A few weeks ago, I noted that the return/risk profiles that we identify for stocks, bonds and precious metals had shifted abruptly. Since then, a decline in bond prices has modestly improved expected returns in bonds, but not yet sufficiently to warrant an extension of our durations. Precious metals have become more overbought, and while we are sympathetic to the long-term thesis for gold, intermediate term risks are now elevated. Finally, we have observed a further deterioration in market conditions for stocks.
Since the early 1980's, I've examined and tested an enormous range of analytical techniques and investment rules, including various versions of "Don't fight the Fed," and "Don't fight the tape." If I had to choose between only these two, "Don't fight the tape" would win, hands down, as Fed-based investment approaches typically endure excruciating drawdowns - even those that succeed in slightly improving long-term returns. That said, there are numerous refinements that perform far better than these simple rules-of-thumb; especially those that reflect broader considerations such as valuation, sentiment, economic pressures, yield trends, market internals, and so forth. If I had to pull a single rule from these combinations, one particular admonition - "Don't take risk in overvalued, overbought, overbullish, rising-yield environments" - is one of the single most important in terms of avoiding major, sometimes catastrophic losses.
Our investment stance is not defensive here based on our concerns with the appropriateness or legality of various Fed actions, nor based on our concerns about the underlying state of balance sheets in the financial sector, nor based on the elevated vulnerability of economic outcomes to small shocks. We are defensive because stocks are presently overvalued, overbought, and overbullish, and this combination is joined by rising yield pressures despite Fed actions.