2015 Strategy and Market Review


The Next Bear Market is underway.

 Over the past year, our quantitative indicators signaled a global correction that had direct consequences for the U.S. markets.  The chickens have come home to roost and the U.S. is now entering into its 3rd bear market since 2000.   This one was caused by dual headwinds from mal-investment (asset bubble) from an “easy” Federal Reserve and a slowing Chinese economy, which funded its growth with massive debt.  The market is now undergoing the “Great Re-valuation” (my term).  This likely will lead the U.S. economy into a profits recession and potentially more market decline.  This analysis led J2 Capital to have remained predominantly in cash for the past few months.

 Review of our analysis over the past year:




It’s important to note that the internal quantitative work we do on markets gives us an advantage.  Since our analysis is our own, we are able to see in real-time, using quantitative screens, any trends or early deterioration in equity markets well before the main-stream or others notice.

 In summary, our analysis lead us to identifying both the decline in the stock markets as well as alerting you to a weakening picture in U.S. corporate earnings and profits over the past 6 months.   We made a strong case in July 2015 that that institutions were selling U.S. stocks and earnings of from all sectors would be coming in lower.


 Major Investment Themes to 2015:


China Devaluation & Slowdown


Puerto Rican Debt


Commodity Crash  - Suply v. Demand


Global GDP


Greece  (again)


U.S. Dollar


FedPolicy-àFed Rate RiseàFed Credibility


Global Stock selloff



 Asset Class Returns 2015:

 Source: http://www.bsam.com/2016/01/11/monthly-commentary-december-2015/ chart using data from BlackRock, Bloomberg, and www.hedgefundresearch.com


As shown in the chart above, almost all major asset classes experienced negative returns.  This made it an especially cruel year for traditional asset allocation, which relies on some deviation in returns. The average return across all these asset classes was -8.30%. 


2015 Strategy Review


RCI/Sector Rotation/Global Rotation: 

Our tactical ETF portfolios managed risk and volatility as designed in 2015, though ended the year in losses.  

We raised cash at the beginning of the year, and maintained an equity under-weight all year. Our portfolios performed extremely well in the August 2015 rout. As the markets raced out to double digit declines in late August, our Tactical ETF portfolios, specifically our RCI models, stemmed losses at roughly half of the market. Though we were heavy in cash throughout 2015 and were right in our market calls, we experienced under-performance in our RCI models early in the 2nd quarter, due to positions in Asia and Japan which were in strong uptrends until late May then fell apart. 

Coming out of the August declines, we felt very good about our heavy cash positioning, knowing full well that it was possible that a short term rally could leave us behind.  Our RCI indicator had improved somewhat but our other quantitative screens picked up on a further weakening of the average stock, and a lack of participation from small company stock and high yield bonds. 

As expected, the markets experienced a large snap back rally in the 4th quarter which we failed to participate in our Tactical ETF portfolios.  Our analysis suggested that it’s more than possible that whatever rally took place, eventually would not hold.  

While the S&P 500 went from being down around -12% (June peak - August trough) to race back to close the year flat we decided to respect our risk models and remain under-invested in equities and sell into the rallies.  I should note, benchmarks, as of this writing (January 8th) are well under-performing our Tactical ETF and Tactical Stock models coming into the year. 


The discipline to our process is what is providing us significant out-performance here to start 2016. 


Allocations as of 1/8/16


RCI Models

All models since the new year are 90% cash and short term fixed instruments.

Sector Rotation: 

70% Cash

15% XLP-Consumer Prod

15% XLK-Technology


Global Rotation:

55% Cash

15% EWJ-Japan

15% IWV-Russell3000

15% EWO-Austria


J2 Risk Managed RS Leaders: Tactical Stock


Our Tactical Stock portfolio did very well throughout 2015.  We finished the year flat after racing out to an 8% gain to finish the 2nd quarter.  We were over 50% cash from early 3rd quarter and on. Our cash holdings continue to increase in the New Year. 


Our sell signals are still in place and we will continue to hold any stock that is ranking higher than cash or the S&P 500. We currently hold just 15 positions and over 60% cash heading into the new year. 


Tactical Stock Model


J2 Risk Mgd RS Leaders


Russell 1000 Growth Idx



Top positions as of 1-8-16


  1. 1.    Cash


  1. 2.    Autozone


  1. 3.    Casey’s General Stores


  1. 4.    Global Payments Inc.


  1. 5.    Tal Education Group


  1. 6.    Vantiv


  1. 7.    CDW Corp


  1. 8.    Delta Airlines


  1. 9.    Tyler Tech


  1. 10.  Pool Corp



The Warnings Signs that Lead us to Remain Cautious: 

At the top of my list was the severe under-performance of small capitalization stocks compared to the Large Cap S&P 500.  As the S&P 500 was experiencing a strong rally in the 4th quarter the smaller Russell 2000 was lagging woefully behind.  The S&P 500 in the 4th quarter was driven by just a handful of Large Cap tech stocks, most others were continuing to sell-off.  Additionally, junk bonds (high yield) were continuing to sell-off, which turns out was the canary in the coal mine for stocks and the economy in the 4th quarter.  Earlier in the year, we dispelled any analysis that suggested it was just energy names effecting High Yields by showing credit spreads of non-energy names widening as well.   

Bear in mind, that as of this writing, the average stock in the S&P 500 is down around 20% from its 52-week high.  The Russell 2000 Small Cap Index is now down over 18% (January 8th).   Most global markets are now in a Bear Market.


A look ahead into 2016: 

As we look ahead the great re-valuation is now taking place.  The market is now in trouble without the backdrop for Fed stimulus. This has now, beyond any doubt, proven to be the wind behind the bull market of 2009-2015. 

As discussed prior, the easy money laid out by the Federal Reserve has led to mal-investment, specifically in oil shale (energy) and technology companies, namely startups.  In 2015, the term “unicorn” entered into investment lexicon which stood for the plethora of billion dollar tech startups i.e. bored money looking for the next Facebook.  

The Fed and their QE (quantitative easing) + ZIRP (Zero Interest Rate Policy) of the past few years were complicit in pulling ahead forward demand and future investment returns.  All of this seems oddly familiar, as the last great bear market (2008) was caused by the same influences ending in asset mal-investment of certain asset classes (mortgages).  Ironically, Hollywood is currently providing a primer on how this works. For those that have seen “The Big Short” you sense the similarities. From a market technician’s standpoint it’s comforting that human behavior is so predictable thus can be modeled. 

The Fed, by my thinking, was about a year late in raising rates. The U.S. and global economy was on decidedly firmer footing from 2014 and into early 2015.  So now with the global and U.S. economy slowing, the Fed appears to be out of ammunition and now looking to get out of the manipulation game - possibly at a bad time with a slowing U.S. Economy.  The Fed is stuck. 

Valuations of the S&P 500 companies were at very lofty levels in 2015 and still continue to be.  Earnings are in decline, corporate profits are mean reverting (i.e. going down) and most global economies are teetering between deflation and stagflation.  All of which should end up washing up on our shores.  The oil and energy sector in my estimation probably will have a larger knock-on effect in the U.S. than many are currently thinking about.  Certain states obviously will get hit harder.  Markets may very well be left to their own devices. 

What you are seeing and will continue to see is an adjustment (great re-valuation) to the reality that the easy-money-Fed is no longer, at the same time the global economy is slowing down significantly. This means that stocks need to be adjusted down. I cannot say how much excess has been built up in the system, or how far the market needs to fall.  As a market technician, I can tell you that the path of least resistance remains down or a long-period of sideways movement.  Given a choice I would prefer to see a large down move occur over the next several months.  This is preferred to the alternate outcome of a sideways go-nowhere market for the next several years.  My latest technical analysis, not prediction, shows a chance of an additional 10-15% market loss from here for the Large Cap U.S. Indexes. That would amount to around a total -20% loss from June 2015 highs. The total loss for Small Caps, could be less, which have already taken a beating.  The S&P 500 as of this writing is currently at 1,943 and the Dow 16,600.  A profits recession for the U.S. is a growing possibility and likely. 

So while my views and current models are certainly bearish I have learned that markets have a way of humbling opinions.  One thing governments have learned, is that the populace hates losing money in stocks.  Thus, I am always wary of coordinated World Central Bank actions, which makes shorting stocks or staying too bearish difficult.  

We will continue to follow our quantitative models and charts and adjust to whatever reality or market direction comes next.  For now, we remain risk managers for you and your clients.  This could, and most likely mean that we will miss out on the first part of any market rally.  We would need to be convinced that any rally going forward is more than wishful thinking.  Our number one goal and philosophy continues to be allowing your clients to sleep comfortably no matter the environment.  With almost all of our models mostly cash I think we are in position to weather to the coming storm.  I am happy to say that we have received very few calls from our clients or advisors the past couple of months.


John Benedict

Portfolio Manager for J2 Strategies

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