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Monthly Archives: April 2017

Chart of the Day

Today’s chart of the day shows cumulative U.S. GDP growth minus federal debt issuance. Most studies and discussions of U.S. economic growth assume that it’s natural, organic, and sustainable, but the reality is that it’s largely juiced by deficit spending (particularly since the Great Recession). According to Peter Cook, CFA:

The cumulative figures are even more disturbing. From 2008-2017, GDP grew by $5.051 trillion, from $14.55 trillion to $19.74 trillion.  During that same period, the increase in TDO totaled $11.26 trillion.  In other words, for each dollar of deficit spending, the economy grew by less than 50 cents.  Or, put another way, had the federal government not borrowed and spent the $11.263 trillion, GDP today would be significantly smaller than it is.

Cumulative GDP growth less Fed. debt issuance

How much longer can we continue juicing economic growth like this? The U.S. federal debt recently hit $20 trillion and is expected to hit $30 trillion by 2028. Despite what Modern Monetary Theorists (MMTers), Keynesians, and similar schools of thought claim, common sense dictates that the endgame is not far off.

Have Treasury Yields Peaked for 2018? BMO Thinks So (Bloomberg)

Strong Demand For 30Y Paper Shows No Shortage Of Buyers Amid Surge In Issuance (ZeroHedge)

Gundlach Says 10-Year Treasury Above 3% Would Drive Down Stocks (Bloomberg)

SP500 performance around Fed tightening cycles (The Macro Tourist)

Dodd-Frank Rollback Optimism Hands Bank ETFs Record Inflows (Bloomberg)

FANG Rally Is Outpacing the Heyday of the Tech Frenzy (Bloomberg)

Apple is inching towards a $1 trillion valuation (Business Insider)

Buying Stocks Now Is Betting On Buybacks (Forbes)

Record Stock Buybacks at Worst Possible Time (Mike “Mish” Shedlock)

4 Reasons To Sell Tesla Stock (Forbes)

Everything is shrinking at GE except its massive debt (CNN Money)

Remembering Bear Stearns & Co (Institutional Risk Analyst)

A Worrying Shift for U.S. Pensions: Retirees Will Soon Outnumber Kids (Bloomberg)

The Coming Pension Crisis – Part I, Part II (Daily Reckoning)

The U.S. Retirement Crisis: The Elderly are Broke (Gold Telegraph)

The stock-market correction may be only half over, if history is any guide (MarketWatch)

JPMorgan Moves Closer to Urging a Rotation Away From Equities (Bloomberg)

Bullish On Oil Because of Trump? Don’t Be! (Mike “Mish” Shedlock)

What Event Will Sink the Stock Market? Yields? Tariffs? Trump? (Mike “Mish” Shedlock)

The Netflix Bubble (Seeking Alpha)


The U.S. Inflation Scare May Be Over (Bloomberg)

Subdued CPI Disappoints Economic Illiterates (Mike “Mish” Shedlock)

Yield-Curve Flattening Gets New Life After Inflation Fears Subside (Bloomberg)

10 years after the financial crisis, have we learned anything? (CNN Money)

Cramer on 2008 crisis: It could happen again ‘because no one went to jail the first time’ (CNBC)

A Decade After Bear’s Collapse, the Seeds of Instability Are Germinating Again (Wall Street Journal)

U.S. CEO Optimism Hits Record (Bloomberg)

Yield Curve Turns Threatening – Again (

Fed Admits ‘Yield Curve Collapse Matters’ (ZeroHedge)

It’s Just Starting: Moody’s Warns A Deluge Of Retail Bankruptcies Is Coming (ZeroHedge)

Economist Lacy Hunt: These Conditions Preceded The Last 7 Recessions (Forbes)

Subprime Auto Bonds Caught in Vise of Rising Costs, Bad Loans (Bloomberg)

Goldman, Atlanta Fed Slash Q1 GDP Forecasts Below 2.0% (ZeroHedge)

America’s inflation problem isn’t high wages, it’s high rent (MarketWatch)

Investors “Unconcerned” About Record Corporate Debt (Dollar

Trillion-Dollar Deficits Far as the Eye Can See (Daily Reckoning)

The Everything Bubble – Waiting For The Pin (David Stockman)

Is The U.S. Economy Really Growing? (Peter Cook, CFA)

Why It’s Right To Warn About A Bubble For 10 Years (Jesse Colombo)

Are U.S. Treasury Bonds Breaking Out? (Jesse Colombo)

BTFD or STFR? (Michael Lebowitz)

Technically Speaking: Chart Of The Year? (Lance Roberts)

March Madness For Investors (Michael Lebowitz)

Is The Dot.Com Bubble Back? (Lance Roberts)

Volatility Is Back (John Coumarianos)

“Peter Cook is the author of the ‘Is That True?’ series of articles, which help explain the many statements and theories circulating in the mainstream financial media often presented as “truths.” The motives and psychology of market participants, which drives the difference between truth and partial-truth, are explored.”

Most people are aware that GDP growth has been lower than expected in the aftermath of the Global Financial Crisis of 2008 (GFC).  For example, real GDP growth for the past decade has been closer to 1.5% than the 3% experienced in the 50 years prior to 2008.  As a result of the combination of slow economic growth and deficit spending, most people are also aware that the debt/GDP ratio has been rising.

However, what most people don’t know is that, over the past ten years, the dollar amount of cumulative government deficit spending exceeded the dollar amount of GDP growth.  Put another way, in the absence of deficit spending, GDP growth would have been less than zero for the past decade.  Could that be true?

Let’s begin with a shocking chart that confirms the statements above, and begins to answer the question.  The black line shows the difference between quarterly GDP growth and the quarterly increase in Treasury debt outstanding (TDO).  When the black line is above zero (red dotted line), the dollar amount is GDP is growing faster than the increase in TDO.  From 1971 to 2008, the amount of GDP typically grew at a faster rate than the increase in TDO, which is why the black line is generally above the red dotted line.

Chart 1

During the 1971-2008 period, inflation, budget deficits, and trade deficits varied widely, meaning that the relationship between GDP growth and TDO was stable even in the face of changes in other economic variables. Regardless of those changing economic variables, the US economy tended to grow at a pace faster than TDO for four decades.  The only interruptions to the pattern occurred during recessions of the early 1980s, early 1990s, and early 2000s when GDP fell while budget deficits did not.

The pattern of GDP growth exceeding TDO changed after 2008, which is why the black line is consistently below the red dotted line after 2008.  A change in a previously-stable relationship is known as a “regime change.”  Focusing first on 2008-2012, the increase in TDO far exceeded GDP growth, due to an unprecedented amount of deficit spending compared to historical norms.  Focusing next on 2013-2017, the blue line has been closer to the red dotted line, meaning that the dollar amount of GDP growth was roughly equal to TDO.

If the pattern of the past was in effect, the black line should have been far above the red dotted line for most of the entire period of 2009-2017, because it would be expected that a recovering economy would have produced an excess of GDP growth over TDO.  But that didn’t happen.  This article will not speculate on why there was a regime change.  Instead, this article is focused strictly on identifying that a regime change occurred, and that few people recognize the importance of the regime change, which is probably why it persists.

Taking a quick detour into the simple math of GDP accounting, the level of GDP is calculated by adding up all forms of spending:

GDP = C + I + G + X

In the equation above, C is consumer spending; I is investment spending by corporations; G is government spending; and X is net exports (because the US has become such a heavy net importer, X has been a subtraction from GDP since 2000).

For context, at the end of 2017, the level of US GDP was $19.74 trillion, per the Bureau of Economic Analysis (BEA).  Of that $19.74 trillion, the Congressional Budget Office (CBO) calculated that the US government spent $3.98 trillion, all of which counts toward GDP. In 2017 the government borrowed $516 billion, meaning that the government spent more than it received via taxes and other sources.  The main insight in understanding how the government calculates GDP is that all government spending counts as a positive for GDP, regardless of whether that spending is financed by tax collections or issuing debt.

Because deficit spending is additive in the calculation of GDP, it makes sense to compare the amount of deficit spending to the amount of GDP growth produced each year. The first four columns in the table below show the annual GDP, the annual dollar change of GDP, the total amount of Treasury debt outstanding (TDO) and the annual dollar change of TDO.  Comparing the second and fourth columns, it is easy to see that the annual increases in TDO regularly exceed the increases in GDP.

Chart 2

The final column to the right shows the increase in TDO as a percentage of the annual change in GDP growth.  When the ratio is greater than 100%, the increase in TDO is responsible for more than 100% of annual GDP growth.  Reinforcing the message of Chart 1, the annual increase in TDO exceeded annual GDP growth in each of the years from 2008-2016. The only year in which annual GDP growth was greater than the increase in TDO was in 2017, possibly due to the debt ceiling caps, which have now been lifted.

The cumulative figures are even more disturbing.  From 2008-2017, GDP grew by $5.051 trillion, from $14.55 trillion to $19.74 trillion.  During that same period, the increase in TDO totaled $11.26 trillion.  In other words, for each dollar of deficit spending, the economy grew by less than 50 cents.  Or, put another way, had the federal government not borrowed and spent the $11.263 trillion, GDP today would be significantly smaller than it is.

It is possible to transform Chart 1, which shows annual changes in TDO and GDP from 1970-2017, into Chart 3 below, which shows the cumulative difference between the growth of TDO and GDP over the entire period from 1970-2017. The graph below clearly shows the abrupt regime change that occurred in the aftermath of the GFC.  A period in which growth in GDP growth exceeded increases in TDO has been replaced by a period in which increases in TDO exceeded GDP growth.

Chart 3

Unfortunately, extending the analysis forward tells us the problem will only get worse.

Chart 4

Over the entire period from 2008 to 2021, the increase in TDO will exceed GDP growth by $7.531 trillion ($15.843 trillion of TDO compared to $8.312 trillion of GDP growth).  While most people would accept that deficit spending is required for short periods to offset economic disturbances, even John Maynard Keynes wouldn’t expect it to become the norm.  Nor would he expect that a dollar of deficit spending would produce less than a dollar of GDP growth.

Investment and Policy Implications

The purpose of this article is to clarify the changing relationship between the dollar amounts of GDP growth and budget deficits, which are funded by TDO.  If indeed GDP growth has become reliant on budget deficits post-2008, there are many implications for investment policies across all asset classes. For example, might poor organic growth in the private sector explain the unexpectedly-low inflation environment and historically-low capital investment?  If so, what are the implications for stocks and bonds?

Also, government policy should acknowledge the regime change and adapt policies accordingly. If massive deficit spending is required to produce a “positive” sign for GDP growth, is it possible that the private sector of the economy is not growing but shrinking?  Is the private sector’s health now completely reliant on continued government deficits?  If so, is there a limit to the government’s ability to run deficits by issuing bonds?  If a dollar of increase in debt leads to less than a dollar of GDP growth, should the US continue to borrow?  Should the Fed raise rates because of increased fiscal stimulus if the link between deficit spending, GDP growth, and inflation has experienced a regime changeCan any economic theory explain what is going on?

These questions will be addressed in upcoming articles.


  • All government spending boosts GDP calculations, regardless of whether government spending is financed by tax collections or deficits financed by debt issuance.
  • Isolating the interaction between increases in TDO and the dollar amount of GDP growth, the data show a regime change post-2008 compared to the period 1971-2007.
  • In the period 1971-2007, the dollar amount of GDP growth exceeded increases in TDO except in years in which the economy was in recession.
  • In the period 2008-2017, annual increases in TDO regularly exceeded the dollar amount of GDP growth, which remarkably occurred during years that GDP was calculated to be growing.
  • In the period 2008-2017, the cumulative increase in TDO was a multiple of cumulative GDP growth. The dollar amount of GDP growth was completely dependent on deficit spending.
  • The efficiency of each dollar of deficit spending is declining, because the dollar amount of TDO is greater than the dollar amount of GDP growth.
  • In the period 2018-2021, the increase in TDO will continue to exceed GDP growth, per forecasts made by the BEA and CBO. That is, GDP growth will be dependent on continued deficit spending.
  • Importantly, if the economy slips into recession, it is possible TDO will grow at well over $2 trillion per year, meaning that the gap between TDO and GDP will get much larger.

As a long-time anti-economic bubble activist (both in the mid-2000s bubble cycle and the post-2009 cycle), a very common charge that’s leveled against me is “you’ve been warning about bubbles for years, but the market keeps going up, up, and away!”, “you’re a permabear!,” and “you’ve been missing out on tons of profits!”

Because of the large scale that I’ve been warning on in the media, I’ve probably heard this criticism over a thousand times. The tweet below (from today) is a perfect example of this criticism:



I find these criticisms to be extremely frustrating, factually incorrect, and completely ignorant of the message that I’ve been preaching over and over – here are the reasons why:

  • I’ve always said that the best bubble warnings are the earliest bubble warnings, because society needs as much lead time as possible to take action to prevent the bubble. Early bubble warnings also give individuals and families time to prepare for a coming bust and deep recession. Just think of how many people lost their homes, businesses, and jobs during the U.S. housing bust 10 years ago: don’t you think they could have benefited from an early warning?! Of course they would have! It’s common sense (which is not so common, unfortunately).
  • “You’re a permabear!,”You’ve missed the bull market!”, etc. This is flat-out wrong: I foresaw and warned of the coming debt and bubble-driven bull market in early-2012 in great detail. I said that we were likely headed for a huge bull market, but it wasn’t going to be a sustainable economic boom, but one that leads to a depression when it pops (which is still ahead).
  • “You’ve been calling for a bear market all along, but the market keeps going up!” – Yes, there will be a tremendous economic crash when this false economic recovery/bull market ends, but I’ve always said that you need to “trade with the trend, not against it” (if you must invest or trade). I have said this probably hundreds of times throughout the years, yet I keep receiving the same criticisms over and over. People simply do not listen. I’m at a complete loss as to how to communicate my ideas so that everyone clearly understands my positions. I think people just assume – without paying attention to the important nuances and caveats – that I’m a stereotypical “bear,” which means that I’m calling for a crash at all times.

Lately, I’ve been hearing the criticism “you’ve been warning about this bubble for 10 years now! When are you going to admit you were wrong?!” Yes, I know it’s been seven years (I started warning about the current bubble in June 2011), but even warning about a bubble for ten years isn’t crazy at all – for an example of this, we only need to look to the U.S. housing bubble, which inflated from roughly 1997 until 2007. I believe that someone would have been completely justified for warning about this disastrous bubble for a full decade. Just imagine the kind of criticisms that would be leveled in the latter stages of the bubble in 2005, 2006, and 2007 at someone who had been warning about the U.S. housing bubble since 1997! They’d probably want to hide under a rock, yet they would have been completely correct. I believe that the current bubble is no different.

The chart below shows the U.S. housing price bubble from 1997 to 2007. I believe that bubbles are a process rather than a specific point in time right before they burst. The U.S. housing bubble was actually a bubble even as early as 1998 and 1999, just like the current “Everything Bubble” was a bubble even back in 2011, 2012, and 2013. A bubble is differentiated from a sustainable economic boom and bull market because of what drives it: cheap credit (typically due to central banks holding interest rates low), rapid credit growth, asset overvaluation, rampant speculation, “fool’s gold” booms in various sectors and industries, and the “gold rush” mentality. Sustainable economic booms and bull markets, however, are driven by technological and scientific advances, rising productivity, improvements in governance and regulation, society or the world becoming more peaceful, individuals and corporations saving and investing for the long-term, debts being paid down and improving credit ratings, and so on.

Case-Shiller Chart #1

Similar to housing prices, the U.S. mortgage bubble inflated from approximately 1997 to 2007. While someone who warned about this credit expansion for ten years would have been written off as a total crackpot in the latter stages of the bubble, there was a method to their madness. If society had actually paid attention to those early bubble warnings, the ultimate crash would have been far less severe or may not have happened at all. Today’s bubble will prove to be no different: if society had listened to people like me back in 2011 and 2012, the coming crash would be far less severe. Instead, people like me are currently being labeled as crackpots, even though everything we’re saying will make complete sense in the next crisis.

U.S. Mortgage Bubble, Chart #1

Contrary to the two charts above, the two charts below illustrate how the mainstream economics and financial world thinks about bubbles: they think you are only correct if you warn about a bubble immediately before it pops. How does that make any sense? To me, it’s completely counterintuitive, but I’ve learned that the mainstream world really does think this way based on my interactions with them and the criticisms they keep hurling at me. Wouldn’t you want to try to prevent an economic crisis as early as possible? Of course, but they just don’t see it that way. The greed encouraged by the speculative bubble completely blinds them from seeing the truth. They can only think in terms of their Profit & Loss statement and tactical market timing signals – ie., if you warn about a bubble, that means that you’re calling “THE TOP,” right here and right now. Heaven forbid you’re slightly early, your financial career and reputation is basically ruined.

Case-Shiller Chart #2

The chart below shows the U.S. mortgage bubble and how the mainstream economics and financial world thinks of it.

U.S. Mortgage Bubble, Chart #2While I believe that the best bubble warnings are the earliest bubble warnings as an anti-economic bubble activist, I obviously don’t approach trading this way! As I explained earlier, I believe you need to trade with the trend, not against it (if you must trade). You should not short early on in a bubble, otherwise you will get destroyed. Again, this is common sense and I’ve said this all along, but people automatically assume that skeptics like me are short all the time. Anti-economic bubble activism is a completely different discipline from successful trading, and this is why people are often confused by my message and position.

"Trade with the trend"

The chart below shows total U.S. system leverage vs. the S&P 500. Rising leverage or debt is driving stock prices higher and has enabled the so-called “recovery” from the 2008 – 2009 crash. I have been warning about this bubble since 2011 and I am proud of it. If I could go back, I would warn about it even earlier – in 2009 or 2010. Every economist should have been warning about it. Each year that has passed since the 2009 bottom, leverage continues to increase, which means that the next crash is going to be even more extreme than 2008 was.

U.S. system leverage

Thanks to the current phase of the bubble that has inflated since 2009, the U.S. stock market is as overvalued as it was in 1929, which means that a painful mean reversion is inevitable. How did the market get to this point? It did so by inflating in 2010, 2011, 2012, and so on. Had society listened to people like me who warned about this inflating bubble back then, the market would not be this overvalued. Now, a massive bear market and financial crisis is “baked into the cake” or guaranteed.

Stock Market Valuation

Right now, with the market as inflated as it is, greed is the dominant emotion by far. Most economists, traders, and the general public only see Dollar signs right now, not the extreme risk that we’re facing as a society. In their minds, the greatest risk or “crisis” is to have missed out on the bull market. Anyone who plays the role of a naysayer and warns about these risks gets shunned. It is really “uncool” to be an economic skeptic right now, but I’m an unusual person – I don’t care about being popular or cool; I care about doing what’s right, which is warning society against dangerous inflating bubbles. I believe vindication is not far away.

Please follow or add me on TwitterFacebook, and LinkedIn to stay informed about the most important trading and bubble news as well as my related commentary.

In recent weeks, I’ve been keeping my eye on an interesting situation: while the majority of market participants expect higher interest rates (and lower bond prices), the “smart money” are expecting the opposite. The mainstream view is that the economic boom is humming along nicely, jobs are being created left and right, there are few economic or financial risks to worry about, and that inflation will start picking up any day now. The reality, however, is that our economy is far too saturated with debt to grow at a very high rate like in past economic cycles and that investors are overestimating the potential efficacy of President Trump’s pro-economic growth policies.

From a strictly technical analysis perspective, U.S. Treasuries have been forming triangle patterns in the past several weeks as market participants digest the February market correction and its implications, as well as wait for more data to confirm the risk of a pickup in inflation. Interestingly, these triangle patterns are breaking out to the upside today.

Here’s the 30-year U.S. Treasury bond:

30 Year Bond Daily

Here’s the 10-year U.S. Treasury note:

10 Year Bond Daily

Here’s the 5-year U.S. Treasury note:

5 Year Note Daily

A slew of weak economic and inflation data has been causing investors to pare back their expectations for much higher interest rates in the shorter-term: the CPI-U increased only 0.2 percent in February (after increasing 0.5 percent in January), retail sales fell for the third month in a row, and Goldman Sachs and the Atlanta Fed have cut their Q1 GDP forecast to under 2.0 percent. I will certainly be watching this Treasury breakout to see if the “smart money” are about to be vindicated on interest rates. A breakdown in crude oil (which is forming its own triangle pattern) would be another catalyst that would send Treasury bonds higher.

Please follow or add me on TwitterFacebook, and LinkedIn to stay informed about the most important trading and bubble news as well as my related commentary.

“Stability breeds instability.” – Hyman Minsky

The answer to the title of this article, the polite version of which is “Buy The Dip or Sell The Rally”, may well be the most important question facing stock investors this year and possibly for years to come. The bull market, now almost ten years old, has been supported by a number of technical pillars. Of these, three of the more significant ones are the “BTFD” mentality, shorting volatility (often referred to as vol), and corporate share buybacks. We are strongly of the opinion that when these technical pillars fail, the stock market will as well. It is important to note that while we wait on technical indicators for price guidance, there is a preponderance of fundamental warnings that should also be considered.

Expanding on Minsky’s theory, former Federal Reserve governor Laurence Meyer clarified the concept stating that “a period of stability induces behavioral responses that erode margins of safety, reduce liquidity, raise cash flow commitments relative to income and profits, and raise the price of risky relative to safe assets–all combining to weaken the ability of the economy to withstand even modest adverse shocks.”

Short Volatility

Over the last ten years, volatility has been transformed from a purely quantitative barometer of perceived future stability and a key input for options pricing to a full-fledged investment vehicle. It has gone from an obscure gauge of price movements, like the tachometer on the dashboard of your car, used mainly by sophisticated investors to one of the pistons in the engine helping propel markets. Since the financial crisis, investors and traders have learned that shorting volatility can provide significant and durable returns to help supplement low yields in traditional asset classes. The recent spike in volatility from all-time lows instantly put an end to this myth.

Many of those shorting vol, via a plethora of exchanged-traded funds and notes (ETF’s and ETN’s) that were designed to profit as market volatility dropped, were badly uninformed about how vol is computed or its longer-term history. The graph below charts the steady price increase in XIV, a short volatility ETN, since 2016 and the rapid evaporation of gains that occurred over just a few days.

A majority of short volatility ETF/ETN holders were of the mindset that the Fed, through its extraordinary interest rate and QE policies and its implicit statements supporting the market, would never let the markets fall again. They erroneously believed the Fed had once-and-for-all ushered in an unprecedented era of stability. There is no question that a lack of volatility, or perceived market stability, in recent years was unlike any other historical period. Given this prevailing mindset, why not short fear and go long stability?

This is exactly what many investors did. As more money chased the easy profits of short volatility strategies, investors were indirectly and unknowingly propelling the market higher in a self-reinforcing fashion. Ironically, as investors went “long stability” (short vol) they were making the markets inherently less stable. These poorly constructed securities came to a punishing end during the first week of February when the VIX index increased by over 100% on February 5th and wiped out or severely impaired those short volatility. XIV has since been delisted closing out at a final observed price of $6.04 per share.

This important technical pillar of equity strength has been permanently damaged and will likely provide much less support going forward.


Another major pillar of support for equity prices is corporate buybacks. The graph below shows the correlation between buybacks and the S&P 500 since 2000 (note that 2018 is an estimate).

Further support for this theory comes from Goldman Sachs who claims that corporations have been the biggest class of buyer of equities since 2010 easily surpassing ETF’s, foreign investors, mutual funds, households and pension funds.

There is currently nothing that leads us to believe that corporations will stop buying their shares back, and if anything the recent tax reform further supports this trend. While buybacks currently show no signs of slowing, the recent increase in interest rates may make buybacks more difficult to conduct as debt has been a main source of funds for buybacks as shown below. Furthermore, higher interest rates may cause the credit rating agencies to downgrade companies who have accumulated large debt loads which would add to the cost of issuing debt and make buybacks more challenging. While this pillar of the bull market is still standing tall, it is worth following.


Since the lows of 2009, BTFD or “buy-the-dip” has gone from a catchy acronym to a most trusted investment strategy.  Those that have followed this advice and bought when the market has shown temporary weakness are batting 1,000%.

When individuals, financial institutions, corporations, and even some central banks have a “can’t lose” strategy, sustainable market support is generated. The initially tentative investor response of BTFD has become emboldened over time and eventually turned in to a muscle memory-like reaction.

We believe it will take a series of market dips followed by rallies that do not quite get back to recent highs to erode confidence in the BTFD strategy. A period of such price action, sequential lower highs and lower lows, will cause “easy” profits to turn in to losses. As doubt and anxiety rise with losses mounting, it will challenge investor beliefs and with it remove critical support underlying the bull market.

Beginning in late January, the S&P 500 fell about ten percent and subsequently recovered about 75% of it. If the equity market fails to reclaim the January highs, then this would begin to look like a textbook technical topping formation. It is not unusual for a topping process to develop at a time of extreme optimism as is currently being experienced.

If, however, the market pushes to record highs, the BTFD’ers will have again been rewarded. Investor confidence reinforced, and the timeline for a major correction would be extended into the future.

When BTFD fails, we suspect investors will slowly gravitate to an STFR (Sell the Rally) mentality. Contrary to BTFD, they will sell or establish short positions when the market rallies. That transition, however, will only occur after much pain has been felt by those whose optimism gradually gives way to the reality of having incurred a series of losses.


Despite fundamental warnings and the collapse of the short volatility trade, we must give the bull market trend and its two remaining key pillars the benefit of the doubt. We believe it is reasonable to maintain long positions but only while remaining cautious and nimble. Watch closely for signs of lower highs and lower lows as well as indications that buybacks may be slowing down.

This bull market, like all others that have preceded it, will eventually fail and years of gains will be erased. Those focused on building wealth will once again face tough choices. Do you continue to trust in the crumbling pillars of the bull market or do you exhibit prudence and protect what you have and wait for the future when prices are much lower and valuations far more reasonable?

We leave you with a few words from Lance Roberts

“The Fed has not put an “end” to bear markets.  In fact, they have likely only succeeded in ensuring the next bear market will be larger than the last.”

Well, I jinxed it.

In this past weekend’s missive I wrote:

“There are generally two events that happen every year – somebody forgets their coat, goggles or some other article of clothing needed for skiing, and someone visits the emergency clinic with a minor injury.”

The tradition continues as my wife fell and tore her ACL. The good news is she tore the right one three years ago, and after surgery is stronger than ever. Now she will get to do the left one.

But, while I was sitting in the emergency clinic waiting for the x-rays to be completed, I was sent a chart of the technology sector with a simple note: “Chart Of The Year.”

Chart Of The Year

Yes, the technology sector has broken out to an all-time high. Yes, given the sector comprises roughly 25% of the S&P 500, it suggests that momentum is alive and well keeping the “bullish bias” intact. (We removed our hedges last week on the breakout of the market above the 50-dma on a weekly basis.)

This is why we are currently only slightly underweight technology within our portfolio allocation models as shown below.

But why “the chart of the year” now? As shown below the technology sector has broken out to all-time highs several times over the last 18-months. What makes this one so special?

The Last Breakout

As stated, breakouts are indeed bullish and suggest higher prices in the short-term. This time is likely no different. However, breakouts to new highs are not ALWAYS as bullish as they seem in the heat of the moment. A quick glance at history shows there is always a “last” break out of every advance.



As I discussed yesterday, the technology sector is once again the darling of “Wall Street” just as it was at the peak of the previous two bull-markets.

“When we compare the fund to Shiller’s CAPE ratio, not surprisingly, since Technology makes up a quarter of the S&P 500 index, there is a high correlation between Technology and overall market valuation expansion and contraction.”

“As was the case in 1998-2000, the fund exploded higher as exuberance over the transformation of the world was occurring before our eyes. Investors globally were willing to pay “any price” to “get in on the action.”  Currently, investors are once again chasing returns in the “FANG” stocks with little regard to underlying value. The near vertical ramp in the fund is reminiscent of the late 1990’s as valuations continue to escalate higher.”

I am not suggesting the current breakout is “THE” last breakout, and from a “trading perspective” the breakout is certainly bullish and should be bought.

However, from a long-term investing viewpoint, the problem is knowing the difference in a “breakout” and “the last breakout.”

In both previous instances, there were no warnings, no fanfare, or any glaring impediment to the technology sector, or the markets. Investors were bullishly optimistic, fully invested, margined, and willing to overlook fundamental valuation problems on the “hope” that “reality” would soon catch up with the price.

They were wrong on both previous occasions and suffered large losses of capital not soon thereafter.

Once again, we are witnessing the same mistakes being played out in “real time.”

But there is a “difference this time” as noted by the brilliant Harold Malmgren yesterday;

The importance of the point should not be overlooked as it has been the key source of liquidity pushing markets higher since 2009.

But that is now coming to an end via ZeroHedge:

“Yet the time of this unprecedented monetary experiment is coming to an end as we are finally nearing the point where due to a growing shortage of eligible collateral, the central bank support wheels will soon come off (the ECB and BOJ are still buying massive amounts of bonds and equities each month), resulting in gravity finally regaining control over the market’s surreal trendline.

It’s not just central banks, however: also add the one nation which 5 years ago we first showed has put the central bank complex to shame with the amount of debt it has injected in the global financial system: China.

Appropriately, this central bank handoff is also the topic of the latest presentation by Matt King, in which the Citi credit  strategist once again repeats that “it’s the flow, not the stock that matters“, a point we’ve made since 2012, and underscores it by warning – yet again – that “both the world’s leading marginal buyers are in retreat.” He is referring to central banks and China, the world’s two biggest market manipulators and sources of capital misallocations.”

With markets heavily leveraged, global growth beginning to show signs of deterioration, breakeven inflation rates falling, and liquidity support being removed – the markets have yet to recognize the change.

So, yes, the breakout in the Technology sector may indeed be the “Chart Of The Year” for 2018. But not for the reason as touted by the overly optimistic “hopefuls,” rather because this could very well mark the “last breakout” of this particular bull market cycle.

Just something to consider.

Outcome versus Process Strategies

It is that time of year when the markets play second fiddle to debates about which twelve seed could be this year’s Cinderella in the NCAA basketball tournament. For college basketball fans, this particular time of year has been dubbed March Madness. The widespread popularity of the NCAA tournament is not just about the games, the schools, and the players, but just as importantly, it is about the brackets. Brackets refer to the office pools based upon correctly predicting the 67 tournament games. Having the most points in a pool garners office bragging rights and, in many cases, your colleague’s cash.

Interestingly the art, science, and guessing involved in filling out a tournament bracket provides insight into how investors select assets and structure portfolios. Before explaining, answer the following question:

When filling out a tournament bracket do you:

A) Start by picking the expected national champion and then go back and fill out the individual games and rounds to meet that expectation?

B) Analyze each opening round matchup, picking winners and advance round by round until you reach the championship game?

If you chose answer A, you fill out your pool based on a fixed notion for which team is the best in the country. In doing so, you disregard the potential path, no matter how hard, that team must take to become champions.

If you went with the second answer, B, you compare each potential matchup, analyze each team’s respective records, strengths of schedule, demonstrated strengths and weaknesses, record against common opponents and even how travel and geography might affect performance. While we may have exaggerated the amount of research you conduct a bit, such a methodical game by game evaluation is repeated over and over again until a conclusion is reached about which team can win six consecutive games and become the national champion.

Outcome Based Strategies

Outcome-based investment strategies start with an expected result, typically based on recent trends or historical averages. Investors following this strategy presume that such trends or averages, be they economic, earnings, prices or a host of other factors, will continue to occur as they have in the past. How many times have you heard Wall Street “gurus” preach that stocks historically return 7%, and therefore a well-diversified portfolio should expect the same thing this year? Rarely do they mention corporate and economic fundamentals or valuations. Many investors blindly take the bait and fail to question the assumptions that drive the investment selection process.

Pension funds have investment return assumptions which, if not realized, have negative consequences for their respective plans. Given this seemingly singular aim of the fund manager, most pension funds tend to buy assets whose expected returns in aggregate will achieve their return assumption. Accordingly, pension funds tend to be managed with outcome-based strategies.

For example, consider a pension fund manager with an 8% return target that largely allocates between stocks and bonds.

Given the current yields in the table above, and therefore expectations for returns on sovereign bonds of approximately 1%, the manager must instead invest in riskier fixed income products and equities to achieve the 8% return objective. Frequently, a pension fund manager has a mandate requiring that the fund hold a certain minimum amount of sovereign bonds.  The quandary then is, how much riskier “stuff” do they have to own in order to offset that return drag? In this instance, the manager is not allocating assets based on a value or risk/reward proposition but on a return goal.

To illustrate, the $308 billion California Public Employees Retirement System (CalPERS), the nation’s largest pension fund, has begun to shift more dramatically towards outcome-based management. In 2015, CalPERS announced that they would fire many of their active managers following repeatedly poor performance. Despite this adjustment, they still badly missed their 7.5% return target in 2015 and 2016. Desperate to right the ship, CalPERS maintains a plan to increase the amount of passive managers and index funds it uses to achieve its objectives.

In speaking about recent equity allocation changes, a CalPERS spokeswoman said “The goal is to eventually get the allocation to the right mix of assets, so that the portfolio will likely deliver a 10-year return of 6.2%.” That sounds like an intelligent, well-informed comment but it is similar to saying “I want to be in Poughkeepsie in April 2027 because the forecast is sunny and 72 degrees.” The precision of the 10-year return objective down to the tenth of a percent is the dead giveaway that the folks at CalPERS might not know what they’re doing.

Outcome-based strategies sound good in theory and they are easy to implement, but the vast amount of pension funds that are grossly underfunded tells us that investment policies based on this process struggle over the long term. “The past is no guarantee of future results” is a typical investment disclaimer. However, it is this same outcome-based methodology and logic that many investors rely upon to allocate their assets.

Process Based Strategies

Process-based investment strategies, on the other hand, have methods that establish expectations for the factors that drive asset prices in the future. Such analysis normally includes economic forecasts, technical analysis or a bottom-up assessment of an asset’s ability to generate cash flow. Process-based investors do not just assume that yesterday’s winners will be tomorrow’s winners, nor do they diversify just for the sake of diversification. These investors have a method that helps them forecast the assets that are likely to provide the best risk/reward prospects and they deploy capital opportunistically.

Well managed absolute return and value funds, at times, hold significant amounts of cash. This is not because they are enamored with cash yields per se, but because they have done significant research and cannot find assets that offer value in their opinion. These managers are not compelled to buy an asset because it “promises” a historical return. The low yield on cash clearly creates a “drag” on short-term returns, but when an opportunity develops, the cash on hand can be quickly deployed into cheap investments with a wider margin of safety and better probabilities of market-beating returns. This approach of subordinating the short-term demands of impatience to the long-term benefits of waiting for the fat pitch dramatically lowers the risk of a sizable loss.

A or B?

Most NCAA basketball pool participants fill out tournament brackets starting with the opening round games and progress towards the championship match. Sure, they have biases and opinions that favor teams throughout the bracket, but at the end of the day, they have done some analysis to consider each potential matchup.  So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets?

Starting at the final game and selecting a national champion is similar to identifying a return goal of 10%, for example, and buying assets that are forecast to achieve that return. How that goal is achieved is subordinated to the pleasant but speculative idea that one will achieve it. In such an outcome-based approach, decision-making is predicated on an expected result.

Considering each matchup in the NCAA tournament to ultimately determine the winner applies a process-oriented approach. Each of the 67 selections is based on the evaluation of comparative strengths and weaknesses of teams. The expected outcome is a result of the analysis of factors required to achieve the outcome.


It is very likely that many people filling out brackets this year will pick Villanova. They are a favorite not only because they are the #1 overall seed, but also because they won the tournament last year. Picking Villanova to win it all may or may not be a wise choice, but picking Villanova without consideration for the other teams they might play on the path to the championship neglects thoughtful analysis.

The following table (courtesy and Koch Capital) is a great reminder that building a portfolio based on yesterday’s performance is a surefire way to end up with sub-optimal returns.

Winning a basketball pool has its benefits while the costs, if any, are minimal. Managing wealth, however, can provide great rewards but is fraught with severe consequences. Accordingly, wealth management deserves considerably more thoughtfulness than filling out a bracket. Over the long run, those that follow a well-thought out, time-tested, process-oriented approach will raise the odds of success in compounding wealth by limiting damaging losses during major market set-backs and by being afforded opportunities when others fearfully sell.

Let me start out by saying I hate market comparisons.

While history certainly does “rhyme,” they are never the same. This is especially the case when it comes to the financial markets. Chart patterns may align from time to time, but such is more a function of pattern-fitting than anything else.

However, when it comes to fundamentals, standard-deviations, extensions, etc., it is a different story. A recent article by Ryan Vlastelica brought this to mind.

“While the strategy of investing in internet-related companies will likely always be first associated with the dot-com era, the long-lived bull market has proved to be just as strong a period for a sector that has influenced nearly every aspect of the economy.

Friday marks the ninth anniversary of the financial crisis bottom, and since that period—by one measure, the start of the current bull market—internet stocks have been among the best performers on Wall Street.”

“’The current tech rally is possibly the greatest investment story ever told,’ wrote Vincent Deluard, global macro strategist at INTL FCStone, who was speaking about the sector broadly, and not these ETFs in particular. He noted that the MSCI World Technology Index has added $5.7 trillion in market capitalization since February 2009, ‘when the entire sector amounted to just $1.5 trillion.’”

Since Ryan was probably in elementary school during the “” era, and many current fund managers weren’t managing money either, it is easy to dismiss “history” under a “this time is different” scenario. Even the ETF’s used as an example of the “this time is different” scenario didn’t even exist prior to the “  bubble” (The QQQ didn’t come into existence until 1999) 

Unfortunately, while the names of the companies may have changed, the current “ boom” is likely more than just a “rhyme” with the past.

Investors Once Again Being Misled

From a fundamental basis, there is a difference between today and the “ days of yore.” In 1999, “” companies were all bunched together and few actually made money. Fast forward to 2018, and the division between an “internet company” and every other company is now invisible. In fact, companies like Apple and Amazon are no longer even classified as “technology” companies but rather consumer goods companies.

But nonetheless, fundamentals don’t discriminate between classifications, and once again investors are paying excessively high prices for companies that generate very little, if any, profit.

Just after the “” bust, I wrote a valuation article quoting Scott McNeely, who was the CEO of Sun Microsystems at the time. At its peak, the company was trading at 10x its sales. (Price-to-Sales ratio) In a Bloomberg interview Scott made the following point.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees.That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are? You don’t need any transparency. You don’t need any footnotes. What were you thinking?

How many of the following “” companies do you currently own which are currently carrying price-to-sales in excess of 10x?  (Price-to-Sales above 2x becomes expensive. If I included companies with P/S of 5x or more, the list was just too expansive for this post.)

As noted above, there were only 3-ETF’s that existed just prior to the “” bubble -SPY, QQQ, and DIA. In order to do some better comparative analysis, I had to dig to find a technology-based mutual fund that existed back in 1990. Not surprisingly, there were very few but the T. Rowe Price Science and Technology (PRSCX) fund fit the bill and tracks the technology index very closely.

When we compare the fund to Shiller’s CAPE ratio, not surprisingly, since Technology makes up a quarter of the S&P 500 index, there is a high correlation between Technology and overall market valuation expansion and contraction.

As was the case in 1998-2000, the fund exploded higher as exuberance over the transformation of the world was occurring before our eyes. Investors globally were willing to pay “any price” to “get in on the action.”  Currently, investors are once again chasing returns in the “FANG” stocks with little regard to underlying value. The near vertical ramp in the fund is reminiscent of the late 1990’s as valuations continue to escalate higher.

The chart below shows this a bit more clearly. It compares the fund to both the RSI (relative strength index) and inflation-adjusted reported earnings of the S&P 500 on a QUARTERLY basis. Using quarterly data smooths volatility of these measures over time.

A couple of interesting points arise.

  1. The RSI of the market is as overbought today as it was leading up to the “” crash and more overbought today than just before the “financial crisis.” 
  2. Despite massive stock buybacks and cost reductions through wage and employment suppression, reported earnings have only grown by a little more than $11 / share since the peak of the market in 2007. In other words, despite the ongoing bullish commentary about how great earnings are, they have actually only achieved a 1.14% annualized rate of growth. 

Of course, investors have disregarded the lack of real earnings growth. The valuation surge is also shown in the analysis below. I have taken the price of the fund and divided by the inflation-adjusted reported earnings of the S&P 500, or a modified “P/E” ratio. While not a strictly apples-to-apples comparison, the point is that since Technology makes up roughly 25% of the market, it is a big driver of the “P” and not a huge contributor to the “E.”

Again, on this basis, investors are once again paying a high price for poor fundamental quality in the “hope” that someday the fundamentals will catch up with the price. It has never been the case, but one can always “hope.”  

Is The Dot.Com Bubble Back?

Whether you believe there is a “bubble” in the Technology stocks, or the markets, is really not important. There are plenty of arguments for both sides.

At the peak of every bull market in history, there was no one claiming that a crash was imminent. It was always the contrary with market pundits waging war against those nagging naysayers of the bullish mantra that “stocks have reached a permanently high plateau” or “this is a new secular bull market.”  (Here is why it isn’t.)

Yet, in the end, it was something unexpected, unknown or simply dismissed that devastated investors.

This is why the discussion of “this time is not like the last time” is largely irrelevant.

Individuals no longer “invest” to become a “shareholder” in a publicly traded business. The “quaint concept” of “valuations” died with the mainstreaming of investing during the 1990’s as the “Wall Street Casino” opened for business.

Today, investors only think in terms of speculating on “electronically traded bits of paper” in the hopes the value will rise over time. The problem, of course, is they are never told when to “sell” to capture that valuation increase which is the most critical aspect of the investment process. Instead, individuals continue to “bet” the “greater fool” will always appear.

For now, the “bullish case” remains alive and well. The media will go on berating those heretics who dare to point out the risks that prevail, but the one simple truth is “this time is indeed different.”  

“When the crash ultimately comes the reasons will be different than they were in the past – only the outcome will remain same.”

Eventually, like all amateur gamblers in the Las Vegas casinos, the ride is a “blast while it lasts” but in the end, the “house always wins.” 

After a bad week in early February when the S&P 500 Index dropped 10% to meet acknowledged definition of a correction, the market has rebounded and investors have mostly regained confidence. On Monday, March 5, the Index bounced over 1% higher making its year-to-date return over 2% — a perfectly respectable return in the early days of March.

However, one can’t help but have an uneasy feeling that it’s a different market environment in 2018 than it was in 2017 when, for the first time in history in one calendar year, the market posted positive gains in every month. Using the S&P 500 Price Index (not including dividends), The market was so anesthetized in 2017 that it posted only 8 days of gains greater than 1% or losses more severe than -1% from the previous day’s close. This year, the market has already posted 16 days of gains greater than 1% or losses more severe than -1% from the previous day’s close.

Moreover, the index experienced no one-day 2% gains or losses in 2017. It has already had three such days in 2018, all of them to the downside.

Another way to look at volatility is to measure the average daily volatility, using absolute value of daily changes. As our chart shows, over the roughly five year period from the start of 2013 through March 5, 2018, the S&P 500 Price Index moved an average of 0.54% on a daily basis. For 2017, that number shrank to 0.30%.

It’s also useful to look at standard deviation, a statistical measure that indicates the range of most, though not all, moves from an average. For the five year period, the standard deviation of the index was 0.77%, while for 2017 the standard deviation was 0.42%.

Lessons for Investors

Investors should learn from this graph that the low volatility of 2017 was unusual and that it’s not reasonable to expect that environment to persist. Investors should also take the opportunity to review their asset allocations. The fact that markets have rebounded since their declines in early February shouldn’t be so much cause for joy as an opportunity to reassess how much volatility is tolerable.

If an investor was unnerved by the market drop in early February, that likely means their allocation was inappropriate. Too many investors have piled into stocks because bond yields are low and long-term historical stock returns promise to make up the difference for under-saving for retirement. But century-long or longer stock returns mask the fact that stocks go through decade-long and two decade-long fallow periods, especially when valuations are as high as they are now.

Investors tend to forget how they feel during bear markets, especially when those bear markets are in the distant pass. We tend to have what behavioral finance professors call an “empathy gap” regarding our own feelings and behavior in stressful markets. But since early February isn’t that far away, investors should use it as an opportunity to reassess how a downturn might make them feel. If you wanted to sell stocks instead of stay put or buy them as prices got cheaper, it’s time to reassess your allocation – while you still can without having to change it after a decline.

Investors should also consider that bonds, though offering lower than normal historical yields, still have a place in portfolios. Their stabilizing influence is often most welcome when investors have written them off as boring next to stocks, their more exciting cousins. As other investors forget risk and unnerve their brokers and advisors with extreme bullishness, it might be a good time to be cognizant of just how much excitement you can tolerate. Investors feeling themselves capable of accepting more risk should also consider the words of investor Howard Marks, — “The truth is, risk tolerance is antithetical to successful investing. When people aren’t afraid of risk, they’ll accept risk without being compensated for doing so, and risk compensation will disappear.”

Chart of the Day

Today’s chart of the day shows U.S. social benefits as a percentage of real disposable income, which comes from Lance Roberts’ must-read piece “Sex, Money & Happiness.” As U.S. economic vibrancy continues to erode throughout the decades and debt saturates practically every sector of our society, American citizens have become increasingly reliant on government transfer payments to survive. As recently as the 1970s, government transfer payments amounted to less than 5 percent of real disposable incomes, but now amount to nearly 1 in 4 dollars worth of real disposable income! How can this situation be sustainable considering how much debt the U.S. government is in, at all levels? The answer is simple: it’s not.

Social Benefits vs Incomes


42 percent of Americans have less than $10,000 saved and may retire broke (CNBC)

Turns out the ‘great inflation scare of 2018’ didn’t happen. Wages still not rising rapidly (MarketWatch)

Why our economy is driven by dangerous asset bubbles (Macromon)

The U.S. Income Inequality Crisis: The American Dream Vanishing? (The Gold Telegraph)

The End of Cheap Debt Will Bring a Wave of Bankruptcies (

The Middle Class Might Nearly Disappear In The Next Decade (Forbes)

Is Your Paycheck Safe From Robots? (Daily Reckoning)

Uber Self-Driving Trucks Delivering Goods in Arizona (Mike “Mish” Shedlock)

Burger Flipping Robot Starts First Shift at California Restaurant (Mike “Mish” Shedlock)

U.S. household debt grows at fastest rate in 11 years (MarketWatch)

All the crazy things happening in San Francisco because of its out-of-control housing prices (Business Insider)

Toys R Us could close all 800 of its US stores (Business Insider)

Abercrombie is closing 60 stores in 2018 (Business Insider)

The Gig Economy Won’t Save American Workers At $3.37 An Hour (Forbes)

Are Subprime Debt Slaves, a Leading Indicator, Worrying the Fed? (Wolf Richter)

Signs Of The Peak: 10 Charts Reveal An Auto Bubble On The Brink (ZeroHedge)

Jim Rickards: China’s Coming Meltdown Will Rapidly Spread to U.S. (Daily Reckoning)

Yield curve still has power to predict recessions, San Francisco Fed paper says (MarketWatch)

The Home-Price Surges in 100 Cities since Housing Bubble 1.0 (Wolf Richter)

Why Another U.S. Housing Collapse Is Coming Right Up (Mike “Mish” Shedlock)

Watch These Triangle Patterns In Stocks And Crude Oil (Jesse Colombo)

Trump’s Volley – Hoover’s Folly? (Michael Lebowitz)

Divorced From Reality: Prices & Fundamentals (John Coumarianos)

4 Ways To Plan For The “Retirement Apocalypse” (Richard Rosso)

Yield Spread Sends “Recession Warning” (Jesse Colombo)

Technically Speaking: Eating Sardines (Lance Roberts)

Mr. Market – “You’re The Top! You’re The Louvre Museum” (Doug Kass)

Sex, Money & Happiness (Lance Roberts)

The Day Liquidity Died (Doug Kass)

S&P 500 Monthly Valuation & Analysis Review (J. Brett Freeze)

This is my most recent Citywire article on an academic study of bubbles. Despite what Eugene Fama asserts, they have telltale signs.


The return of volatility earlier this month set stock markets on edge, but are we really in bubble territory?

On Tuesday, I presented at the Financial Planning Association (FPA) Conference in Houston at which I discussed the issues surrounding financial planning in an environment of high valuations and low forward returns. After my presentation, a few CFP’s approached me to discuss the premise that recent “tax cuts/reforms” will lead to a resurgence of economic growth which will boost earnings and therefore negate the overvaluation problem.

This is unlikely to be the case and something that I discussed recently in “There Will Be No Economic Boom.”  However, that article focused on the impact of the passage of the 2-year “Continuing Resolution” which will lead to a surge in the national deficit as unconstrained spending negates the effect of “tax reform” on the U.S. economy.

But there is more to this story.

When the “tax cut” bill was being passed, everyone from Congress to the mainstream media, and even the CFP’s I spoke with yesterday, regurgitated the same “storyline:”

“Tax cuts will lead to an economic boom as corporations increase wages, hire and produce more and consumers have extra money in their pockets to spend.” 

As I have written many times previously, this was always more “hope” than “reality.”

Let me explain.

The economy, as we currently calculate it, is roughly 70% driven by what you and I consume or “personal consumption expenditures (PCE).” The chart below shows the history of real, inflation-adjusted, PCE as a percent of real GDP.

If “tax cuts” are going to substantially increase the growth rate of the U.S. economy, as touted by the current Administration, then PCE has to be directly targeted.

However, while the majority of consumers will receive an “average” of $1182 in the form of a tax reduction, (or $98.50 a month), the increase in take-home pay has already been offset by surging health care cost, rent, energy and higher debt service payments. As shown in the table below – the biggest constituents of the “non-discretionary family budget” are rising the most.

So, since tax-cuts, by themselves, are unlikely to offset rising prices of essential goods and services it’s hard to see how they fuel a significant surge in consumer spending.

“No problem. The ‘windfall’ to corporations (since that is where the bulk of the tax-reform legislation was focused) will lead to a surge in employment, higher wages and increased production.

After all, since corporations can now repatriate those ‘trillions of dollars’ sitting overseas they will surely be magnanimous of enough to ‘share the wealth’ with the workers. Right?

Maybe. But anyone who has watched corporate behavior since the “financial crisis,” should know that such a belief is heavily flawed.

However, now that we are a couple of months into the New Year, the data is in and we can see exactly what “corporations” are doing with their dollars.

Wage Increases

Immediately after the passage of the tax reform bill, companies lined up to garner “political favor” by issuing out $1000 bonus checks to employees. While the mainstream media, and the White House, gushed over the “immediate success” of tax reform, the bigger picture was entirely missed.

A $1000 bonus to an employee is a one-time “feel good” event. Wage increases are “permanent and costly.”

The reality is that companies are NOT increasing wages because higher wages increase tax liability, benefit costs, etc. Higher payroll costs erode bottom line profitability. In an economy with very weak top-line revenue growth, companies are extremely protective of profitability to meet Wall Street estimates and support their share price which directly impacts executive compensation.

So, while companies are gaining media attention, and political favor, by issuing one-time bonus checks; the bottom 80% of workers are falling woefully behind the top 20%.

Wages are failing to keep up with even historically low rates of “reported” inflation. Again, we point out that it is likely that your inflation, if it includes the non-discretionary items listed above, is higher than “reported” inflation and the graph below is actually worse than it appears.

But this is nothing new as corporations have failed to “share the wealth” for the last couple of decades.


The conundrum from “corporate executives” is that if consumers don’t have more money to spend, they can’t buy the goods and services offered which drives corporate revenue. If revenue does not substantially rise at the top line, profits will be impacted at the bottom line ultimately threatening “executive compensation.”

Not surprisingly, the easiest cure for that little problem has been, and remains, share buybacks. As I discussed previously:

“The use of ‘share buybacks’ to win the ‘beat the estimate’ game should not be readily dismissed by investors. One of the primary tools used by businesses to increase profitability has been through the heavy use of stock buybacks. The chart below shows outstanding shares as compared to the difference between operating earnings on a per/share basis before and after buybacks.”

I want to draw your attention to the bottom part of the graph Since 2009, the TOTAL growth in sales per share has only been 39% or roughly 3.9% a year and yet earnings grew at 253% or roughly 25.3% a year. The 21.4% differential has been heavily driven by the reduction in shares outstanding.

The important point here is that 70% of the economy is driven by consumption and the very weak rates of sales (or consumption) show why economic growth remains weak.

So, are companies using their newfound wealth to boost wages? Not so much. As Jesse Colombo recently showed:

“The passing of President Donald Trump’s tax reform plan was the primary catalyst that encouraged corporations to dramatically ramp up their share buyback plans.”

SP500 Buybacks & Dividends By Year


Of course, corporate executives (who tend to own a LOT of company stock and options) can also reward themselves through increases in the dividend payout.  Not surprisingly, as noted by Political Calculations, corporate boards have used the recent tax reform to their advantage.

“When it comes to the number of dividend increases declared during a single month, the U.S. stock market just recorded its best February ever.”


This issue of whether tax cuts lead to economic growth was examined in a 2014 study by William Gale and Andrew Samwick:

“The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel.However, theory, evidence, and simulation studies tell a different and more complicated story. Tax cuts offer the potential to raise economic growth by improving incentives to work, save, and invest. But they also create income effects that reduce the need to engage in productive economic activity, and they may subsidize old capital, which provides windfall gains to asset holders that undermine incentives for new activity.

In addition, tax cuts as a stand-alone policy (that is, not accompanied by spending cuts) will typically raise the federal budget deficit. The increase in the deficit will reduce national saving — and with it, the capital stock owned by Americans and future national income — and raise interest rates, which will negatively affect investment. The net effect of the tax cuts on growth is thus theoretically uncertain and depends on both the structure of the tax cut itself and the timing and structure of its financing.”

While tax cuts CAN be pro-growth, they have to focused on the 80% of American’s that make up the majority of the consumption in the economy. With the benefits of tax cuts being hoarded by the top-20%, which already consume at capacity, there is little propensity to substantially increase consumption as opposed to the accumulation of further wealth.

Furthermore, tax reform does little to address the major structural challenges which provide the greatest headwinds for the economy in the future:

  • Demographics
  • Structural employment shifts
  • Technological innovations
  • Globalization
  • Pensions
  • Financialization 
  • Debt

These challenges have permanently changed the financial underpinnings of the economy as a whole. This would suggest that the current state of slow economic growth is likely to be with us for far longer than most anticipate. It also puts into question just how much room the Fed has to extract its monetary support before the cracks in the economic foundation begin to widen.

Simply, until you can substantially increase the consumptive capability of the bottom 80%, there will be no “economic boom.” 

It seems banal to say, but financial planning requires return projections or estimates. If you’re saving money for a goal like retirement, sending a child to college, buying a home, or taking a vacation, you need to know three things (at least) — how much to save, how much of a return that savings will earn, and the distance to the goal. Without any of those three things, there can’t be a plan. And all of this doesn’t take into consideration your own temperament or how you react to volatility and the potential for permanent loss.

Of course, the return projection won’t be precise if any part of the capital is being invested in stocks. It’s not easy to forecast how much stocks will return over a given time, and the shorter the distance to the goal the more unpredictable and random stock returns are. And that’s one reason stocks shouldn’t be used for short-term financial goals. They can do virtually anything over one- or two-year periods of time. However, over longer time frames — 7-10 years or more – forecasts can be more reasonable, though still not precise. But one is never absolved from making an estimate or a range of estimates.

Unfortunately, some prominent financial planners, who often double as pundits, denigrate all forms of forecasting. Financial planner and sometimes New York Times columnist Carl Richards recently tweeted that the only thing we know about projections is that they are wrong. He applied the hashtag “projectionfreeplanning,” which, of course, is an oxymoron. There’s no such thing as financial planning or projecting a future value of an investment, after all, without a return estimate.

Similarly, prominent advisor and pundit, Barry Ritholtz, has argued that forecasting is “almost useless” and that we “stink at it.” Ritholtz says assertions like “stocks tend to go higher” are vague enough to be exempted from his critique, but “The Dow will hit 25,000 by the second quarter of 2018” aren’t. What’s frustrating about his writings is that they don’t say anything about the ordinary forecasting of long term (say, 10- or 20-year) returns financial advisors must do to satisfy future value calculations for their clients.

The pundits like to say that the Shiller PE isn’t a valid metric anymore because it’s been well over its long-term average – around 16.5 – for over 25 years. But the annualized return of the S&P 500 Index, including dividends has been 5.4% from 2000 through 2017, and the Shiller PE was over 40 in 2000. In other words, in 2000, it did a good job of telling investors future returns would likely be tepid. Moreover, that return has depended on the dazzling 15% return of the index since the financial crisis that has driven the Shiller PE up again to the low 30s. And, as Rob Arnott has said, we can have a reasonable argument about whether the new normal for the Shiller PE is 20 or 22, but not whether it’s 30.

Advisors are rebelling so much against forecasting because they don’t like to deliver bad news to clients. Bad news can be bad for business. Clients will choose the advisor with the highest future returns projections because they want to be soothed. But delivering optimism when it’s unwarranted can lead to projections that border on malpractice on the part of the advisor. Investment professionals usually know this when it comes to bonds. It’s difficult for a bond or a portfolio of bonds to return more than its yield-to-maturity. However, when it comes to stocks, advisors often resort to using the longest term return numbers they can find. Those usually come from Ibbotson Associates, now a division of Morningstar, which popularized a stock market return chart dating from 1926. But most investors aren’t investing for a century, and there have been enough 10- and 20-year periods of poor returns to give investors and advisors pause. More importantly, those periods are associated with high starting valuations.

And now it has become clear that estimating, say, 7%, for a balanced portfolio over the next decade is a stretch. Bonds are likely to deliver less than 4%, and that means stocks will have to deliver more than 8.5%. Advisors are becoming increasingly pessimistic about that possibility for stocks, but they aren’t responding by expressing that pessimism clearly Instead, they are responding by bashing forecasting altogether. It’s not the most mature response, but the possibility of losing clients because of poor forecasts has its bad effects. And it’s true that the Shiller PE — or any other valuation metric — isn’t perfect in forecasting returns, but it can’t be prudent to count on stocks delivering 8.5% for the next decade with a starting Shiller PE in the low 30s.

Investors should question their advisors about returns, because they need to know how much money their current savings rate will leave them with to spend in retirement. The return assumption is just that — an assumption — but that means investors can ask for a range of assumptions to see what different returns will deliver. That doesn’t mean the optimistic assumptions are truer ones though, but it helps investors understand what they’re up against without being precise. And that is far from useless. The second thing investors should do is something financial journalist Jazon Zweig discussed in an old column – they should ask their advisors how much return the advisor would deliver to the client in a “total return swap,” whereby the client hypothetically hands over their entire portfolio and gets an annualized return on that portfolio in exchange. There’s no better way to put the screws to your advisor when it comes to getting his or her opinion on future returns.

Watch the triangles in oil and stocks

After the sharp early-February market correction in both U.S. equities and crude oil, traders and investors have been racking their brains trying to figure out what the next major market move will be – will it be another leg down or a return to the late-January highs? As a result of this back-and-forth debate, the major U.S. stock indices and crude oil have been tracing out triangle patterns, which are consolidation chart patterns that indicate another major move is likely ahead upon a breakout or breakdown from the pattern. What makes these patterns particularly interesting is the fact that they’re occurring in both equities and crude oil, which are correlated with each other.

Here’s the triangle pattern in the Dow Jones Industrial Average:

Dow Daily ChartSource:

Here’s the triangle pattern in the SP500:

SP500 Daily Chart


Here’s the triangle pattern in the Nasdaq 100:

Nasdaq 100 Daily ChartSource:

Here’s the triangle pattern in West Texas Intermediate (WTI) crude oil futures:

WTI Crude Oil Daily Chart


Here’s the triangle pattern in Brent crude oil futures:

Brent Crude Oil Daily Chart


The ultimate direction that these triangle patterns break-out (either up or down) are likely to determine the next major market move. Ideally, the breakouts in stocks and crude oil should confirm each other, versus breaking out in different directions, which would increase the odds of failure of both breakouts. It is also worth noting that the “smart money” or commercial futures hedgers are very bearish on crude oil, which increases the probability of a breakdown (but confirmation is needed, either way). Stay tuned for future updates when a breakout eventually occurs.

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“You load sixteen tons, what do you get?
Another day older and deeper in debt
Saint Peter don’t you call me ’cause I can’t go
I owe my soul to the company store” 
– Sixteen Tons by Tennessee Ernie Ford

Shortly following Donald Trump’s election victory we penned a piece entitled Hoover’s Folly. In light of Trump’s introduction of tariffs on steel and other selected imports, we thought it wise to recap some of the key points made in that article and provide additional guidance.

While the media seems to treat Trump’s recent demands for tariffs as a hollow negotiating stance, investors are best advised to pay attention. At stake are not just more favorable trade terms on a few select products and possibly manufacturing jobs but the platform on which the global economic regime has operated for the last 50 years. So far it is unclear whether Trump’s rising intensity is political rhetoric or seriously foretelling actions that will bring meaningful change to the way the global economy works. Either as a direct result of policy and/or uncharacteristic retaliation to strong words, abrupt changes to trade, and therefore the role of the U.S. Dollar as the world’s reserve currency, has the potential to generate major shocks in the financial markets.

Hoover’s Folly

The following paragraphs are selected from Hoover’s Folly to provide a background.

In 1930, Herbert Hoover signed the Smoot-Hawley Tariff Act into law. As the world entered the early phases of the Great Depression, the measure was intended to protect American jobs and farmers. Ignoring warnings from global trade partners, the new law placed tariffs on goods imported into the U.S. which resulted in retaliatory tariffs on U.S. goods exported to other countries. By 1934, U.S. imports and exports were reduced by more than 50% and many Great Depression scholars have blamed the tariffs for playing a substantial role in amplifying the scope and duration of the Great Depression. The United States paid a steep price for trying to protect its workforce through short-sighted political expedience.

Although it remains unclear which approach the Trump trade team will take, much less what they will accomplish, we are quite certain they will make waves. The U.S. equity markets have been bullish on the outlook for the new administration given its business-friendly posture toward tax and regulatory reform, but they have turned a blind eye toward possible negative side effects of any of his plans. Global trade and supply chain interdependencies have been a tailwind for corporate earnings for decades. Abrupt changes in those dynamics represent a meaningful shift in the trajectory of global growth, and the equity markets will eventually be required to deal with the uncertainties that will accompany those changes.  

From an investment standpoint, this would have many effects. First, commodities priced in dollars would likely benefit, especially precious metals. Secondly, without the need to hold as many U.S. dollars in reserve, foreign nations might sell their Treasury securities holdings. Further adding pressure to U.S. Treasury securities and all fixed income securities, a weakening dollar is inflationary on the margin, which brings consideration of the Federal Reserve and monetary policy into play.

The Other Side of the Story

The President recently tweeted the following:

Regardless of political affiliation, most Americans agree with President Trump that international trade should be conducted on fair terms. The problem with assessing whether or not “trade wars are good” is that one must understand the other side of the story.

Persistent trade imbalances are the manifestation of explicit global trade agreements that have been around for decades and have historically received broad bi-partisan support. Those policies were sponsored by U.S. leaders under the guise of “free trade” from the North American Free Trade Agreement (NAFTA) to ushering China in to the World Trade Organization (WTO). During that time, American politicians and corporations did not just rollover and accept unfair trade terms; there was clearly something in it for them. They knew that in exchange for unequal trade terms and mounting trade deficits came an implicit arrangement that the countries which export goods to the U.S. would also fund that consumption. Said differently, foreign countries sold America their goods on credit. That construct enabled U.S. corporations, the chief lobbyists in favor of such agreements, to establish foreign production facilities in cheap labor markets for the sale of goods back into the United States.

The following bullet points show how making imports into the U.S. easier, via tariffs and trade pacts, has played out.

  • Bi-partisan support for easing multi-lateral trade agreements, especially with China
  • One-way tariffs or producer subsidies that favor foreign producers were generally not challenged
  • Those agreements, tariffs, and subsidies enable foreign competitors to employ cheap labor to make goods at prices that undercut U.S. producers
  • U.S. corporations moved production overseas to take advantage of cheap labor
  • Cheaper goods are then sold back to U.S. consumers creating a trade deficit
  • U.S. dollars received by foreign producers are used to buy U.S. Treasuries and other dollar-based corporate and securitized individuals liabilities
  • Foreign demand for U.S. Treasuries and other bonds lower U.S. interest rates
  • Lower U.S. interest rates encourage consumption and debt accumulation
  • U.S. economic growth increasingly centered on ever-increasing debt loads and declining interest rates to facilitate servicing the debt

Trade Deficits and Debt

These trade agreements subordinated traditional forms of production and manufacturing to the exporting of U.S. dollars. America relinquished its role as the world’s leading manufacturer in exchange for cheaper imported goods and services from other countries. The profits of U.S.-based manufacturing companies were enhanced with cheaper foreign labor, but the wages of U.S. employees were impaired, and jobs in the manufacturing sector were exported to foreign lands. This had the effect of hollowing out America’s industrial base while at the same time stoking foreign appetite for U.S. debt as they received U.S. dollars and sought to invest them. In return, debt-driven consumption soared in the U.S.

The trade deficit, also known as the current account balance, measures the net flow of goods and services in and out of a country. The graph below shows the correlation between the cumulative deterioration of the U.S. current account balance and manufacturing jobs.

Data Courtesy: St. Louis Federal Reserve (NIPA)

Since 1983, there have only been two quarters in which the current account balance was positive. During the most recent economic expansion, the current account balance has averaged -$443 billion per year.

To further appreciate the ramifications of the reigning economic regime, consider that China gained full acceptance into the World Trade Organization (WTO) in 2001. The trade agreements that accompanied WTO status and allowed China easier access to U.S. markets have resulted in an approximate quintupling of the amount of exports from China to the U.S.  Similarly, there has been a concurrent increase in the amount of credit that China has extended the U.S. government through their purchase of U.S. Treasury securities as shown below.

Data Courtesy: St. Louis Federal Reserve and U.S. Treasury Department

The Company Store

To further understand why the current economic regime is tricky to change, one must consider that the debts of years past have not been paid off. As such the U.S. Treasury regularly issues new debt that is used to pay for older debt that is maturing while at the same time issuing even more debt to fund current period deficits. Therefore, the important topic not being discussed is the United States’ (in)ability to reduce reliance on foreign funding that has proven essential in supporting the accumulated debt of consumption from years past.

Trump’s ideas are far more complicated than simply leveling the trade playing field and reviving our industrial base. If the United States decides to equalize terms of trade, then we are redefining long-held agreements introduced and reinforced by previous administrations.  In breaking with that tradition of “we give you dollars, you give us cheap goods (cars, toys, lawnmowers, steel, etc.), we will most certainly also need to source alternative demand for our debt. In reality, new buyers will emerge but that likely implies an unfavorable adjustment to interest rates. The graph below compares the amount of U.S. Treasury debt that is funded abroad and the total amount of publicly traded U.S. debt. Consider further, foreigners have large holdings of U.S. corporate and securitized individual debt as well. (Importantly, also note that in recent years the Fed has bought over $2 trillion of Treasury securities through quantitative easing (QE), more than making up for the recent slowdown in foreign buying.)

Data Courtesy: St. Louis Federal Reserve

The bottom line is that, if Trump decides to put new tariffs on foreign goods, we must presume that foreign creditors will not be as generous lending money to the U.S. Accordingly, higher interest rates will be needed to attract new sources of capital. The problem, as we have discussed in numerous articles, is that higher interest rates put a severe burden on economic growth in a highly leveraged economy. In Hoover’s Folly we stated: Further adding pressure to U.S. Treasury securities and all fixed income securities, a weakening dollar is inflationary on the margin, which brings consideration of the Federal Reserve and monetary policy into play.

It seems plausible that a trade war would result in potentially controversial intervention from the Federal Reserve. The economic cost of higher interest rates would likely be too high a price for the Fed to sit idly by and watch. Such policy would be controversial because it would further blur the lines between monetary and fiscal policy and potentially jeopardize the already tenuous independent status of the Fed.

Importantly, this is not purely a problem for the U.S. Still the world’s reserve currency, the global economy is dependent upon U.S. dollars and needs them to transact. Any disruption in economic activity as a result of rising U.S. interest rates, the risk-free benchmark for the entire world, would most certainly go viral. That said, for the godless Communist regimes of China and Russia, a moral barometer is not just absent, it is illegal. Game theory, considering those circumstances and actors, becomes infinitely more complex.


Investors concerned about the ramifications of a potential trade war should consider how higher interest rates would affect their portfolios. Further, given that the Fed would likely step in at some point if higher interest rates were meaningfully affecting the economy, they should also consider how QE or some other form of intervention might affect asset prices. While QE has a recent history of being supportive of asset prices, can we assume that to be true going forward?  The efficacy of Fed actions will be more closely scrutinized if, for example, the dollar is substantially weaker and/or inflation higher.

There will be serious ramifications to changing a global trade regime that has been in place for several decades. It seems unlikely that Trump’s global trade proposals, if pursued and enacted, will result in more balanced trade without further aggravating problems for the U.S. fiscal circumstance.  So far, the market response has been fidgety at worst and investors seem to be looking past these risks. The optimism is admirable but optimism is a poor substitute for prudence.

In closing, the summary from Hoover’s Folly a year ago remains valid:

It is premature to make investment decisions based on rhetoric and threats. It is also possible that much of this bluster could simply be the opening bid in what is a peaceful renegotiation of global trade agreements. To the extent that global growth and trade has been the beneficiary of years of asymmetries at the expense of the United States, then change is overdue. Our hope is that the Trump administration can impose the discipline of smart business with the tact of shrewd diplomacy to affect these changes in an orderly manner. Regardless, we must pay close attention to trade conflicts and their consequences can escalate quickly. 

There are many ways of assessing the value of the stock market. The Shiller PE (price relative to the past decade’s worth of real, average earnings) and Tobin’s Q (the value of companies’ outstanding stock and debt relative to their replacement cost) are likely the two best. That doesn’t mean those metrics are accurate crash indicators, or that one can use them profitably as trading signals. Expensive stocks can stay expensive or get more expensive, and cheap stocks can stay cheap or get cheaper for inconveniently long periods of time.

But those metrics do have a good record of forecasting future long-term (one decade or more) returns. And that’s important for financial planning and wealth management. Difficult though it is sometimes, everyone must plug in an estimated return into a formula for retirement savings. And if an advisor is plugging in a 7% or so return for a balanced portfolio currently, he or she is likely not doing their job well. Stocks will almost certainly return less than their long-term 10% annualized average for the next decade or two given a starting Shiller PE over 30. The long-term average of the metric, after all, is under 17.

Another way of looking at how expensive the market has gotten recently is to look at sales of the S&P 500 constituents and relate it to share price. Companies are always manipulating items on income statements to arrive at a particular earnings number. Recently, record numbers of companies have supported net income numbers with non-GAAP metrics. That can be legitimate sometimes. For example, depreciation on real estate is rarely commensurate with reality. But it can also be nefarious, as Vitaliy Katsenelson recently argued in criticizing Jack Welch’s stewardship of General Electric, which Katsenelson characterized as being more interested in beating quarterly earnings estimates rather than in creating long-term wealth. And that’s why sales metrics can be useful. They are less easily manipulated.

So I created a chart showing sales per share growth and price per share growth of the S&P 500 dating back to the end of 2008. From the beginning of 2009 through the end of 2016, companies in the index grew profits per share by nearly 4% annualized, a perfectly respectable number for a mature economy. But price per share grew by a whopping 14.5% over that time. Over that 8 year period, sales grew less than 50% cumulatively, while share prices tripled.

Anyone invested in stocks should worry about this chart. How do share prices get so divorced from underlying corporate sales? One likely answer is low interest rates. But there must be other reasons because we’ve had low interest rates and low stock prices before – namely in the 1940s. That was after the Great Depression, and stocks were still likely viewed as suspect investments. Today, by contrast, stocks are not viewed with much suspicion, despite the technology bubble peaking in 2000 and the housing bubble in 2008. Investors still believe in stocks as an asset class.

And yet, the decline in rates over the past four decades has been breathtaking, as has Federal Reserve intervention. James Montier of Boston asset manager, Grantham, Mayo, van Otterloo (GMO), has studied stock price movements over the past few decades and found that a significant percentage of upward price movements have occurred on or before Federal Open Market Committee (FOMC) days. Montier estimated that 25% of the market’s return since 1984 has resulted from movements around FOMC days. Moreover, the market has moved higher regardless of what the FOMC decision was.

If this is a stock market bubble – and the data shows unusually high prices relative to sales and earnings – it is a strange one. One doesn’t hear the anecdotal evidence of excitement – i.e., cab driver’s talking about their latest stock purchases, etc…. This is perhaps a kind of dour bubble, where asset ownership at any price seems prudent in an economy that is becoming less and less hospitable to ordinary workers. Or, as Montier wrote in a more recent paper, this may be a “cynical” bubble where investors know that shares are overpriced, but think they can be the first ones out when the inevitable decline begins.

Are you a pre-retiree ready for the right-lane switch?

There are a group of pre-retirees who become masters of the “right lane.” They’re at a life’s bend point (as I call it), where the exit from current career paths are easily visualized. Simply, their retirement body clocks are beginning to ring and they’re listening and preparing accordingly. At Clarity, we believe if you’re 3-5 years from rebirth, reinvention, reignition, then congratulations! You’re a pre-retiree.

At our Clarity Right Lane to Retirement Workshops, in face-to-face meetings, and questions that come in through Real Investment Advice, we address financial pitfalls that have potential to veer investors off course. A comprehensive plan at this juncture exposes financial vulnerabilities that may require a pre-retiree to remain in the workforce 2 to 4 years longer than expected. Several pitfalls we observe often are misallocated portfolio allocations, long-term care insurance coverage shortfalls, misconceptions about Social Security and cost-prohibitive healthcare expenses pre and post-Medicare enrollment.

Warning to pre-retirees: Multiple headwinds have arrived; if you haven’t done so, please prepare accordingly. A strong bull market in stocks, especially since the presidential election has fostered overconfidence and complacency, especially when it comes to expectations for future portfolio returns.

It’s time to face reality.

The winds, they are a shiftin.’

Larry Swedroe a principal and director of research for Buckingham Strategic Wealth, penned a strong piece for Advisor Perspectives titled “The Four Horsemen of the Retirement Apocalypse,”  which was expanded upon for a Real Investment Report,  by RIA team member, and analyst, John Coumarianos.

If you can envision a right-lane switch, then it’s time to change-up your thinking, make some adjustments then hit the turn signal.

I’ve corralled these horsemen into four broad categories – Portfolio allocation, healthcare, retirement income, and long-term care.

From a planning perspective, pre-retirees should consider:

  1. A portfolio asset allocation re-shuffle:

Think conservative. Don’t fret over missing out on the possibility of future portfolio gains. Focus on potential losses that can postpone retirement plans. If it reduces FOMO (fear of missing out), consider how rich stock valuations are today as measured by the average of 5 and 10-year inflation-adjusted earnings.

With the current Shiller P/E at 33x and other market valuation metrics at stretching points, those who are 5 years or less from retirement should take action today to reduce portfolio risk.

Our CAPE-5, a more-sensitive adjunct compared to the Shiller P/E, correlates highly with movements in the S&P 500.

There is a positive correlation between the CAPE-5 and the real (inflation-adjusted) price of the S&P 500. Before 1950, the CAPE and the index closely tracked each other. Eventually, the CAPE began to lead price. The current deviation of 63.23% above the long-term five-year CAPE ratio has occurred only three times in the last 118 years.

Unfortunately, valuation metrics such as cyclically-adjusted price earnings ratios are extremely poor at pinpointing turning points in markets. However, they are relevant predictors of the probability of future returns. Hey it’s math. Math eventually wins. Rich valuations are always worked off through reversion to averages.  Based on current levels, the most likely outcome is stock returns that average low single figures or negative (yes, negative). Three to five years before retirement as well as through the initial phase of a distribution or retirement income cycle (3-5 years), the primary focus should be on risk reduction and how withdrawals affect portfolio longevity.

Unfortunately, where you retire in a market cycle is primarily a spin of the roulette wheel. Basically, luck. If you’re retiring today, welcome to the headwind. Adjust accordingly.

However, one truth remains – when attempting to produce a steady stream of retirement income from variable assets like stocks and to some extent bonds, then distributions must be consistently monitored and possibly adjusted depending on market head or tailwinds.

If I had to go out on a limb using current valuations as a guide, I am confident that those close to retirement or just beginning the journey are going to face greater obstacles to future returns.

Ignore market experts who appear knowledgeable and push self-serving narratives to validate overinflated stock prices. As we’ve witnessed in the past, faith in financial media darlings doesn’t end well for investors. After all, these pundits are rarely called out. Unfortunately, if you fall for their sound bites, you’re going to pay the price. Your plans will be ruined.

Generally, a stock allocation that doesn’t exceed 30% should be considered. If greater, a sell discipline must be employed to minimize losses. There’s nothing wrong with maintaining two to three years of estimated future living expenses (or needs), laddered in short-term bonds or certificates of deposit that are staggered in maturities from six months to three years.

I’ve recognized how brokers do a great job at selling product but are overwhelming deficient with helping clients rebalance portfolios. Most likely your allocation to stocks is too aggressive for an investor so close to a retirement date.

There should be a sense of urgency to meet with a financial professional, preferably a fiduciary, who can assist with portfolio rebalancing suggestions.

Think virtual. Brick & mortar banks are late to the game to raise rates on savings. Consider FDIC-insured online banks right now. For example, as of March 6, has a rate of 1.55% on high-yield savings.

  1. Don’t mess up Medicare enrollment periods or it’ll cost you.

Unless you have a working spouse with employer-covered health insurance that is eligible to cover you as well, or fortunate enough to have healthcare benefits as part of a corporate retirement package, purchasing healthcare insurance or ‘bridge coverage’ before Medicare benefits begin is going to be cost prohibitive in most cases.

If you’ve decided to postpone Social Security benefits to take advantage of the annual 8% delayed retirement credit that accrues after full retirement age up until age 70, you’ll need to proactively sign up for Part A and B coverages during the initial enrollment period which begins the first day of the third month before your 65th birthday and extends for seven months. Part A or hospital coverage has been paid through payroll taxes. Part B requires ongoing monthly premiums. The standard Part B premium is $134 per recipient and may be higher depending on income. If your modified adjusted gross income is above specific thresholds then you’ll pay the standard premium plus an “Income Related Monthly Adjustment Amount.”

Part B (inpatient/medical coverage) enrollment can be tricky. For example, if covered by a qualified employer plan that covers 20 or more employees during the initial enrollment period, then you may postpone signing up until you leave employment or group coverage is terminated, whichever occurs first. Now, this special enrollment period goes out eight months from the first day of the month employment ends. However, it’s best not to wait. Sign up for Medicare before group coverage ends to prevent a lapse of healthcare coverage.

The problem I witness often is when Medicare Part B special enrollment intersects with COBRA which is a temporary continuation of former employer group health insurance coverage. Those who utilize it are under the misperception that COBRA is employer coverage thus it qualifies for the Medicare special enrollment period. COBRA may be continued as secondary coverage for expenses Medicare doesn’t cover; however missing special enrollment may result in a permanent late enrollment period penalty of 10% for each year (12-month period), missed.

There exist multiple enrollment windows and open enrollment periods for Medicare coverages – Prescription Drug Coverage (D), Medicare Advantage, Medigap or supplemental coverage. It can easily get confusing which makes it important to work with a financial adviser who is well versed in Medicare planning.

Make sure your financial plan accounts for healthcare expenses which thank goodness can be quantifiable due to Medicare which is comprehensive in nature.

  1. Retirement Income: Be smart about Social Security maximization strategies.

We teach attendees at our workshops – “Your Social Security claiming decision is a family decision,” as the decisions made by retirement beneficiaries can also affect spousal and survivor benefits.

Do not underestimate the lifetime income that Social Security can provide. Future recipients should begin the integration of Social Security into their retirement planning as part of a right lane to exit mindset.

According to a The Nationwide Retirement Institute® Consumer Social Security PR Study conducted by Harris Poll, it’s not surprising to discover than ½ of a retiree’s fixed expenses are covered by Social Security benefits.

Per the study, surprisingly few retirees have a financial advisor who provides advice on Social Security strategies. The total incidence of having a financial advisor who provided Social Security advice was a dismal 11%.

A 2015 study by the Consumer Financial Protection Bureau indicates that more than 2 million consumers choose when to begin collecting Social Security retirement benefits. Many make the decision based on limited or incorrect information.

Of those given Social Security advice by their advisors, roughly half or more had to initiate the discussion themselves.

Now with pensions all but gone, Social Security is the only guaranteed monthly income for roughly 69% of older Americans.

Unfortunately, in 2013, 75% of retirees chose to start collecting before full retirement age which results in a permanent reduction in lifetime benefits. This may be a very shortsighted decision.

Read: The One Social Security Myth.

As Wade Pfau, Ph.D., CFA and professor at the American College outlines in the 2nd edition of his Retirement Researcher’s Guide to Reverse Mortgages:

“Delaying Social Security is a form of insurance that helps to support the increasing costs associated with living a long life. It provides inflation-adjusted lifetime benefits for a retiree and surviving spouse, and those lifetime benefits will be 76 percent larger in inflation-adjusted terms for those who claim at seventy instead of sixty-two.”

According to Social Security expert Elaine Floyd, ignorance is the primary reason. The CFPB report outlines studies that represent how much people don’t know about claiming. One study for example outlined that only 12% of pre-retirees knew how benefits differed if benefits were claimed before, at, or after full retirement age.

If you’re having a difficult time finding the help required, it’s worth the investment in a comprehensive Social Security analysis tool. The one I suggest was created by Laurence Kotlikoff, Professor of Economics at Boston University and available at The tool will guide you to the highest benefit you or you and a spouse may receive from Social Security.  It will assess thousands of strategies before it suggests the one that maximizes lifetime benefits. The output is easy to interpret. There’s the ability to run “what if” scenarios, too.

The $40 annual license for a household is good for a year and worth the cost.

  1. Long-term care. The financially-devastating elephant in the room.

Three out of every five financial plans we generate reflect deficiencies to fully meet long-term care expenses.

The Genworth Cost of Care Survey has been tracking long-term care costs across 440 regions across the United States since 2004.

Below as of June 2017, are the median monthly costs of the four levels of care from home health to nursing home:

Genworth’s results assume an annual 3% inflation rate. In today’s dollars a home-health aide who assists with cleaning, cooking, and other responsibilities for those who seek to age in place or require temporary assistance with activities of daily living, can cost over $45,000 a year in the Houston area. On average, these services may be required for 3 years – a hefty sum of $137,000. We use a 4.25-4.5% inflation rate for financial planning purposes to reflect recent median annual costs for assisted living and nursing home care.

Long-term care insurance is becoming cost prohibitive. Not only is insurance underwriting to qualify draconian to say the least, insurers are increasing annual premiums at alarming rates. In some cases, by more than 90% ostensibly forcing seniors to drop coverage or find part-time work to pay premiums.

In addition, the number of insurers available is dwindling. Today there are less than 12 major insurers when at one time there were 106.

As I examine policies issued recently vs. those 10 years or later, it’s glaringly obvious that coverage isn’t as comprehensive and costs more prohibitive. The long-term care crisis is rarely addressed by the media; there isn’t a governmental solution to the growing needs of an aging population. Unfortunately, the majority of those who require assistance will place the burden on ill-prepared family member caretakers or need to undertake drastic measures to liquidate assets. According to Genworth, roughly 70% of people over 65 will require long-term care at some point in their lives.

So, what to do?

One option is to consider a reverse mortgage. The horror stories about these products are way overblown. The most astute of planners and academics study and understand how for those who seek to age in place, incorporating the equity from a primary residence in a retirement income strategy or as a method to meet long-term care costs can no longer be ignored. Those who talk down these products are speaking out of lack of knowledge and falling easily for overblown, pervasive false narratives.

Reverse mortgages have several layers of costs (nothing like they were in the past), and it pays for consumers to shop around for the best deals. Understand to qualify for a reverse mortgage, the homeowner must be 62, the home must be a primary residence and the debt limited to mortgage debt. There are several ways to receive payouts. One of the smartest strategies is to establish a reverse mortgage line of credit at age 62, leave it untapped and allowed to grow along with the value of the home. The line may be tapped for long-term care expenses if needed or to mitigate sequence of poor return risk in portfolios. Simply, in years where portfolios are down, the reverse mortgage line can be used for income thus buying time for the portfolio to recover. Once assets do recover, rebalancing proceeds or gains may be used to pay back the reverse mortgage loan consequently restoring the line of credit.

Our planning software allows our team to consider a reverse mortgage in the analysis. Those plans have a high probability of success. We explain that income is as necessary as water when it comes to retirement. For many retirees, converting the glacier of a home into the water of income using a reverse mortgage is going to be required for retirement survival and especially long-term care expenses.

American College Professor Wade Pfau along with Bob French, CFA are thought leaders on reverse mortgage education and have created the best reverse mortgage calculator I’ve studied. To access the calculator and invaluable analysis of reverse mortgages click here. Also, read my RIA commentary on reverse mortgages here.

Insurance companies are currently creating products that have similar benefits of current long-term care policies along with features that allow beneficiaries to receive a policy’s full death benefit equal to or greater than the premiums paid. The long-term care coverage which is linked to a fixed-premium universal life policy, allows for payments to informal caregivers such as family or friends, does not require you to submit monthly bills and receipts, have less stringent underwriting criteria and allow an option to recover premiums paid if services are not rendered (after a specified period).

Unfortunately, to purchase these policies you’ll need to come up with a policy premium of $50,000 either in a lump sum or paid over five to ten years. However, for example, paying monthly for 10 years can be more cost effective than traditional long-term care policies, payments remain fixed throughout the period (a big plus), and there’s an opportunity to have premiums returned to you if long-term care isn’t necessary (usually five years from the time your $50,000 premium is paid in full). Benefit periods can range from 3-7 years and provide two to five times worth of premium paid for qualified long-term care expenses. As a benchmark, keep in mind the average nursing home stay is three years.

It’s crucial to complete a comprehensive financial plan before investigating available long-term care products. A plan will help quantify how much coverage is necessary. In other words, your long-term care plan can be subsidized by a reverse mortgage or liquidation of assets. From there, a financial and insurance professional educated in long-term care can assist with the proper amount of coverage required.

The four horsemen of the retirement apocalypse are real. They must be taken seriously. For pre-retirees, there’s time to heed their warnings and adjust. For current retirees, it’s a wake-up call to re-assess portfolio withdrawal rates, spending habits, think outside the box with reverse mortgages and rebalance their allocations.

A few weeks ago, I wrote a piece in which I estimated when the next U.S. recession and bear market would start based upon where we were in the current yield curve cycle and comparing it to the prior six economic cycles. According to that admittedly simple exercise (it wasn’t a hard prediction, but just an estimate based on history), the next stock market peak would occur in September 2019 and the recession would start in February 2020.

In today’s piece, I wanted to discuss in further detail an important chart that I included in my “When Is The Next Recession And Bear Market” piece: the 10-Year/2-Year U.S. Treasury yield spread. I’ll start with a brief refresher: in a normal market, and assuming that the bonds are of the same credit rating, longer-term bond yields are higher than short-term bond yields to compensate investors for the greater risk of holding during a longer period of time (default and inflation risk).

A steep or “normal” yield curve is typically seen early on in the economic cycle and lasts for the majority of the cycle and can be thought of as a “green light” for investors. As the economic cycle matures, the yield curve takes on a flat shape. A flat yield curve can be thought of as a “yellow light” for investors. In the very final stages of an economic cycle, the yield curve often inverts as the Fed’s aggressive rate hikes causes short-term interest rates to actually rise above longer-term interest rates. An inverted yield curve can be thought of as a “red light” for investors.

The 10-Year/2-Year U.S. Treasury bond spread is a very simple, yet powerful, way of visualizing the U.S. Treasury yield curve. To create this chart, the current two-year Treasury note yield is subtracted from the current ten-year Treasury note yield and plotted over time. When the spread is over 100 basis points or 1 percent, it is consider to be a normal or steep yield curve. When the spread is between 0 percent and 1 percent, it is equivalent to a flat yield curve, which is the “recession warning zone” because it signifies that the economic cycle is becoming long in the tooth and that a recession is likely to occur within a few years. When the spread goes under 0 percent into negative territory, that’s when the yield curve is inverted, which implies that a recession is imminent. According to the 10-Year/2-Year U.S. Treasury bond spread, we are currently in the “recession warning zone,” but not the “recession zone” just yet.

10-Year/2-Year U.S. Treasury Spread

The yield curve inverted before every U.S. recession in the past half-century, which is why it is worth paying close attention to (on the chart above, the gray zones show when historic recessions have occurred). In recent years, many bullish market commentators have promoted theories supposedly explaining why inverted yield curves are obsolete as a recession predictor, why “this time is different,” and so on, but a brand new San Francisco Fed paper confirmed that the yield curve is still the most accurate predictor of U.S. recessions.

Why do inverted yield curves predict economic recessions? The main reason is because banks borrow at lower, short-term interest rates and lend money out at higher, longer-term interest rates, and the differential or “spread” between the two rates is where they earn their profit. In addition, yield curve inversions typically occur after several years of interest rate hikes, which have a dampening effect on the economy and financial markets. As fund manager Jeffrey Gundlach has said, the Fed has usually raised interest rates “until something breaks.” My major concern is that it will be the extremely dangerous “Everything Bubble” that breaks this time around.

Please follow or add me on TwitterFacebook, and LinkedIn to stay informed about the most important trading and bubble news as well as my related commentary.

This past weekend, I discussed the recent weekly violation of the market back below its respective 50-dma and the triggering of actions in our underlying portfolios.

‘If the market fails to hold the 50-dma by the end of this week, we will add our hedges back to portfolios, rebalance risk in portfolios and raise cash as needed.

We did exactly that on Friday by reinstating our short-market hedge and raised some cash by reducing some of our long-equity exposure. While previously we had only hedged portfolios, the action this past week to simultaneously reduce some equity exposure was due to both of our primary “sell” signals being tripped as shown below.”

Notice that while the much surged more than 1% on Monday:

  • Both “sell signals” remain firmly entrenched at relatively high levels
  • The market is not oversold as of yet; and,
  • Prices remain below the short-term moving average.

All of this suggests the correction process is not yet complete.

On a short-term trading view, the consolidation process continues with the Monday’s rally also remaining below the 50-dma keeping short-hedges in place for now. This is particularly the case given the confirmed “sell” signal on a weekly basis as noted above.

Most importantly, the market is currently in the process of building a consolidation pattern as shown by the ‘red’ triangle below. Whichever direction the market breaks out from this consolidation will dictate the direction of the next intermediate-term move.”

“Turning points in the market, if this is one, are extremely difficult to navigate. They are also the juncture where the most investing mistakes are made.”

Over the last several weeks, I have been providing constant prodding to clean up portfolios and reduce risks. I also provided guidelines for that process –  click here.

The rally on Monday was not surprising, due to the short-term oversold conditions that existed. However, as discussed in the newsletter:

“It isn’t too late to take some actions next week as I suspect we could very likely see a further bounce on Monday or Tuesday.

Use that bounce wisely.”

For now, it is important to note the “bullish trend” remains solidly intact and, therefore, we must give the “benefit of the doubt” to the bulls. However, with “bearish signals” beginning to mount, the increase in risks certainly justifies become more cautious currently.  Goldman Sachs recently noted the potential of a further corrective process:

As has been discussed in previous updates, the market could also be starting a much bigger/more structurally corrective process, counter to a V wave sequence from the ‘09 lows. If that’s the case, there should be room to continue a lot further over time. At least 23.6% of the rally since ‘09 which is down at 2,352.

Bottom line, it’s worth considering the possibility of continuing further than 2,467-2,449. Doing so might imply that this is not an ABC but rather a 1-2-3 of 5 waves down, in a larger degree ABC count that could take months to fully manifest. While it is still far too early to make this call, the important thing to note is that the 2,467-2,449 area will likely be trend-defining.”

Searching For The Greater Fool

ValueWalk recently published the following note:

Klarman writes when purchasing stocks:

“You may find a buyer at a higher price—a greater fool—or you may not, in which case you yourself are the greater fool.”

Here’s an excerpt from Klarman’s book, Margin of Safety, in which he discusses the importance of doing your homework and avoiding speculation when it comes to investing:

“There is the old story about the market craze in sardine trading when the sardines disappeared from their traditional waters in Monterey, California. The commodity traders bid them up and the price of a can of sardines soared. One day a buyer decided to treat himself to an expensive meal and actually opened a can and started eating. He immediately became ill and told the seller the sardines were no good. The seller said, “You don’t understand. These are not eating sardines, they are trading sardines.”‘

Like sardine traders, many financial-market participants are attracted to speculation, never bothering to taste the sardines they are trading. Speculation offers the prospect of instant gratification; why get rich slowly if you can get rich quickly?

Moreover, speculation involves going along with the crowd, not against it. There is comfort in consensus; those in the majority gain confidence from their very number. Today many financial-market participants, knowingly or unknowingly, have become speculators. They may not even realize that they are playing a ‘greater-fool game,’ buying overvalued securities and expecting—hoping—to find someone, a greater fool, to buy from them at a still higher price.

There is great allure to treating stocks as pieces of paper that you trade. Viewing stocks this way requires neither rigorous analysis nor knowledge of the underlying businesses. Moreover, trading in and of itself can be exciting and, as long as the market is rising, lucrative. But essentially it is speculating, not investing.

You may find a buyer at a higher price—a greater fool—or you may not, in which case you yourself are the greater fool.”

I really enjoyed this analysis as it epitomizes the problem facing investors today. Investors are currently faced with a “binary” choice given an overvalued, overly bullish and extended market.

  1. Stay out of the market and miss out on short-term gains but remain protected against a future “mean reverting event;” or,
  2. Chase the market for short-term capital appreciation but potentially suffer severe capital destruction in the future.

It is an impossible choice.

Let me explain.

In an overly valued, extended and bullish market, the logical choice would be to go to cash (sell high) and wait for a “mean reverting” event to redeploy capital (buy low) at much better valuations. The chart below shows, even using a simplistic process for doing so, the long-term returns have far outpaced those of “buy and hold” investors.

Yes, as notated, investors would have “missed out” of the market for nearly 3-years in 2000, almost 2-years in 2008, and 6-months in 2016. Yet, using even a simplistic method of risk-management, in this case a 12-month moving average, the net result greatly outweighed the mainstream “buy and hold” approach.

But it’s impossible for most individuals to actually do. 

The reality is that most investors “sold” the lows in 2002, and 2008, and waited far too long to get back “in.” As has always been the case, investors tend to do the exact opposite of what they should.

“Buy high and sell low.” 

As study after study shows, investors are driven by their emotions of “greed” and “fear.” Those emotional biases are fed by the mainstream media who consistently berate individuals for “missing out” and “not beating the market.” Yet, scream “panic” at the first sign of trouble.

This drives investors to consistently do the wrong things at the wrong time. Repeatedly.

Currently, investors are riding a nine-year-old bull market with an inherent belief they will be smart enough to get out before the next bear market begins. This is the very essence of the “greater fool theory.”

Unfortunately, most individuals will once again be “eating their sardines.” As discussed previously:

While the answer is ‘yes,’ as there is always a buyer for every seller, the question is always ‘at what price?’ 

At some point, that reversion process will take hold. It is then investor ‘psychology’ will collide with ‘margin debt’ and ETF liquidity.

When the ‘robot trading algorithms’  begin to reverse, it will not be a slow and methodical process but rather a stampede with little regard to price, valuation or fundamental measures as the exit will become very narrow.

Importantly, as prices decline it will trigger margin calls which will induce more indiscriminate selling. The forced redemption cycle will cause catastrophic spreads between the current bid and ask pricing for ETF’s. As investors are forced to dump positions to meet margin calls, the lack of buyers will form a vacuum causing rapid price declines which leave investors helpless on the sidelines watching years of capital appreciation vanish in moments.

Currently, the markets remain above their 12-month moving average which keeps portfolios allocated on the long-side.

However, such will not always be the case.

Trying to beat a “benchmark index” is a fool’s errand and should be left to the “fools.”

1) The index contains no cash

2) It has no life expectancy requirements – but you do.

3) It does not have to compensate for distributions to meet living requirements – but you do.

4) It requires you to take on excess risk (potential for loss) in order to obtain equivalent performance – this is fine on the way up, but not on the way down.

5) It has no taxes, costs or other expenses associated with it – but you do.

6) It has the ability to substitute at no penalty – but you don’t.

7) It benefits from share buybacks – but you don’t.

In order to win the long-term investing game your portfolio should be built around the things that matter most to you, and your money.

– Capital preservation

– A rate of return sufficient to keep pace with the rate of inflation.

– Expectations based on realistic objectives.  (The market does not compound at 8%, 6% or 4%)

– Higher rates of return require an exponential increase in the underlying risk profile.  This tends to not work out well.

– You can replace lost capital – but you can’t replace lost time.  Time is a precious commodity that you cannot afford to waste.

– Portfolios are time-frame specific.  If you have a 5-years to retirement but build a portfolio with a 20-year time horizon (taking on more risk) the results will likely be disastrous.

Investing is not a competition and, as history shows, there are horrid consequences for treating it as such. So, do yourself a favor and turn off the media. Focus instead on matching your portfolio to your own personal goals, objectives, and time frames. In the long run, you may not beat the index from one year to the next, but you are much more likely to achieve your investment goals which is why you invest in the first place.

Unfortunately, the rules are REALLY hard to follow. If they were easy, then everyone would be wealthy from investing. They aren’t because investing without a discipline and a strategy tends to have horrid consequences.

Personally, I hate the  “taste of sardines.” 

* A broad market top may be forming now
* My blueprint remains the same… I plan to sell into strength
* Yell and roar and sell some more

“Life is really simple, but we insist on making it complicated.”

I would also take my cue from the Portfolio Insurance induced drop in October, 1987, below — after all, like the action of the last few days the 1987 crash was also a liquidity event:

As you can see in the 1987 chart, that template produced a Monday obliteration which was followed, like today, by a “Turnaround Tuesday.” That sharp rally continued for only a day or two. But soon thereafter, two tests of the bottom occurred. First, a week later and, again in early December.

I would not be surprised if that pattern is repeated in the next few weeks.”

– Kass Diary, My Blueprint Remains The Same

History Rhymes

So far the October, 1987/February, 2018 analog is holding up.

Similar to October, 1987, the S&P Index has experienced a +9% rally (from 2540 to 2785) the capitulation lows of several Fridays ago (this compares to the initial thrust of +14% in the first October, 1987 rally).

As was the case 32 years ago we then had a retest (to 2645) late last week (bouncing off the 100-day moving average) and, adjusted for the futures rise this morning, to about 2730 – basically in line with my 2725-2750 target I expressed three days ago.

If history rhymes (see chart of October-December, 1987 above), stocks will meander for several weeks (perhaps with a slightly declining bias) and, in several weeks, will make another retest of the lows.

Accordingly, I plan to expand my short book into the current rally.

Looking Beyond Our Noses…

Source: Zero Hedge

Unlike in December, 1987, I dont expect the markets to take off in 2018 — just the opposite. As I wrote in my closer, “A Maturing Bull Market”:

“I wanted to observe that my highest probability outcome is that the S&P Index is making a broad top now.

The tremor was possibly seen in early February but the quake may lie ahead.

While this view wont surprise many — it is in marked contrast to what I am hearing in the business media and from leading strategists.

Above all, as expressed earlier today in my Diary, the possibility of policy errors is multiplying (policy process in Washington, DC is broken, incoherent and done “on the fly”) — at a time in which the core fundamentals of the global economies are still not as secure as the consensus believes (see chart above), central bankers are pivoting and when valuations are elevate.”

In terms of the intermediate term I am basically on board with Goldman Sach’s technical analysis team’s thinking (H/T Zero Hedge):

“The index saw an initial selloff that was impulsive in nature (wave A). This tends to mean that there’s likely going to be another impulsive 5-wave decline to complete an ABC 5-3-5 count. From current levels, an eventual C wave could reach somewhere close to 2,449.

Having said that, it’s not uncommon for wave B to form complex structures (often triangles). Although ultimately bearish, there’s scope for some initial consolidation/range-bound price action while still in the “body” of the February range.

The next significant retrace level below is 61.8% from Feb. 9th at 2,631. The 200-dma will likely be critical at 2,560. This particular moving average held very well at the prior low. Getting a break below it would therefore help to confirm that this is in fact wave C targeting at least ~2,449.”

Goldman sees overlapping price action in between 2,600 and 2,800. A break below the 200-dma will open up for a minimum target down to 2,449.

“Reaching this 2,449 level would also mean retracing ~38.2% of the immediate advance from Feb. ’16 (2,467). This would therefore be an ideal target from a classic wave count perspective; that is, if correcting the rally from Feb. ’16.

As has been discussed in previous updates, the market could also be starting a much bigger/more structurally corrective process, counter to a V wave sequence from the ’09 lows. If that’s the case, there should be room to continue a lot further over time. At least 23.6% of the rally since ’09 which is down at 2,352.

… it’s worth considering the possibility of continuing further than 2,467-2,449. Doing so might imply that this is not an ABC but rather a 1-2-3 of 5 waves down, in a larger degree ABC count that could take months to fully manifest. While it is still far too early to make this call, the important thing to note is that the 2,467-2,449 area will likely be trend-defining.”

Bottom Line

“At words poetic, I’m so pathetic
That I always have found it best,

Instead of getting ’em off my chest,
To let ’em rest unexpressed.
I hate parading my serenading
As I’ll probably miss a bar,
But if this ditty is not so pretty,
At least it’ll tell you how great you are.

You’re the top! You’re the Colosseum,
You’re the top! You’re the Louvre Museum,
You’re a melody from a symphony by Strauss,
You’re a Bendel bonnet, a Shakespeart sonnet,
You’re Mickey Mouse…

You’re the nose
On the great Durante

I’m just in a way
As the French would say, “de trop”

But if, baby, I’m the bottom
You’re the top!”

Cole Porter, “You’re The Top” 

My baseline expectation is that we may be seeing a broad market top forming in February-March that could be in place for some time and might morph into a more lengthy and deeper correction than the consensus expects.

Volatility — normally a vital feature of changing market complexion — seems likely to expand geometrically as liquidity has died in a market dominated by passive investing (ETFs) and risk parity and volatility targeting/trending products and strategies. The aforementioned are contributing to a market that is random, unpredictable and makes its “appearance” (over the short term) less real, more artificial and transitory — conditions that are ripe for opportunistic trading and intermediate term positioning for those that are impassioned and unemotional.

The tremor was felt in early February, the quake may lie ahead.

The rally has taken the S&P Index back into my 2725-2750 price target — I am a seller and, given the volatility, I plan to expand my net short exposure (on a scale higher). (I have added to my SPY short at $273.15 in premarket trading.)

For the intermediate term, I am on board with Goldman’s technical team who sees either a base or break of 2,467-2,449 support. (If the S&P breaks these levels Goldman sees a more lengthy and deeper corrective process lies ahead.)

Yell and roar and sell some more!