Transcript:
Tom Vaughan:
I do like to start off every show with a summary for what I saw happening in the market this week, awful lot going on right now with the market really, you know, having some troubles right now with the rates of return and what have you. So what I decided to do today is a little bit different, I want to present in fairly good detail, you know, what we’re doing in this type of market environment. The market just changed from a upward trending market to what I would consider and I’ll just, I’ll tell you this, how this works. But what I would consider a sideways trending market, and you know, might be heading into a down market might reestablish an uptrend. But there’s different types of strategies that we use to invest depending on what type of market that we’re in. And I want to describe the strategy that we’re using now. I especially want to get this out to the clients because I do think that this timeframe, we can, there’s some things we can do to take advantage of what’s happening. But it’s going to take a lot of patience. And that’s one of the things I talked about last week, just really, you know, having some patience for what might transpire here. So I’m going to share the screen and kind of show you some of the different charts and such to, to kind of go through I’m going to bring Easan in on this also, so he can make some comments or ask some questions.
And here we go. Okay, so what I have here is a chart for the leading economic indicator LTI. This has been around since 1960. It’s one of my favorite indicators to just look at overall economic situation, there’s 10 indicators in this one basket is put out by the Conference Board. And you can see here, if you look closely, all of these gray lines are recessions. And the blue line is the indicator. And it’s pretty amazing how many times that it peaked and came down prior to the recession, you know, one after another all the way through time. And so that’s one of the pieces I look at, I want to see how the economy is doing because I have a big belief that in order to have a big downturn, you need to have a stock market downturn happening plus an economic downturn happening. And so those two together equal big, you know, downturns. The other type of downturns that happen here are pretty consistent, you know, you get that 10,15 20% downturn on a fairly regular basis. But those often can recover fairly quickly. And you can actually take advantage of those if you know what you’re looking for.
So one of the other key things that I look at is interest rates, because they’re one of the key drivers matter of fact, the thought of raising interest rates right now is what’s driving this market downward as we speak. This is the Fed funds rate, which is when they talk about the Federal Reserve raising interest rates, this is what they’re talking about this goes back to 1955. You can see the different recessionary time periods. Also notice how many times interest rates are increased prior to the recession, increased recession, increased recession, etc. all the way through, including, you know, here’s 2000 was on the rise. And then we had a recession 2008, you know, rise recession, this, this increase right here that happens, you know, more recently, we ended up with a 20% downturn, just in the S&P 500 At the end of 2018. Before they started to lower the rates again in 2019. But right now it’s at zero. Okay, so that’s important.
Generally speaking, when the rates are very low or falling, the stock market does quite well. And so we’ll, we’ll talk about that. So let’s, let’s go back and take a look here just at 2000. Okay, so 2000, the leading economic indicator was coming down, right, really in late 99, early 2000. And then if we go look at the interest rates were on the rise, right? flattening out a little bit, but rising in that timeframe. Yeah. So that’s can be problematic, two things economy’s coming down, interest rates are going up. And then here’s the here’s the chart for the S&P 500, from 95, to 2005. And you can see, you know, this up and down motion here, this blue line is the 200 day moving average, right. And so here, it turned down. So that’s another thing that I use. So I consider a down market to be when the economy’s coming down, looking at the leading indicators, interest rates are going up. And the 200 day moving average is going down. So that’s a point when you want to get defensive, reduce risk, as far as that goes, because we might end up with a downturn that’s higher than 20% in that environment. And that’s certainly what happened here. This is about a 45% drop in 2000.
If we look at let’s just quickly look at 2008. Right, so here’s the peak actually happened late in 2006. For the economic indicators here, you know, 21 rate increases prior to that downturn. That’s pretty dramatic, actually. And, and look what happened to the market again, went up and in here at the beginning of 2008, the 200 day moving average turned down and the market fell actually I think it’s 57% from high to low here on the S&P 500 So this would have been a point to get quite conservative. Yeah. Let’s look at what’s happening today. leading economic indicators straight up. They’re not currently yet they could, but they’re not yet. We just got the report today for the December leading economic indicator was up 2.8%, which is pretty good, actually. And the Conference Board that makes this indicator grouping, projected that we would have a 3.5%. Gross in the gross domestic product for 2022. So that’s better than we were doing before the pandemic. So we’re supposed to have good economic growth. We already know that so far, you know, over 80% of the companies that have reported earnings have beat their earnings by an average of 8.5%. So earnings are good. Again, markets down, right. So if we look at kind of what’s happened here, here we go. Right, this is the S&P 500, for the last nine months, kind of this is a regression channel, you can look at that for directions, obviously, it’s up.
But I put in a secondary Regression Channel here, for starting on the 22nd of November, that to me, that’s an important point, because on the 22nd of November, the White House reconfirmed the Federal Reserve Governor Powell to be re-nominated for another four year term. And right after that, he met with the Senate Banking Committee, and all of a sudden things changed. They went from a period where they were trying to support the market, when the market would come down, they come out and say positive things, to a period where they were just aggressively talking about raising rates, cutting back on stimulus, eventually talking about reducing the balance sheet at the Federal Reserve to fight inflation, I believe that if I’m in power, if I’m a politician, in the party that’s in power, I’m much more afraid about inflation than the stock market. So in other words, every one of the voters out there who might vote for me is affected by inflation. But not every one of the voters that might vote for me is affected by the stock market. And so I think there’s been a shift. And so you can see what’s happened, I’ve got another multiple regression channel built in here from the 22nd. to now, the market is essentially going sideways. So obviously, you can see it’s coming down here in this particular time frame year to date. But I don’t consider that a down market. This is my own definition, I don’t consider that a down market until this 200-day moving average is going down, the leading indicators are going down, and the interest rates are going up.
So interest rates are going up, we have that we don’t have the other pieces yet. So I have a different strategy for these types of sideways motion markets are these even, I think it’s gonna fall farther than what we’re seeing here. But they’re still the same thing to me, you know, until those things all transpire. I don’t see really big downturns. I designed portfolios, so that you know that 20% drop is already kind of built in, you have enough bonds to mitigate the risk. So you know, maybe of 30% bonds, or 40%, or 20% bonds, or 80%, bonds, whatever it is, that’s designed to handle these kind of zero to negative 20%, you know, drops as far as that goes. And then I’ll show you kind of what I do to try to take advantage of these. But that’s, that’s the process that that we’re looking at. And so I don’t see the big downturn pieces, but I do see that we’ve shifted from an upward trending motion, different strategies that I use for that type of market to a sideways trending, again, a different strategy.
Easan Arulanantham:
Can you explain what a channel is? And like how you create these channels? And like what they kind of signify?
Tom Vaughan:
Yeah, that’s a good question. So the middle line is a multiple regression line, which for all intents and purposes is kind of an average of all of the data points, the closing points all the way along. And so it’s, it’s it’s sort of a midpoint. But also I look at it from a directional standpoint, so it’s going up, right. And then the top channels depends on what these are different channels. So this is what’s called a 100 channel, it’s just going to take into account you know, both. So you can see it’s touching down here at the bottom. So this channel is this wide at the bottom, it’s going to be equally distance on the top. This is actually a multi a same thing, regression line in the middle. And then this is basically a standard deviation differential between these as far as that goes. So in the end, though, the middle line makes the most difference to me, which is just really looking at direction. So we went from an upward moving direction over that this is nine months period to a sideways motion. Both of these are what’s called multiple regression channels. And it just a drawing tool that we have, right here on this particular chart. I have a whole bunch of other things on here. The blue and a red part is the momentum breakout bands and you know, there’s a whole bunch of things that I look at. This is actually a slimmed down chart versus what I normally look at on a daily basis, but the 200 day moving average is this blue line here. So that’s, that’s a critical component. For me, it is important that, you know, we’re breaking through this 200 day moving average here on the on the S&P 500. But that’s not critical. That happens fairly frequently. And we don’t end up with a 30% downturn. So because I’m not, I don’t design portfolios to try to get in and out on 5% drops or 10% drops. But I will get more defensive when economic indicators go down. Interest rates are coming up in the 200, day moving average goes down, just looking back historically, those three things were present, most of the times when we had really big downturns, I don’t want to ride through the next great depression, I don’t want to ride to the next 60% downturn, but I am willing to ride through, you know, the 20% downturns because there you have to, they happen fairly frequently. And by the time you get out for those generally the markets already starting back up.
Okay, so here’s, here’s, I’ll introduce the portfolio I have right now, there’s some important components of this. And then I’ll tell you how we manage this, which is a little bit different than what we used to do. So what we have here we have 75%, this is our 100% equity portfolio. In broad market indexes, I’ll grab those in a moment, and 25%, essentially 24, to be honest, in targeted indexes. And so when when I have an upward moving market, I’m trying to find pieces that are moving faster and in higher than the market. And so that’s what these generally will be. In this particular market where you got the sideways motion, I want to have things in here I have high confidence in that even if they drop, I still want to buy more. And so for the big pieces, we’ve got the Vanguard Total Stock market index that’s like over 4000 stocks. This is the most broad index that I can find, actually. And then we have two pieces of S&P 500 got the normal, you know, Vanguard S&P 500 FICO, and then I have a ESG screened S&P 500 from Spyder State Street. And I’m big believer in the ESG component, that I have high confidence in that area, it’s really growing ESG is environmental, social and governance. And so what they’re doing is screening the S&P 500 for those criteria. And I’ll show you how that’s doing in a moment. But that that’s the big pieces. We’ve got a little bit of short term real estate. This is very interesting. This is the S&P 1500. So we’ve got the S&P 500. Right, so that’s part of it. And then their next one is the SMP 400, Mid Cap, and then the S&P 600 Small Cap, if you add that all together, that comes out to 1500.
So these are all three SMP indexes combined into one ETF, again, by State Street there. What we’re finding is that there’s a quality screen, the Standard Poor’s chooses those, there’s 4000 stocks, only 1500 of them end up on their three indexes. And so they’ve been doing a little bit better than the overall stock market. I think, because of that quality screen, I’ve got a chunk of semiconductor in here. This has been falling pretty well. But I’m a big believer, right now, there’s only certain companies that make semiconductors, the demand for semiconductors has skyrocketed, the future demand for semiconductors is probably going to continue. I saw an article the other day that the number of semiconductors in a car is 10 times higher over the last 10 years than it was and is projected to just keep going, I think we’re going to have semiconductors and so many things. And there’s only so many companies that make them and it’s very difficult for new competitors to come along because it’s so expensive to open up these these these fabrication facilities. And it’s very sophisticated.
So I love the semiconductor arena right now. And then Apple, they have just a unbelievable loyalty grouping. And even though they have troubles once in a while, what have you they continue to march along. People really like their products that some people hate them, but the people that like them really love them. So these are things all all the way around here that I have high confidence in. So if we’re going to rebound, which I’ll talk about how that works in a minute, you know, we’re going to end up re buying some of these pieces as the market comes down. I want to be able to feel confident that you know, if you’re going to sell me Apple at a cheaper price, I’m going to take it until things all fall apart. I’m going to keep buying Apple at a cheaper price. For example, if you’re gonna sell any semiconductors at a cheaper price, all the way through. And so just real quickly, this is the 60% portfolio just didn’t get an idea. You know, we have a breakdown on the bond portion. And what happens in a rebalancing situation is that sometimes you’re you know, bonds held up a little bit better than the stocks you might be selling. And we did a rebalance today. We had some of the BND you know sold because it held up better and buying some of the VTI and I’ll describe some rebalancing here in a moment, but I wanted to get you an idea of kind of what’s in there. We have two broad market, you know, bond pieces here, one with iShares. This one’s a little bit broader, it’s got a little bit of high yield in it. This has got 17,000 bonds in it. So it’s, you know, very, very broad, short term treasury inflation protected securities do well in high inflationary environment, and inflation rate, hedged high yield, that’s actually been doing very well on a relative basis. And then we have a managed treasury inflation protection security piece in here also. So you know, this, this, again, is our 60% model.
And if we look now, okay, here’s VTI, right, I’m just going to quickly go through the pieces. So if you look at VTI, right, here’s the channel, it’s kind of showing an upward trend good. last nine months, S&P, the 200, day moving average is still going up, or through the, or through the average on the price. Okay, so that’s a problem. But the 200 day moving average still going up so that that’s good. And that this is a very broad, this is the entire market, it’s one I use it as an index, just for comparison purposes to all my portfolios. Here’s the S&P 500. As as, as presented by Vanguard, again, trend up price, actually, the price is just now coming through the 200 day moving average as we speak, but the 200 day moving average is still going up. And then down here, this blue line, this is what’s called relative strength. So what this shows is how well this particular investment has done. Versus in this case, the total stock market index that we just had this, this one here VTI. So if we look here, you can see that it is doing better than that whole market as a whole, pretty consistently since mid November, right? So I like that I’m a big believer in relative strength. And that’s what gives me conviction to to want to continue to buy that because it continues to do better than the overall stock market. The next one in here is the ESG screened version of the S&P 500 EFI V is a ticker symbol. And so look at that, that’s been actually outperforming the total stock market index, since back in October, fairly consistently. Again, that’s why I like ESG, and whatnot, too. So and then here’s the real estate, you know, again, 200, day moving average is going up, it’s well above the 200. day moving average, its relative strength is high. Here is the S&P 1500.
Right, Large Cap, Mid Cap and Small Cap altogether, outperforming the overall market again, 4000 stocks, the overall market 1500 Here, the quality screen that S&P 500 is putting into this seems to be working at the moment for this particular market. And we’re seeing out performance, S&P, the 200 day moving average is going straight up, that’s good. Here’s Apple, well above its 200 day moving average 20 day moving average is going up. And it’s basically been flat, you know, even against the total stock market index, since you know, middle of December, so it’s not outperforming. But again, I like that it’s hanging in there as far as that goes. And then here’s the semiconductor above the 200, moving average, you know, 200, day moving average still going up. This one’s broken down a little bit, in terms of this last rundown that it had, it has brought it below VTI instead of instead of the total return, having said that, the red line here represents VTI. So over the last month, nine months is still ahead as far as that goes. But I like it again, I think that there’s a good, you know, reason to own these because of the fact that there’s so much demand. And they really can’t create new companies here very easily. So, you know, again, if it gets cheaper, I’ll continue to buy it. And so here’s how it works for the rebalancing, we have a tool called IRA rebal that we use. It’s provided by TD Ameritrade. And so what happens is we can pre create a band around each holding.
And so if you look at Apple here, it’s at 6% as our target in this particular model. And so what happens there is we have a band of 20%, which just means we can go plus or minus 20% of six is 1.2. So that means we can go to 7.2 or 4.8. And so that when Apple just floats around between 7.2 and 4.8, when it gets below 4.8, which means that basically dropped faster than some of the other things here. We want to buy more. Again, we have high conviction high belief in Apple’s abilities to do well and be at a higher rate at some point in the future. And, again, if it’s above 7.2, we want to you know, remove that piece, unless we’re in an upward trending market. So an upward trending market, I don’t rebalance. I let the winners run and because Apple if it’s on fire, I don’t want to take pieces off. So again, We’re in it, we’re not in an upward trending market, we’re not in a downward trending market, we’re in the site, what I consider a sideways trending market, I’m going to continue to rebalance. And so we we go through, and there’s a 20% band around every one of these pieces. And here’s the 60% model, again, 20% band around all of these pieces, and we run the rebalancing tool on every day we look at it, and just when we see a lot of rebalances, that can be done, then we actually do it, I think we’ve done it three times so far this year, and allows us to kind of go in and buy what’s low, and sell what’s high on a relative basis. And that’s what you want to do in this particular environment, in my opinion, as far as that goes, is just to be able to kind of have this, you know, mixture that we can essentially allow, you know, to to grow, and then take advantage of these fluctuations that are happening.
My base case scenario, right at the moment is that, you know, the market is having a tough time adjusting to what’s happening here with the interest rate increases. And, you know, we’ll have to see how that plays out. But this, this is our strategy right now. And again, I bring this up, because it’s going to take some patience, no matter what, you know, this market is going to struggle for a while here, I would suspect we’re gonna have a tale of two halves, really, first half of the year could be a lot more rough and the second half of the year could be better. We have a midterm election that could make the second half of the year better. You know, all of these types of things, inflation could be better in the second half, etc. So anyway, that’s what’s happening so far this week. Pretty long winded discussion about it, but I think it’s important once in a while to do a deeper dive, I would consider this more of an advanced educational component. You know, the more you can understand about what I’m talking about here, the easier will be to get through these particular types of situations.