Our early estimate is that DRIV Core returned +1.87% in June and is up approximately +6.63% YTD.  Below is a brief synopsis of DRIV’s positioning.

Bottom line:  We held our defensive positioning for the month.  Equities ramped after the steep May sell-off.   Macro conditions continue to worsen with regional PMI’s at near their worst levels in a decade.   Bond markets deepened their inversions in the U.S. and globally.  The 3 mo.-10 yr UST curve has been at or nearly inverted since March.  Nearly $13 trillion of global debt is trading at negative yields.   On many metrics, market valuations have never been this steep historically and signal low to negative real returns over long horizons.  Wilshire 5000 to GDP is c. 140% of GDP after peaking at a record 146% in Sep 2018.   To put things in perspective, the Nikkei bubble in 1989 peaked at around 130% of GDP.   The UST 10 year yield declined further to 2.00% from 2.51%  at the beginning of May and 3.25% in October 2018—a massive decline in yield.      We are long 75% U.S. Treasury and 5% cash exposure, while our approx. 20% equities risk style is tilting toward growth and our largest single combined exposure is large value.  We remain significantly underweight small caps.   

With our risk barbell of 20% equities / 20% longer duration U.S. Treasuries / 60% ST USTs and cash, DRIV is very defensive.     Our dashboard is negative on valuation, bond market analysis and macroeconomic conditions.  We will need broad market valuation and bond market conditions to resolve themselves before materially increasing equity exposure.

Related Commentary:

Central Banks: The Fed and Quantitative Tightening (QT): Monetary policy is still critical to maintaining markets though the Fed tightening cycle is clearly having effects on the real economy.   The Fed opened the door to cuts in June.  This is a complete 180 degree turn from Chair Powell’s October “nowhere near neutral” comments.  Fed Fund Futures may be interpreted to price approx. 1.25% in interest rate cuts through the end of 2020.  U.S. monetary policy is creating a dollar shortage globally, which could be negatively impacting activity. 

Trade War

At the G20 the U.S. backtracked on trade negotiations failing to raise tariffs to 25% on the remaining c. $300 billion of untaxed Chinese imports and also allowing U.S. chip companies to send components to Huawei.  On net, China came out the winner from the summit and U.S. semiconductor stocks briefly rallied.      

When our models suggest that positive conditions and trends have resumed we will update you with any key changes as they arise. 

 


Also of note, our DRIV Core strategy generated a positive return for May, while major stock indicies were down 6-7%.  In fact, DRIV has produced positive returns for every month so far this year.  We remain in a defensive posture as we see a continuing erosion of economic data coupled with a bond market that is pricing in significantly lower growth.  DRIV Core’s tactical approach can offer a great compliment to a static asset allocation, or equity-based investment approach.  We believe downside protection will be increasingly attractive to investors in the coming months.

As always, we’re happy to answer any questions or talk in more detail.

All the best,

Mike, Jeff & Chris

Additional Notes:

  • We remain in our most conservative allocation as equity valuations on a range of metrics are at/near prior “bubble peaks”
  • The strategy is currently well positioned to absorb a pullback or sell-off, while still maintaining some upside capture
  • DRIV Core offers a great compliment to an all equity portfolio, or anyone looking to more proactively diversify risk

As some broad U.S. indices reach highs, please join CIO Chris Recker for a webinar on May 1, 2019 at 11:30 CT / 12:30 ET to discuss the U.S equity market and how in many ways it is comparable to other extremes in history.

Registration URL:

https://zoom.us/webinar/register/WN_gNX_75zPQReR_eWmO3tJtQ

We look forward to talking with you soon.

Good Afternoon,

Last week we made another allocation shift to further reduce our equity exposure from 50% to 20%, putting the strategy in its most defensive posture.  Cash and bonds (currently a short-duration U.S. Treasury ETF) now constitute 80% of the portfolio.  Previously, we reduced equity from 65% to 50% in October.

 

Our objective is not to forecast the short-term moves of the stock market, which we feel is a fool’s errand.  Rather, we aim to identify whether broad financial conditions are supportive of stock investing and adjust portfolio exposures accordingly to help navigate long market cycles.  To that end, we monitor a broad range of data that in combination have historically proven to be reliable indicators.

 

Our allocation shift in October was primarily driven by worsening changes in credit markets.  A simple interpretation is that market price changes reflected a reduction in liquidity and participants’ willingness to bear risk.  Our recent shift was informed by worsening trends across equity, credit and other macro data.

 

Driven by a small group of technology stocks, the market has delivered above average performance for quite some time. A pullback should not come as a big surprise.  However, markets tend to work in cycles and have a history of reverting to averages.  For many investors, it’s easy to let emotions influence decisions in ways that can be counterproductive.   With this in mind, DRIV Core is designed to offer a data-focused foundation to navigate times like these.

 

We will continue to monitor key data.  When market and financial conditions improve, we will look to increase our exposure to stocks and take advantage of future opportunities.

 

Sales Notes:

DRIV Core may be a fit for several different client situations.  Specific client details should be discussed.

 

  1. Timid investors – Not sure when to get in or out of the market?  Tired of making ill-timed decisions?  Don’t let emotions rule the day.   DRIV Core can offer data-driven allocation guidance over the course of long-term market cycles.

 

  1. Stock investors who have downside sensitivities – Need stock market returns to help grow your portfolio but can’t handle the downside?  DRIV Core seeks to participate in the stock market during bull markets and limit exposure during bear markets.

 

  1. Balanced investors who want a managed allocation – Do you think your 60/40 portfolio should hold the same percentage of stocks at all times?  Age and risk tolerance are important, but so are market conditions.  DRIV Core can be used to improve upon static allocations.

 

  1. Tactical piece of a larger pie – Do you have a large portfolio of stocks and bonds.  Consider adding a tactical allocation sleeve in the “middle” of the portfolio to help make your portfolio more adaptable to market cycles.  Example: 40% stocks, 20% DRIV Core, 40% bonds.

 

Additional Notes:

·         Our DRIV Core strategy returned approximately -4.70% for 2018, exceeding our Morningstar Tactical Category peer group which lost -7.88%.

·         In January 2018 we held an allocation of 65% equity and 35% bonds.  At that time, 20% of the equity was invested in developed international stocks, a top performer in 2017.  We reduced international in July.

·         In October 2018 we shifted stocks down from 65% to 50% and further reduced international exposure.

·         As of January 2, 2019 we hold 20% equity and 80% bonds.  Among stocks, we favor large caps with a slight tilt toward value.  In the bond portion of the portfolio, we currently favor short-duration Treasuries.

 

Please feel free to contact us anytime at 312-429-0880, or visit our website.

We wanted to share the following update to our DRIV Core strategy.  We made a minor shift yesterday, reducing our exposure to Developed International (IEFA) by approximately half and re-allocating the proceeds among Large Cap Growth, Large Cap Value and Mid Cap Growth.  This brings our international weighting to approximately 10%, while our overall equity exposure remains at roughly 65%.  The move was driven by our momentum indicators–as developed international markets have stalled after a strong performance in 2017.  The table below briefly summarizes current positioning.

 

Some additional strategy observations:

 

  • Our largest equity holding is now Large Cap Value (19%), followed by Large Cap Growth (15.5%) and Mid Cap Growth (13%).
  •  Among the areas of the stock market that we survey in this model, the above assets classes are showing the highest expected returns on a comparative basis.  Both price and earnings momentum remain strong in these overweight segments.
  • We continue to favor short duration investment grade corporate bonds as credit spreads remain tight.
  • Though valuation appears attractive in international markets, we suspect that the model is picking up on headwinds relating to dollar funding issues and emerging markets exposures.

 

Our DRIV Core strategy has returned approximately 1.90% year-to-date through 8/13, remaining ahead of the Morningstar Tactical Category which has a slight negative return of -0.02%.

DRIV Core Fact Sheet 2018Q2

Attached is our Q2 Market Commentary.  This was included in all quarterly client reports and we wanted to share it with you as well.  Please feel free to contact us with any questions, or to discuss in more detail.  Have a great weekend.

2018Q2 Market Commentary

July 6, 2018

Dear Investor,

We hope you had a great 4th of July and are having a relaxing and enjoyable summer. With the first half of the year in the books, we wanted to provide a brief look back and offer our views of the market going forward. As always, if you would like to discuss your portfolio in more detail, please do not hesitate to contact us.

Through the end of June, the S&P 500 is up 2.65%. 84% of that gain comes from the performance of the four largest companies: Apple, Microsoft, Amazon and Facebook. By contrast, the Dow Jones Industrial Average (DJIA) lost approximately 1.7% in the first six months of the year. Small cap stocks have performed better with the Russell 2000 Index up approximately 7% through the end of June as they benefited disproportionately from the corporate tax cuts. With talk of the U.S. addressing its long standing trade deficit, Chinese stocks are in a bear market (off 20% or more from their 52 week high) while global equities and global bond aggregates are in negative territory year-to-date.

Index returns are becoming increasingly concentrated in a select group of technology companies, while most publicly traded stocks are in a correction (down more than 10% from their 52 week high) and a significant number are in a bear market.

The first half of 2018 is noticeably different from 2017. Last year stocks experienced very little volatility, with the VIX Index hovering around 11 – about half its long-term average. This year stocks have already experienced the third and fifth largest point gains (+669.40 & +567.02) and the two largest point declines (-1175.21 & -1032.89) in the history of the DJIA. Most recently, fears of a trade war have added to general uncertainty, causing markets to reverse a strong start to June and end slightly negative for the month. These rollercoaster-like returns can lead to consternation and frustration in even the most disciplined among us.

“The investor’s chief problem and his worst enemy – is like to be himself. In the end, how your investments behave is much less important than how you behave.”

Benjamin Graham,

The Intelligent Investor

As we begin the third quarter, our focus remains on analyzing data and being prepared to adapt and adjust to any changes in market conditions that we consider material. We view the Federal Reserve (Fed) as the real driver of how the market will behave going forward. The current investing backdrop is one of low unemployment, increasing GDP growth, tight credit spreads, and strong corporate earnings. All of these factors cause us to retain a positive outlook on stocks. The greatest uncertainty lies in how the market will digest increased Quantitative Tightening (QT) from the Fed.

As of July, the Fed’s QT program – in which bonds, that were once purchased by the Fed to infuse a cash stimulus into the economy, are now being sold into the market – is running at $30 billion per month and increasing to $50 billion per month in September. This process of unloading securities, coupled with continued increases in the Fed Funds rate, means 2018 is back-loaded with elements of tightening credit conditions. This is an environment that could lend itself to increased volatility and is something we wanted to proactively communicate.

Specific to our investment strategies, we will continue to stay apprised of changing conditions and are prepared to respond accordingly. Our tactical strategies continue to remain overweight equities and favor developed international and large cap value stocks, while our bond holdings are short-duration investment grade corporate bonds. In this tactical approach, we are currently holding approximately 65% stocks, 31% bonds and 4% cash.

Our options strategies favor put writing as a way to establish more attractive entry levels in stocks we have targeted for purchase. We are also selling calls and using other hedging techniques selectively to provide downside protection. The underlying stocks we own exhibit “value” characteristics, as we see quality companies trading between 10-12 times next year’s earnings. Globally we also see attractive opportunities and are stepping up exposure on a select basis.

Our income strategies remain in a risk-off posture as the yield curve has flattened and our municipal bond holdings continue to be in high coupon intermediate duration bonds, A-rated or better. This defensive posture offers greater protection against rising rates and affords our investors greater income to purchase new bonds at higher interest rates.

Our outlook for the remainder of 2018 is cautiously optimistic. We don’t see a full blown trade war occurring, macro conditions continue to be favorable, and we are reverting to a market driven by earnings and profits rather than artificial stimuli. As referenced above and in earlier communications, the QT program could cause uncertainty and volatility, but should that take place we believe we are well- positioned to respond.

Please feel free to contact us with any questions, as we are happy to talk in greater detail about your portfolio. We value and appreciate your continued trust.

Sincerely,

Jeff, Mike, and Chris
AZA Capital Management

May Market Recap

  • Large cap equity markets advanced in May while investment-grade bonds declined. For the month, the S&P 500 Index returned +2.41%, the international EAFE Index dropped -2.19%, and the MSCI Emerging Markets Index declined -3.52%. U.S. small caps, represented by the Russell 2000 Index, increased +6.07%. The Barclays U.S. Aggregate Bond Index was up +0.71%. Additional information on index performance and risk measures can be viewed on page 7.
  • Market Indicators: The bond yield curve has flattened as the difference in rates between short and long durations continues to shrink. However, comparison of 3-Month T-Bills to 10-Year Treasuries still indicates a friendly environment for growth. Stock market valuations are supported by strong earnings growth and are showing reasonable risk premiums. Financial conditions are favorable and credit spreads are tight. Oil prices have been range bound.
  • Economic Indicators: Housing starts, auto sales, and energy investment are conducive to continued growth. Employment growth is steady. Manufacturing and leading economic indicators are at positive levels. Fiscal policy is expansionary.
  • Risk/Fear Measures: The VIX Index, a measure of market volatility, traded between 12 and 17, ending the month near 15. The SKEW Index, a measure of crash “insurance” cost, spiked and subsequently increased substantially as concerns around European financial stability appeared. The term structure of volatility is pricing historically average systemic risk in the near term.

Read the entire May Market Recap

AZA Market Recap 2018-05

Summary 2018 Q1 Commentary

  • In Q1 2018 stock returns were mixed among U.S. large capitalization (-0.75%), international developed (-1.41%), and emerging markets (+1.38%).
  • The Barclays U.S. Aggregate Bond Index declined -1.46%, and high yield bonds were down -0.91%.
  • The U.S. Dollar declined relative to other major currencies.
  • Price and earnings momentum in equities are positive heading into Q2 2018.
  • Equity risk premiums are supportive of current valuations while other metrics suggest overvaluation and more potential downside risk. Yield levels have moved up as the Fed has raised the Fed Funds interest rate and has begun quantitative tightening (“QT”). The yield curve has flattened significantly but is still upward sloping. Libor-OIS spreads, a measure of short-term funding risks, have widened causing some concern.
  • Economic conditions suggest we are in the middle to later stages of a cycle. The fiscal stimulus from the tax reform could extend the cycle.
  • Financial conditions have become less supportive, but financial stress indicators remain at low levels.

Read the rest of the 2018 1st Quater Summary

2018 Q1 Market Commentary