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Dynamic Allocation Model Portfolio Update 2018 End Of Year Update

|Includes: BND, MTUM, PRF, SPXL, SPDR S&P 500 Trust ETF (SPY), TLT

What a challenging year! After two years of strong gains, volatility returned in 2018. We had two corrections during the year. The -20% drawdown in Q4 is very likely the first leg of a new bear market. As we projected at the end of last year, two important themes have been affecting the financial markets this year. The first factor, also the most important one, is continued tightening by the Fed. Fed raised interest rate four times this year and continued winding down its portfolio and extracting liquidity from the economy. This trend will very likely continue into 2019 and the effect of all the tightening since 2016 on the real economy will be more prominent next year. The second factor, though less important but also significant, is the trade war. Thus far, the effect of the trade war on the US economy is psychological only. However, a prolonged trade war may permanently disrupt logistics and affect profit of multinational companies. There are some positive signs that a deal or at least a truce may be likely during the first half of next year. China finally realized multi-front confrontation with the US is not in its best interest, at least not at this stage of Chinese growth trajectory. It is apparent China is ready to make concessions to help make a deal. On the US side, the recent market volatility, the clear early signs of economy weakness and the Republican defeat in the midterm election, has weakened Trump’s hand and made him more willing to make a deal. A trade war deal will certainly be positive for the markets. However, its effect will likely be temporary. The main driving force next year will still be Fed tightening and if the accumulative effect of the tightenings will affect the real economy.

Our portfolio had the first yearly loss since 2016. In 2018, our portfolio lost 11% vs 6% drop for the S&P 500 index. After following a major up trend for two and half years, we had the “sell” signal in mid December and moved to conservative assets. Despite the recent loss, our portfolio still outperforms the S&P 500 index by 33% (56% vs 23%) since 2016. ~15% drawdown during trend reversal is typical for our trend following strategy. Similar drawdowns occurred in the past during deep corrections or onset of bear market (Figure below). Patience and persistence is important in the challenging environment.

Looking forward to 2019, we anticipate the volatility will continue. As stated above, Fed policies and the effect on real economy will continue to the most important driving force for financial markets. The recent drawdown is very likely part of a larger bear market. A recession is not likely in 2019. However, the anticipation of a recession will be higher and the expectation of recession will drive volatility in the market. Nevertheless, we will continue follow our strategies and invest accordingly.

Disclosure: I am/we are long BND, VXX.