In a week that was clearly traumatic in equity markets where all indexes fell by 4 %, our Model Portfolio ended the week flat, despite our decision to cover our hedging positions too early.
Since recording a new all-time high on September 21, 2018, the SP 500 fell by -8% and tested its 200 days moving average for the first time since 2016.
On a Year-to-date basis, the outperformance of our Model Portfolio against ALL the world equity indexes and benchmarks has become significant, reaching +19.88 % against the MSCI World index and +29,69 % against the MSCI Asia Pacific All Countries Index.
The warning signs of the corrections were clear, we warned about its probability of occurence and our model portfolio was hedged accordingly through short futures, Precious metal positions and our strategic short positions in individual US technology stocks.
Delivering double-digit positive performance over a period where all markets are in negative territory is what managing money should be all about in our investment philosophy.
At a time where investors started getting really scared and individual investors panicked, we took profits on our hedges, on half our individual tech shorts and re-invested in India, Japan, China Indexes and Chinese technology stocks.
We were two days too early in covering our shorts and would have delivered positive performance over the week had we done it on Thursday rather than on Tuesday, but the signals coming from the bond market were telling us that we where nearing the end of the correction.
On Tuesday, we covered our index shorts, took our profits on our AMD short position, and went long Europe, o Wednesday we went long India again, on Thursday we took advantage of the panic in the market to accumulate Chinese tech stock, and on Friday morning we re-instated our long Japan position that we had sold 10 % higher.
Our Model Portfolio is now 90 % long equities, 12 % short equities, still long 4 % bonds and 12 % commodities and still short 5 % Bitcoins.
In equities, we increased our exposure to China, Japan, India and Europe and reduced our net short USA.
Our decision to go long again and to cover our hedges, while still retaining our systemic protection through Gold and Silver, hinges on the fact that the current panic is in our view only one of the elements of what is otherwise a large topping out process for the US equity market.
Investors are finally realizing that inflation is back, that interest rates and bond yields are bound to go higher, that liquidity is withdrawing and that the extremes of valuation reached in an environment of ultra-low interest rates will no longer be justifiable in an environment of higher interest rates.
On the other hand, the shot in the arm delivered by the Trump Tax cuts at the beginning of 2018 are still impacting corporate earnings. The reporting season started last Friday and the Q3 earning should still deliver strong numbers, North of 20 % growth year-on-year.
However, the combination of higher interest rates, higher oil prices, tariffs and the disappearance of the base effect in the first quarter of 2019 will change that and this is where we see US equities go into a global bear market.
In the mean time, we see a sharp rally developing in November and December, particularly in China, Japan, Europe and Emerging Asia, after a re-test of the lows seen this week, probably just before the Nov 8th mid-term elections.
It is our analysis that the mid-term elections will constitute a massive vote of no-confidence for Donald Trump and that the Republican Party will lose its majorities.
Last week was a typical wash-out
The S&P went from 52-week high to below its 200-day average in only 3 weeks. That ended a streak of more than six months above its 200-day average.
Every other times it underwent a quick change in character, from a 52-week high to below its 200-day average in fewer than 30 days, the markets performed positively in the next few months.
A clearly positive signal is that the SP500 went through its 200-days moving average but finally closed above it on Friday.
Smart money is definitely stepping in. The spread between Smart and Dumb Money Confidence is getting extreme. Dumb Money Confidence dropped from 60% last week to under 30% on Friday.
Every time the spread between the two has become this wide, annualized returns were excellent
Emerging markets and China are delivering a strong BUY signal.
The MSCI Emerging Markets index rallied more than 2.5% on Friday after setting a 52-week low on Thursday.
This has been a consistent sign that sellers were exhausted, with one exception, when the financial crisis overpowered any buying interest in 2008.
But we are nowhere near the systemic conditions that prevailed in 2008, and China delivered strong export figures for September, far beating the consensus and confirming that the US Tariffs are having very little impact on the Chinese economy.
Last but not least, the true signal came form the US bond market.
The very big risk of a 1987 crash would have materialized IF US bond yields kept crashing up towards 4 % as is was technically possible.
Panic had set in in the bond market and a sharp move in bond yields would have sent global equities crashing.
Instead, both the CPI and the core CPI published on Thursday came in below expectations, re-assuring a bond market that had gone to extreme short positioning. US 10-year bond yields fell by 7 basis points on the week and a bottom in bonds has probably been seen for the coming months.
We expect a continuation of volatility for the next three weeks, and maybe a re-test of the lows in the US markets, but we see Asia and China starting a sharp rally even before the end of the month.
The US tech sector has been structurally damaged and any attempts to go higher will be met by individual investors trying to cash-in on their accumulated profits of the past years. We stay structurally short the US tech while going seriously long the Chinese tech.
Cryptocurrencies have fallen sharply and will soon test the all-key 6’000 level. Precious metals should do well as individual investors start looking for a safe haven.