Relative Strength Newsletter - 1st Quarter 2019

Fourth Quester Recap

Where to begin… The fourth quarter of 2018 will be remembered as one of the most eventful quarters in market history. Not only was December the worst December since 1931, but U.S. indices also undercut their February 2018 lows causing significant technical damage to the charts. In our asset class rankings,

U.S. Equities gave up some ground but remain the number one ranked asset class. International Equities remain in the second position followed by Commodities, Fixed Income, Cash and Currencies. The fact that U.S. Equities have remained in the top position, despite the pullback, and that more defensive classes like cash and fixed income did not gain meaningful strength is a positive development and is an indicator to us that this is still a correction in an otherwise bull market.

The quarter began with a severe market correction that fell just short of the January/February 2018 lows. An early November rally was short lived and by Thanksgiving the market was retesting the lows.

Continued fears of a trade war between the United States and China, a Federal Reserve Policy mistake and slowing global growth finally proved too much weight for market participants to bear. Those fears and the generally dour mood had the market in “sell” mode. The lows from earlier in the year failed to hold and the S&P 500 traded at levels not seen since the spring of 2017. Just about the time most people had given up hope of a Santa Claus rally, the market staged an impressive rally from the day after Christmas into the New Year.

It wasn’t all bad news, though you would have a difficult time discerning that from the headlines. Corporate earnings, while coming down from the one-time boost due to the new tax law, continued on solid footing, the unemployment rate flirted with post-WWII lows and the consumer, which represents approximately 70% of the U.S. economy, remained in good shape. Healthy consumer sentiment is partially due to lower gas prices at the pump attributable to robust oil supply. In October the United States’ energy trade balance moved positive indicating that the U.S. is now energy independent. Our country is now exporting more energy than it imports and since 2012, the U.S. has nearly doubled its oil output!

Tactical Asset Allocation Update

Tactical Asset Allocation had a tough year in 2018. Two things worked against tactical strategies: Major trend changes, and the fact that those changes were very rapid. At the beginning of the year, the strength was in Domestic Equities. Energy markets also did very well, and you could have gained exposure through actual commodities or buying the stocks of energy companies. International Equities were an area you wanted to avoid early. That was a big trend change from the prior year. With rates going up, anything interest rate sensitive (bonds, utilities, REIT’s, etc…) was also on the avoid list.

Then came the 4th quarter. It’s always nice when everyone decides to do just the opposite of what they had been doing. It actually worked for George Costanza from Seinfeld. Instead of tuna on toast, coleslaw, and a cup of coffee, George decided everything in his life should be done differently so he went with chicken salad on untoasted rye, potato salad, and a cup of tea! Doing the exact opposite got George a date with the pretty blonde at the counter. It even landed him a job with the Yankees when against his better judgment, he told off George Steinbrenner, who hired him on the spot. If only things were as easy as they appear on TV. Well, I guess if you are on CNBC they are, but I would imagine most of you are dealing in real life. In real life drastic, rapid changes rarely work over the long term.

In 2018, only 1 of the 10 asset classes, or 10%, had positive returns. Those were Aggregate Bonds with a return of a whopping 1 basis point. Even though they were positive, it wasn’t much to write home

about. The data also shows that this 10% positive rate for asset classes is the lowest percentage since the beginning of the dataset in 1971. Just think about all the different markets we have seen since 1971. Even in 2008, both the bond index and gold were positive, giving you a 20% reading. In 2002, there were 4 things positive (bonds, commodities, gold, REIT’s). Even a transition year like 2001 had half the components with a positive return. So what we saw last year was abnormal by historical standards, and it was tough to find a place to hide.

The overall range of returns from the 10 asset classes was also very small by historical standards. When the range is very small the opportunities from over and underweighting are not as significant. During the year that range was much larger, but the reversals in Q4 brought everything back in line.

It was a tough year all around, and tactical asset allocation strategies were not immune. Any given day in the fourth quarter, Twitter was loaded with, “This is the first time in 30 years this has happened,”

tweets. The question people will ask is, “Are these models broken?” Looking at the data, I would say they are not. It is easy to see why some of these tactical models had a poor year. There wasn’t much with positive returns, the dispersion in returns was low, and there were dramatic trend changes. The data shows this is the exception rather than the rule. It is probably a good idea not to take advice from George Costanza and just do the opposite because things didn’t work as planned last year. History is on your side if you are looking for better opportunities among asset classes.

Portfolio Perspective

The fourth quarter was rough for global markets. What started out as a good year for equities, and high momentum equities in particular rapidly unwound and left most asset classes with losses for the

year. Domestic equities, as measured by the S&P 500 Total Return index TR.SPXX, were down -13.5% for the quarter and -4.4% for the year. Those returns were decent compared to small-cap stocks. The Russell 2000 Total Return index was down -20.2% for the quarter and -11.0% for the year. A widely accepted definition for a bear market is a decline of 20% or greater so small caps entered bear market territory in the fourth quarter alone. The returns of International stocks were actually better in the fourth quarter than returns of Domestic stocks. International stocks had been lagging all year. Emerging markets had been a notable laggard earlier in the year as the U.S. Dollar surprised most people and shot upward in the spring. In the fourth quarter, the MSCI EAFE Total Return index was down -12.5% and Emerging Markets as measured by the MSCI Emerging Markets Total Return Index were down -

7.4%. While these returns aren’t great, the outperformance of International equities during the quarter is certainly worth watching going forward. The biggest losses for the quarter were in Commodities. The S&P GSCI Commodity index was down -22.9% led lower by the terrible performance from Oil. Energy had been a solid performer earlier in the year, but that completely unwound during the final three months of 2018. Bonds provided some relief as both the Barclays Aggregate and BofA 7-10 US Treasury indexes finished in positive territory to end the year.

The decline has been severe and has caused a number of measures to not only enter oversold territory but also get to levels that have rarely been seen historically. The NYSE High Low

Index NYSEHILO, which measures how many stocks are making 52-week highs vs. lows finished the year below 2%. This is an incredibly low reading, and shows just how washed out this market is. The NYSE Bullish Percent BPNYSE was at around 16 to end the year. The indicator is considered oversold when it falls below 30, and trips below 20 are very rare. There was also an endless stream of, “this market has only done this some small number of times,” posts if you follow

twitter or the financial media. We also managed to have the largest up day in history (based off of Dow points, which isn’t the best indicator) mixed in with all the negatives, which only added to the overall volatility. All of this just shows there was a tremendous amount of uncertainty and a lack of confidence in the markets and the economy. This happens during every large decline. We hadn’t seen a decline of this magnitude for quite some time. It is always a shock when it happens, but looking back historically, markets continually overshoot and things like this happen more often than people remember. According to research from John Lynch at LPL, the average S&P 500 drawdown in a midterm election year is -16.0%. We are pretty close to that. The good news is the average gain from the trough is +32.0%. Nobody knows if that will be the case this time, but it does serve as a good reminder of how markets have performed across different environments.

It seems that a lot of the hand wringing has been brought on by economic concerns. Investors seem to be concerned with two major things: the trade war and rising rates. It is difficult to talk about one without the other. People are concerned that the trade war will slow the economy down and crimp corporate profits. The Federal Reserve, however, seems to believe the economy is on solid ground and has continued to raise interest rates. A slowing economy with rising rates is about the last thing investors want to see. The Yield Curve, which measures the spread between longer-term and shorter-term bonds, has gotten very flat as a result of the economic and interest rate outlook. When the curve inverts it has historically been a leading indicator of a recession. We haven’t gotten there yet (as measured by the 2yr-10yr spread), but we are close.

Where we go from here is impossible to determine at this point. Our strategies don’t rely on prediction or forecasting, which is incredibly beneficial right now. We will continue to make changes to the portfolios as this market unfolds; the disciplined nature of our process keeps our emotions out of the equation. We have designed our processes for just these sorts of situations – when the market outlook is unclear and emotions are high. These are the times when astute investors begin to push more chips on the table. We can’t be sure the downside is done, but we are certainly better off at current levels than we were at the end of the 3rd quarter! Mike Moody, a former Dorsey Wright portfolio managers, used to say, “Bear markets are garage sales for people with money.” These are the times when it is difficult to keep your nerve, but also the times that have a meaningful outlook on your long-term returns.

Tumlin Levin Sumner Wealth Management of Raymond James

Any opinions are those of TLS Wealth Management and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets or developments referred to in this material. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Russell 2000 index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. Gold is subject to special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have potential for instability; and the market is unregulated. Bond prices and yields are subject to change based upon market conditions and availability. If bonds are sold prior to maturity, you may receive more or less than your initial investment. The MSCI EAFE (Europe, Australasia, and Far East) is a free float-adjusted market capitalization index that is designed to measure developed market equity performance, excluding the United States and Canada. The EAFE consists of the country indices of 22 developed nations. The MSCI Emerging Markets is designed to measure equity market performance in 25 emerging market indices. The index’s three largest industries are materials, energy, and banks. The Barclays Capital Aggregate Index measures changes in the fixed-rate debt issues rated investment grade or higher by Moody’s Investor Service, Standard & Poor’s, or Fitch Investors Service, in that order. The Aggregate Index is comprised of the Government/Corporate, and Mortgage- Backed Securities and the Asset-Backed Securities indices.