October, 2015 PCM Quant Coalescence

Before we begin, I want to provide a quick reminder that we have enhanced our website at One of the main enhancements is that we now include performance for both our indexes and our composites, as applicable. Also new; you will be asked to enter your email address to get into the website. There will be no password required, so you won't have to worry about forgetting it. This is partly due to helping us stay in compliance with requirements in our industry that we know who has reviewed our website content. Also, links in this newsletter to individual indexes have been removed. Please use the website link above to see all of our indexes and composites. Now let's move on to the October quant analysis...

After a very volatile August and September, Janet Yellen and the Federal Reserve decided not to raise rates on September 17th. Initially the market sold off until the minutes of the meeting were released at the end of September. After the minutes revealed a rate hike could be delayed until well into 2016, we also had employment numbers come out showing dismal job growth that hugely missed expectations. This further confirmed that the Fed would have to wait to raise rates as bad news became good news. Since then, the market has had its best monthly performance in over 4 years and is in the top 1% of "turnarounds" since 1986. The Fed's decision to hold off on a rate hike also lead to a weakening of the US dollar, which has been very strong the past few quarters and been blamed for hurting the earnings of large, multi-national companies. The anticipation of a delayed rate hike, improved earnings on a weaker dollar, improved earnings for energy and materials companies on higher commodity prices and one of the biggest "short squeezes" in history, contributed to the parabolic rebound in the markets. The rise in commodity prices is a strong theme for our current allocation, as commodities, commodity exporting countries and commodity currencies all came into play.

Before we break down the October allocations, let's also take a look at some statistics on 3rd quarter earnings to date.

Earnings growth for Q3, 2015 is now estimated to come in at -4.6% according to estimates at FactSheet. The real picture would be much worse if not for historical levels of stock buybacks and further "financial engineering" associated with earnings reporting. According to Barclay's, profit margins have slipped 60 bps in the last 12 months to 8.5%. Historically high profit margins, achieved with technology enhancements and reduced workforces since 2009, have been a major driver in the growth in earnings over the last several years. This all comes at the same time that revenues and earnings will be down year over year for the last two quarters, which hasn't happened since 2009. Looking forward at both estimates and leading indicators, the Baltic Dry Index, which is an indicator of the demand for shipping containers in international trade, is at its lowest seasonal level since 1986. Goldman Sachs has lowered their earnings estimates for the S&P 500 for both 2015 and 2016 to $109 and $120 respectively, with the expectation that earnings multiples will fall as well. As an extreme example of what this could mean, if price to earnings multiples fell to low double digits in 2016, the S&P 500 could be trading at around 1200 ($120 in earnings times a multiple of 10). This is down 40% from our current levels. Although that sounds nearly impossible to think about, earnings multiples have historically gone much lower than 10 and earnings could be revised down from these lower estimates. This latter noted to put into perspective why we remain committed to our multi directional, non-correlated, quantitative approach that can be opportunistic in both rising and falling markets. Let's move on with the October allocation with the weaker dollar theme.

The October allocation leaned towards cash equivalents, government bonds, precious metals, commodities, commodity exporting countries and commodity exporting currencies. The PCM US Bond Total Return Index sm is allocated to investment grade corporate bonds and U.S. Treasuries along the entire yield curve from 3 years to 20 years. The PCM Absolute Bond Index sm is allocated to 20 year U.S. Treasury bonds and international government bonds.

PCM Absolute U.S. Sector Index sm is spread between inverse U.S. equities and long utility stocks with the remainder allocated to cash equivalent. PCM U.S. Industries Total Return Indexsm is in cash equivalents, with the only exposure to U.S. Industries for this trading period being utilities. The PCM Absolute Equity Income Indexsm remained in a cash equivalent position with the remainder also in utility stocks. The PCM Currency Indexsm followed the commodity theme by going into the Canadian dollar, which benefits from oil exports that have gone up in price with the weaker U.S. dollar.
The October reallocation of the PCM Emerging Market Total Return Equity Indexsm is on the sidelines in cash equivalents. Long U.S. Treasuries, U.S. utilities and precious metals are also represented in the PCM Total Return Portfolio Indexsm and PCM Stable Growth Plus+ Portfolio Indexsm. Both Indexes also hold the Canadian dollar. (Please note that performance numbers on the website for indexes do not include dividends and are appropriately calculated sequentially.)

The PCM Global Tactical Indexsm is consistent with the weak dollar trend with gold, utilities, U.S. Treasuries, the Canadian dollar and New Zealand, which is another commodity exporting country. The Global Macro Indexsm, which has been invested since the first day of October, is heavily in cash equivalent with additional exposure to U.S. Treasuries.

The PCM Alpha 1 Indexsm is exposed to precious metals. The PCM Absolute Metals Indexsm is in silver and palladium, while the PCM Absolute Commodities Indexsm is in gold and silver, continuing the precious metals theme.

PCM Index Strategy composites have been recognized for performance by Informa Investment Solutions; most recently for the PCM Absolute Bond Compositesm for the three year performance ending the 4th quarter of 2014, as well as previous awards for 1-year trailing performance and 3-year trailing performance. As of 2nd quarter 2014, the PCM Absolute Bond Compositesm and the PCM Absolute Commodities Compositesm both won a "Top Gun" award for performance in their respective category for the 1-year trailing performance period, with the PCM Absolute Bond Compositesm also winning the "Top Gun" award for 3-year trailing performance. The PCM Alpha 1 Compositesm was awarded the "Top Gun" performance award for the 1st quarter of 2014. We are very pleased to see these particular multi directional strategies being recognized, as the PCM Absolute Bond Strategysm and PCM Alpha 1 Strategysm are particularly timely for where we are in the current market cycle.
To view Morningstar Fact sheets of all of our index models, please visit our website at under the "PCM Strategies" tab.

By: Melissa Wieder, CFP®, Director Institutional Services

Collaborative insight provided by CIO Michael Chapman

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