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Mark Biller

Mark Biller

Executive Editor

Mark joined SMI in 2000. He leads SMI’s overall content strategy, managing the editorial direction and writing many articles. He led the company’s efforts to create its first web site, helped develop several of SMI’s investment strategies, and has been a contributing author to the Sound Mind Investing Handbook. 

In addition, Mark helped design and launch the three Sound Mind Investing mutual funds. He has served as the Senior Portfolio Manager since the original SMI Fund was launched in 2005.

Prior to joining SMI, Mark worked at Tax and Accounting Software Corporation. 

Mark received an undergraduate degree in Finance from Oral Roberts University.   

Mark and his wife, Cindy, have three children at home.

Most Recent Articles

A Helpful DAA Visual

As the old saying goes, a picture is worth a thousand words. One of my SMI Advisory partners came up with the following chart, which helps visually convey some of the important Dynamic Asset Allocation principles we've written about often.

This chart simply takes the rolling 12-month return of the S&P 500 stock index and subtracts the rolling 12-month return of DAA. It vividly illustrates how when the stock market is doing well (the upward spikes), DAA tends to lag the market. But when the stock market isn't doing well (downward spikes), DAA has tended to massively outperform.

A few additional observations about this chart:

Note how there are more upward spikes than downward. But when the downward spikes occur, they tend to be of significantly greater magnitude. This shows the tendency for the market to be advancing more frequently than declining. However, when declines (bear markets) do come, they tend to be fierce.

It's the greater severity of the downward moves that allows DAA to make up so much ground relative to the market so quickly during bear markets.

The recent period of stock market outperformance relative to DAA roughly matches the previous longest period of stock market outperformance ('94-2000). Obviously, what followed would have made investors want to have had DAA in their portfolios as that leadership switched swiftly and sharply to DAA.

It's worth noting that the excellent overall performance we reported in our January 2013 DAA introductory article ony included the period from 1982-2012. Looking at the chart, it's very clear that DAA's long-term performance (relative to the market) would have been substantially enhanced had we added the prior decade. We didn't primarily because some of the data sets we had to use to backtest pre-1982 weren't the same as what we used post-1982. Plus the results from 1982-present were convincing enough.

Most people use DAA within a portfolio that also includes other stock market investments (Just-the-Basics/indexing, Upgrading, Sector Rotation, etc.). Another way of looking at this chart is to think of the upward spikes as the times when those strategies have outperformed DAA, and the downward spikes as the times when DAA has outperformed those strategies. Thinking in terms of total portfolio returns is going to help us not get frustrated with the performance of the individual strategies, which is important because when we get frustrated, we tend to make emotional decisions.

The chart makes it really clear that there has never been a period in the past 45 years when stocks have outperformed DAA longer than the period we're in right now. That doesn't mean it won't happen this time — we're only looking at 45 years of data, after all, not 450 years. But it does give a pretty good idea of the length of past market cycles and when they've tended to reverse. If that pattern holds true, the protective aspects of DAA are likely to be needed before much longer.

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New Year, Same Concerns About This Market

If I had to write everything I think I understand about stock market cycles on an index card, this would be it:

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DAA — New Recommendations For January 2017 (Part 2)

There is a second change to make to DAA for January. Read on for the full details.

DAA is a core portfolio strategy that is designed to help SMI readers share in some of a bull market’s gains, while minimizing (or even preventing) losses during bear markets. The strategy involves using exchange-traded funds to rotate among six asset classes, holding three at any one time. DAA is a defensive, low-volatility strategy that nonetheless has generated impressive back-tested results, demonstrating the power of “winning by not losing.”

The recommended categories/ETFs for January are (in order of current momentum):

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DAA — New Recommendations For January 2017 (Part 1)

There is one "for sure" change to make to DAA for January. There is also a good chance of a second change that will be announced later this afternoon. Read on for the full details.

DAA is a core portfolio strategy that is designed to help SMI readers share in some of a bull market’s gains, while minimizing (or even preventing) losses during bear markets. The strategy involves using exchange-traded funds to rotate among six asset classes, holding three at any one time. DAA is a defensive, low-volatility strategy that nonetheless has generated impressive back-tested results, demonstrating the power of “winning by not losing.”

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Sector Rotation - January 2017 Update

Sector Rotation is a high-risk/high-volatility strategy. While its peaks and valleys have been more extreme than SMI's other strategies, it has generated especially impressive long-term returns, as discussed in Sector Rotation is Risky, But Highly Rewarding. Sector Rotation has been a great performer in 2016, gaining 19.5% with one day left to go.

There is no change being made to Sector Rotation for January. Here are the details.

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Stock Upgrading — New Fund Recommendations for January 2017

Our most aggressive core strategy, Stock Upgrading is a “momentum” strategy premised on the idea that recent past performance tends to persist. The strategy has you diversify your portfolio across five stock fund “risk categories” (along with up to three bond fund categories). You then buy the funds SMI objectively determines to have the highest momentum, occasionally replacing lagging funds with those showing stronger momentum. With only monthly maintenance, Fund Upgrading has generated better long-term returns than the overall market. This article explains the changes to put in place for the coming month.
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Rebalancing Your Portfolio For The New Year

An “asset class” is a broad category of investments that tend to have similar risk characteristics and respond similarly to market forces. The most common classes are stocks, bonds, real estate, commodities, and cash equivalents.

Additional breakdowns can also be made within asset classes. For example, SMI divides stock funds into subgroups that are growth-oriented, value-oriented, and size-oriented (size being determined by market value).

The way you, as an investor, spread your money among these various asset classes and sub-groupings is your “asset allocation.” As we discuss this process for 2017, remember that the most important characteristic of your portfolio—the factor that influences the performance of your portfolio more than any other—is your asset allocation.

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Successful Stock-Fund Upgrading Requires Owning Only 5 Funds

SMI’s Fund Upgrading strategy diversifies your portfolio across five stock categories. Within each category, we recommend three fund options.

If you wish, you can invest in all three funds in each category. However, we assume that most of our members keep things simple by investing in only one fund in each category, and that’s fine.

With such an approach, you invest in the top-ranked fund in each category at the outset, and when it’s time for a fund you own to be replaced, you sell it and invest the proceeds in the fund that is top-ranked at that time. (The top-ranked fund is not necessarily the most recently recommended fund.)

Readers following our Upgrading recommendations naturally expect their results to be similar to those published in the newsletter. But there’s a rub. Our published results are necessarily based on all of our fund recommendations, which means the average of all three of the funds recommended in each risk category. In other words, you would need to own all 15 of the recommended stock funds listed on the Upgrading Recommendations page to get our published results. However, due to fund minimums and brokerage availability, that may not always be possible. Even if it were, owning that many funds requires more effort and a level of complexity that would not be welcomed by every reader.

So that raises the question: How would buying only the top-ranked funds impact your returns as opposed to owning all of the recommendations?

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The Impact of Rising Interest Rates

There are two key points to understand about yesterday's Federal Reserve decision to boost interest rates another 0.25%:

  1. The decision to raise rates was made primarily in response to positive economic news
  2. The markets' reaction was less about this hike than it was the revelation that the Fed anticipates more future hikes than it had previously communicated

The first point is important to understand in terms of the response of the stock market. Stocks fell yesterday after the announcement, but today are trading higher again. That's because the same factors that caused the Fed to raise rates are also good for business and corporate profits. This is partly the "Trump effect" everyone has been discussing — the general anticipation that governement policy is about to take a sharp turn toward being more business-friendly. And it's also a result of seemingly sunnier-by-the-day economic news being reported, both here and abroad, indicating that the world economy may finally be gaining a little traction.

Digging a little deeper, experienced investors may raise an eyebrow at the idea that rising rates can be a positive (or at least, not negative) factor for stocks. Historically, it's been true that rising interest rates often choke off bull markets. I'm on the record regarding the idea that tightening monetary conditions, of which rising interest rates are a big part, is what will eventually end the current bull market. But multiple analysts/economists have pointed out that historically, rising interest rates have only been negative for stock prices at higher absolute yield levels. For example, this analysis indicates that when the 10-year Treasury bond yield is less than 5%, stock prices and bond yields have tended to move in the same direction. In other words, one would expect stock prices to rise along with bond yields from today's low levels of interest rates. It's only when yields rise above 5% that stock prices and bond yields have tended to move in opposite directions, with rate hikes hurting stocks at that point.

I wouldn't put a lot of faith in the 5% level itself — I think we could run into trouble long before we hit that historical tipping point, given how low rates are starting and how fragile the economic recovery is/has been. But the general analysis is sound: when interest rates are low, early rate hikes typically signal a return to healthy growth, which is a net positive for stocks. Eventually that dynamic shifts though, and additional interest rate hikes become negative for stocks. Thus the old market sayings like "Three steps and a stumble" referring to the historical tendency for stocks to be okay during the first couple rate hikes of a cycle, but eventually repeated hikes cause stocks to fall. (For those of you scoring at home, we've now had two rate hikes, or "steps." Just saying.)

Given that tendency for stocks to move higher with interest rate increases at today's low levels, why did markets respond poorly to yesterday's rate hike? That brings us to point #2 from the beginning of the article — it wasn't the hike itself, which had been widely anticipated for weeks, but rather the forward guidance that the Fed issued. Prior to yesterday's announcement, the Fed's public expectation had been for two additional rate hikes in 2017. Yesterday, they changed that to an expectation of three additional hikes next year.

It needs to be pointed out that these future expectations are flimsy, at best. A year ago, when the Fed hiked for the first time, their stated expectation was for four addtional rate hikes in 2016. Obviously, that didn't occur and we barely got one (yesterday's). So while the absolute number of hikes will be dictated by conditions as 2017 unfolds, what yesterday's announcement signals to the market is that the Fed is factoring in the same economic data and "Trump enthusiasm" that have been driving stocks higher. And if the Fed believes these factors are real and is preparing to act based on them, that signals stocks may have less stimulus for a shorter period of time (i.e., rates won't be as low for as long). And the eventual tipping point where higher interest rates start to cut into economic growth and stock returns will be arriving sooner than was previously expected, even if no one knows exactly where that point is.

These rising interest rates have many implications. Some of the more obvious ones are that borrowing costs are heading higher, whether that's credit card debt, auto loans, existing adjustable-rate mortgages, or new mortgages. On the flip side of that more obvious coin, savers may soon start earning a little interest again. It's incredible that we've got a whole generation who have come of age in an environment where simple savings earned nothing. (I've forced my kids to save since they were little, but my soon-to-be college age oldest has never had a "normal" bank savings account because they haven't earned anything for so long.) A decade ago, high-yield savings accounts paid 4.50% interest. We're still a long way off from those levels, but over the next year we can expect to see some of the savings accounts that have been stuck on 0.01% (seriously) start to tick higher.

On a more general basis, we should expect financial markets to become more volatile as the "fire hose of liquidity" gets turned down. Economists can quibble over whether the recent interest rate decisions represent "tapping the brakes" vs. "easing up on the accelerator." But what's unquestionably the case is that the worldwide concerted effort to pump as much liquidity into the world's economy has peaked and is retreating. That much has been obvious in the U.S. for some time, but it's happening elsewhere too. Japan recently backed away from its negative interest rate experiment, and the ECB last week announced that it would begin tapering its bond purchases starting next April. Markets optimistically took that as a net positive — the ECB extended its bond-buying program! But this is an unequivocal sign that monetary policy is tightening. Again, the reasons are good — the economic patient is getting off the sickbed and no longer requires as drastic a level of support. But those who remember the "taper tantrum" surge in bond yields when the U.S. started the exact same process in 2013 will recognize the potential for increased volatility.

When there's a huge layer of monetary stimulus sloshing around in the financial system, unexpected shocks are more muted. Take away that cushion (even gradually) and volatility is going to increase. After 10 years of central bank anesthesia, it may be a bit painful getting reaccustomed to what life without pain-killers is like.

Wrapping up with a note on gold, given its particular interest among DAA investors, yesterday's news would sure seem to be the final nail in the coffin. Not only are higher rates bad for gold (yields on competing safe-haven investments go up, while the overall need for safe-havens decreases in the face of better economic growth), but the relative position of U.S. interest rates compared with yields around the world virtually ensures that the dollar is going to stay strong (or get even stronger). With gold priced in dollars, a strong dollar puts additional pressure on gold's price. It seems likely we'll be replacing it at month-end in DAA. It's not a simple decision whether to sell it now or wait until month-end for the formal signal: given the sharp declines it has experienced, it could be due for a bounce. Either way, it would seem DAA investors will likely be moving on from gold before long.

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The Best Predictor of Future Bond Returns

An expectation of higher interest rates is nothing new, as experts have been predicting higher rates for over a decade now. But it appears the wheels may finally be in motion to produce those long-anticipated higher rates. The Federal Reserve finally hiked rates for the first time a year ago and the market is clearly anticipating a second hike this month. And the Trump election win has poured gasoline on the higher-rate expectation fire, given that three of his primary issues (fiscal stimulus, less immigration, and trade protectionism) would be expected to directly contribute to higher rates. And that doesn't even address whether Trump, working with Republican majorities in Congress, will be able to rev up the economy's growth rate with a more business-friendly agenda. If they can, that impact would certainly tilt the field toward higher interest rates as well. Perhaps not surprisingly, then, the 10-year Treasury yield has jumped from 1.88% on Election Day to 2.4% today.

The prospect of higher interest rates has many bond investors feeling fearful. After all, the most fundamental rule to understand regarding bonds is that as bond yields rise, bond prices fall (and vice versa). That's not a prediction or a historical tendency, it's a mathematical fact.

But while bond investors are understandably worried about rising interest rates cutting into their bond principal (via falling bond prices), the news isn't quite as dire as many think. That's because of the rising income dynamic that comes into play as interest rates rise. It's true that on any specific individual bond, the rate is fixed, leaving only the downside of its price falling as rates rise (which only matters if the bond is sold before it matures). But even with an individual bond, the bond owner has the opportunity to reinvest the income that bond is producing in new bonds that are sporting higher yields.

In the context of a bond fund, this dynamic is perhaps easier to see. The existing bonds in the portfolio will decline in value as interest rates rise. But the income being produced is being re-invested in new higher-yielding bonds. Over time, there's a tradeoff between capital losses from the bond principal and higher income from the newer, higher-yielding bonds. That tradeoff doesn't always even out — it's possible for that combination to net out to an overall loss — but it's not the one-sided coin that some bond investors think of when contemplating higher interest rates.

A few years ago, Vanguard founder John Bogle pointed out that the best predictor of future bond returns is actually today's current yield. He noted that since 1926, the entry yield on the 10-year Treasury explained 92% of the annualized return an investor would have earned over the following decade if they held that Treasury to maturity and reinvested the income at prevailing rates. That's not what most bond fund investors are doing, but it's still relevant. Other studies have found similar results. For example, "the entry yield on the Barclays U.S. Aggregate Bond index (of investment-grade U.S. bonds) explains 90% of its 10-year returns for the years 1976 to 2012, says Tony Crescenzi, a portfolio manager and strategist at Pacific Investment Management Co."

Let's take a look at the Vanguard Intermediate-Term Bond Index fund (VBIIX) and see how this comparison has held up recently. Ten years ago, in December of 2006, the 10-year Treasury yield was 4.6%. Today it is just 2.4%. That means the 10-year Treasury yield has roughly fallen by half. Yet the 10-year annualized return on VBIIX has been 5.2%, just a bit better than the starting 10-year Treasury yield a decade ago.

This is something of a double-edged sword for bond investors today. At just 2.4%, today's 10-year Treasury yield doesn't exactly inspire a lot of excitement in terms of the next decade's likely bond returns. But it should be a little reassuring that in spite of the 10-year Treasury yield falling by half over the past decade, the annualized returns of VBIIX didn't move much higher than the starting yield at the beginning of the period. By extension then, it's reasonable to expect that if rates were to double over the next decade, annual returns might be a bit lower than today's starting yield of 2.4%, but probably not as much as some investors fear. If you're thinking rising rates are likely to cause crippling losses in short- and medium-term bonds, that's not likely to be the case.

In fact, the article linked to above points out that in the past, the more sharply rates rose, the wider the divergence between the entry yield and overall returns became — in a positive direction. Due to interest rates spiking in the late-1970s, the annualized returns of bond yields for the decade ending in 1986 came in at 10.5%, despite the starting yield being just 6.8%. So even if interest rates go up sharply from here, for investors who remain invested in bonds, the long-term implications of that aren't necessarily as bad as many fear.

Bottom-line, at least for short- and intermediate-term bonds, yield matters more to long-term returns than what is happening with their capital gains/losses. Rising yields, while painful in the short run, won't necessarily ruin returns for bond investors the way many fear they will. And longer-term, a return to more "normal" interest rate levels is almost certainly a good thing overall, providing the economy can handle the higher levels. Savers in particular have been crushed by the past eight years of unnaturally low interest rates and higher rates would be sweet relief to them. The journey back higher won't necessarily be pleasant, but it may not be quite as rough as many bond investors have been expecting either.

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