End Of Q3 Stock Market Update

by: David Kotok

We published a Q3 commentary on the US stock market on September 19. That piece is available here. To paraphrase Keynes, things changed and so did we.

In our volatility and leveraged volatility strategy, we had an entry in September and became fully invested. This strategy is dependent on a lot of math. It had previously given us an entry signal at the end of June, on the second day of the Brexit selloff. As this is written, those accounts remain invested. The September entry in the mild selloff (mini taper tantrum) was used for the benefit of those new clients who hadn't funded previously. So as of this writing, the vol strategy is fully invested. Any new cash must wait for another entry to reveal itself via our quantitative work.

The US ETF and US core ETF strategies are also fully invested. They were positioned with some cash reserves in September. The energy sector was raised to our largest over weight. That changed after our Sept. 19 commentary.

Two elements are working their way toward clarity. The first is politics in the US. Every day, the clock on election outcomes runs closer to the zero hour. Markets are continually discounting the results for the House of Representatives (likely to stay Republican and be conservative).

The Senate outcome is close as it stands today. It does not appear that either party will achieve a big sweep. So a filibuster-proof 60-vote margin can only be obtained by means of the wrangling we find in our American version of politics. This theatre will continue for several more years. Ugh!

Whoever is elected to the White House will have to deal with both chambers of Congress. Clinton or Trump will need Senate confirmations for appointments. The Supreme Court will come to the forefront, as the current 4-4 split is deterring our legal system from making precedent-setting decisions. Ugh!

Likewise, our Federal Reserve awaits the filling of two governor positions. Sadly for our country, the central bank of the world's reserve currency has been a political hostage since before the financial crisis and for the ensuing decade. One governor's political contribution sure doesn't help the Fed claim political independence. Ugh!

When it comes to monetary policy, the actions in September have cleared the fog for a while. Ten central banks either kept rates unchanged or lowered them. The combined balance sheets of those banks exceed 20 trillion USD equivalent. They combine to be the largest percentage of global GDP in history. Their combined policies have reduced global interest rates to historically low levels.

Interest earnings on savings have been repressed. Millions of smaller investors and savers have been harmed by performance that has failed to meet their expectations and needs. Meanwhile, wealth effects have been hugely positive. Asset prices rise when interest rates persist at near zero. Stocks, real estate, bonds, precious metals, and other assets have seen protracted bull markets. Hence risk, as measured by traditional metrics, is now very high.

But those metrics have been superceded by TINA: There Is No Alternative is the operable but even more dangerous metric. Relative to zero, stocks and other assets look good.

At Cumberland, we are very aware of TINA's seductive power. And that seduction masks financial ills, shrinks credit spreads, and invites nontraditional investment behaviors.

At Cumberland, we continually keep an eye on risk. We are in markets now. But we want to be fluid and to protect clients' capital. TINA can turn on her heel and reverse course quickly. TINA will not announce that the change is coming. At Cumberland, part of our job is to keep clients safe from TINA.

The world has witnessed eight years of zero interest rates. That regime will not last forever. The clock is running. The downward movement of global rates is over or nearly over. And the harmful effects of negative rates are spreading and are increasingly observed and understood.

As rates plateau around zero and then commence on a gradual upward path, TINA's seductive force will diminish and then subside. We believe that turn is approaching, and we must be alert to position portfolios ahead of it.

Today, we are fully invested in US stocks. That could change at any time. Today, in our bond accounts we are shortening duration and becoming more defensive. That stance is likely to continue.

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