US stocks have struggled since the April 29 peak.  Could this recent period have seen a bull market peak, with a new bear market now underway?  Possibly.  

Or, could it be an interim peak, with the stock bull market going higher after a correction period?  Maybe.  Ask four Wall Street professionals, commentators, investors, and media and you will get five opinions.  Simply put: we don’t know.  Neither does anyone else if they are honest with you.

From April 29 through today’s close, June 15, the Standard & Poor’s 500 Index benchmark ETF (symbol: SPY) price change is down by 6.90%.  Other indicators are also down by significant amounts.  The S&P 400 Mid Cap Index (symbol: MDY) is down by 8.00%, and the S&P 600 Small Cap Index (symbol: IJR) is down by 8.15%.  At Cumberland, we use the actual ETFs and their performance as references, as opposed to the indexes themselves.  These three are liquid, tradable names that represent the respective components of the S&P 1500 Index.

As we dig deeper into the sectors, we see how dramatic the recent changes have been.  From April 29 to June 15, the price performance of the ten US sectors ranged as follows:

Telecommunications (symbol: IYZ):  -1.96%
Utilities (symbol: XLU):  -0.97%  
Materials (symbol: XLB):  -8.96%
Consumer Staples (symbol: XLP):  -1.94%
Consumer Discretionary (symbol: XLY):  -6.56%
Health Care (symbol: XLV):  -1.25%
Industrials (symbol: XLI):  -8.67%
Energy (symbol: XLE):  -10.51%
Financials (symbol: XLF):  -10.07%
Technology (symbol: XLK):  -7.89%

Cumberland made major changes right after the April 29 peak.  All energy positions were sold, moving away from a very substantial overweight position.  We increased the health care component while continuing to avoid the financial sector. We have been watching it but not buying it. One of our key positions in the US ETF portfolios is the WisdomTree Dividend ex-Financials ETF (symbol: DTN).  It is down around 3% during this selloff.  We have taken that to an overweight position.  Its yield support makes it a defensive holding and one of the better-performing broad-based ETFs.

We have made sector rotation decisions based upon the appearance of a slowdown in the US economy.  It is unknown whether this slowdown will have a long life, or the economy will resume a more robust rate of growth later on this year.  The jury is out on the economic outlook.   We do not expect a full-blown double dip but we are worried about it.

Let us shift our focus to some other unknowns that hang over the market.  Some are of a more strategic nature.

First we have the ongoing turmoil in the Middle East and North Africa.  It will be months, if not years, before any resolution becomes clear.  Saudi Arabia and a Sunni composition define one side;  Iran and a Shia component define the other.  This turmoil has spread well beyond any single national border.  

Secondly, we have turmoil in the US political system.  There is uncertainty over budget negotiations, long-term spending, trillions in deficit reductions, tax changes, and tax increases.  These debates will continue through the summer, and eventually the political process will have to face the voting on debt limits. Political season runs for the next year and a half.

Markets have been complacent about the debt ceiling.  Market practitioners believe the United States will roll its debt, avoiding default.  We are in that no-default camp.  There is no justification for any politician to vote against a debt-ceiling extension.  Even one minute is too long.  That said, our political process is polarized, with intense extremes on both sides.  Under such circumstances, extreme results are possible.  These uncertainties hang over the markets, raising risk premiums and causing securities pricing to be altered.

Thirdly, the activity in the European markets is continually haunted by the processes with Greek and other peripheral-country debt.  The European Central Bank is a holder of Greek debt, and European banks are part of a systemic risk. The European Union is attempting to formulate some type of compromise.  In addition, the 17 Eurozone members are trying to preserve the euro as a major world currency.

The political outcomes will reflect pressure from the parliamentary electoral systems that form governments in these countries.  The big fear is that a parliament in a country like Greece will suffer a no-confidence vote, subsequently changing the structure of government.  Then the new government would repudiate its debt.  That is the terrifying uncertainty.  We believe the risk of this is rising.

Fourth, questions concerning the durability of the US economic recovery continue to loom.  Housing data is not supportive of a bullish outcome.  The US economy requires housing to stabilize before it can begin sustainable, robust recovery.  Foreclosure and delinquency rates illustrate this instability. Other data suggests more slowdown looms ahead.

Finally, there is the Federal Reserve.  The Fed has announced the end of QE2.  The Fed is moving to a policy change in the second half of the year in which it will maintain the size of its balance sheet by replacing maturities with new purchases of treasuries.  Fed policy is moving to a neutral, wait-and-see position.  The Fed will continue to look at incoming data, send messages through statements and speeches, and attempt to explain what will probably be a multi-year period of gradual rebalancing and extraction. Markets do not know how the change in monetary policy will unfold.  There are many and diverse views.  But no one knows for sure; hence, they are speculative.  

These uncertainties weigh on the markets.  Stocks have had a big recovery from the March 2009 low.  The US stock market has now returned to a level where it is no longer cheap.  It may become cheap again if the US economy has a robust, sustainable recovery.  It also may suffer if the earnings potential and profits of American companies begin to erode because of economic weakness.  

Because of this, Cumberland has been maintaining a cash reserve.  The cash reserve in this climate earns zero, but it does not go down in price.  And it is available for any buying opportunity. Cumberland’s US portfolio accounts have held that cash reserve in place since early May.  It may be committed, or maintained, raised, or lowered at any time.  We are doing this as incoming data gives us better information on which to base our decisions.