Author: Thomas Connolly

Summary Comments:

I believe we are in the Final Countdown to a large move one way or the other. A blow-off top or a break down lower that may prove to be dramatic is in the cards. Broad support for a move higher is present and consistent in terms of Advancing Volume and Issues, coupled with New Highs and Lows validating the gains. These facts represent a movement of money into equities that strikes me as being oblivious to the broader economic and fundamental conditions that are clearly not supportive of current equity prices. This type of behavior is characteristic of a next phase blow-off top to bring us to “bubble” territory, a state we are not at presently. It calls for caution and prudence.

Below are the various contributions to the development of my view that we are in a very high risk state. Across the board from: (1) the movement of investing to non-paper means of value (ie Bitcoin, gold, real estate, etc); to (2) the decline in currencies, the decline in bond yields, the declining rates of change in economic measures and the rise in commodities, all undermine the future returns to be realized from holding equities. As you read the individual pieces below, please keep in mind that I do hold a meaningful equity position in companies that provide me a blended dividend yield of over 3%, and as such I do not want to see an equity market decline. But the state of things is such that I have complimented my equity holdings with short hedges and with precious metal investments to offset the potential negative effects of future equity price declines.

Finally, in these summary comments, I feel it necessary to say that the requirements to bring about a high level of confidence that the investing future will be positive and robust are simply not present today. We do not have expanding earnings and cash flows. We have a Bond market and a Foreign exchange market that are signaling problems, yet our equity market behaves as if the highest intelligence in the room, Bonds and FX, have it wrong this time. It is not different this time, and taking the lead from the Fixed income and Currency markets may prove to be the best decision one can make.

Prior week’s investing activity: During the past week I was very active in moving capital amongst various asset classes. I meaningfully increased my precious metal positions on Thursday, while adding to short positions in the option market and in increasing positions that are based on ETFs that profit on market declines and on increases in market volatility.

My portfolio’s performance and composition for the YTD period ending and ended on June 3, 2016, are set forth below:

The Portfolio’s composition as of June 3, 2016 is as follows:
• Cash 47.7%
• Equities 37.2%
• Gold 11.5%
• Fixed Income 3.6%

Forecast for the coming week: I believe we are set-up for a big move and would not be surprised to see it begin this coming week. This past Friday’s US employment report should have been market moving. It was in the fixed income and currency arena, but not in equities. I believe equities are digesting a lot of information and in this state of digestion has not settled on direction. I expect that to be resolved very shortly. The path lower seems most likely from here, however, a blow-off move higher cannot be ignored given the strength of the market in the face of the poor economic data. While both scenarios are possible, my expectation is that we are close to a point in time when the market makes those investors who have been ignoring weakness in the fundamentals to be made to regret being on the long side in an over-weighted fashion.

My focus to improve returns on invested capital will concentrate on the downward turn that is needed to return to a balanced risk reward profile that supports capital investment. If we are to maintain current equity values and possibly increase them, we need an acceleration in revenues and earnings. Should we fail to realize this acceleration the market will reset lower to bring cost of investment in line with desired return on investment. Presently the market projections of earnings and revenue growth for 2016 and 2017 do not reflect the needed growth, so we need surprises to the upside to avoid the anticipated equity index decline that I see as the most likely outcome from today’s levels.

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

The indexes were mixed this week. Some moved higher, some lower and some stayed relatively constant. This is a market in search of a theme to either move higher more broadly or to reset lower more broadly. Which equity index will prove to be the leader?

The Relative Strength readings remain in the 60s, reflecting a trending market higher (a reading above 50 points to an upward trend). However, the RS readings have been declining over the past month when they previously read in the high 70’s to low 80’s. It should be noted that in five of the last six weeks the DJIA closed lower than the prior week. For the NASDAQ, the moves were evenly split with three up weeks and three down weeks over the past six weeks. Again, who will ultimately lead the other?

Price Earnings multiples are north of 24X for the S&P 500 and 19X for the DJIA, indicating an expensive market to invest in at these levels.

The DJT remains in a declining chart pattern. It has been a leading indicator of the broader market, and with the rotational trading that has been taking place, a return to the selling of the Transports would be a strong negative for the overall market.

The DJU has moved to a new high as investors seek yield reflecting the cautionary investing strategy of a market that poses greater risk then reward for investing in growth oriented businesses. Safety is being sought.

What is the current score on the “Market Tells metric”?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 116, a negative rise from the prior week’s reading of negative 104. When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -116 reading indicates a very expensive market. The highest negative reading here was -182 on November 6, 2015. The strongest positive reading was +28.5 on February 12, 2016. Last year at this time (June 5, 2015) the reading was -82, which foretold the summer of 2015 declines in equity prices.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 18.71X as compared to last week’s 18.57X. These are relatively high readings of price to cash flow when compared to the historic median of 16.92X. This does not reflect an extreme overvalued market (not a “bubble”) based on historic fundamental comparisons, but in the context of the surrounding economic and market data it is a value that is unsustainable. Why unsustainable? Because it is one that conflicts with the environment of prior extreme positions from the perspective that those historic positions had economic vibrancy driving the enthusiastic buying of financial instruments, whereas today we have economic malaise in a highly priced market as investors search for returns above the negligible returns of fixed income and other alternative investments. As it has been said, when the tide goes out we find out who is naked from chasing returns that are not based on fundamental value. To this mind, the tide is receding.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 69 companies were priced above their DCF value which exceeds the historic average of 60 for the portfolio. This supports an expected fall in the market as more companies have become overvalued.

The dollar spread between the Current Price and the Discounted Cash Flow Price utilizing 2017 cash flow projections on the 187 Portfolio Companies has narrowed and is now at $16.58, pulling back from the February high of $25.14. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. The difference today is below the historic median of $22.39. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains absent a significant improvement in future earnings and cash flows.

What is the position of the weekly net up down Vol/Issues?

The week’s volume and issues were not aligned with the index point moves. The volume and issues over the past five days provide a deepening support for the market to move higher during a week where the market did not advance. This typically presages a meaningful breakout to the upside in the days to come.

What are the daily point vs issues and point vs volume measures indicating up or down?

The daily metrics of (1) index point moves being supported by the daily volume in rising and falling issues, and (2) the index point moves being supported by the daily rising and falling number of issues traded were both meaningfully supportive of a market direction to the upside.

Where are the New Highs and Lows moving toward?

The New Highs and New Lows this past week in both the NYSE and the NASDAQ indicated a continued improvement in market action and a rotation between industry sectors. Signs here point to higher prices given the broadening of participation in the various stock exchanges.

How well are Market Tells correlating with Market trading internals?

The technical market internal indicators are very supportive of rising equity prices whereas the Market Valuation Tells are strongly indicating the need for a price correction lower. At some point either better revenue and earnings will arise to better align value and price or the market will reprice equities lower to bring them in line with their economic value. The economic data that is currently available in the market strongly points to lower prices.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?

The reading is -4 as this rise shows fatigue and topping in the face of an expensive market and political uncertainty. Range is from +7 to -7. Contributors are:

Other:

Bitcoin rose again this week to $575 per coin. The continued rise in this digital currency is telling us something important. I believe it is the economic and political turbulence in world markets that is creating demand here, and it reflects a foreshadowing of greater uncertainty and loss of confidence in the Central Banks of the world. Something is happening in the alternative currency sphere that should not be ignored in terms of the implications for the broader financial markets. The per unit value based in the low $400 area over the past three months. Over the past year, the price has increased by 150% from the $230 area. I hold a position in Bitcoin as we move closer to digital currencies vs paper money and coinage. Please note I also own stock in the company PayPal (symbol “PYPL”) and Square (”SQ”) given the success and reach of digital online payment platforms.

The Dollar Index has round-tripped back to the 93 area and now sits at 93.94. Over the past twelve months it has traded between 93 and 100. The dollar has appeared to be range-bound in this area, but the latest global economic data failed to indicate economic improvement in the United States, and likewise softness in other geographies throughout the world, which pressured the dollar lower. We may see the break of lower resistance levels that were last tested a few weeks back. A break under 93 brings us into a void area where there is no support until we get to the 88 area. Additionally, the Chinese currency is pegged to the US Dollar, so a decline in the dollar helps currencies that are pegged to the dollar become more competitive in world trade. This dollar decline eases pressure on the Chinese authorities and Emerging Markets, but exacerbates the global pressures on other non-dollar based countries to compete based on their currencies relative value. Declines in the dollar elicit government responses to lower values of other currencies. This drives investments to non-paper holdings and feeds price rises in precious metals and digital currencies. Paying attention to the movement of the dollar is important given the fragile state of the global economy.

Gold closed the week at the $1,246.50 per ounce, approximately $30 higher than the prior week. The decline in the dollar’s relative value and the view that the Central Banks will continue to ease in the face of slowing economic growth are leading investors to seek the perceived safety of hard assets such as Gold and Silver. In the past week, the Gold and Silver Miner equities rallied. Given the continued global uncertainty and currency volatility issues that exist, I do see material price increases for gold and silver in the foreseeable future and for Gold to advance higher above the $1,300 level. I will therefore maintain my PM positions to offset potential equity price declines from the broader market.

The Ten-year bond yield closed at 1.70% down from 1.85% at last Friday’s close. We are now getting very close to low yields last seen in 2012 (1.64%). The economic signals I see from the latest government releases show an economy that is contracting. The behavior of the Bond market is confirming that economic slowness. Of concern is a flattening of the yield curve (recession) and the absence of economic activity that a steeper yield curve, if we had one, would indicate. We are below the weekly closing low for the calendar year that occurred on April 8 at 1.72%, and are still below the 2015 year-end rate of 2.27%. Our Central Bank is weighing when to institute another increase in the Fed Funds rate which could be this month. At some point this will likely weigh on the equity markets if the cost of short-term US dollar financing rises.

Commodities: As this week closed and the dollar weakened, we saw the CRB commodities index rise to 488.21, just below the April 29th weekly closing high. We are now at levels last seen in July 2015. This is great for Emerging Markets as they derive so much of their economic wealth from raw material mining and exporting.

The High Yield vs Investment Grade spread continues to appear to be trying to form a near-term bottom. We closed this week at 4.178% as compared to 4.205% last week. Over the past two weeks the range has been 4.115% to 4.298%. The narrowing of the HY/IG spread is a positive for equities as dividend yields push more money toward the stock market then the bond market. Should a bottom be put in and the spread widen, then risk returns in a way that may push the equity markets lower. High Yield is at 7.059% and Investment Grade is at 2.881%. If the oil market holds the price of a barrel near the $50 mark or higher, the health of high yield should continue to improve.

That about covers it for this week.

As always, have a great week!

Tom

My timing was ill-timed this past week. I had a clear view that the market would not move higher in any material way during the week and that the odds were tilted meaningfully toward a decline in the equity indexes. I acted on that view, a view that was and remains well supported by the market’s over-valuation metrics. What did I learn? That I did not have all of the legs of the stool on firm ground to support acting in a material way when the correct call was to act marginally. By being too aggressive I yielded a negative return for the week. Outcomes like this make me go back to the drawing board to learn why. In this instance the question to be answered was “Why was I overly biased that the market would move down and why was that bias misplaced?”

After much thought I came to understand that I needed to compliment my analysis of the current state with a perspective of projected moves and how those potential moves would place the market in the context of past high points and past low points. It is one thing to see the current market as overvalued, but to not include an assessment of how far from the midpoint we are to the outer extremes prevents an understanding of how much the market may comfortably move higher in an otherwise overvalued state, or move lower in an otherwise undervalued state. By undertaking this additional analysis, I found that the market at the beginning of last week was not very far from the mid-point in terms of distance from an extreme high or an extreme low based on historic market ranges. Accordingly, the correct investing stance would have been to remain long of equities with modest short hedges in place that addressed the risk of overvaluation. The actions that I did take to get aggressively short through futures and options was ill-timed and resulted in losses that should have been avoided. We learn through experience from our correct and incorrect decisions, and this week I learned to include another dynamic in my assessment of where the market may move and to use this dynamic to guide me in determining the size of the hedge and risk positions I put in place.

So what is that dynamic indicating after the market index gains of the past week? It reveals a 3% upside is the distance from where market internals peaked at the last high point of November 2015, and an 8 – 12% downside is the distance from where market internals bottomed at the last low point of February 2016. To be clear, the market internal range is not based on prior index point highs or lows, but is based on the fundamental market metrics that existed at the time of those index highs and lows. We now have higher odds of a decline of magnitude versus a rise of magnitude. This supports the short hedges and a pro-active posture to meaningfully increase the risk positions that will profit from a market decline WHEN the other market factors of advancing/declining volume, issues, and New Highs/Lows show alignment with the market fundamentals of valuation. Additionally, it is important to note that the Market Tell indicator (discussed below) is at -104. This is a very strong negative reading and points to future market declines. Presently, for the S&P 500 we have a 60-point potential rise versus a 200-point potential decline. These ranges of potential moves are driven by the current market metrics, indicators, and valuation measures. One should trade/invest accordingly given the high valuation we have when compared to the earnings and cash flow results and forecasts that populate today’s market.

Prior week’s investing activity: During the past week I aggressively purchased Put Options on the S&P 500 and added more short S&P 500 E-Mini futures contracts. On Friday, after incurring losses on these positions, I closed them as I began the process of reassessing the analysis I relied upon to initiate the original investment activity. The Precious metal holdings also were down on the week and contributed to the reduction of the Year-to-Date gain within the portfolio.

My portfolio’s performance for the YTD period ending on May 27, 2016, and the portfolio composition at that date is set forth below:

The Portfolio’s composition as of May 27, 2016 is as follows:
• Cash 46.3%
• Equities 39.3%
• Gold 10.9%
• Fixed Income 3.5%

Forecast for the coming week: Last week I wrote “Yet market internals are not reflecting the voiced concerns, almost acting as if the market wants to catch the largest number of investors as is possible off-sides. Something has to give……….and there is a battle being waged.” This week the market did catch the large number of bearish investors who were short the market, including me. I expect this trend to continue, but as noted above we are approaching an extreme level of high market valuation.

My focus to improve returns on invested capital will concentrate on the downward turn that the fundamentals are indicating is needed to return to a balanced risk reward profile that supports capital investment. If we are to maintain current equity values and possibly increase them, we need an acceleration in revenues and earnings. Should we fail to realize this acceleration the market will likely reset lower to bring cost of investment in line with desired return on investment. Presently the market projections of earnings and revenue growth for 2016 and 2017 do not reflect the needed growth, so we need surprises to the upside to avoid the anticipated equity index decline that I see as the most likely outcome from today’s levels.

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

All of the indexes moved in a constructive fashion this week. Broad support is present and consistent in terms of Advancing volume and issues, coupled with New Highs and Lows validating the gains (although the NYSE New Highs were a bit lower then I would have expected). Overall trading volume was a bit off but that is typical for a holiday shortened week.

The Relative Strength readings remain in the 60s, reflecting a trending market higher. There is a concern from the perspective of downward contributors approaching a level that historically sets-up for a replenishment decline.

Price Earnings multiples are north of 24X for the S&P and 19X for the DJIA, indicating an expensive market to invest in at these levels.

The DJT remains in a declining chart pattern. It has been a leading indicator of the broader market, and with the rotational trading that has been taking place, a return to the selling of the Transports would be a strong negative for the overall market.

The DJU has come off the recent highs due to profit taking and the potential for rising interest rates.

What is the current score on the “Market Tells metric”?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 104. When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -104 reading indicates a very expensive market. The highest reading here was -182 on November 6, 2015.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 18.65X as compared to last week’s 17.90X. These are relatively high readings of price to cash flow when compared to the historic median of 16.91X.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 68 companies were priced above their DCF value which exceeds the historic average of 60 for the portfolio. This supports an expected fall in the market as more companies have become overvalued.

The dollar spread between the Current Price and the DCF price utilizing 2017 cash flow projections on the 187 Portfolio has narrowed and is now at $16.59, pulling back from the February high of $25.14. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. The difference today is below the historic median of $22.47. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains.

What is the position of the net up down Vol/Issues?

The week’s volume and issues were aligned with the index point moves. Volume was a bit lower than normal but the holiday week impacts this metric.

What are the daily point vs issues and point vs volume measures indicating up or down?

The daily metrics of (1) index point moves vs the daily volume in rising and falling issues, and (2) the index point moves vs the daily rising and falling number of issues traded, were supportive of the market direction to the upside.

Where are the New Highs and Lows moving toward?

The New Highs and New Lows this past week in both the NYSE and the NASDAQ indicated an improvement in market action and a rotation between industry sectors.

How well are Market Tells correlating with Market trading internals?

The market internals do not reflect any weakening at this point which would indicate a broader concern is emerging for the expensive value of the stocks within the market. At some point either better revenue and earnings will arise or the market will reprice equities to bring them in line with their economic value.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?

The reading is -2. Range is from +7 to -7. Contributors are:

Other:

Bitcoin is at $530 per coin and moved dramatically higher this week. The commentary in the market is that heavy buying was taking place in China in an effort to move currency out of the Yuan. The per unit value based in the low $400 area over the past three months. Over the past year, the price has increased by more than 100% from the $230 area. I hold a position in Bitcoin as we move closer to digital currencies vs paper money and coinage. Please note I also own stock in the company PayPal (symbol “PYPL”) and Square (”SQ”) given the success and reach of digital online payment platforms.

The Dollar index has rebounded from the 93 area and now sits at 95.70. Over the past twelve months it has traded between 93 and 100. The dollar appears to be range-bound in this area, and the impact of FED tightening by raising the FED Funds rate will likely increase the dollar’s strength. This is problematic for commodities, oil and emerging markets. Additionally, the Chinese currency is pegged to the US Dollar, so a rise in the dollar puts pressure on China, and may elicit a market moving response from the Chinese Financial authorities that would be negative for the equity market. Paying attention to the movement of the dollar is important given the fragile state of the global economy.

Gold closed the week at the $1,216.25 per ounce, approximately $40 lower than the prior week. The metal has been declining. In the past week, the gold miners pulled back and my portfolio reflected the negative impact of that price decline. Given the continued global uncertainty and currency volatility issues that exist, I do not see material price weakness for gold in the foreseeable future and view this decline as a pull-back before another advance higher toward the $1,300 level. I will therefore maintain my PM position to offset potential equity price declines from the broader market.

The Ten-year bond yield closed at 1.85% and has shown a great deal of volatility day-to-day. The prior trend did appear to be leaning toward lower rates but the release of the Fed minutes and the hawkish tone of FED speakers to raising interest rates has had a meaningful impact on the term structure of rates within the United States. Of concern is a flattening of the yield curve (recession) and the absence of economic activity that a steeper yield curve, if we had one, would indicate. We are above the weekly closing low for the calendar year that occurred on April 8 at 1.72%, and are still below the 2015 year-end rate of 2.27%. Our Central Bank is weighing when to institute another increase in the Fed Funds rate which could be this month. At some point this will likely weigh on the equity markets if the cost of US dollar financing rises.

Commodities: On April 29th the CRB index of commodities rose to its highest weekly closing level since July 2015. This past week, the CRB index was flat.

The High Yield vs Investment Grade spread appears to be trying to form a near-term bottom. We closed this week at 4.205% and over the past month we have been in a declining environment. This narrowing of the spread is a positive for equities as yield plays push more money toward the stock market then the bond market. High Yield is at 7.194% and Investment Grade is at 2.989%. If the oil market holds the price of a barrel near the $50 mark or higher, the health of high yield should continue to improve.

That about covers it for this week.

Watch carefully, and as always, have a great week!

Tom

Commentary: The market whipsawed me and it was not fun. I closed and or reduced a number of long positions with the expectation that the market would and will decline, and took on positions that would profit from such a decline. It is an expensive market, and expensive markets resolve themselves through unanticipated higher revenues and earnings or through price declines to bring equilibrium between economic returns and price to own those returns. I expected price declines and they did not come, and I underperformed the market as a result of the short side investments I made and the decline in price of the Gold miners as the precious metal fell by $40 per ounce this week. I do not see more changes to the portfolio other than reestablishing a meaningful short when the time is right. As I said last week, it is getting close to the time when we need to strap on our seat belts in preparation of greater volatility, price declines and a rise in the ownership of safety assets such as gold. The upcoming ride will likely not be a smooth one.

Good Luck and have a great week!

New Additions

1. Proshares Ultra Vix Short

Increase in Holdings

1. Proshares UltraPro Short S&P 500
2. Twitter

Complete Dispositions

1. Alibaba
2. Apple
3. Costamare
4. Frontline
5. Olin Corp

Partial Decrease in Holdings

1. Great Batch
2. Greenbrier
3. Nucor
4. Paypal
5. S&P 500 E-Mini Short Futures
6. Ten Cent Holdings

Overall Equity Portfolio holdings

1. Alamos Gold
2. Apple – Closed position
3. ASA
4. Arm Holdings
5. Alibaba – Closed position
6. Bank of America
7. Bank of America Preferred C
8. BB&T Corp
9. Brocade
10. Brookfield Total Return
11. Chevron
12. Con Ed
13. Costamare – Closed position
14. CISCO
15. Corning
16. Disney
17. Eastman Chemical
18. Endo Int’l
19. Ericsson
20. First Solar
21. Ford
22. Frontline – Closed position
23. General Electric
24. GLD
25. Golar LNG
26. GreatBatch – Decreased position
27. Greenbrier – Decreased position
28. Halliburton
29. Hecla Mining
30. Hershey
31. Ingredion
32. IROBOT
33. JP Morgan
34. JP Morgan Preferred D
35. Matson
36. Microsoft
37. MTN Group
38. New Gold
39. Nokia
40. Nordic American Tanker
41. Norfolk Southern
42. Nucor – Decreased position
43. Olin Corp – Closed position
44. PayPal – Decreased position
45. Phillips 66
46. Pro Shares Ultra Short – Increased position
47. Pro Shares Ultra Vix Short – Opened New position
48. Qualcomm
49. Reaves Utility Income Fund
50. S&P E-mini short futures – Reduced position
51. Square Inc
52. Synaptics
53. Ten Cent Holdings – Decreased position
54. Travelers
55. Twitter – Increased position
56. Viacom
57. Wells Fargo
58. Yahoo
59. Yum! Brands
60. Zimmer Biomet Holdings

Summary Comments:

The composite view of the 187 companies I track on a daily basis is uninspiring. Operating forecasts are weak and values are expensive. Yet internal market measures are range-bound, neither high or low in offering direction for the next likely move in the overall market. Couple the market measures with uninspiring economic trends and Central Bank uncertainty, and this is what an Ebb Tide feels like.

My gut tells me the market wants to go higher not lower, yet it cannot find the catalyst to do so. If an upside catalyst does not materialize soon, the market will likely break to the downside as fatigue from hanging in this environment of thin air will force a descending move to create some breathing space.

Some facts to put a light on the character of the dilemma:

1. The Levered Cash flow growth rate over the next 3 years for the 187 companies I track is at its lowest level since right after the 2008 Financial Crisis. Current forecast is for 8.94% annual growth, which compares to over 18% in 2006, and over 10% in 2014 (it has been in a constant state of decline over the past two years).

2. The Enterprise Value (market equity value plus net debt) divided by EBITDA (earnings before interest, taxes, depreciation and amortization) is at its highest level in six years, indicating that the combined equity price plus debt is very high compared to internally generated cash from operations.

3. Earnings multiples are significantly above historic norms.

4. Interest rates are significantly below historic norms

5. The normal favorability of interest rate returns above dividend returns has collapsed in this low interest rate environment. From a yield perspective investors prefer to receive dividends from stock ownership over interest payments from debt instruments (the current yield spread is only eight tenths of one percent). This drives stock buying in search of yield.

6. The investing activity in rising stocks versus declining stocks in slightly biased to the upside but offers no clear direction that is normally found in extreme readings or turning points. Everyone is treading water.

7. Economic indicators are all slightly below zero in terms of period over period change. Minimal to negative growth is what our economy is telling us.

Prior week’s investing activity: During the past week I bought more small stakes in a number of companies, but I did not commit any meaningful capital to work. I closed and/or reduced my market short positions, lost some value due to declines in the precious metal miners I hold, and increased a short position in one particular company using a vertical option spread.

My portfolio’s performance for the YTD period ending on May 20, 2016, and the portfolio composition at that date is set forth below:

• Cash 50.8%
• Equities 32.9%
• Gold 14.7%
• Fixed Income 1.6%

Forecast for the coming week: There are many things weighing on the psyche of the market. Sentiment wants to take the market higher. The calendar with the Fed, Brexit and BOJ creates great uncertainty. Market leading investors are voicing concerns and expectations of a meaningful market decline. The movement of the US Dollar higher and the impact on commodities and emerging markets is of great concern. Yet market internals are not reflecting the voiced concerns, almost acting as if the market wants to catch the largest number of investors as is possible off-sides. Something has to give……….and there is a battle being waged.
My forecast for the week is more of the same meandering. I will not commit more capital to work until this market corrects down or real economic growth suddenly materializes. I will continue to hold my Gold investments to protect my net worth in these very uncertain times. I will look to go short quickly if we get any market dislocations, for the recent battering of the lower resistance points in the charts of the equity indexes could cause them to give way to dramatic moves lower. I am pessimistic, but forever hopeful that we will find a strong bottom that is followed by economic growth and a return to real productivity that benefits all.

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

After three weeks of declines in the DJIA, the DJT, the S&P 500 and the NASDAQ, this past week saw all but the DJIA bounce higher. The Relative Strength readings have all moved into the 60s, reflecting a weakening from the prior weeks. This is reflective of the recent point declines, and helps to clear away excesses of the past bounces higher. We are now moving to more of a neutral position in the RS readings.

Price Earnings multiples are north of 23.72X for the S&P and 18.71X for the DJIA, indicating an expensive market to invest in at these levels.

The DJT bounced higher this week but remains in a declining chart pattern. It has been a leading indicator of the broader market, and with the rotational trading that has been taking place, a return to the selling of the transports would be a strong negative for the overall market.

The DJU had a meaningful correction down and reflects the expensive nature of the DJU given the prior investor preference for yield and safety being challenged by a potential rise in interest rates coming from the Federal Reserve. If it continues to move lower and there is an absence of confirming economic growth, this may be an area to once again invest in after its correction down has run its course.

What is the current score on the “Market Tells metric”?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 11. When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -11 reading indicates a mildly expensive market but is not reflective of a market that has come too far too fast.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 17.95X as compared to last week’s 17.76X. These are relatively high readings of price to cash flow when compared to the historic median of 16.91X. Of greater concern to me is the coupling of this high multiple based on current price and the 2016 year expected performance with the low growth rate over the following three years that is noted earlier in this letter. Subpar growth on a high multiple is not supportive of higher future prices.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 65 companies were priced above their DCF value which exceeds the historic average of 60 for the portfolio. This supports an expected fall in the market as more companies have become overvalued.

The dollar spread between the Current Price and the DCF price utilizing 2017 cash flow projections on the 187 Portfolio has narrowed and is now at $19.51, pulling back from the February high of $25.14. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. The difference today is below the historic median of $22.51. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains.

What is the position of the net up down Vol/Issues?

The week’s volume and issues were aligned with the index point moves. Having said this, there was no directional indication that greater declines or increases are likely. This lack of a tidal buildup tells me the overall market is not expecting a strong move in either direction.

What are the daily point vs issues and point vs volume measures indicating up or down?

The daily metrics of (1) index point moves vs the daily volume in rising and falling issues, and (2) the index point moves vs the daily rising and falling number of issues traded, were supportive of the market direction to the upside.

Where are the New Highs and Lows moving toward?

The New Highs and New Lows this past week in both the NYSE and the NASDAQ indicated a slight weakening in market action and a rotation between industry sectors. This is of concern as it feels like the child’s party game of trying to find a seat when the music stops, a “game” that has been embraced by the traders and will be in full swing until we get a dramatic move one way or the other. Remember, at some point the seats dwindle to the point where there is no place left to go.

How well are Market Tells correlating with Market trading internals?

Technically, the 5-day activity in volume and issues is supporting the change in prices but not with any degree of enthusiasm that strongly pushes sentiment one way or the other.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?

The reading is -5. Range is from +7 to -7. Contributors are:

Other:

Bitcoin is at $441 per coin and is showing stable growth development. The per unit value based in the low $400 area over the past three months. Over the past year, the price has increased by roughly 100% from the $230 area. I hold a position in Bitcoin as we move closer to digital currencies vs paper money and coinage. Please note I also own stock in the company PayPal (symbol “PYPL”) and Square (”SQ”) given the success and reach of digital online payment platforms.

Gold closed the week at the $1,252.9 per ounce, approximately $20 lower than the prior week. The metal has been range bound lately, and has failed to break through the $1,300 per ounce level. In the past week, the gold miners pulled back and my portfolio reflected the negative impact of that price decline. Given the continued global uncertainty and currency volatility issues that exist, I do not see material price weakness for gold in the foreseeable future and will therefore maintain my PM position to offset potential equity price declines from the broader market.

The Ten-year bond yield closed at 1.84% and has shown a great deal of volatility day-to-day. The prior trend did appear to be leaning toward lower rates but this past week’s release of the Fed minutes and the hawkish tone to raising interest rates had a meaningful impact on the term structure of rates within the United States. Of concern is a flattening of the yield curve (recession) and the absence of economic activity that a steeper yield curve would imply. We are above the weekly closing low for the calendar year that occurred on April 8 at 1.72%, and are still below the 2015 year-end rate of 2.27%. Our Central Bank is weighing when to institute another increase in the Fed Funds rate. At some point this will likely weigh on the equity markets if the cost of US dollar financing rises.

Commodities: On April 29th the CRB index of commodities rose to its highest weekly closing level since July 2015. This past week, the CRB index weakened along with the strengthening of the US Dollar. This decline in prices hurts the Emerging Markets.

The High Yield vs Investment Grade spread appears to be trying to form a near-term bottom. We touched 4.255% on May 2nd and since then there has been a modest turn upwards. We closed this week at 4.314% and over the past three weeks the range has been very tight in terms of the spread. If this spread breaks out and moves upward this will be problematic for the equity markets as it will reflect greater market risk.

That about covers it for this week. I remain less aggressive and committed in terms of conviction than I like to be, but sometime you just have to play the hand you are dealt.

Watch carefully, and as always, have a great week!

Tom

Commentary: The market showed this week that it can bend without breaking. I was surprised, for I thought it would break. I positioned my portfolio to capture significant gains from a dislocation to lower levels, and while I did move in and out as the market moved, my gains from the moves were muted by the lack of decline in the overall indexes and the softness in the price of the Precious Metal Mining group. At week’s end I paired back some of my short exposure and added to select equites, including two preferred issues that yield close to 6%. The volatility in the market is without conviction to higher or lower levels. This makes it difficult to navigate which drives many decisions to safety, such as the Preferred Issues I note above. At some point we will see this market move with purpose, either to challenge new highs or to retest recent lows. Sentiment wants to move the market higher, fundamentals are pointing lower. Technical indicators are short-term unbiased, but chart patterns of the indexes are mid-term bearish. It will be eventful in the not too distant future, so put on your seat belts and be careful, very careful.

Good Luck and have a great week!

New Additions
1. Bank of America
2. Bank of America Preferred C
3. JP Morgan Preferred D

Increase in Holdings
1. Brookfield Total Return
2. First Solar
3. Greenbrier
4. Hecla Mining
5. Netflix Put Option position
6. Square Inc
7. Synaptics
8. Twitter

Complete Dispositions
1. Proshares UltraPro Short S&P 500

Partial Decrease in Holdings
1. S&P 500 E-Mini Short Futures

Overall Equity Portfolio holdings

1. Alamos Gold
2. Apple
3. ASA
4. Arm Holdings
5. Alibaba
6. Bank of America
7. Bank of America Preferred C – Opened New Position
8. BB&T Corp
9. Brocade
10. Brookfield Total Return – Increased position
11. Chevron
12. Con Ed
13. Costamare
14. CISCO
15. Corning
16. Disney
17. Eastman Chemical
18. Endo Int’l
19. Ericsson
20. First Solar – Increased position
21. Ford
22. Frontline
23. General Electric
24. GLD
25. Golar LNG
26. GreatBatch
27. Greenbrier – Increased position
28. Halliburton
29. Hecla Mining – Increased position
30. Hershey
31. Ingredion
32. IROBOT
33. JP Morgan
34. JP Morgan Preferred D – Opened New Position
35. Matson
36. Microsoft
37. MTN Group
38. New Gold
39. Nokia
40. Nordic American Tanker
41. Norfolk Southern
42. Nucor
43. Olin Corp
44. PayPal
45. Phillips 66
46. Pro Shares Ultra Short – Closed position
47. Qualcomm
48. Reaves Utility Income Fund
49. S&P E-mini short futures – Reduced position
50. Square Inc – Increased Position
51. Synaptics – Increased position
52. Ten Cent Holdings
53. Travelers
54. Twitter – Increased position
55. Viacom
56. Wells Fargo
57. Yahoo
58. Yum! Brands
59. Zimmer Biomet Holdings

Summary Comments:
Listen. It is one of the most important things we do and it must be done well to realize success.

This past week I went for a 5 mile run in Central Park. At the 3 mile mark my right calf muscle began to ache. I know this ache, for I have torn my calf muscles four times, three while running and once while skiing. I had a decision to make, press on to my goal with the risk that I would tear the muscle or stop my run. Tearing the muscle would take running away from me for anywhere from three to six months. I listened to my body. Stopping when I did served to keep me in the game. I just ran three miles today, Saturday, and it felt great.

Listen to your body, listen to the market, simply listen in life, and then, when digested and understood, respond in a way that protects you for the future while capitalizing on the opportunity of today.

As I listen to the market, I hear and feel an internal weakening, a need to reset, a need to create a value opportunity that is presently absent. The message from the market, its rhythm, its feel, echoes with the lyrics of Buffalo Springfield’s “For What it’s Worth”:

“There’s something happening here, what it is ain’t exactly clear….
…I think it’s time we stop, children, what’s that sound….”

For the past three weeks the market has been meandering, digesting a strong ten week upward move that countered an equally strong ten week downward move. This week, the market moved in a way that seemed to say, “Listen to me, take my pulse, feel and hear what I am telling you, and make a decision of whether to press on or to protect yourself.” This is what I listened to, and how I am acting in response:

• The revenue and earnings for the first calendar quarter of 2016 and the guidance for the future is weak. To be clear, the S&P 500 earnings forecast for 2016 that existed on January 1, 2016 was 6.63% higher than it is today, yet the market is basically the same price.
• On a weekly comparison basis, the NASDAQ index is meaningfully weaker than the DJIA and the S&P 500. On September 18, 2015 the NASDAQ peaked at a value that was 29.46% of the DJIA. Since then, the NASDAQ has declined consistently and on a relative basis today is at 26.90% of the DJIA.
• Economic trends are uninspiring. Domestic Auto production, Durable Goods, Factory Shipments, Factory Operating rates, Industrial Production, Business Sales, and New Factory Orders are all below the prior year, and reflect a continued decline in growth since 2013.
• Free Reserves in the US Banking system peaked in August 2014. Today they are $430 billion less as the FED has ended its QE program thereby withdrawing liquidity from the market.
• On a daily closing basis, this Friday the DJIA broke support that was important if we were to try and challenge the past highs in the market. The action in the market points to further weakness, and last week’s market commentary report “Aligning the Sun, the Moon and the Stars with Leadership” reflects the downward alignment that I see in the market. A 1,000 point DJIA decline would be consistent with the pattern and set-up of the market’s behavior.
• The Dow Jones Transports has broken support and is heading lower.
• The US Dollar that had been weakening after the G-20 Finance minister meeting in February found strength this week. If the US Dollar continues to strengthen the implications throughout the asset price chain is for lower prices.
• The 11 and 22 day averages of net volume have become strongly negative in a way that is very similar to patterns that have preceded large equity index declines in the past.

The market questions and answers that will be discussed below echo with the sounds of fatigue, of lackluster energy, of a tired market that wants to reset. Accordingly, I am more strongly positioned on the short side, coupled with cash ready and willing to be invested should the reset deliver value opportunities that are compelling.

During the past week I reshuffled parts of the portfolio, buying some beaten down names and increasing my short hedges. The Gold Miner equities sold off again this week but I held my positions as I see future strength given the uncertainty that exists in the market and the underweight of gold investing in most market portfolios. My portfolio’s performance for the YTD period and the resulting period-end portfolio asset allocation is set forth below.

The Connolly portfolio and the market performance for the Year-to-Date period ending on May 13, 2016 is as follows:

Portfolio composition as of May 13, 2016 is as follows:
• Cash 50.5%
• Equities 33.1%
• Gold 14.9%
• Fixed Income 1.5%

Forecast for the week: I am currently positioned, and will likely expand that position, to profit from a market decline. This past week’s breaking of downward resistance on the daily charts has me focused on the weekly charts for confirmation of weakness in the coming week. A decline of 40+ points on the NASDAQ creates the momentum to contract market multiples with significant price drops. A 30+ point decline on the DJIA then brings a 300 point decline into play, and if that does not hold, there is a vacuum lower. An S&P 500 decline of 20+ points brings into play a 30 point decline, and if this does not hold, the decline will accelerate rapidly. There is material risk in the market today, and everyone should be very careful.

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?

All of the indexes, other than the Utilities, are showing weakness to the downside. The NASDAQ is the most pronounced in pointing to continued declines. The consistency, whether in Relative Strength readings north of 70 for DJIA, S&P and NASDAQ that are weakening, earnings multiples north of 23.65X for the S&P and 18.77X for the DJIA, and chart patterns that reveal resistance to further moves to new highs, indicates meaningful risk exists to any investor who puts additional capital to work in equities.

The DJT has dropped under support and look as though greater declines are in store for this index. If it continues to break lower it could quickly drop by approximately 1,000 points.

The DJU had a meaningful correction down of approx. 5% in late April but has now reversed and is back close to new highs. It continues to reflect the safety of yield in a nervous world of Central Bank easing and Negative interest rates on foreign government debt.

What is the current score on the “Market Tells metric”?

The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 11. When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -11 reading indicates an only mildly expensive market. If we get the market declines that the other indicators are forecasting, we should see real value opportunities begin to emerge on the Market Tells metric.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 17.76X as compared to last week’s 17.93X. These are relatively high readings of price to cash flow when compared to the historic median of 16.8X.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 65 companies were priced above their DCF value which exceeds the historic average of 60 for the portfolio. This supports an expected fall in the market as more companies have become overvalued.

The dollar spread between the Current Price and the DCF price utilizing 2017 cash flow projections on the 187 Portfolio has narrowed and is now at $20.31, pulling back from the February high of $25.14. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. The difference today is below the historic median of $22.53. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains.

What is the position of the net up down Vol/Issues?

The week’s volume and issues were aligned with the index point decline. Having said this, there was no directional indication that greater declines or a reversal to the upside are likely. This lack of a tidal buildup tells me the overall market is not expecting a strong move in either direction, which I believe is wrong and if the momentum starts to swing it could result in large moves as the crowd moves to one side or the other.

What are the daily point vs issues and point vs volume measures indicating up or down?

The daily metrics of (1) index point moves vs the daily volume in rising and falling issues, and (2) the index point moves vs the daily rising and falling number of issues traded, were supportive of the market direction.

Where are the New Highs and Lows moving toward?

There is divergence in terms of degree between the New York Stock Exchange and the NASDAQ. The companies traded on the NYSE are exhibiting an expansion of both New Highs and New Lows. The companies on the NASDAQ are showing fewer New Highs and an expanding number of New Lows over the past three weeks. Combined as a market measure, this is a net negative.

How well are Market Tells correlating with Market trading internals?

Technically, the 5-day activity in volume and issues is supporting falling prices but not with any degree of enthusiasm that strongly pushes sentiment one way or the other. The fundamentals of the Market are indicating a somewhat expensive story. A breakout to the downside feels as though it is pulsing beneath the surface given the overall combination of technical and fundamental indicators.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?
The reading is -6. Range is from +7 to -7. Contributors are:

Other:

Bitcoin is at $455 per coin and is showing stable growth development. The per unit value based in the low $400 area over the past three months. Over the past year, the price has increased by roughly 100% from the $230 area. I hold a position in Bitcoin as we move closer to digital currencies vs paper money and coinage. Please note I also own stock in the company PayPal (symbol “PYPL”) given the success and reach of its digital online payment platform and, in the mobile space, its penetration of the Millennial generation with the Venmo App platform for mobile devices.

Gold closed the week at the $1,274.30 per ounce. Continued currency weakness and Central Bank actions to keep interest rates at low or at negative levels is supporting the price of Gold. Additionally, China continues to purchase meaningful quantities of Gold and just launched a Gold trading vehicle priced in their local currency vs US dollars. The price action and the demand for equities of Gold and Silver mining companies has been very strong this year. Many of these companies have more than doubled in price.

The Ten-year bond yield closed at 1.70% and has shown a great deal of volatility day-to-day. The trend does appear to be leaning toward lower rates. We are below the weekly closing low for the calendar year that occurred on April 8 at 1.72%, and is well below the 2015 year-end rate of 2.27%. Our Central Bank is weighing when to institute another increase in the Fed Funds rate. At some point this will likely weigh on the equity markets if the cost of US dollar financing rises.

Commodities: On April 29th the CRB index of commodities rose to its highest weekly closing level since July 2015. This past week, the CRB index is firm. This rise in prices helps the Emerging Markets navigate the economic challenges of being resource providers to the world markets. With higher raw material prices in the world markets they can sell their natural resources at better prices and thereby support the social and economic needs of their countries at a more comfortable level. As a precautionary note, I should point out that any strength in the dollar and associated rise in US interest rates will likely cap any future price increases here.

The High Yield vs Investment Grade spread has found a near-term bottom it appears. We touched 4.255% on May 2nd and since then there has been a turn upwards. We closed this week at 4.457%. If this spread continues to move upward this will be problematic for the equity markets as it will reflect greater market risk is being priced into the overall financial markets.

That about covers it for this week. I believe we are in the midst of a transition to lower prices in the equity market.

Watch carefully, and as always, have a great week!

Tom

Commentary: The market activity this week tracked what I anticipated, with early gains ultimately fading into a net loss for the week. This had me relatively quiet as I waited to see if trend confirmation to the downside was to occur. Sure enough on Friday the market reversed off of its bounce higher in the morning and kept pressing lower throughout the day. I added to my E-Mini short once mid-day resistance points were breached on Friday. The companies I increased my long positions in were very modest in size as I do not believe the selling is done, but nonetheless felt there was value to be bought, and so in small increments I added to existing positions. Risk remains to the downside, so trade carefully.
Good Luck and have a great week!

New Additions
1. None

Increase in Holdings
1. Apple
2. Brocade Communications
3. First Solar
4. Nokia
5. Qualcomm
6. Square Inc
7. S&P E-mini short futures position
8. Twitter
9. Yum Brands

Complete Dispositions
1. Google

Partial Decrease in Holdings
1. None

Overall Equity Portfolio holdings
1. Alamos Gold
2. Apple – Increased position
3. ASA
4. Arm Holdings
5. Alibaba
6. BB&T Corp
7. Brocade – Increased position
8. Brookfield Total Return
9. Chevron
10. Con Ed
11. Costamare
12. CISCO
13. Corning
14. Disney
15. Eastman Chemical
16. Endo Int’l
17. Ericsson
18. First Solar – Increased position
19. Ford
20. Frontline
21. General Electric
22. GLD
23. Golar LNG
24. Google (Alphabet) – Closed position
25. GreatBatch
26. Greenbrier
27. Halliburton
28. Hecla Mining
29. Hershey
30. Ingredion
31. IROBOT
32. JP Morgan
33. Matson
34. Microsoft
35. MTN Group
36. New Gold
37. Nokia – Increased position
38. Nordic American Tanker
39. Norfolk Southern
40. Nucor
41. Olin Corp
42. PayPal
43. Phillips 66
44. Pro Shares Ultra Short
45. Qualcomm – Increased position
46. Reaves Utility Income Fund
47. S&P E-mini short futures – Increased position
48. Square Inc – Increased Position
49. Synaptics
50. Ten Cent Holdings
51. Travelers
52. Twitter – Increased position
53. Viacom
54. Wells Fargo
55. Yahoo
56. Yum! Brands – Increased position
57. Zimmer Biomet Holdings

Summary Comments:

Who is leading whom?

Having a leader is the natural order of things. All species seek order through the presence of one who leads. This serves to create a form of social process that provides comfort and assurance to the larger group that there is a unified direction on which we can move as one and not as a divergent group that moves randomly with a meandering sense of chaos. However, in order to realize success, leadership must be accompanied by alignment.

Markets also need leadership, and as we engage in market making activities we search for where the leadership exists at any point in time. Identifying the leader and the leader’s potential to remain in that role through real or perceived strength is very often the way in which we successfully position our participation that maximizes returns. In today’s financial markets we have seen a struggle for leadership amidst conflicting information and a swirling rip tide that often emerges suddenly with movement that was not anticipated. In this week’s report I will offer my perspective on the leadership that I see in the murky waters of the investing sphere but more importantly, it is the emerging alignment that strongly indicates to me that the market leaders are now deciding which way to move in unison.

For quite some time market leadership has been found in interactive digital media (think Facebook, Amazon, Netflix, and Google (“FANG”)), Biotech and Pharma (think Valeant, Celgene, Gilead, Mylan, Allergan, Biogen, etc), and Commodity/Energy plays. One by one they have fallen, with upward leadership now becoming more and more narrow, while downward leadership has been expanding in numbers. This troubles me from an overall market perspective and with recent concerns about Apple, Microsoft, Google, Netflix the semi-conductor chip companies, coupling with a possible retracement by energy and continued softness in Life Sciences, the continued expansion of downward pressure has more than a mere correction feel to it. It has alignment.

To give you an idea of how this downward leadership and alignment shows up in one underlying metric, consider these two facts: (1) Between April 22nd and April 29th the Dow Jones Industrial Average fell by 230 points. The number of declining issues for that week totaled 1,528 companies. Between April 29th and May 6th the DJIA fell comparatively by only 33 points, yet the number of declining issues totaled 1,759 yielding an additional 231 companies with declining prices for the week; and (2) for the same periods noted above and looking at the more tech heavy NASDAQ exchange we see an April 22nd to April 29th point decline of 131 points with 1,853 declining issues, and the April 29th to May 6th point decline of only 39 points with 2,001 declining issues. Again, more companies went down in price on the NASDAQ during a week when the index was less negative. This is a warning as the breadth is expanding to the downside at a faster pace then the indexes are declining, confirming a narrowing of upside leadership and the expanding of downside leadership. A fragile market is the current state, so be very careful in how you position yourself. Additionally, the NASDAQ is falling faster than the other indexes and is taking the lead as it seeks a new lower foundation. The other equity exchanges will likely follow the leader as more and more of the broader market internals align with the NASDAQ index path lower.

The market questions and answers that will be discussed below confirm this trend but, more importantly, the mixed signals of the prior weeks have now been replaced with greater alignment of direction for the majority of indicators. That alignment coupled with the former upward leaders now leading to the downside is a dangerous combination.

During the past week I reshuffled parts of the portfolio, buying some beaten down names and moving my short hedges around the markets movements. The Gold Miner equities sold off during the week but did bounce up on Friday, but not enough to make up for the earlier declines. I still hold the miners as a hedge and believe they are destined to move higher in a turbulent market. My portfolio’s performance for the YTD period and the resulting period-end portfolio asset allocation is set forth below.

The Connolly portfolio and the market performance for the Year-to-Date period ending on May 6, 2016 is as follows:

YTD Connolly portfolio gain as of May 6, 2016 equals +5.90%
S&P 500 Index YTD gain as of May 6, 2016 equals +0.65%
NASDAQ Index YTD loss as of May 6, 2016 equals -5.42%

Portfolio composition as of May 6, 2016 is as follows:
• Cash 50.5%
• Equities 33.0%
• Gold 15.0%
• Fixed Income 1.5%

Forecast for the week: Given the recent weekly declines in the indexes a technical bounce higher would not surprise me. I expect the market to begin the week with upside action that fades. Having said this, simply due to the structure of the charts, the change in market internals and the fundamental expensive nature of the present market causes me to focus on preparing for a great level of risk that the market will decline to levels that are meaningfully below where we currently reside. So if we get the upside bias this week, I will use it to prepare for the anticipated deeper pull-back I foresee within the next eight or so weeks.

What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?
All of the indexes are showing weakness to the downside. The NASDAQ is the most pronounced in pointing to continued declines. The consistency, whether in Relative Strength readings north of 70, earnings multiples north of 24X for the S&P and 19X for the DJIA, and chart patterns that reveal resistance to further moves to new highs, indicates meaningful risk exists to any investor who puts additional capital to work in equities.

The DJT has reversed to the downside and is now joining the NASDAQ in leading the market trend down. It is at a resistance point and if it can break higher it would be a positive sign for the overall market, however if it breaks lower through this resistance it could quickly drop by approximately 1,000 points.

The DJU had a meaningful correction down of approx. 5% in late April but has now reversed and is back close to new highs. It continues to reflect the safety of yield in a nervous world of Central Bank easing and Negative interest rates on foreign government debt.

What is the current score on the Market tells metric?
The Market Tell indicator, which is a comparison of the market’s current cash flow and valuation metrics to its historic medians, closed the week at negative 13. When we have a high positive reading this is a strong buy signal and when we have a high negative reading it is a strong sell signal. The -13 reading indicates an only mildly expensive market and reflects the pullback of the past two weeks as its prior reading was -41.

The Portfolio’s Cash flow multiple based on expected 2016 full year results is 17.93X as compared to last week’s 17.74X. These are relatively high readings of price to cash flow when compared to the historic median of 16.8X.

Comparing current equity prices as the week closed on the 187 portfolio companies to their Discounted Cash Flow values indicates 65 companies were priced above their DCF value which exceeds the historic average of 60 for the portfolio. This supports an expected fall in the market as more companies have become overvalued.

The dollar spread between the Current Price and the DCF price utilizing 2017 cash flow projections on the 187 Portfolio has narrowed and is now at $19.69, pulling back from the February high of $25.14. A higher spread indicates greater value to invest in whereas a lower spread indicates subpar returns will be realized from investing at current prices. The difference today is below the historic median of $22.52. In this environment it should be apparent that future performance has been pulled into the current pricing in a manner that reduces potential gains.

What is the position of the net up down Vol/Issues?
The week’s volume and issues were aligned with the index point decline. There was higher volume on down days and greater volume into declining equities then rising equities.

What are the daily point vs issues and point vs volume measures indicating up or down?
The daily metrics of (1) index point moves vs the daily volume in rising and falling issues, and (2) the index point moves vs the daily rising and falling number of issues traded, were consistently declining and supportive of a market that should move lower.

Where are the New Highs and Lows moving toward?
There is divergence in terms of degree between the New York Stock Exchange and the NASDAQ. The companies traded on the NYSE have a relatively static number of New Highs over New Lows whereas the companies on the NASDAQ delivered a greater number of New Lows over New Highs. The NASDAQ results are troublesome because companies hitting new 52 week lows should be small in number given where the index is now (down 5.42% YTD) vs where it was in February (down 13.4% YTD).

How well are Market Tells correlating with Market trading internals?
Technically, the 5-day activity in volume and issues is supporting falling prices. The fundamentals of the Market are indicating an expensive story and so these two are re-enforcing one another in terms of calling for a market decline.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation Index (“CEDATEV”)?

The reading is -4. Range is from +7 to -7. Contributors are:

Negative in the following areas:

Other:
Bitcoin is at $459 per coin and is showing stable growth development. The per unit value based in the low $400 area over the past two months but this week it advanced again. Over the past year, the price has increased by roughly 100% from the $230 area. I hold a position in Bitcoin as we move ever closer to digital currencies vs paper money and coinage. Please note I also own stock in the company PayPal (symbol “PYPL”) given the success and reach of its online payment platform and, in the mobile space, its penetration of the Millennial generation with the Venmo App platform on mobile devices.

Gold closed the week at the $1,289.70 per ounce. Continued currency weakness and Central Bank actions to keep interest rates at low or negative levels is supporting the price of Gold. Additionally, China continues to purchase meaningful quantities of Gold and just launched a Gold trading vehicle priced in their local currency vs US dollars. The price action and the demand for equities of Gold and Silver mining companies has been very strong. Many of these companies have more than doubled in price since the beginning of the year.

The Ten-year bond yield closed at 1.78% and has shown a great deal of volatility day-to-day. The trend does appear to be leaning toward lower rates. We are near the weekly closing low for the calendar year that occurred on April 8 at 1.72%, and is well below the 2015 year-end rate of 2.27%. Our Central Bank is weighing when to institute another increase in the Fed Funds rate. At some point this will likely weigh on the equity markets if the cost of US dollar financing rises.

Commodities: On April 29th the CRB index of commodities rose to its highest weekly closing level since July 2015. The past week saw a slight pull-back. This rise in prices helps the Emerging Markets navigate the economic challenges of being resource providers to the world markets. With higher raw material prices in the world markets they can sell their natural resources at better prices and thereby support the social and economic needs of their countries at a more comfortable level. As a precautionary note, I should point out that any strength in the dollar and associated rise in US interest rates will likely cap any future price increases here.

The High Yield vs Investment Grade spread has found a near-term bottom it appears. We touched 4.255% on May 2nd and since then each day has seen a turn upwards. We closed this week at 4.512%. If this spread continues to move upward this will be problematic for the equity markets as it will reflect greater market risk is being priced into the overall financial markets.

That about covers it for this week. I believe we are in a period of transition to lower prices in the equity market.

Watch carefully, and as always, have a great week! Happy Mother’s Day to all.

Tom

Commentary: The market is providing some indications of value opportunities which caused me to reduce my net overall short hedge position (reduced my E-Mini S&P 500 short, but also added to my Pro-Shares Ultra Short). Having said this, I am troubled by the price action of the broader equities that showed greater weakness than the indexes would imply. Cross-currents are very evident and as a result, for me, this is a very unsteady stock market. In regard to opportunities that I acted upon, price declines made some equities more attractive to me. Small bite sized long trades were the order of the week, and I remain ready to pause in buying and to more aggressively short the overall market. As always, patience is the key here and it will dominate my attitude as I watch each and every move in the upcoming days ahead.
Good Luck and have a great week!

New Additions
1. Google
2. IROBOT
3. Square Inc

Increase in Holdings
1. Apple
2. Brookfield Total Return
3. Endo Int’l
4. Frontline
5. Golar LNG
6. Hecla Mining
7. Matson Inc
8. Pro-Shares Ultra Short
9. Twitter
10. Yahoo

Complete Dispositions
1. Great British Pound Short Position

Partial Decrease in Holdings
1. Alibaba
2. Olin Corp
3. Reaves Utility Income Fund

Overall Equity Portfolio holdings
1. Alamos Gold
2. Apple – Increased position
3. ASA
4. Arm Holdings
5. Alibaba – Reduced position
6. BB&T Corp
7. Brocade
8. Brookfield Total Return – Increased position
9. Chevron
10. Con Ed
11. Costamare
12. CISCO
13. Corning
14. Disney
15. Eastman Chemical
16. Endo Int’l – Increased position
17. Ericsson
18. First Solar
19. Ford
20. Frontline – Increased position
21. General Electric
22. GLD
23. Golar LNG – Increased position
24. Google (Alphabet) – New Position
25. GreatBatch
26. Greenbrier
27. Halliburton
28. Hecla Mining – Increased position
29. Hershey
30. Ingredion
31. IROBOT – New position
32. JP Morgan
33. Matson – Increased position
34. Microsoft
35. MTN Group
36. New Gold
37. Nokia
38. Nordic American Tanker
39. Norfolk Southern
40. Nucor
41. Olin Corp – Reduced position
42. PayPal
43. Phillips 66
44. Pro Shares Ultra Short – Increased position
45. Qualcomm
46. Reaves Utility Income Fund – Reduced position
47. Square Inc – New Position
48. Synaptics
49. Ten Cent Holdings
50. Travelers
51. Twitter – Increased position
52. Viacom
53. Wells Fargo
54. Yahoo – Increased position
55. Yum! Brands
56. Zimmer Biomet Holdings

Commentary: I took advantage of what I think are market opportunities this past week. Apple, First Solar, Synaptics and Twitter sold off meaningfully this week. In each of them I see long-term value and added modestly at this time. The market strikes me as being in flux with a great degree of uncertainty being felt by investors. In that there is often opportunity. At the moment I seek returns from short positions (S&P 500 E-Minis) that hedge my long portfolio and will be quick to liquidate them based on market changes. I also opened a short position in the UK Pound that reflects the Brexit tension and a view that the US dollar may bounce higher. My weekly market analysis post indicates the dollar may continue to weaken, so I will be very watchful of FX moves to cut any losses very quickly. I expect volatility as there is much confusion out there so please be careful.
Good Luck and have a great week!

New Additions
1. Apple
2. Pro Shares Ultra Short
3. Yahoo
4. Sold Great Britain Pounds

Increase in Holdings
1. First Solar
2. Synaptics
3. Twitter

Complete Dispositions
1. None

Partial Decrease in Holdings
1. None

Overall Equity Portfolio holdings

1. Alamos Gold
2. Apple – New Addition
3. ASA
4. Arm Holdings
5. Alibaba
6. BB&T Corp
7. Brocade
8. Brookfield Total Return
9. Chevron
10. Con Ed
11. Costamare
12. CISCO
13. Corning
14. Disney
15. Eastman Chemical
16. Endo Int’l
17. Ericsson
18. First Solar – Increased position
19. Ford
20. Frontline
21. General Electric
22. GLD
23. Golar LNG
24. GreatBatch
25. Greenbrier
26. Halliburton
27. Hecla Mining
28. Hershey
29. Ingredion
30. JP Morgan
31. Matson
32. Microsoft
33. MTN Group
34. New Gold
35. Nokia
36. Nordic American Tanker
37. Norfolk Southern
38. Nucor
39. Olin Corp
40. PayPal
41. Phillips 66
42. Pro Shares Ultra Short – New Addition
43. Qualcomm
44. Reaves Utility Income Fund
45. Synaptics – Increased position
46. Ten Cent Holdings
47. Travelers
48. Twitter – Increased position
49. Viacom
50. Wells Fargo
51. Yahoo – New Addition
52. Yum! Brands
53. Zimmer Biomet Holdings