time would not change the conclusion that the directional trend has been up in yields and down in prices. 

2012 Daily Treasury Yield Curve Rates

2012 Daily Treasury Real Yield Curve Rates

We can now date the last long term secular bond bear market as starting around 1950 after the FED ending a period of rate manipulation and ending in 1981-1982. 10-Year US Treasury Note Yield Since 1790 - Business Insider; 200 years of US interest rates in one chart; 

For the first fifteen years or so of that earlier 31 to 32 year long term bond bear market period, investors may have remained modestly comfortable with bonds. There was not a huge upswing in yields after the market reset to higher rates after the FED ending its abnormal monetary policies that had anchored the 10 year treasury yield at abnormally low levels for several years. (see Before the Accord: U.S. Monetary-Financial Policy, 1945-51) Inflation numbers were milder then compared to now for the most part through the 1950s and early 1960s. 

The massacre of the Bond Ghouls started to gather steam in the late 1960s with the coup de grâce administered throughout the 1970s and into 1981. So looking back from 1960, I doubt that I would have dated the commencement of the long term bear market in bonds as being in 1950 as I do now. I would have so dated the start no later than 1970 if I had then addressed the issue. 

My approach is to trade intermediate term corporate bonds and to use the proceeds to buy primarily higher quality corporate bonds maturing in 2020. I can pick up more yield with those bonds than I can in the 10 year treasury now. 

As I mentioned in a recent post, the treasury yield curve is really flat from 2 years to 30 years: 

Treasury Rates

2018 Daily Treasury Yield Curve Rates

Only a slightly higher yield is obtained by going from a 2 year treasury out to one maturing in 30 years.  

If longer term rates continue to trend down, I have a significant weighting in long term and high quality Tennessee municipal bonds that would be going up in price. If short term rates continue to rise, I have short term securities maturing just about every day now that can be redirected into higher yielding short term bonds and CDs.      

The last long term bear market in bonds, which is seared into my memory banks, is a bogeyman waiting to be let loose again on those that have never experienced one.  When is a matter of debate. If is not the question.

One  possible future course would be a gradual market reset to higher interest rates as central banks gradually exit their extraordinarily abnormal monetary policies, thereby freeing bond investors for the first time in over a decade to set rates free from their heavy hands using traditional metrics like a normal spread to anticipated inflation over the debt's life and credit quality. 

Then something else would come into play, possibly with a long delay after the reset to normalized rates, which is what occurred in the 1950s after another abnormal period of Fed intervention. Instead of a major bloodletting, it would be like a series of paper cuts until something really major and predictable now as a possible scenario. 

For example, hyper inflation in a major economy caused by failed sovereign debt auctions and a monetization of the debt by the central bank causing a collapse in that nation's currency.  Just give it some time.  

My timetable for the U.S. government's Day of Reckoning is currently in the 2028-2035 time frame. All of this is out-of-sight and out-of-mind at the moment.