HOPE is a Powerful Force, but so is The FOURTH Turning
For many years, the CTA Industry has pilgrimed to Miami each January. More specifically to the Fontainebleau Hotel in South Beach. This week the Wall Street Journal reported that this iconic hotel has asked for “forbearance” on millions of dollars of interest payments on their near $1bn worth of bonds due to “potential cash flow concerns”. With Optimism still high in the financial markets they probably will be given more time.
Decades of solving debt issues both in the private and public sector with even more debt, continues to fuel Hope & Optimism in the markets. In the second quarter, the US Government will borrow $4trillion, which is 3.5 times the prior record, made in the second quarter of 2008. And US Corporations are not too far behind. In the first five months of this year, investment-grade companies took on another $1 trillion in debt, by far the most in history. Oh…and Argentina just defaulted for the ninth time. But there seems to always be an optimistic creditor willing to “lend a hand”.
In May, Hope & Optimism continue to drive asset prices higher (together with the rapidly growing FED balance sheet, now topping $7trillion for the first time ever). Not only did this help equities continue to recover towards their old all-time-highs, it also propelled some sectors of the bond market to optimistic extremes, such as short-term muni yields, which are near 0%.
Another sector is the junkiest of junk bonds. These are bonds of companies with the worst credit structures who have a high likelihood of bankruptcy. No worries: These bonds, with seriously low ratings, had the best total return in the month of May within the junk bond sector. Only in an environment of excessive optimism would investors see fit to bid up the bonds of companies that are on the verge of collapse, but that they “hope” won't.
Hope seem indeed to be the fuel of what is currently happening in the markets, seducing investors to ignore much of the data. For example, on Friday the Atlanta Fed cut its real-time GDPNow indicator to minus 51.9% annualized for the second quarter from a prior estimate of a 40.4% decline.
In addition to the explosion in unemployment around the world, President Trump speaking from the Rose Garden, turned up the heat in the cold war with China, who this week approved a new security law for Hong Kong which will place mainland security forces in Hong Kong for the first time since the the UK handed it over in 1997.
BUT the Hope and Optimism we currently see, is not unusual. In fact you could say, it's very predictable. You see, as Neil Howe explained in his book The Fourth Turning, every generation moves into a new phase of life about every 20 or 22 years that pushes society into a new social mood and so if you think of four basic generational archetypes each about 22 years long the total “cycle” is about 90 years.
We are currently in a Fourth turning and fourth turnings is when we suddenly realize that that kind of world is not meant for survival and that we suddenly need order. We want direction, we need authority and we are usually shocked into that realization by a catalyst that suddenly plunges the world into a very negative mood. Suddenly big institutions particularly individualistic market institutions no longer seem to work anymore.
In fact, some of the big catalysts were great stock market crashes like 1857, 1929 and sooner or later they ultimately took the world into great Wars historically. According to Howe, this latest Fourth turning started around the time of the Great Financial Crisis (2008-2009) and he thinks we're gonna be in it all the way until around the year 2030, so a good 22 years, and by the way…back in 1991 he wrote a cover story for American demographics in which he predicted America was headed for a great crisis right around 2020…so I think its worth paying attention to what he says.
We don't know how all of this turns out, but having a healthy allocation to a strategy that does not rely on an orderly, nor predictive outcome given all this uncertainty…seems like a good idea.
Now let's dive in to see how the trends developed.
Market moves this month:
Trend Barometer statistic this month
The Trend Barometer finished the month at a very low level of 23, reflecting well all of the trend reversals that we saw in May.
The next chart below shows a snapshot of a 44-market portfolio with markets listed in “groups” of market sectors:
The number of markets recorded in a trending state at the end of the month halved to 7…down from 14 in the previous month, and even if we include those ending right at the neutral reading (indicated by the “grey” shade right at the 30% level) we only get up to 10, which leaves the Trend Barometer in a NEGATIVE state. Please note that for the individual markets a reading of 30 is considered neutral as opposed to the Trend Barometer itself, where this level is 45.
In the RED camp (down trends) this months, we find Coffee, SoybeanMeal and Nat Gas. Carrying the GREEN flag (up trends) at the end of the month, we find Short Sterling, Nasdaq, Nikkei and Silver.
In the chart below, I have grouped the markets into 10 sectors. Since last month, the number of sectors exhibiting an overall trending state, plunged from 3 to 0 out of 10 sectors. So again confirming the transition or correction phase most markets are finding themselves in at the moment.
As mentioned above, the world could well be entering a difficult time, that will last for a whole decade. This does not mean that markets won't trend. On the contrary, I think we could well see the return of much higher general volatility and sustained market trends.
But if we do, the importance of having a truly diversified portfolio can not be overstated and it is my guess that divergent strategies, such as trend following will be one of the most important components of such truly diversified portfolios.
If you want to check the current state of trend following, join me each weekend on The Systematic Investor Series, where we give you a raw and honest account of what it's like to be a rules based investor and share with you which trends are happening right now.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS
I hope you found the information useful as part of your own evaluation of the trend following part of your investment portfolio. I will continue to do my best to keep you up-to-date with regards to the environment for diversified trend following strategies and would love to discuss any of this information with you. Just reach out to me.