What’s going on with MONCON – A look inside our recession probability model

I’ve been staying away from the heavy “blah, blah, blah,” technical writing in an effort to keep everyone focused on what I think the proper mindset should be during this crisis. However, I need to publish an update on what’s been up with our MONCON recession probability model.

People want to know, “WTF MONCON!?”

Even though MONCON failed to predict this recession based on how swiftly the conditions changed on the downside, I still believe it is an effective tool for risk management. In particular, when to remove risk and when to add risk to your investment portfolio. I also want to remind everyone what an effective tool it was in helping us navigate the numerous head fakes over the past five years.  Staying invested over periods like the bear market in January 2016, the selloff in January 2018, and the recession fears in December 2018 are easily forgotten success stories of our MONCON Recession Plan.

The most important thing to remember about the MONCON recession probability model is the age of the data. The data that gets loaded into the model lags by about ten days.  In normal times, that is not a problem since the increasing probability of a recession is usually something that builds over time.

However, given the swift and sudden nature of this crisis, ten days turned into an eternity.

Data that was loaded into the model from March 20th gave us a new MONCON reading on Tuesday, March 31st.  At that time, MONCON moved from MONCON 5 to MONCON 4.

Even before the move from 5 to 4, we had started liquidating securities across our managed portfolio independent of MONCON as specific securities triggered sell alerts. In normal times, when a security triggers a sell alert, we use the proceeds from the sale to repurchase a new security.

Because of the rapid sell-off and the lack of visibility into the economic impact of this event and its probable negative impact on future corporate earnings, we kept the proceeds in cash out of an abundance of caution and to act as a cost-free hedge against a continued sell-off.

As you can see above and read more about in our original “how to manage a recession” blog post, a move from MONCON 5 to 4 does not set the conditions for Monument to raise cash in managed portfolios. Under normal times, there is a 50/50 chance that a move to 4 results in a move back to 5.

It is not until MONCON moves from a 4 to 3 that our risk management rules direct us to proactively raise cash across our managed portfolios.  Again, in normal times.

The latest data loaded into the current MONCON reading is from the 27th of March. That data caused the reading to surge from MONCON 4 directly to 1.

Obviously, that is a massive and rapid move for the model, and it is simply not designed to forecast recessions that are caused by sudden events, crises, or pandemics.

In fact, nothing is.

That does not make MONCON useless, but it does beg the question, “What does it mean now?”

The economic indicators that feed into the model are not going to recover in lockstep over 7 days in the same way they crashed. In fact, I think they will recover slowly and normally, making it an effective tool to help us determine an opportunity to put money in our managed portfolio’s back to work for long-term growth.

As such, we have begun to slowly redeploy cash reserves that were raised in February across our managed accounts. As I said in my last video (and I have written about in most of my recent blogs), it is impossible to know when we have hit A BOTTOM or even THE MARKET BOTTOM. However, I am optimistic that we will continue to make progress on fighting the virus and the U.S. economy will get back on its feet very quickly.

When we look back at the history books, I think everyone will agree that April will be viewed as a good opportunity to invest in the future you.

It’s possible we could go down from here proving that this may not be THE BEST opportunity that presents itself.

It’s also possible that March 23rd will prove to have been THE BEST opportunity when the Dow was at 19,992.

When I’ve decided I want to own something and suddenly see it on sale at 20% off, my natural inclination is not to say, “I’m gonna wait for it to be 30% off.”

My inclination is to say, “I was willing to buy XYZ at its normal price and now that it’s 20% off, that’s a good deal so I’m going to buy it now.”

Everyone’s mindset should be, “I want to be investing in the future me” and not “Where is this market going over the next 2-3 months?”

And down 20% is a better long-term opportunity than down 15%, 10%, or 5%.

Our Portfolio Update email will be out to clients shortly and will highlight the securities we sold, why, and how we chose to redeploy SOME of the cash we raised in that process.  Our Portfolio Manager and Private Wealth Advisor, Erin Hay, CFA will also be highlighting the reasons why we continue to hold some securities.

This market seems to be trading daily on nothing more than good news outweighing bad news and vice-versa.  Keep the below chart in mind – I think it helps to see the previous 12 months of returns rather than focus on the past six weeks of returns.

It should help you too…

Keep looking forward,

Dave

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