Special Weekend Update

Good evening.

With the recent dashboard enhancements, the only information you’ll need ever to make investment decisions is now all in one place. Period.

If you really need to know what to do now, whether you should jump back into the market, etc., read on. The answer is at the bottom.

Market Barometers

Let’s take a look at two key metrics.

The Objective Sentiment Survey

The number of stocks on buy vs sell for the S&P 100 and NASDAQ 100 indexes are going in the wrong direction, albeit very, very slowly.

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Usually, there will be no downside action until the number of buys cross below the number of sells.

Historical Risk Profile

The historical risk profile for the S&P 500 Index is still way down in the lower right quadrant, reflecting a slow but steady ascent. So slow and steady in fact, that the headline on CNBC was The market is doing something it hasn’t since 1995:

The S&P has failed to close lower by 1 percent or more since Oct. 11, for the longest such string of not-down-1-percent-plus days since the one ended in December 1995. Notably, 1995 was an incredibly quiet year for the market — earlier in 1995, the S&P went 110 days without a 1 percent drop, according to a CNBC analysis of FactSet data.

Before that, the longest such streak was in 1985, when 112 straight non-1-percent drops were enjoyed.

Unsurprisingly, both 1985 and 1995 were glorious years for the market, with the S&P rising 26 percent and 34 percent, respectively. Yet 1995 makes the better comparison to the current period.

Let’s take a walk down memory lane. The orange dot represents the month captioned.

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You can see that the markets of the 60s, 80s and 90s were completely different. High returns AND high volatility combined to create the perfect environment for hit and run trading. Now look at 1977, 2007 and 2017. The action has been dead as f*ck, making it so that anyone trying to “trade” doesn’t get far. It’s an environment for asset allocation, passively tending to your investment portfolio.

This brings us to the latest in a steady stream of “active” (stock pickers, traders, hedge funds) strategies unable to outperform their benchmarks. Clients are jumping ship, switching to index funds and ETFs.

$1 billion per DAY is pouring into Vanguard. Even Goldman Sachs, is giving up and building a robo-advisor for the masses. Ironically, the more money that goes into these “passive” strategies and vehicles, the more difficult it becomes for the survivors:

Among the biggest trends in the world of markets is the rise of passive investing. Rather than pay high fees to active mutual fund managers (who often fail to beat the market), people are pouring money into passive strategies that track major indices, but with little cost. So what are the ramifications of this trend for investors who choose to remain active? On this week’s Odd Lots podcast, we speak with Michael Mauboussin, who heads global financial strategies at Credit Suisse and is not just an expert on the world of investing, but also on the role of luck in success. As he sees it, trading is like a game of poker, and in poker you want to play against weaker, less-skilled players. But as more and more of those less-skilled players opt not to trade (choosing passive strategies) then the game gets harder.

Stock Ranking

The strange phenomenon seen over the last few weeks, one where the broad index itself is in the top ten, is still with us. This time, it’s the NASDAQ 100 Index in second place, right behind Philip Morris. The worksheet is online here.

There’s no need to “pick stocks.” Just buy QQQ and PM and pray. I’ve spent the last three weeks or so, ever since the S&P and NASDAQ indexes shot into the top ten stock rankings, figuring out how to explain this. Once you understand the reason, expect a huge eureka moment.

Portfolio Ranking

The same phenomenon has also spread to the model investment portfolios, not just ours, but everywhere. Because the S&P 500 Index has risen slow AND steady, any investment portfolio that is not 100% invested in the S&P 500 Index is lagging on BOTH reward-to-risk ratio AND return. Even a volatility-weighted S&P Sector SPDRs benchmark cannot beat the S&P 500 Index.


It only gets worse. On a reward-to-risk basis, the S&P 500 index is even beating it’s own 10 Sector SPDRs, threatening the careers of investment professionals everywhere.

How it is possible that the 500 stocks in the index are able to outperform the same 500 stocks regrouped as 10 Sector SPDRs? Why Virginia, it’s because the S&P 500 Index is cap-weighted:

Market-capitalization weighted indexes (or market cap- or cap-weighted indexes) weight their securities by market value as measured by capitalization: that is, current security price * outstanding shares. The vast majority of equity indexes today are cap-weighted, including the S&P 500 and the FTSE 100.

In a cap-weighted index, changes in the market value of larger securities move the index’s overall trajectory more than those of smaller ones.

Let me show you what this means. These are the current top 10 stocks of the S&P 500 and their weights in the index:

If the same 500 stocks were equally weighted, not only are the names of the top ten stocks totally different, but the percentages vary by orders of magnitude.

What we have here is a situation where stocks that are going up in price count more toward the index, while the ones going down count for less. The S&P 500 Index as we know it then, is driven by price momentum alone. We can actually show you the outperformance of the (cap-weighted) S&P 500 Index against the equal-weighted version since the election.

Investment Decisions Made Simple and Easy

I know many of you think I’ve been very cautious. Many of you also cannot stand the idea of buying bonds. It’s also unsatisfactory to see model investment portfolios “lagging” (since they are not 100% invested in the top-performing asset class, stocks as represented by the S&P 500 Index).

It’s very tempting now to go all in with stocks, but the decision is actually quite easy to make.

Ask yourself a single question: Knowing that the S&P 500 Index has been driven by Apple, Microsoft, Johnson & Johnson, Exxon, Amazon, Berkshire Hathaway, Facebook, JP Morgan, Wells Fargo and GE, am I willing to risk it all on these ten stocks? If yes, am I willing to own this with no insurance in the form of bonds (or maybe gold)? If yes, then just buy the S&P 500 and pray this doesn’t crack. If you want some diversification, then the only model investment portfolio currently with a reward to risk ratio above one is the US$ Sector SPDRs (formerly Bethlehem).

In Conclusion

We are all old enough to know things will change over time, and sometimes very quickly. Now that you know exactly what questions to ask yourself thanks to having the essential information at your fingertips, investment decisions aren’t really that difficult to make. You can also be satisfied in knowing that you did the right thing for yourself in your current circumstance.