The Best Suboptimal Strategy

being able to execute your plan or strategy is more important than find a perfect strategy because most of the time people are terrible at following their plan.  

“a suboptimal strategy that you can execute is better than an optimal strategy you can’t execute.”

A decent sub optimal strategy is to just own the market over any 7 year period.  The dividend adjusted nominal SP500 return has been positive over basically every 7 year period

http://www.simplestockinvesting.com/SP500-historical-real-total-returns.htm

However, inflation adjusted returns have a few 7 year periods that under performed.  The main question to consider in your sub optimal portfolio is how cheap or expensive the market is compared to 5 year T-notes. About 90% of the time markets will outperform the notes.  If you're young put every dollar that you don't need into the SP500 unless the market is in the upper 2nd standard deviation of DCF using Sp500 expected earnings compared to 5 year T-notes.  

Visa suspension program at Turkish consulate causing markets to go bidless.  Turkey central bank is trying to intervene, but they do not have the cash.  Will likely see continued declines in the Lira.  Expecting new highs in USD/TRY

Rate hikes and how they've affected market historically:

Four phases of monetary policy

In a recent report by Bank Credit Analyst (BCA) Research they highlighted the four phases of a monetary policy cycle based on the interaction between the level of rates and their direction. Policy is deemed to be easy if the fed funds rate is below its equilibrium level (Phases I and IV), and tight if it's above that level (Phases II and III). You can see the four phases, and the accompanying stock market performance, in the table below.

Source: BCA Research Inc. *Table excludes Phase III (July '95 to September '98) and Phase IV (April '01 to May '04) incidences distorted by the dot-com bubble. If they were included, Phase III's mean and median CAGRs (compounded annual growth rate) would be -4.4% and -1.1%, respectively, over 7 incidences and Phase IV's would be 20.3% and 9.2% over 9 incidences. The 2-month Phase II incidence spanning the October '87 crash (-80% CAGR) has also been excluded.

We have been in Phase IV since January 2008 and will remain there until the first rate hike. As noted by BCA, the durations of Phase IV and Phase I are significant because the level of rates (easy or tight) has trumped their direction (lower or higher) when it comes to explaining S&P 500 returns. In fact, all of the stock market's returns in the past 50-plus years were achieved when monetary policy was easy.

Neutral / Equilibrium fed funds level, not a fixed number but a non-dampening/ non-stimulative rate.  Estimated at 3.5 - 5.5% fed funds rate
https://www.frbsf.org/education/publications/doctor-econ/2005/april/neutral-monetary-policy/

Pullbacks have been mild historically

It is common to experience some volatility and initial pullbacks when moving toward the initial rate hike. In looking at the past five rate hike cycles, the average pullback—nearly always having concluded before the actual first hike—was less than 6%, therefore not even qualifying as a "correction," which is -10%. The magnitude of the pullback was directly tied to the magnitude of the back-up in two-year Treasury yields. So keep an eye on those as we approach the initial rate hike.

Dot plot

2/2018 still in Phase 1, easy / hikinh mode

fred.stlouisfed.org/series/FEDFUNDS  2/2018 = 1.42%

Fed Funds Rate

www.bloomberg.com/graphics/fomc-dot-plot/       2/2018 =     2.75%

Equilibrium Level

Ray Dalio Linked in post:
https://www.linkedin.com/pulse/its-all-classic-main-questions-timing-what-next-downturn-ray-dalio/

In the “late-cycle” phase of the short-term debt/business cycle, when 
a) an economy’s demand is increasing at a rate that is faster than the capacity for it to produce is increasing and 
b) the capacity to produce is near its limits, prices of those items that are constrained (like workers and constrained capital goods) go up. 
At that time, profits also rise for those who own the capacities to produce those items that are in short supply. Then the acceleration of demand into capacity constraints and rise in prices and profits causes interest rates to rise and central banks to tighten monetary policy, which causes stock and other asset prices to fall because all assets are priced as the present value of their future cash flows and interest rates are the discount rate used to calculate present values. That is why it is not unusual to see strong economies accompanied by falling stock and other asset prices...

What we do know is that we are in the part of the cycle in which the central banks’ getting monetary policy right is difficult and that this time around the balancing act will be especially difficult (given all the stimulation into capacity constraints and given the long durations of assets and a number of other factors) so that the risks of a recession in the next 18-24 months are rising. While most market players are focusing on the strong 2018, we are focusing more on 2019 and 2020 (which is the next presidential election year). Frankly, it seems to be inappropriate oversight to not be talking about the chances of a recession and what that recession might look like prior to the next election.

the bond market is, after all, a fairly short-term instrument with an aggregate average maturity of 8 years and an effective duration of 5.7 years.

The historical data we have does not support many beliefs investors and advisors have relied on for many years. Careful analysis reveals some simple truths:

1)      Rates have risen since the election. It is a response to the expectation that new administration will reduce many regulations impeding economic expansion. Optimism has improved and capital has shifted out of fixed income and into equities and commodities. The Fed has had no impact on this shift.

2)      Long-term rates have risen more than short-term rates and already permitted banks and lending institutions to expand lending to businesses. The T-Bill/10yr Treasury rate spread which began to widen in July 2016 has become much wider since the election. When long-term rates rise faster than short-term rates, there is always an expansion in lending and equity prices rise. When short-term rates rise faster than long-term rates, lending slows. When the T-Bill/10yr Treasury rate spread shifts to 0.0%, economic activity and equity markets stop rising and enter correction-every time!

3)      Close examination of Fed actions on the Fed Funds rate reveal that the Fed acts after T-Bills have shifted. The Fed’s goal is to keep Fed Fund rates above T-Bill rates. They respond 1mo-3mos after there has been a market determined shift in T-Bill rates.

There are many market myths.  Value Investors do not invest with myths. They invest using facts! It is why they are called Value Investors. The current environment with lending beginning to expand is very positive for equity investors. The Fed will raise rates as they have done historically to keep up with market induced changes in T-Bill rates. What the Fed does with Fed Fund rates has no impact on economic growth.

Summary:

Investors should ignore Fed actions on Fed Fund rates. There is no impact on economic activity. Investors should focus on market induced changes to the T-Bill/10yr Treasury rate spread. A widening spread portends higher equity prices.