Equity Portfolio Activity for the Week Ended May 27, 2016

Equity Portfolio as of May 27, 2016

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

In Search of a Catalyst

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning May 23, 2016
With Market Questions and Answers

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:

YTD Connolly portfolio gain as of May 20, 2016 equals +4.51%
S&P 500 Index YTD gain as of May 20, 2016 equals +0.41%
NASDAQ Index YTD loss as of May 20, 2016 equals -4.75%

Portfolio composition as of May 20, 2016 is as follows:

• 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.

Market Questions and Answers

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:

Negative in the following areas:
Environment
Duration
Calendar
Valuation
Trend

Positive in the following areas:
None

Neutral in the following areas:
Action
Emotion

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

Equity Portfolio Activity for the Week Ended May 20, 2016

Equity Portfolio as of May 20, 2016

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

Listen to the Rhythm and Pulse of the Market

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning May 16, 2016
With Market Questions and Answers

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:

YTD Connolly portfolio gain as of May 13, 2016 equals +5.53%
S&P 500 Index YTD gain as of May 13, 2016 equals +0.13%
NASDAQ Index YTD loss as of May 13, 2016 equals -5.79%

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.

Market Questions and Answers

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:

Negative in the following areas:
Environment
Duration
Action
Valuation
Trend
Emotion

Positive in the following areas:
None

Neutral in the following areas:
Calendar

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

Equity Portfolio Activity for the week ended May 13, 2016

Equity Portfolio as of May 13, 2016

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

Aligning the Sun, the Moon and the Stars with Leadership

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning May 9, 2016
With Market Questions and Answers

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.

Market Questions and Answers

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:

Environment
Valuation
Trend
Emotion

Positive in the following areas:
None

Neutral in the following areas:
Calendar
Duration
Action

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

Equity Portfolio Activity for the week ended May 6, 2016

Equity Portfolio as of May 6, 2016

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

Equity Portfolio Activity for the Week Ended April 29, 2016

Equity Portfolio as of April 29, 2016

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

The Plaza Accord Revisited 2016 Style

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning May 2, 2016
With Market Questions and Answers

Summary Comments:
They say a picture is worth a thousand words. As I contemplated what was top of mind for me this week, my thoughts kept coming back to the relative value of the US dollar and the performance of the US economy. Our economic growth is lackluster in many areas and, as the world’s largest economy, this is depressing global growth. The world needs us to grow at a much faster pace to drive demand, trade and economic expansion across the developed and emerging territories. Because of our lack of growth and the timing of the financial market turbulence in January and February of this year, a rather significant change occurred in February that I believe will be discussed in history books. Before I get ahead of myself from a narrative perspective, let me give you those thousand word pictures with some brief explanations, and then I will add my thoughts as to what happened in February and what it may mean going forward.

First up is a picture of the U.S. Dollar, and please know I do not have an editor so what you see is my handiwork at chart preparation (making fun of my skills here is perfectly acceptable).

US Dollar April 2016

This Friday, April 29, 2016, the dollar fell slightly below the 2015 low as it closed at 93.02. If this decline continues there is a lack of support until we get to 88.55. Ask yourself why is the US Dollar weakening?

Next up is the U.S. data on exports and imports.

Exports vs Imports

The level of Imports into the United States and Exports from the United States have been relatively flat over the past 18 months. US demand has been stagnant, and WW demand lacks momentum, particularly given the expensive nature of US goods arising from the strength of the US dollar since 2014.

The next set of pictures reflect a lackluster historic view of various US performance metrics on our Business Sales and Inventories, Factories, Housing, Autos, and inflation (or lack thereof).

Bus Sales % of Inventory

The low level of sales per dollar of inventory at 70.88% reflects a dramatic decline over the past few years in a manner similar to the recessionary periods we experienced in 2001/02 and 2008/09. Excess inventories lead to cutbacks and deflationary pricing.

In this environment what are our factories telling us?

US Fact Op Rate

Fact Inv, ship, orders

They are telling us that inventories reached levels that far exceeded new orders and shipments, and as a result our factories have cut back and reduced their output as a percentage of capacity. We have been clearly running at sub-optimal rates for a period of close to two years, and have been on a downward trajectory for quite some time as we have become more of a service economy. There is still much factory based inventories to be worked off, and we need an increase in demand to show up in New Factory Orders to bring about a more historically balanced set of relationships here.

Some of the fundamental economic results within the United States can be seen by the demand for New Homes and Automobiles. This demand typically arose from expanding incomes. Unfortunately, the average US Household income level has not increased since the year 2000. As a result, borrowing stepped in to enable demand creation. We all know the degree to which we over-leveraged to obtain New Homes and Cars, but that only went so far. We are now at a stage where to enable new demand we need rising incomes. The data on New Home Starts and Domestic Autos is as follows:

New Housing starts

Domestic Autos

While we have improved from the 2008/09 recessionary lows, we are still meaningfully below the historic levels of a robust economic environment, and in some sense we appear to be plateauing without any further catalyst to drive incremental new demand.

Finally, let’s look at inflation vs deflation. In the United States I prefer to look at the inputs at the Producer level and therefore track the Producer Price Index vs the Consumer Price Index.

PPI

Clearly over the past two years’ prices have been falling. This corresponds with the strength in the dollar over that period as buyers seek price discounts in a world where foreign exchange is unfavorable and where global demand is lackluster.

After digesting the information above, as well as many other factors, the thought process that has evolved for me and which I am choosing to share here sees a parallel with the Plaza Accord that took place in 1985. At that time the world economic leaders met in New York to agree on a coordinated plan to drive the US Dollar lower versus other currencies. Remember, we had recently exited a significant recession of the early 1980s. The actions taken at the New York Plaza Hotel in 1985 led to a multi-year economic boom.

Putting that history into the context of today, we have seen years of lackluster growth since the Great Recession of 2008/09. As a result, is it possible that the world leaders have decided to take an “old” bold step that may be needed to address today’s global malaise and lack of economic strength/leadership from the world’s largest economy? The United States heretofore has been unable to drive global demand because it has been impaired by the strength of the dollar. And now it is interesting to see the recent weakness of the US Dollar which just happens to follow the G-20 Finance Minister meetings that were held on February 26/27, 2016 in Shanghai, China (US Dollar was at 98.09 on 2/26/16 and is now at 93.02). Since that date the US Dollar has weakened considerably. Foreign Central Banks have pulled back from their own easing actions (think of the Bank of Japan doing nothing last week, and the European Central Bank taking no further action as well), while the US Fed chose to stay in a holding pattern rather than raise interest rates in the US that would increase the gap between global rates and the US rates of return. If this is a coordinated approach, it is not likely short-term in nature and to that end a careful eye on the movement of the dollar will be very important. The global benefit of a weaker US currency to the Emerging markets, the support of prices in the commodity area (the rise in the price of oil without any OPEC actions is curious, yes?), and the stimulative nature to US Multi-Nationals’ foreign operations and of U.S. exporters are all outcomes of a sustained lower dollar. If right, we may just see a meaningful rise in future economic activity and in prices to defeat deflation.

This is a very dicey position to be in at the moment, for market internals and sentiment have been very positive while fundamentally the market is expensive based on current revenues, earnings and cash flows. Conflicting messages are everywhere and many traders are scratching their heads trying to make heads or tails from the varying price movements of the different asset classes. Putting capital at risk is this environment must be done prudently, so be very careful and do not try and be a hero in these swirling waters.

The thoughts reflected above did not drive my market activity during this past week, but they are now front and center in my mind. For the week I traded around the Thursday and Friday declines by getting smaller, then larger, then smaller again in the Futures Market, and in some specific cases I chose to buy small positions in equities that were punished during the week (think Apple, Twitter etc). The end result was a modest weekly gain.

The Connolly portfolio and the market performance for the Year-to-Date period ending on April 29, 2016 is as follows:

YTD Connolly portfolio gain as of April 29, 2016 equals +7.05%
S&P 500 Index YTD gain as of April 29, 2016 equals +1.05%
NASDAQ Index YTD loss as of April 29, 2016 equals -4.63%

The Connolly Portfolio composition as of April 29, 2016 is as follows:
• Cash 50.3%
• Equities 33.0%
• Gold 15.2%
• Fixed Income 1.5%

Forecast for the week: I anticipate that the market weakness of this past Thursday and Friday will continue into the upcoming week. There are multiple dynamics at play ranging from continued first quarter earnings’ releases, geographic economic releases, political and territorial tensions that abound, and an investing climate that feels as though it is moving from “resilience” to uncertainty. The market does not like uncertainty. Accordingly, I will maintain a modestly hedged position and will look to take advantage of market declines.

However, given my earlier comments during the first section of this weekly report, I will be very attuned to data and price movements that could see me move either bullishly or more bearishly. Fundamentally, I still believe the market should price lower, but if my sense of optimism around a coordinated currency agreement gains traction, then my long-side buying could accelerate. No need to rush here, but be aware of the multitude of dynamics at play and the volatility that may become very real as the market wrestles with incomplete information.

Finally, given the time I committed to preparing the economic discussion above, I will not detail the Market questions and answers this week. The summary of what that data would convey is that the market remains expensive, but less so given this past week’s late sell-off, and that the market internals continue to express optimism and support for a move higher in the indexes. Current quarter earnings’ releases are showing a continuation of lower performance and that is problematic. But, there is always light at the end of the tunnel and we need to be ready to see it early enough to be positioned to enjoy returns that add to our own sense of financial security. Be well, and as always, have a great week!

Tom

Be Wary of the Siren’s Song

Tom Connolly’s Equity Market Forecast
for the upcoming week beginning April 25, 2016
With Market Questions and Answers

Summary Comments:
If I had a dollar to invest today where would I put it? The growing crowd is telling me to invest in the equity market.
Should I follow the crowd, my instincts, or should I look to history for guidance?

The crowd is moving more together then since early February when everyone was running for the exits. Now they are running into the building. The overall Market Bullish sentiment readings reveal a bullish bias for higher market prices. The Consensus Index of Bullish sentiment is presently at 66%. Higher prices are anticipated and the recommendations of investment advisors is to put more money to work in the equity markets. The flow of money into advancing stocks which is being confirmed by the daily and weekly advancing volume and the number of advancing issues is like the Siren’s Song. The money is moving into stocks. These facts indicate that I should take my dollar and buy stocks.
But wait, what is it about my education and the lessons found in Greek mythology that seem to nag at me? Ah, yes, it is the Sirens who were beautiful yet dangerous creatures, who lured nearby sailors with their enchanting music and voices to shipwreck on the rocky coast of their island. Is that the theme of today’s song?

My instinct tells me to wait. I like to follow the crowd when it is possible to be near the front of the line, not at the back of the line. I have a preference for the best seats in the house, and they come with being early. My instincts tell me it is late to get on the line even though everyone seems to be in agreement that the show is worth the admission, even for a bad seat. So, I am choosing to not follow the crowd today. I do need to do something else with this dollar in an environment where no one wants to borrow my dollar and pay an interest fee that would make me happy. Do I just stick it under the mattress? Will that make me sleep better at night? A dollar that stays a dollar with no opportunity to make a return means I will only have a dollar in the future, and if there is inflation, it will buy even less than it can buy today. My instinct wants safety, and maybe that is more valuable to me today than the alternatives. Yes, my instinct votes for the mattress, but what does history tell me to do?

History is telling me to revisit past times when we approached turning points or continuation points. I want to know if the odds based on past performance are indicating that we are closer to a turning point in the market or to a continuation pattern?
After reviewing many aspects of the market, the continuation view wins, but I have to add that the market is not presenting enough of a reward to compensate for the risk. Commentators are downplaying the risk as they opine on how resilient the market has been as it digests and continues to move forward even with less than robust news from its leaders such as Google (Alphabet), Microsoft, JPMorgan, Goldman Sachs, Caterpillar, etc. Climbing that wall of worry is the refrain I seem to be hearing a lot of lately. I question the resilience that is being touted because I am convinced that one meaningful piece of bad news will begin a fast unravelling of the advances made since February, and the degree of potential decline far exceeds the degree of potential advance. Why do I see the weighting to the downside? Because, in terms of value, the potential prize to the upside is dwarfed by the potential pain to the downside? The analysis I just completed sites eleven points of a turning point to the downside and eight points of a continuation to the upside. The upside wins because of the overwhelming positive sentiment that is present today. However, when you read the points which I will detail below, I believe the best conclusion is to let sentiment have its day and to trust in value as the ultimate decider of future market behavior. Today value is stretched like that very wound rubber band, and when it snaps it will do so with speed and velocity that will not give time to get to the exits before losses become untenable. If I am right, then my lack of participation in aggressively investing in this market now will enable me to be there after the declines with available capital to invest in true value opportunities that will provide long-term growth and enhanced returns on that dollar. Today that dollar will remain in a state of preparedness as it waits in the mattress, in some gold, and in some strong dividend paying companies.

Continuation Factors
• Leading economic indicators are rising
• Equity indexes have broken through upward band resistance points
• Rising commodity prices and improvement in freight shipping rates support expectations of improving economic conditions as demand increases
• The Dow Jones Transports is in an uptrend, reaching some near term resistance, but nonetheless in an uptrend. If it continues this bodes well for economic expansion
• The Dow Jones Utilities has pulled back by 5% indicating money is leaving a safe haven and is seeking higher returns by taking on higher risk with a greater degree of confidence in positive outcomes
• New Highs, Advancing Volumes and Advancing Issues all support rising index values
• The spread between dividend yields and bond rates is under 1%, thereby supporting the movement of investment dollars into equities
• The improvement in crude oil prices and commodities has mitigated fears of disruption in the energy sector and in the high yield market
• The spread between High Yield and Investment Grade credits has narrowed appreciably indicating a reduction in perceived market risk which supports higher equity prices.
• Sentiment is bullish and market participants view the overall market as favorable for taking on additional risk as the Central Banks provide liquidity and a low cost of capital

Turning Points
• The percentage change in earnings is falling behind the percentage change in equity prices. Since December 31, 2015 earnings have lagged price performance by over 8%.
• The Price Earnings ratios are all well above historic averages, and that includes the ratios based on current earnings, forward 2016 earnings and forward 2017 earning projections.
• The NASDAQ has been underperforming the S&P and the DJIA based on weekly comparisons going back to September 2015. As the NASDAQ reflects a meaningful share of the growth oriented companies and technology, this does not bode well for future growth of the broader economy.
• The equity indexes have not had a 3% down move in ten weeks. Over that ten-week period the indexes are up in excess of 12%. The historic averages for time of continued upward moves and for increases during that period are 9 weeks and 9%, respectively. So we are above the historic averages for the length of time for a continued advance higher and for the amount of the increase realized during that period.
• Dollar weakness has resulted in the dollar reaching historic based inflection points. Given the relative favorable interest rate returns in the US and the better performing equity market, it is likely that the demand for dollars will strengthen from its recent lows and by doing so put pressure on emerging markets and the overall global economy.
• The DJIA, S&P 500 and NASDAQ indexes are all at levels equal to upward resistance points in a downward channel. If they fail here the pullback may be significant.
• The cumulative up points for the indexes over the past 12-weeks are at historically high levels, levels that generally presage a market reversal to the downside.
• Some of the key growth companies have recently reported growth rates that are below their historic averages
• Bonds are favored over equities when combining the historic readings of equity market volatility to today, cash flow growth to today, and cash flow multiples to today, against the spread between dividend yield and bond yields.
• The comparison of Enterprise Value (Market Value of equities plus the net debt) to EBITDA (annual cash flow generated) results in a multiple that is near the top of historic peaks. This typically indicates an overvalued market with limited upside price potential.

Given the above, who should we listen to? The crowd, our instinct, or history?

It should not come as a surprise that I did nothing this week in terms of buying or selling risk assets. My portfolio’s performance for the YTD period and the resulting period-end portfolio asset allocation is set forth below.

The portfolio and market performance for the YTD period ending on April 22, 2016 is as follows:

YTD Connolly portfolio gain as of April 22, 2016 equals +6.11%
S&P 500 Index YTD gain as of April 22, 2016 equals +2.33%
NASDAQ Index YTD loss as of April 22, 2016 equals -2.02%

Portfolio composition as of April 22, 2016 is as follows:
• Cash 51.1%
• Equities 34.9%
• Gold 12.4%
• Fixed Income 1.6%

Forecast for the week: This coming week will see some market moving earning announcements. These include Apple and Facebook. The expectations for Apple are very modest given its product release cycle. For Facebook the growth is expected to be very meaningful to continue to support the high multiples that FB trades at (79X cash flow vs a market average of 18.13X). As a backdrop, the reported weaknesses we saw in the earnings’ announcements of some very important companies, whether that be in Tech, the Financials, or the industrials, may begin to take their toll if the results from other companies continue to point to modest or below trend rates of growth. Apple and Facebook could be catalysts here.

For the week I anticipate the weight of the recent market rise coupled with the less than robust revenue and earnings’ releases to begin to pressure the market to the downside. Further, the coming FED meeting and the macro-economic and market results from the key territories such as China, Japan, and the European region may add pressure to the market’s advance. Couple this with the recent noise on Greece again and the looming vote in Britain on BREXIT, and the recipe for a turbulent and declining market gain traction. I will look to keep my E-Mini short in place and to monitor the precious metals market for signs that fear may reassert itself on the investment scene.

Market Questions and Answers
What are DJIA, DJT, DJU, S&P and NASDAQ metrics indicating?
All of the indexes appear to be in topping patterns of one sort or another. The consistency, whether in Relative Strength readings north of 70, earnings multiples north of 20X for the S&P and approximately 19X for the DJIA, and chart patterns that reveal resistance to further moves higher, indicates meaningful risk to putting additional capital to work in equities.
The DJT continues to lead the market trend up. It is at a resistance point and if it can break higher it would be a positive sign for the overall market.
The DJU has had a meaningful correction down of approx. 5%. It continues to reflect the safety of yield in a nervous world of Central Bank easing and Negative interest rates on foreign government debt. Profit taking dominated the action this week, and it also served as a source of liquidity to move funds into more aggressive equity holdings.

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 41. 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 Portfolio’s Cash flow multiple based on expected 2016 full year results is 18.13X as compared to last week’s 18.32X. 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 71 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 Forward DCF price utilizing 2017 cash flow projections on the 187 portfolio has narrowed and is now at $18.72, pulling back from the February high of $25.14. This narrowing spread indicates that future performance has been pulled into the current pricing in a manner that reduces potential gains in the future.

What is the position of the net up down Vol/Issues?
The week’s volume and issues were strongly aligned with the index point rises. New highs are also indicating a broader participation. The market’s internals are very well aligned with continued market support from money moving to risk on assets versus risk off assets.

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 positive and supportive of a market that should move higher.

Where are the New Highs and Lows moving toward?
Confirmation of a positive trend continues to be evident as New Highs are on the rise. Actual net new highs for the past five days came in at a cumulative net of 309 new highs over new lows. The strength here is very supportive from a technical perspective, but an improvement of earnings and cash flow are needed to provide support that these new highs are sustainable over time.

How well are Market Tells correlating with Market trading internals?
Technically, the 5-day activity in volume and issues is supporting rising prices. The fundamentals of the Market are indicating a different story. From a trading perspective the technical attributes of the market point to a continuation of the rise in value, while the Fundamentals point to a longer term valuation issue. If the valuation concerns begin to dominate trading, the technical indicators will quickly flip from positive to negative. Time will tell if this view has merit.

What is the composite reading of the Calendar, Environment, Duration, Action, Trend, Emotion and Valuation (“CEDATEV”)?
The reading is +1 as compared to last weeks’ assessment of zero. Contributors are:
Negative in the following areas:
Environment
Valuation
Duration
Positive in the following areas:
Calendar
Action
Trend
Emotion
Neutral in the following areas:
None

Other:

Bitcoin is at $449 per coin and is showing stable growth development. The per unit value based in the low $400 area over the past month but this week it advanced more than 5%. 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 $1,243.25 per ounce price. 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 is 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 1.89% and has risen meaningfully over the past two weeks (off the low for the calendar year on April 8 at 1.72%, but 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, and the recent back-up in rates and the late week rally in the value of the dollar indicate an increase is coming closer to being enacted from a calendar perspective. At some point this will likely weigh on the equity markets as the cost of US dollar financing rises and the ROW reacts to the monetary tightness of the US and the lower liquidity that this engenders in foreign markets.

Commodities: For the week, the CRB index of commodities rose to its highest level since July 2015. This 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 we have reached a period over period increase in the CRB Index that historically has tended to indicate a subsequent deceleration of price advances. 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 continued to contract in a way that reveals high demand for yield while accepting greater risk. Clearly the increase in the price of crude oil has been interpreted as a lifeline for many highly leveraged companies. This may prove to be too much too soon, and I advise all to maintain a constant awareness of the moves in oil as this price impacts many companies’ ability to service their debt. Any bumps in the road here in terms of oil price declines could easily spill over into the broader market with nasty downdrafts in overall equity pricing.
The spread between HY and IG bond yields closed on Friday at 4.4% which is down from 6.24% on Feb 16, 2016. The HY closing quote on Friday was 7.391% vs 9.62% on Feb 16. The Investment Grade close of 2.991% compares to 3.50% on Jan 6, 2016. These are all positive moves for the market that have occurred recently. They indicate that investors presently assess there is less risk in the market.

Have a great week!

Tom