Happy belated New Year!

After a very busy 4th quarter here at SMI, I was able to unplug from the markets for a few days recently. It was nice to not think about money and investing for a while. I highly recommend it.

Having just returned to the saddle yesterday, I don't have anything earthshaking to offer you today. Instead, let's muse for a few moments on a bigger picture theme. As always when we look at "macro" issues, please keep in mind that we don't base our investing decisions on this sort of analysis. But it can be helpful to have at least some understanding of what's going on around us as we navigate the investing waters.

Bull Market Status

It's been my contention since fairly early on in this bull market that the good times would continue until the monetary conditions changed substantially. Over the past 20 years, I've gradually been won over to the point of view that while psychology is often a good indicator in identifying bear market bottoms (think of those scary bear market charts you've seen with those nasty V-shaped bottoms), monetary conditions are the best indicator of bull market tops. Or perhaps a better way to put it would be that monetary conditions are usually the most helpful tool in identifying that the conditions which might end a bull market are developing.

This bull market is soon going to hit its sixth anniversary. And as you all know, there have been many (loud) voices saying it was about to end all the way through. While predictions aren't our thing, we've tried to balance this negative point of view with some rationale as to why this bull market might continue longer than anyone expected. And it has, which has been great (it's nice to get a few right here and there, even if predictions aren't your thing!).

That said, the factor I've pointed to all along as the best reason to believe the bull would continue is getting ever closer to ending. In May of 2013 when the Fed first started talking about tapering their QE purchases and the markets went a little crazy, I suggested those actions probably weren't enough to end the party, because even after QE ended monetary conditions would still be super loose by historical standards. So far, so good. But QE ended last October, and the day of reckoning when the Fed starts to actually increase short-term interest rates draws ever closer.

I don't think that the initial interest rate hikes are likely to be the death knell for the bull market in stocks. But in fairness, if the Fed's largesse was the primary rationale for the bull market continuing all these years, it's only fair to point out that those conditions may soon be changing. I expect the Fed will probably start hiking interest rates by mid-year, barring some slowdown in the US economic data between now and then. And while I think that's generally a good thing (a return toward more normal conditions and away from the financial repression that has punished savers over the past six years), it also creates conditions where the end of the bull market becomes increasingly likely.

So get it straight — this isn't a prediction that the bull is ending anytime soon. I don't know when that will happen, and don't honestly believe anyone else knows either. However, it is a warning that the conditions are likely changing and moving in that direction. Could take quite a while, or it might not. With these sort of issues, it's often a matter of the higher interest rates not mattering until all of a sudden the market decides that they do.

One potentially key factor that's hard to weigh is the impact of international cash flows into the US market. There's a pretty stark gap right now between the rest of the world's economy and the US economy. That gap is reflected in the fact that while the rest of the world's central banks are cutting interest rates and talking about more stimulus, the Fed has ended its stimulus program (QE) and is talking about raising interest rates. As foreign investors see this disparity and move capital to the US, that demand dynamic can prolong the bull markets in stocks and bonds here. I believe that's part of the reason why bond yields fell last year (rather than rise, as everyone expected), and it wouldn't surprise me to see that dynamic continue this year.

How to respond

As I said, this isn't the sort of analysis that we encourage anyone to base their investing decisions on. However, if you're wanting to gradually tone down the risk in your portfolio, the past two days have offered an excellent illustration of how to accomplish that.

I'm writing with an hour still to go in today's market session, so these numbers may not hold up for long. But as I write this at about 3pm, the S&P 500 ETF (SPY) is down about -2.4% from where it closed last Friday. Yet those using our Dynamic Asset Allocation strategy are actually up 0.3% for the week so far, due to the other two components of that strategy rising 1.8% and 1.6% even as stocks have fallen. Not a bad outcome for a couple days when the stock market has been smacked around a bit. Fund Upgraders who moved part of their bond holdings into our new bond upgrading recommendation have been similarly rewarded this week.

Again, I'm not trying to say that anyone should make changes to their portfolio based on this information. But if your portfolio has been allocated aggressively in recent years — as I've acknowledged from time to time in recent years that mine has been — it's at least worth considering that the environment could soon be changing. Thankfully, we've been developing tools over the past few years to prepare us for this eventual market shift, whenever it actually does arrive. Make sure you're putting them to use in your portfolio!