Asset-class rotation: Risk assets vs. safe havens

Asset-class rotation is an extremely important issue for market professionals. In the liquid global investment markets, the majority of assets are controlled by institutional investors. Those investors either have an appetite for risk-oriented assets, such as equities, or assets that are considered safe havens, such as government debt (bonds, notes, and bills) and gold.

Every week I prepare a table that lists the current and year-to-date performances of over 40 sectors and asset classes. What I saw recently was a perfect example of this risk versus safety shift in capital markets that happens often. The following table shows that global large-cap equities (risk assets) performed the best and safe-haven assets (gold and government bonds) performed the worst. Let’s stretch out our time horizon to the year-to-date period. We see that the safe-haven asset classes performed the best and the risk asset classes performed the worst.

If there were a single way to perfectly predict these ranking changes, you can rest assured all investment managers would be using the technique. However, there are tools, techniques, and methodologies that can reliably identify trend changes and spot developing trends as they occur.

The changing leadership in asset classes is among the many reasons that Flexible Plan Investments uses sophisticated strategic diversification when crafting portfolios. That means we approach portfolio development employing several factors: 1. many different asset classes, 2. multiple investment strategies, 3. varying time frames for different strategies, and 4. each strategy using its own investment rule set.

Given that risk asset classes tend to rotate leadership with safe-haven asset classes, let’s take a look at one of the risk asset class leaders this past week: the S&P 500 Index. The following chart is a daily basis graph produced by Investor’s Business Daily.

Let’s start with the resistance level as drawn across the highs at the top of the chart. It is defined by the price rallies that have reversed at that resistance level. I want to point out the one down arrow identified by a “W,” which indicates a sign of weakness that happens when a rally reverses below the level of resistance. At the right side of the graph, I have identified that the S&P is now back up near the key resistance zone for the sixth time in nine months. Time will tell if it will muster enough strength to break out. I have also identified the support level of the past three months with up arrows.

The line in the middle of the graph is the NYSE advance/decline line. Since it is moving out to new highs, technical analysts would interpret this as a bullish indicator. Keep in mind though that this particular indicator is influenced by the large number of closed-end bond funds that are traded on the NYSE.

Countering the bullishness of the advance/decline line is the trend of volume over the period of the advance since the February low. Generally increasing volume is considered a good thing for a trend since it shows growing support for the trend. On the other hand, decreasing volume during a trend is considered a warning sign since it shows diminishing support for a trend.

So, from a scoring perspective, the S&P 500 Index is approaching significant resistance with bullish influence from the advance/decline indicator and bearish influence from the trend-of-volume indicator. Netting that all out we come up with a neutral composite indicator. While it is tempting to visualize a short-term setup for an upside breakout for the S&P 500, the evidence is inconclusive at this point in time. I would not be surprised by a long-awaited breakout or yet another reversal.