Late this week our investment policy committee made the decision to remove U.S. stock and  other equity exposure given our concerns highlighted in our last briefing. We have seen confirmation of a breakdown in equity averages below our lower threshold used for risk management.  We had been overweight equities to take advantage of potential, seasonal, year-end strength despite having a number of concerns with the market and the economic backdrop. Namely, we remain concerned about global economic growth and deflationary forces as seen in the precipitous drop in commodities.  

The earnings picture has continued to erode since the spring and we are likely entering a profits recession as evidenced by the latest round of guidance from companies reporting third quarter results. The dollar continues to rise, creating additional headwinds to large company profits. As a result of slowing economic and earnings growth, valuations remain elevated above historic norms. With analysts continuing to lowering consensus 2015 earnings estimates, price-to-earnings multiples are higher than they were at the summertime highs.   

The tailwind of monetary easing is over and the Federal Reserve’s era of the “Zero Interest Rate Policy” (ZIRP) is coming to a close.  There are also numerous technical flaws that exist: the Russell 2000 failed to recapture the 200 day moving average, new 52 week highs failed to expand during the rally and high yield spreads have widened since May. This has adverse implications for both activist investors and corporate share buybacks. Recent earnings misses from large retailers and multinationals are also a cause for concern.  We have also seen a large shift in sentiment back to the bullish side during this rally which is viewed as a contrary indicator. 

Finally, the consensus is for the Fed to raise interest rates before year-end and thus set in motion the next interest rate tightening cycle.  These types of cycles are brutal for equities unless they are accompanied by strong growth. This is not the case  with the current economic environment.

We will continue our disciplined approach to risk management and portfolio management. If conditions change for the better, and the market shrugs off these negatives we will look to add equity exposure back into our managed accounts.