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October 2019

Dear Valued Clients and Friends,

In this installment of our quarterly update, we'll first briefly highlight possible changes in trends that have supported the bull market thus far. Then, we'll examine the small cap space and ponder the question of whether investors are too bearish.

Two trends that have provided support for rising stock prices since the bull market started over a decade ago are stock buybacks and corporate insider buying. Since 2010, increasing corporate buybacks have fueled a significant portion of stock gains. Companies, possibly lacking sufficient investment opportunities to grow top line revenues, have found that one expeditious route to higher earnings per share has often been to simply reduce the number of outstanding shares. Some companies have gone so far as to leverage historically low interest rates, issuing more debt to fund their corporate buybacks, a practice that might come back to haunt them.

From the chart below, the last two quarters have seen a notable drop in the dollar volume of company stock repurchases. While a two quarter drop is not alarming, a continuation of the decline could negatively impact share prices.

Also noteworthy is that corporate insiders, no doubt eager to capture gains from the bull market, are selling near record amounts of company shares. In fact, insider share sales are at a two decade high. Again, one year is not a trend. But historically, insider selling can be a bearish sign for stocks.

As we head into the home stretch to finish out the year, bearish investors can easily point to the behavior of small cap stocks as justification for their concern. As is readily apparent in the chart below, small cap stocks have gone nowhere for two years.

Before we delve into what is going on here, we'll examine the Russell 2000 index ("small caps") so we can have a sense of what they may, or may not, be telling us about the future direction of the market. The Russell 2000 index is a market capitalization weighted index and is the most widely used benchmark representing US-based small capitalization "small-cap" companies. These companies are not really all that small however with an average valuation of $2.4 billion and the median valuation of over $800 million. Domestically focused, Russell 2000 constituents generate about 82% of their revenues in the US (roughly double the percentage of domestic revenues of their large cap brethren). The index has companies from all sectors of the economy but differs somewhat in sector weightings from the S&P500. Compared to the S&P500 and other large cap indexes, it tends to be underweight technology, owing to the dominance of the FAANG stocks (Facebook, Apple, Amazon, Netflix, and Google) which make up nearly 10% of the S&P500 on their own. Also however, the Russell 2000 is overweight in financials, due primarily to an abundance of regional banks. These attributes collectively make the Russell 2000 perhaps a better proxy for the health of the US economy. The recession fears that have held down interest rates and are routinely discussed in the financial press appear to be reflected in both the volatility and the lack of upward progress in the small cap space. Another surprising note about small caps: 1 out of 4 of them are currently unprofitable. This seems almost inconceivable in a healthy economy. But it turns out to be about the normal range for this group, compared to 1 out of 20 for US large cap stocks.

What has not received so much attention about these companies is that during the current bull market, they have binged on debt enabled by historically low interest rates. Debt among Russell 2000 companies is at an all-time high as shown in the chart below.

The obvious concern is that when the inevitable recession arrives, which many view as likely in the next couple of years, the financial squeeze on these companies will be enormous. This is clear risk for these stocks.

Still, in the short term, the myriad of woes that have restrained the market may actually be a bit bullish. Stocks have held up shockingly well. Any good news: a Brexit resolution, an easing in the trade war/tariffs, a jump in home and/or auto sales resulting from low interest rates etc. could be enough to boost markets in the short term, especially given investors' low expectations and recent memory of the traumatic collapse in stocks only a year ago. The list of economic and political worries is long, but as JP Morgan Chase CEO Jamie Dimon remarked in the company earnings call this week, "The consumer is not under strain. The consumer is doing fine." Perhaps reflecting Mr. Dimon's bullish view: US homebuilders are trading at a 52-week high!

Inevitably one of these world views is going to break, either homebuilder stocks will tumble, or the rest of the stock market will follow their lead upward. We obviously don't know which of the above forces will win out in the near-term. But, as always, we are paying close attention.

To future profits,

Don Lansing
Chief Investment Officer.

Garrett Beauvais
Portfolio Manager

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About MarketTrend Advisors

MarketTrend Advisors is an investment advisory firm that specializes in the trend-following strategies outlined in this report. We offer a variety of strategies that can be used to build portfolios to meet almost any investment objective. We divide our strategies into two main groups: "Long" strategies and "Trend" strategies. The Trend strategies follow the trend up or down. The "Long" strategies are typical investment portfolios that usually remain fully invested, potentially raising cash or moving to income-focused investments when the market is weak. We have a variety of "Long" strategies depending on how aggressive or conservative you want to be. These strategies will make their money when the market is moving higher. The "Trend" strategies will provide protection in a down market and add to gains in an up-trending market. By combining the Long and Trend strategies you get all the components needed to build a successful long-term portfolio:
  1. A portfolio invested in the best performing indexes, ETFs, or stocks
  2. Substantial exposure to global growth through international holdings
  3. Protection for your overall portfolio from down-trending markets When the market is going up, you benefit as aggressively as you wish.
When the market is going down, your assets are protected, or even profiting. Over time, you will see returns that exceed the market if only by AVOIDING market corrections and bear markets. By using one of our more aggressive long strategies in an uptrend, you will see even better performance.

  1. MarketTrend Advisors, Ltd. is an independent registered in the States of California, Florida, New York and Texas.
  2. Other Securities Industry Affiliations or Activities. MarketTrend Advisors, is not registered as a broker or dealer, nor do we have any partners or employees who are affiliated with any broker or dealer. See Form ADV, Part II for official declarations.
  3. MTA portfolio strategies assume risk and no assurance is made that investors will avoid losses. No representation is made that clients will or are likely to achieve profits or incur losses comparable to those shown. Performance results are shown for illustration and discussion purposes only. The performance information has not been audited. However, the information presented is believed to be accurate and fairly presented. All performance figures in this presentation are net of management fees and commissions. Management fees are charged to actual client accounts on a monthly basis. Accounts include both taxable and non-taxable IRA accounts.
  4. Regarding the MTA Blend strategy: This strategy was migrated into the MTA Wealth Builder strategy and closed in December 2008.
  5. Regarding actual performance: Actual performance for all strategies includes all commissions as well as management fees (fees range from 1% to 2%). Actual performance statistics are based on the inception date of each strategy through the end of the last business day of the most recent month listed in the monthly performance section of this report. Starting with Q4, 2006, returns include only assets of Fidelity clients who were fully invested in their respective strategies. Returns before Q4, 2006 include all Fidelity client assets regardless of investment status. Results do not include the assets of clients at other brokerage firms.
  6. Regarding future performance: Past performance may not be indicative of future results. Therefore, you should not assume that the future performance of any specific investment or investment strategy will be profitable or equal to corresponding past performance levels.
  7. S&P 500 refers to the Standard & Poor's 500 Large-Cap Corporations Index. The index is designed to measure performance of the broad based US market and consists of 500 American companies. This index is used for comparative purposes only. (Data is taken from Yahoo! Finance.)
  8. MarketTrend Advisors is not liable for the usefulness, timeliness, accuracy, or suitability of any information contained in its web site or of any of its services. The user understands that the information given can and will fail to predict the direction and magnitude of market price movements and the user can lose money when using this information.
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