Monthly Archives: July 2016

Justifiable Bullishness Or Is It Willful Blindness?

Currently, there is much bullish commentary suggesting stocks can only go higher from here. Is the bullishness in the markets justifiable, or is it willful blindness?

John Stoltzfus, CIO of Oppenheimer, is clearly in the bullish camp:

“We remain very bullish on this market. You’re going to see money beginning to further move out of the bond market, and it makes all the sense in the world to be positioned in equities.”

This seems a little optimistic given the amount of money that has already flooded into the 5-largest “mega-cap” stocks which have accounted for a bulk of this years market returns.

Nonetheless, it is an interesting question.

From the bulls viewpoint the focus has been the ability for these companies to grow earnings.

The bearish view is the problem with valuations.

As noted in “COT Positioning – Back To Extremes,” the Nasdaq set repeated new highs in 2020, which is astonishing given the depth of the economic recession. To wit:

“While the S&P 500 is primarily driven higher by the largest 5-market capitalization companies, it is the Nasdaq that has now reached a more extreme deviation from its longer-term moving average.”

COT Positioning Extremes, Technically Speaking: COT Positioning – Back To Extremes: Q2-2020

“Moving averages, especially longer-term ones, are like gravity. The further prices become deviated from long-term averages, the greater the “gravitational pull” becomes. An “average” requires prices to trade above and below the “average” level. The risk of a reversion grows with the size of the deviation.

The Nasdaq currently trades more than 23% above its 200-dma. The last time such a deviation existed was in February of this year. The Nasdaq also trades 3-standard deviations above the 200-dma, which is another extreme indication.” 

It’s The Fed Stupid

The immediate conclusion is the drive higher in the markets is a function of massive amounts of liquidity being injected into the financial markets by the Federal Reserve. As shown below that was certainly the case during March and April.

However, since then the tapering of the liquidity injections by the Fed has been marked as the slowing uptake of the various programs reduced demand.

While there is indeed truth to the Fed’s impact on the market, it is not solely responsible for the dislocation of prices from the underlying fundamentals.

As shown, the decline in fundamentals didn’t start during the pandemic. The decline in earnings started in early 2019 as economic growth slowed, and accelerated during the pandemic. However, during that same period stock prices rose, which is almost entirely attributable to “valuation expansion.”

Dumb Money All In

E*Trade recently released survey data which showed that despite the market plunge in March, bullish sentiment has returned:

  • Bullish sentiment returns. Half of surveyed investors (51%) are bullish, rising 13 percentage points since last quarter.
  • Investors are more likely to believe the market will rise. Over half of investors (51%) believe the market will rise, skyrocketing 20 percentage points this quarter.
  • But volatility will persist. More than half of investors (56%) believe volatility will continue, gaining nine percentage points since last quarter.
  • And investors expect a long road to recovery. More than half (54%) believe it will take more than one year to recover from the pandemic, and just one out of five investors (23%) would give the economy an “A” or “B” grade.

You get the idea. Just one quarter after panic selling lows, investors are once again “back in the pool.” Despite the economy just printing a nearly 40% decline in Q2, and earnings having dropped by nearly 40% from their peak, the “dumb money” is back to chasing stocks.

In particular, not only are “retail investors” chasing stocks, they are doing it with increased leverage by using options. As noted by CNBC recently:

Investors have reentered the market at a record rate following the coronavirus-induced sell-off in March, and as traders look to profit, options volume has soared to an all-time high.

The average daily value of options traded has exceeded shares for the first time, with July single stock options volumes currently tracking 114% of shares volumes.

In other words, the options market is now larger than the shares market.”

We have seen record lows in the Put/Call ratio three times in 2020. All three lead to corrections.

Willful Blindness

Willful blindness, also known as willful ignorance or contrived ignorance, is a term used in law. Being “willfully blind” describes a situation in which a person seeks to avoid civil or criminal liability for a wrongful act by keeping themselves unaware of the facts that would render them liable or implicated.

Although the term was originally used in legal contexts, the phrase “willful blindness” has come to mean any situation in which people avoid facts to absolve themselves of their liability. 

“‘Willful blindness’ is most prevalent in the financial markets. Investors regularly dismiss the ‘facts’ which run contrary to their current opinion. In behavioral investing terms this is also known as ‘confirmation bias.'” 

As markets rise, investors take on exceedingly more risk with the full knowledge that such actions will have a negative consequence. However, that “negative consequence” is dismissed by the “fear of missing out,” or rather F.O.M.O.

As “greed” overtakes “fear,” investors become more emboldened as rising markets reinforce the conviction that “this time is different.” Ultimately, when the negative consequence eventually occurs, instead of taking responsibility for their actions, they blame the media, Wall Street, or their advisor.

This currently where we are in the markets today.

Value Proves It

Investors know there is a rising risk of loss, but, they are willfully ignoring the facts and and piling into risk because the narrative has simply become “fundamentals don’t matter.”  In 2020, investors are again chasing “growth at any price” and rationalizing overpaying for growth. 

“Such makes the mantra of using 24-month estimates to justify paying exceedingly high valuations today, even riskier.”

Value, #MacroView: Value Is Dead. Long Live Value Investing

This is also where there is the greatest disparity between growth and value on record.

Value, #MacroView: Value Is Dead. Long Live Value Investing

There are two critical takeaways from the graph above:

  • Over the last 90 years, value stocks have outperformed growth stocks by an average of 4.44% per year (orange line).
  • There have only been eight ten-year periods over the last 90 years (total of 90 ten-year periods) when value stocks underperformed growth stocks. Two of these occurred during the Great Depression and one spanned the 1990s leading into the Tech bust of 2001. The other five are recent, representing the years 2014 through 2019.

In other words, there is high probability that investors chasing “growth” are going to pay a heavy price in the future..

It’s The Economy

The problem, as discussed in “Insanely Stupid,” the ability for stocks to continue to grow earnings at a rate to support high valuations will be problematic. Such is due to rising debts and deficits which will retard economic growth in the future. To wit:

“Before the ‘Financial Crisis,’ the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.

The ‘COVID-19’ crisis led to a debt surge to new highs. Such will result in a retardation of economic growth to 1.5% or less.” 

Insanely stupid, “Insanely Stupid” To Chase Stocks As Economy Plunges? 07-31-20

Slower economic growth, combined with a potential for higher taxes, increases the probability that  “risk” may well outweigh “reward” at this juncture.

Such doesn’t mean that stocks can’t go higher in the near term, and despite some wiggles along the way, it is quite likely they will simply because of momentum and lot’s of “bullish bias.” 

“We’ve often noted that during times of unhealthy market environments, when fewer than 60% of stocks can hold above their 200-day averages, that periods of high optimism tend to lead to below-average forward returns.

We’re seeing that now, to a historic degree. Since we’ve been tracking this data, just over 20 years, there has never been a day when Dumb Money Confidence was at or above 80% while fewer than 60% of stocks in the S&P 500 were trading above their 200-day averages. Until now.” – Sentiment Trader

The Problem Of Eternal Bullishness

The problem of “eternal bullishness” is it leads to the “willful blindness” of risks, rather than having a healthy respect for, and recognition of, those risks. This leads to the unfortunate problem of being “all-in” on every hand which has a devastating consequence when a mean reverting event occurs.

Our job as investors is to navigate the waters within which we currently sail, not the waters we think we will sail in later. Higher returns come from the management of “risks” rather than the attempt to create returns by chasing markets.

I recently quoted Robert Rubin, former Secretary of the Treasury, in “This Is Nuts,” as it defined our philosophy on risk.

‘As I think back over the years, I have been guided by four principles for decision making. The only certainty is that there is no certainty. Second, every decision, as a consequence, is a matter of weighing probabilities. Third, despite uncertainty, we must decide and we must act. And lastly, we need to judge decisions not only on the results but also on how we made them.

Most people are in denial about uncertainty. They assume they’re lucky, and that the unpredictable can be reliably forecasted. Such keeps business brisk for palm readers, psychics, and stockbrokers, but it’s a terrible way to deal with uncertainty. If there are no absolutes, all decisions become matters of judging the probability of different outcomes, and the costs and benefits of each. Then, on that basis, you can make a good decision.’” – Robert Rubin

Focus On Risk

It should be evident that an honest assessment of uncertainty leads to better decisions.

The problem with “Eternal Bullishness” and “Willful Blindness” is that the failure to embrace uncertainty increases risk, and ultimately loss.

We must be able to recognize and be responsive to changes in underlying market dynamics. If they change for the worse, we must be aware of the inherent risks in portfolio allocation models. The reality is that we can’t control outcomes. The most we can do is influence the probability of specific outcomes.

Focusing on risk not only removes “willful blindness” from the process, it is essential to capital preservation and investment success over time.

Major Market Buy Sell Review: 08-10-20

HOW TO READ THE MAJOR MARKET BUY SELL REVIEW 08-10-20

There are three primary components to each Major Market Buy/Sell chart in this RIAPro review:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise, when the buy/sell indicator is above the ZERO line, investments have a tendency of working better.

With this basic tutorial, let’s review the major markets.

Major Market Buy/Sell Review 08-10-20

S&P 500 Index

  • SPY is now both extremely overbought and pushing into 3-standard deviations above the 50-dma.
  • This is the point where a correction usually begins to some degree. 
  • The push now is for the market to claim “all-time highs,” but I suspect we will see a correction shorly thereafter. Exuberance is a bit on the extreme side.
  • Caution is advised. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $305 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow continues to underperform other major indices due to its lack of the 5-major FANG stocks.
  • With the buy-signal extremely extended, pushing into 3-standard deviation territory, and underperforming other assets, we are going to focus our attention elsewhere for now.
  • Short-Term Positioning: Bearish
    • Last Week: No position..
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • QQQ’s outperformance of SPY turned up a bit last week as expected. We added to our tech exposure two weeks ago.
  • The QQQ’s remain massively overbought, the buy signal is extremely extended, and QQQ is still pushing 3-standard deviations above the 200-dma. 
  • However, for now, tech really is about the “only game in town.”
  • Take profits and rebalance as needed.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: Added to tech holdings (MSFT, AAPL, NFLX, AMZN, ADBE, CRM, XLK)
    • This Week: No changes this week. 
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • Small-caps finally broke above the 200-dma and are now historically overbought and 3-standard deviations above the mean. 
  • With the buy-signal extremely extended, and the market under-performing, the risk is still too high.
  • With small-caps very susceptible to weak economic growth, we are still avoiding this area of the market. 
  • Support is critical at the $58 level.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $58
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. However, MDY also broke above the 200-dma resistance. It is now testing previous highs and is 3-standard deviations above the mean. 
  • We are also avoiding mid-caps for the time being until relative performance improves.
  • The $320 stop-loss remains. Use this rally to reduce if needed. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $320
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets have performed better on a relative basis but are now extremely extended. As with all other markets, the buy signal is at the highest level on record.  
  • Look for a correction that does not violate the 200-dma to add a trading position. Target is $41. 
  • There dollar decline, responsible for EEM performance, is well overdone. Look for a counter-trend rally which will push EEM lower. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $40 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • EFA was holding up better but is being tested by the rally in the dollar.
  • It will be important for EFA to hold support at the 200-dma, but the overbought condition puts this at risk. 
  • As with EEM, EFA is dollar sensitive, so we also added a dollar hedge. 
  • Short-Term Positioning: Bearish
    • Last Week: Sold position in EFA.
    • This Week: No position.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Oil prices are struggling to move higher and are running into the 200-dma resistance. 
  • We suggested last: “Look for a correction to reverse some of the extreme overbought.” That correction hasn’t occured yet, but may have started on Friday. 
  • Oil is also subject to a reversal in the dollar, another reason we are adding a dollar hedge.
  • Energy stocks are underperforming oil prices currently, which suggests more trouble in the sector. However, there remains relative value in some energy companies which may perform better than oil prices in the near-term. 
  • Oil should hold support between $30 and $35 and we will look to increase our holdings on pullbacks.
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long our current position in IAU, but did take some profits last week due to the risk of a counter-trend rally in the dollar. 
  • Gold is extremely overbought and starting to push 4-standard deviations above the 200-dma. 
  • We suggest taking some profits for now and look for a pullback to increase our sizing. 
  • We believe downside risk is fairly limited, but as always maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss moved up to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • While bonds are overbought short-term, with every other market extremely extended into overbought territory, if a correction occurs, TLT should hedge risk to some degree as rates push towards zero. 
  • There is potentially some short-term risk of a short-term correction, but given the extreme extension of the equity markets, dips should be bought. 
  • There is still upside potential in bonds if there is a dollar rally or a correction in equities as we move into August. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • The dollar bounced off support on Friday, so we will see if we get some follow through this week.
  • Given the large number of analysts with “bearish” forecasts on the dollar the probability of a dollar rally has risen. We have started building a trading position for such a counter rally and to hedge our international, energy and gold holdings.
  • Trading positions can be added to hedge portfolios but there is not likely a huge move available currently given the current market dynamics. 
  • Stop-loss adjusted to $93

New RIA PRO Features

New RIA PRO Features

We always get lots of great suggestions from our users, and we are working closely with our development team to incorporate as many suggestions as we can.

Turing Point Analytics

Many of our users have requested a more active portfolio trading style which both goes long and short individual securities. We have recently fulfilled that request by striking a deal with Jeffrey Marcus of Turning Point Analytics. 

“Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points. TPA has been serving institutional clients with their trading ideas and strategies.”

Get up to 3-emails each week discussing markets, trades, outlook, and tactics.

Plus receive real-time alerts of portfolio changes. 

Add TPA to your currently subscription by clicking here.


This weekend we also released 2-NEW Site-Wide Features 

NEWS

On your dashboard you will see a new tab your alert table below the latest Articles and Commentary boxes.

We have added all incoming news headlines in the first tab for the day, so that you can see what is potentially moving the markets. 

Of course, our main news page remains under the RESEARCH tab so that you can review news from previous days from any of our sources as needed. 

Importantly, next to the new HEADLINES tab remains the News, Alerts, Dividend, and Earnings data for any of the positions you have added to your personal watch lists or portfolios.

New Data Feed = New Resources

We have recently acquired a data stream for the site as well which is giving access to a variety of new information sources to enhance your portfolio management opportunities. 

The first integration of the new data can be found under the RESEARCH tab by clicking on OPTIONS.

Under this tab you will find all of the option chains for an individual security you are interested in. You will find all of the available strike months, call and put options for each month and strike, as well as the current bid and ask for each option.

With this data you can start to construct a variety of hedging strategies from writing puts, to covered calls, cashless collars, ratio spreads, etc. 

Much More Coming

Over the next few months we have a lot of new features in the works for you. Such as:

  • A premium technical charting service which will allow you to save your settings, create multiple charting templates, access to dozens of indicators, etc. 
  • Insider trading information 
  • Corporate announcements.
  • Click-to-trade
  • Automated portfolio management
  • Financial planning 

We are dedicated to making RIAPro a useful tool for your personal money management needs. With your help and suggestions, we will continue to improve. 

Thank you for using RIAPro and let us know how we can serve you. 

David Robertson: The Emanation Of Inflation.

One of the interesting aspects of investing is that many of the momentous changes that can make a big difference to portfolio performance only come around once in a great while. The emanation of inflation may be one of those changes. As a result, some of the trickiest aspects of investing are recognizing those big turning points and then having the courage to act decisively when the time comes.

It takes a unique set of skills and a unique mindset to pull this off; it is all-too-easy to find oneself disabled by indecision right when it matters most. Fortunately, there is a straightforward way to hack this natural weakness: The answer is to bone up on financial history. With the winds of inflation blowing again, there may be no better time to do it.

Russell Napier

One of the people uniquely suited to help with this endeavor is Russell Napier. He has worked in the investment business for 30 years and wrote a book on the historical lessons of bear markets entitled Anatomy of The Bear: Lessons From Wall Street’s Four Great Bottoms. Napier also founded a course in “The Practical History of Financial Markets.” He is always quick to explain why he founded the course, too:

“Because the business schools don’t teach it.”

In the aftermath of the GFC, Napier recognized the condition of exploding levels of government debt differed from the experience in World War II. During a 2010 presentation to the CFA Society of Baltimore, he noted:

“Through WWII the US only borrowed money to ‘kill people.’”

In other words, using debt in extreme circumstances of existential necessity is acceptable.

After the GFC, however, the rationale changed:

“Now the US is borrowing money to keep people alive – which is more expensive.”

The ongoing and nonproductive (at least in economic terms) nature of the borrowing did not provide the necessary ingredients for inflation.

At the time, Napier’s prognosis of disinflation competed with calls for increasing inflation and a “beautiful deleveraging.” He predicated his forecast on the faulty transmission mechanism of monetary policy.

As he noted in an interview with The Market/NZZ,

QE was a fiasco. All these central banks have achieved over the past ten years is creating a lot of non-bank debt.”

Looking back over the last ten years, Napier got the big points right.

Anatomy Of The Bear

His book, Anatomy of the Bear, also provides helpful lessons for investors. Napier describes the book as a “field guide for the financial bear.” Napier analyzed 70,000 articles from the Wall Street Journal to capture the contemporaneous sentiment of bear market bottoms. He also distinguished factors which  “proved to be good markers to the future, and those which are  misleading.”

The critical strategic conclusion from the book is that swings in equity valuation are driven primarily by changes in inflation. As a result, the catalyst to “reduce equities to cheap levels” typically involves “a material disturbance to the general price level.” He also notes “All four of our bear-market bottoms occurred during economic recessions.”

So, where does that leave investors today? Napier started telegraphing a change in sentiment from his deflationist views after the March selloff. I highlighted his comments from Grant’s Interest Rate Observer in an early April blog post: “Government interventions to bail out an entire commercial system or portion of the commercial system, in my opinion, are entirely novel.”

Since then, Napier’s perspective has evolved, and he explains why:

It’s a shift in the way the creation of money has changed the game fundamentally … Such is money creation in a way that is completely circumventing central banks … And more importantly, the control of money supply has moved from central bankers to politicians.

Napier explains the significance of this change in the Financial Times: “As a result, investors need to prepare for a new era of inflation.

Emanation Of Inflation

As talented as Napier is at analyzing the investment environment and understanding it from a historical perspective, he is at least as gifted at communicating what the implications are. Importantly, inflation will come along with a policy to cap rates below the inflation rate. As to what that means, Napier expounds:

“Savers, through government-mandated bond holdings, will have to bear the burden of capped yields and will watch a portion of their savings eaten away through inflation.

In economic terms, it is the very definition of financial repression. Such can be hard to understand for two reasons. One is that it is an abstract concept. Another is that it involves politicians intentionally causing harm to people and organizations that save money. In a separate interview with MacroVoices, Napier describes how this works in plain terms:

“I was once asked by a retired lady how I would put that phrase [financial repression] into English. Such is an excellent question, I think. And I replied that it was stealing money from older adults slowly. And the ‘slowly’ bit is significant. Because you ‘don’t want to frighten the horses. You want to try and keep them corralled in fixed-interest securities. So, on the whole, doing it slowly is probably the democratic way to do it.”

Financial Repression

While an environment of financial repression is not a good place for savers, it isn’t a good place for people who invest on behalf of others either. In the same interview, Napier described that most of the skills developed by investors over the last forty years are “probably redundant”.

He goes as far as to recommend his institutional clients promote emerging markets people to lead their developed markets groups. The reason is that those people are much more familiar with the “higher levels of inflation, government interference, and capital controls” that will now also be pervasive in developed markets.

The investment strategy for dealing with the new inflationary environment falls into the category of “simple, but not easy.” It is simple because it focuses on preserving wealth in a system designed to slowly “steal” it. It is not easy because it requires a mindset and a commitment to do something very different from what has worked in the past.

In this new age of repression, the secret to preserving the purchasing power of savings lies not in the mix of assets, but the quantities. Investors should hold as much gold and as little government debt as they feel comfortable with.

The Rationale Of Gold

In his MacroVoices interview, he elaborates on the rationale for gold:

“But that is where the gold price gets a second kick. It is not an asset which is easy to manipulate for governments.”

In other words, gold protects not just against inflation, but government intervention in the form of financial repression. Such also has implications for the types of exposure to gold: The less potential for government intervention, the better.

Such a radically different environment for investing will also create a radically different environment in which companies operate. Historically, the beneficiaries of higher inflation are companies with large fixed assets that don’t have high reinvestment requirements. Conversely, the relative losers are the asset-light companies that have been the stars of the last forty years.

Although Napier expresses the conviction that inflation will emerge and be an essential factor for long-term investors, he also acknowledges this forecast depends on the velocity of money increasing. While he does expect spending patterns to resume and the savings rate to decline, any delays in those dynamics would also delay the emergence of inflation.

Another factor that could delay (but not prevent) his forecast would be deflationary pressures originating outside of the US. Before the COVID lockdowns, Napier was concerned that outside of America, “most of the credit risk still rests on bank balance sheets.” Although other news has overshadowed the woes of European banks recently, the potential for bad debts to create problems remains high.

Conclusion

China could also be a factor. As the home of incredibly high credit growth and uncertainty surrounding its exchange rate, China has a great deal of potential to transmit deflationary forces. Besides, escalating tensions between the US and China threaten to further weigh on global trade, which would exacerbate those forces.

All in all, though, it looks like we are finally going to experience inflation in the not-too-distant future, and this is the key takeaway for long-term investors. It is also important to remember as this unfolds, however, that official communications will not be helpful but crafted instead to keep the “horses from being frightened.”

There will be PR campaigns describing why a “little” inflation is a good thing. Other communications will describe measures as “temporary”. There will be other platitudes too.

It helps to appreciate that this is probably one of the relatively few big turning points that can materially affect wealth distribution. For the intellectually curious, it is a rare and exciting chance to observe and learn. For savers, it is crucial to understand precisely how different and how damaging this will be. Either way, it’s a great time to embrace the lessons of financial history.

Shedlock: Employment Report Not Nearly As Strong As It Seems

The employment report showed an increase of 1.8 million in July, nearly in line with the economic consensus. However, looking below the headlines the report was not nearly as strong as it seems.

The BLS Employment Report for July shows employment rose by 1.8 million in July following a gain of 4.8 million in June and 2.7 million in May. The unemployment rate fell slightly to 10.2%.

Initial Reaction

The Bloomberg Econoday consensus jobs estimate was +1.677 million, and the unemployment rate consensus was 10.5%.

The BLS said that errors that plagued the household survey since March was not as bad this month.

BLS Error Rate

For March through June, BLS published an estimate of what the unemployment rate would have been had misclassified workers been included. Repeating this same approach, the overall July unemployment rate would have been about 1-percentage point higher than reported. However, this represents the upper bound of our estimate of misclassification and probably overstates the size of the misclassification error. 

According to usual practice, we accept the data from the household survey as recorded. To maintain data integrity, we take no ad hoc actions to reclassify survey responses.      

Add 1-percentage to the unemployment rate for a better estimate.

Job Revisions

The change in total nonfarm payroll employment for May was revised up by 26,000, from +2,699,000 to +2,725,000, and the change for June was revised down by 9,000, from +4,800,000 to +4,791,000. With these revisions, employment in May and June combined was 17,000 higher than previously reported.

(Monthly revisions result from additional employment reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.) 

BLS Jobs Statistics at a Glance

  • Nonfarm Payroll: +1,800,000 – Establishment Survey
  • Employment Report: +1,350,000 – Household Survey
  • Unemployment: -1,412,000 – Household Survey
  • Baseline Unemployment Rate: -0.9 to 10.2% – Household Survey
  • U-6 unemployment: -1.5 to 16.5% – Household Survey
  • Civilian Non-institutional Population: +169,000
  • Civilian Labor Force: -620,000 – Household Survey
  • Not in Labor Force: +230,000 – Household Survey
  • Participation Rate: -0.1 to 61.4% – Household Survey

Part-Time Jobs

  • Total Part-Time Work Change: -1,571.000
  • Involuntary Part-Time Work: -1,605,000 – Household Survey
  • Voluntary Part-Time Work: +2,743,000 – Household Survey

Don’t try to make sense of those numbers as they never add up. I list them as reported.

BLS Employment Report Statement

Total nonfarm payroll employment rose by 4.8 million in June. The unemployment rate declined to 11.1 percent, the U.S. Bureau of Labor Statistics reported today. These improvements in the labor market reflected the continued resumption of economic activity curtailed in March and April due to the coronavirus (COVID-19) pandemic and efforts to contain it. In June, employment in leisure and hospitality rose sharply. Notable job gains also occurred in retail trade, education and health services, other services, manufacturing, and professional and business services.

Unemployment Rate – Seasonally Adjusted

Nonfarm 2020-08C

The above Unemployment Rate Chart is from the BLS. Click on the link for an interactive chart.

Month-Over-Month Changes By Job Type

Nonfarm 2020-08D

Hours and Wages

Average weekly hours of all private employees declined 0.1 hours to 34.5 hours while average weekly hours of all private service-providing employees decline 0.1 hours to 33.5 hours. For manufactures, average weekly hours rose 0.7 hours to at 39.7 hours.

Average Hourly Earnings of All Nonfarm Workers rose $0.07 to $29.39.

Year-over-year, wages rose from $28.05 to $29.39. That’s a gain of 4.7%.

The month-to-month and especially year-over-year gains are very distorted because more higher-paid workers kept their jobs than lower-paid employees.

Average hourly earnings of Production and Supervisory Workers fell $0.11 to $24.63.

The decline is a good thing in that it reflects more people returning to work.

Year-over-year, wages rose from $23.54 to $24.63. That’s a gain of 4.6%.

For a discussion of income distribution, please see What’s “Really” Behind Gross Inequalities In Income Distribution?

Birth Death Model

Starting January 2014, I dropped the Birth/Death Model charts from this report.

For those who follow the numbers, I retain this caution: Do not subtract the reported Birth-Death number from the reported headline number. That approach is statistically invalid.

BLS Covid-19 Statement on the Birth-Death Model

The widespread disruption to labor markets due to the COVID-19 pandemic and the potential impact on the birth-death model have prompted BLS to revisit research conducted in the aftermath of the Great Recession (2008-2009) and incorporate new ideas to account for changes in the number of business openings and closings. The BLS is implementing two areas of research to improve our birth-death model’s accuracy in the CES estimates. These adjustments will better reflect the net effect of the contribution of business births and deaths to the estimates. These two methodological changes are the following:

1: A portion of both reported zeros, and returns from zero, in the current month from the sample, were used in estimation to better account for the fact that business births and deaths will not offset.

2: Current sample growth rates were included in the net birth-death forecasting model to better account for the changing relationships between business openings and closings.

BLS will determine monthly if the adjusted birth-death model described here continues to be necessary. We will disclose these changes each month in the Employment Situation news release. All months in the tables of net birth-death forecasts on this page include footnotes for any month in which we use a regressor to supplement the forecasts.

The Birth-Death model is essentially garbage but we likely will not find how distorted this is until the annual revisions next year.

Table 15 BLS Alternative Measures of Unemployment

Nonfarm 2020-08A

Table A-15 is where one can find a better approximation of what the unemployment rate is.

The official unemployment rate is 10.2%. However, suppose you start counting all the people who want a job but gave up. Then count all the people with part-time jobs that want a full-time job. Finally, add all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc. Now, you get a closer picture of the unemployment rate. That number is in the last row labeled U-6.

U-6 is much higher at 16.5%. Both numbers would be way higher still, were it not for millions dropping out of the labor force over the past few years.

Some of those dropping out of the labor force retired because they wanted to retire. The rest is disability fraud, forced retirement, discouraged workers, and kids moving back home because they cannot find a job.

Strength is Relative

It’s essential to put the jobs numbers into proper perspective.

If you work as little as 1-hour a week in the household survey, even selling trinkets on eBay, the BLS considers you employed.

Furthermore, in the household survey, if you work three part-time jobs, 12 hours each, the BLS considers you a full-time employee.

In the payroll survey, three part-time jobs count as three jobs. The BLS attempts to factor this in, but they do not weed out duplicate Social Security numbers.

The potential for double-counting jobs in the payroll survey is large.

Household Survey vs. Payroll Survey

The payroll survey (sometimes called the establishment survey) is the headline jobs number, which the BLS releases on the first Friday of every month. The BLS bases its estimates on employer reporting.

The household survey is a phone survey conducted by the BLS. It measures unemployment and many other factors.

If you work for one hour, you are employed. If you don’t have a job and fail to look for one, you are not considered unemployed; rather, you drop out of the labor force.

Looking for jobs on Monster does not count as “looking for a job.” You need an actual interview or send out a resume.

These distortions artificially lower the unemployment rate, artificially boost full-time employment, and artificially increase the payroll jobs report every month.

Seasonal Adjustments

The report this month is weaker than it looks. Huge seasonal adjustments were in play as were temporary Census jobs.

I discussed this yesterday evening in Seasonal Adjustments Likely to Boost Friday’s Job Numbers

Recovery Will Take Years

Last month I noted The Fed Promotes a Quickening that Takes Many Years

This report provides evidence. The recovery has slowed. Furthermore, huge headwinds remain, and the reopenings reversed in July. 

The economy has added about 9.5 million jobs since the April lows. 

However, jobs remain nearly 13 million jobs below the February 2020 peak. Millions of those jobs will not return.

Bulls Chant Into A Megaphone – “All-Time Highs”


In this issue of, “Bulls Chant Into A Megaphone – ‘All-Time Highs:”

  • Bulls Charge To All-Time Highs
  • Exuberance Abounds
  • The Megaphone
  • Risk/Reward Ranges
  • MacroView: Everything The Fed Does Is Deflationary
  • Sector & Market Analysis
  • 401k Plan Manager

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virus, Stocks Struggle As The Bull Market In Virus Cases Rises 07-17-20


Catch Up On What You Missed Last Week

 


Bulls Charge To All-Time Highs

As discussed previously in “Insanely Stupid,” we noted the market remained confined to its consolidation channel, but the bullish bias was to the upside.

“While the market has not been able to push above the recent July highs, support is holding at the rising bullish trend line. With the short-term ‘buy signals’ back in play, the bias at the moment is to the upside.

However, as we have discussed over the last couple of weeks, July held to its historical trends of strength. With a bulk of the S&P 500 earnings season behind us, we suspect the weakening economic data will begin to weigh sentiment on August and September.

While weaker economic data has not yet dented the “bullish sentiment” at this juncture, it doesn’t mean it won’t. However, as we have discussed over the last several weeks, a breakout of the consolidation range, which was capped by the June highs, would put all-time highs into focus. 

A Weighted Distortion

The concern is that what you see with the market, is not necessarily what you get. The chart below shows the number of stocks trading above the 200-dma versus the S&P 500 trading above its 200-dma.

In theory, if the “market” is above its 200-dma, then a large number of stocks, usually about 80%, should also be. However, such is not the case, as only 55% currently do so. 

The market is currently being driven to new highs by the “chase” into the largest mega-capitalization stocks. Sentiment Trader noted this on Friday:

The biggest stock in the U.S. and nearly the world, Apple, keeps powering higher. At the end of June, the value of Apple alone was nearly 80% of the Russell 2000 index’s market capitalization. As of today, it’s nearly 90%. This is astounding – in the past 40 years, no single stock has come close to dwarfing the value of so many other companies.

By itself, this data point does not have a lot of historical relevance. However, it does tend to be more of an indication of underlying “exuberance” in the market. 

The point here, however, is the top-5 stocks are distorting the overall market participation.

Let Me Explain The Math

Currently, the top-5 S&P stocks by market capitalization (AAPL, AMZN, GOOG, FB, and MSFT) make up the same amount of the S&P 500 as the bottom 394 stocks. Those same five also comprise 26% of the index alone. 

What investors are missing is that the top-5 stocks are distorting the movements in the overall index.

For each $1 put into each of those top-5 stocks, the impact on the index is the same as putting $1 into each of the bottom 394 stocks. Such is clearly not a true representation of either the market or the economy. 

As we have noted recently, if you own anything OTHER than those top-5 stocks, your portfolio is likely underperforming the market this year.

Exuberance Abounds

This past week, we discussed with our RIAPro Subscribers (Try Risk-Free for 30-days) the dangers of chasing markets, which have deviated extremely from their long-term means. The risk, of course, is that markets always, without exception, revert to the mean. The only question is the “timing” of the event. 

Specifically, we noted the deviation of the Nasdaq from its 200-dma, which remains near a record high. 

Moving averages, especially longer-term ones, are like gravity. The further prices become deviated from long-term averages, the greater the ‘gravitational pull’ becomes. An ‘average’ requires prices to trade above and below the “average” level. The risk of a reversion grows with the size of the deviation.

The Nasdaq currently trades more than 23% above its 200-dma. The last time such a deviation existed was in February of this year. The Nasdaq also trades 3-standard deviations above the 200-dma, which is another extreme indication. 

Such does not mean the market is about to crash. However, it does suggest the ‘rubber band’ is stretched so tightly any minor disappointment could lead to a contraction in prices.”

COT Positioning Extremes, Technically Speaking: COT Positioning – Back To Extremes: Q2-2020

Again, this deviation is driven by the largest cap-weighted names. Still, there are also more extreme signs of speculative appetite currently flowing into the markets. 

The Greed Factor

The RIAPro sentiment gauge, which is based on actual investor positioning, is at more extreme levels.

The put/call ratio is also at a historic low, which suggests that investors have given up hedging risk in portfolios entirely. I have marked the previous points where the put/call ratio was this imbalanced.

Importantly, this is all very “bullish” for now.

The point about these indicators, is that in the short-term (a few days to a few weeks) it suggests the markets will likely continue to rise. Such is because “momentum” is a tough thing to kill.  

However, longer-term, they have a long history of suggesting increasing levels of risk, which eventually leads to less pleasant outcomes.

The Megaphone

In the short-term, there seems to be little worry about. I thought this sentiment was summed up best by Jeffrey Marcus, who manages the TPA Analystics long-short portfolio for RIAPro:

However, in the longer-term, the bulls may be walking into a trap. 

While the bulls are chanting “all-time highs,” it falls within the context of an ongoing topping process referred to as a “megaphone” pattern. Here is the definition:

“A broadening formation is a price chart pattern characterized by increasing price volatility and diagrammed as two diverging trend lines, one rising and one falling. 

These formations are relatively rare during normal market conditions over the long-term since most markets tend to trend in one direction or another over time. The formations are more common when market participants have begun to process a series of unsettling news topics. Topics such as geopolitical conflict, a change in Fed policy, or a combination of the two, are likely to coincide with such formations.

 

Broadening formations are generally bearish for most long-term investors since they are characterized by rising volatility without a clear move in a single direction.” 

It’s Just A Chart

This broadening, or megaphone, pattern is seen below on the monthly chart. Importantly, despite the “correction,” in March, the “bull market” that began in 2009 remains intact as the low monthly close did not break the 4-year moving average. 

Furthermore, this is a “monthly” chart, so it is very slow to form. As such, it is critical to consider this analysis in context. The chart does not mean the markets are about to crash, nor is it a useful tool to try and “time” the market.

The market will hit new highs as it reaches the top of the upper trendline, where it will meet more formidable resistance. With the market back to a more extreme overbought condition, the “low hanging fruit” has been picked.

Risk/Reward Ranges

Nonetheless, as discussed below, the current levels of “bullish sentiment” and “momentum” keeps our portfolios allocated toward “risk.” However, we are moving closer toward the “exit,” so we are not the last one trying to get out of the theater when someone yells “fire.” 

With the markets closing just at all-time highs, we can only guess where the next market peak will be. Therefore, to gauge risk and reward ranges, we have set targets at 3500, 3750, and 4000 or 4.4%, 12.2%, and 19.5%, respectively. 

Here are the current risk/reward ranges:

  • +4.4% to 3500 vs. -4.3% to June high breakout support. 
  • +4.4% to 3500 vs. -5.7% to the 50-dma.
  • +12.2% to 3750 vs. -9.6% to the 200-dma 
  • +12.2% to 3750 vs. -11.5% to the June consolidation lows.
  • +19.5% to 4000 vs. -22.17% to the March closing low. (Not shown)

Given there is no good measure to justify upside potential from a breakout to new highs, you can personally go through a lot of mental exercises. While there is certainly a potential the market could rally 19.9% to 4000, it is also just as reasonable the market could decline 22.2% test the March closing lows. Completion of the “megaphone pattern” discussed above would be a 37.43% decline. 

Just in case you think that can’t happen, just remember no one was expecting a 35% decline in March either. 

As we said last week, “risk happens fast.”

Portfolio Positioning

Let me restate our position for the last several weeks.

“With our portfolios almost entirely allocated towards equity risk in the short-term, we remain incredibly uncomfortable.”

Such remains the case this week. While we certainly enjoy the markets lifting our client’s portfolio values higher, we are keenly aware of the risk. 

As Chuck Prince, CEO of Citigroup, once stated:

“When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing,” July 2007

Note the date. 

Just as it was then, stocks kept running well into 2008. But eventually, the music stopped, and poor Chuck was left without a chair. 

Given we are now getting more extreme short-term overbought conditions, the risk of a short-term reversion has risen. 

As noted last week, we have continued to maintain our equity exposure to the markets. Still , we have continued to “hedge around the edges,” by adjusting our bond duration, adding a long-dollar position to hedge our gold exposures, and adding more “defensive” names to our equity allocation. 

Our job remains the same, protect our client’s capital, reduce risk, and try to come out on the other side in one piece. 

While we are certainly more bullish on markets currently, as momentum is still in play, it doesn’t mean we aren’t keenly aware of the risk.

Pay attention to what you own, and how much risk you are taking to generate returns. Going forward, this market will likely have a nasty habit of biting you when you least expect it.


The MacroView

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • The “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • The table shows the price deviation above and below the weekly moving averages.


Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels.

Sector-by-Sector

Improving – Financials (XLF), Industrials (XLI), and Energy (XLE)

While Financials remain the improving quadrant, they are still vastly underperforming the market. Conversely, Industrials have broken above their 200-dma and are performing better. The sector is very overbought short-term, so a pullback to the 200-dma that holds will allow us to add more to our exposure. Energy continues to underperform the market vastly. While there is value in the sector, there is no reason for overweight holdings currently.

Current Positions: XLI

Outperforming – Materials (XLB), and Discretionary (XLY)

Discretionary stocks have broken out to new highs and continue to perform well due primarily to AMZN. However, the sector is extremely overbought, and a correction is likely. Take profits and rebalance risk accordingly. Materials are also struggling at all-time highs and are also extremely extended.

Current Positions: None

Weakening – Technology (XLK), and Communications (XLC)

After adding more exposure to our Technology holdings, the sectors have gone vertical with the rush to chase the 5-mega cap names. Once again, we need to take profits due to the extreme extension potentially. A correction is likely. The same goes for the Communications sector as well.

Current Position: XLK, XLC

Lagging – Healthcare (XLV), Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Previously, we added to our core defensive positions Healthcare. We continue to hold Healthcare on a longer-term basis as it tends to outperform in tougher markets and hedges risk. Healthcare is overbought after the expected rally, Look for a correction back to support at the 200-dma.

Our defensive positioning in Staples has finally played catchup to the rest of the market. Staples are very overbought, so rebalance risk accordingly. Utilities continue to lag, but performance is improving.

Current Position: XLU, XLV, XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Both of these markets continue to underperform, but did perk up this past week. We suspect this will be a temporary rotation, so take profits and rebalance longs if you have them. 

Current Position: None

Emerging, International (EEM) & Total International Markets (EFA)

Emerging and International Markets have performed better recently. We added a long-dollar hedge to our portfolios, which will weigh on international exposure. However, we will look to add international back to portfolios once the dollar reversal occurs.

Current Position: None

S&P 500 Index (Exposure/Trading Rentals) – We currently have no “core” holdings.

Current Position: None

Gold (GLD) – Previously, we trimmed our exposure to IAU. Gold is a bit overbought short-term, so we are looking for a pullback to rebuild exposures. The Dollar is extremely oversold; we have added a small UUP position to hedge downside risk in Gold. 

Current Position: IAU, UUP

Bonds (TLT) –

We continue to hold our bond holdings as a hedge against market risk. However, those positions are starting to get very extended, so we will likely rebalance soon. No change this week.

Current Positions: TLT, MBB, & AGG

Portfolio / Client Update

As noted last week, we are heading into two of the seasonally weak months of the year. Over the last couple of weeks, we made changes to portfolios to rebalance risk, add a hedge, and shift exposures into protected areas against risk.

I was having a discussion with a client last week about “relative performance” in portfolios. Here are the important points of that discussion. 

    1. We run an “equally” weighted portfolio versus a “market cap” weighted portfolio. The chart of an equal-weight and market-cap weight S&P is below for clarity.
    2. We also run a stock/bond allocation model versus an all-equity benchmark. 
    3. Given roughly 80% of the returns have come from about 10-stocks in total, ANY portfolio allocation containing more than those “mega-cap” stocks has underperformed this year. 
    4.  

Here is the point. 

If you are looking at the S&P 500 index and wondering “how you can get some of that,” I can certainly do that for you. We need to put everything you own into FB, AAPL, MSFT, NFLX, GOOG, and AMZN. 

I highly suspect you understand the absurdity of making such a move with your retirement money. 

Unfortunately, this is the absurdity of the market we currently live with. 

As John Maynard Keynes once quipped:

“The markets can remain irrational longer than you can remain solvent.”

Solvency is what we are focused on with YOUR money.

Portfolio Changes

In both models, we added a value position in AT&T. 

For the full reasoning behind this trade, please read our report from our analyst Nick Lane:

Nick Lane: The Value Seeker Report- AT&T (T)

We continue to look for opportunities to abate risk, add return either in appreciation or income, and protect capital. 

Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

A Conservative Strategy For Long-Term Investors


If you need help after reading the alert; do not hesitate to contact me


Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only and should not be relied on for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.  


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Compare your current 401k allocation, to our recommendation for your company-specific plan as well as our on 401k model allocation.

You can also track performance, estimate future values based on your savings and expected returns, and dig down into your sector and market allocations.

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Arete’s Observations 8/7/2020

Market observations

One of the hardest things about managing this market is determining which price moves are informative and actionable and which ones are not. A huge part of the problem for long-term investors is that there is so much short-term trading and so much momentum that big moves can appear more meaningful than they are.

It isn’t exactly rocket science, but when something has happened “never times before” like the performance of gold over the last few weeks, there is a good chance the activity is extreme.

John Authers discussed the gold phenomenon at some length in his “Points of Return” email from Aug. 6. He revealed a model indicating “that fair value [of gold] has risen sharply to reach its previous record in recent weeks, and that the actual price is significantly higher.”

There are lots of different models that say different things, but this strikes me as about right. It also illustrates a couple of important investment challenges right now.

One of those challenges is reconciling how both gold and the Nasdaq can be realizing the same kind of parabolic appreciation at the same time. One possibility is that Nasdaq stocks are actually defensive, but that is a huge stretch. More likely in my mind is that reasons don’t really matter right now – flows do. What sets the price is simply a significant enough contingent of investors willing to chase a trend. Such inconsistencies are just one more indicator of how untethered from economic reality prices have become.

That raises another challenge. If long-term investors like the defensive characteristics of gold but are concerned about overpaying in the near-term, what should they do? It is an excellent question and there are no great answers. Primarily it depends on one’s current exposure and opportunity cost.

That said, when any asset becomes popular and people buy it simply because others are buying, those are typically not “strong hands”. In other words, when the going gets a little tougher, or when the price just stops going up so much, many of those people will sell just as quickly as they bought. In addition, such times are also often associated with forced selling which exacerbates any decline. These situations create much better buying opportunities.

Economy

In order to establish the most robust perspective on a subject, it helps to observe it from different angles. This is especially true in the economic environment right now when so many traditional metrics do not provide a clear view.

FEDUPBIZOWNER posted a terrifically insightful thread beginning with the tweet at the right on small business lending. In short, the banks aren’t doing it.

Some of the highlights of the thread include evidence of a collapse in the pace of funding for small businesses, reluctance to lend even with the 80% guarantees of the CARES Act, and efforts to increase loan guarantees from 80% to 90%.

It doesn’t take long to appreciate just how “stuck” opportunities for small business growth are. It also doesn’t take long to feel sick about the role of banks in impeding progress. The irony is that by taking such hard positions on government loan guarantees, banks may also be sealing their own loss of autonomy in the future. Why should banks be allowed to earn any profit if the government takes the vast majority of the credit risk anyway?

Coronavirus

It is interesting in hindsight that so many people and policy makers responded to the pandemic by simply suspending expectations for about three months and then expecting things to magically pick up where they left off.

While it was always possible for such an outcome to be realized, what was almost universally overlooked was that it would take good planning, communication, and widespread conscientiousness to happen. In short, expectations were established on hope and without giving any consideration to what needed to be done to execute on those expectations.

Now that it is obvious we came up short on all of these counts, a good baseline assumption at this juncture is that a second wave will emerge and will be even worse than the first …

Avoiding a Second Wave

 “there’s a growing likelihood that the remainder of the year – if we’re not careful – could bring far larger disruptions than most people seem to envision.”

“The problem is that the pool of infected cases has expanded again, and it remains large enough to keep us teetering right at the edge of a second exponential outbreak. It’s important to understand how bad this could get, and how quickly the situation could deteriorate in response to even a slight easing of containment – unless we shrink the infective pool first.”

One point is “the 1918-1920 influenza pandemic … occurred in multiple ‘waves,’ where the second episode was markedly worse than the first.” There are good reasons for this. An important variable is the size of the infective pool and it is larger the second time around. It’s really just math.

Another point is that policies and communications regarding pandemic response are still woefully inadequate and inconsistent. John Hussman has been one of a handful of people who have consistently provided useful insights. The commentary listed not only provides a helpful framework for managing transmission of the coronavirus, but also highlights some important considerations for reopening schools.

It is also interesting to observe that the phenomenon of establishing expectations based on hope rather than well considered plans is par for the course in the corporate world as well. The blurb at the right came out of the second quarter earnings presentation for Borg Warner, but is representative of many companies. The company provides high and low scenarios for production for the remainder of the year, but the low scenario assume there is no second wave. Doesn’t sound very low to me.

The triumph of hope over experience is also clearly evident in emerging markets. The FT published a good overview of the situation in Turkey on Tuesday noting “The government is betting that the economy will not be hit by a second wave of infections.”

The report goes on to quote Brad Setser from the Council on Foreign Relations who says Turkey is coming “about as close as it gets” to what he calls a “classic first generation emerging market financial crisis”. So, this is one more data point suggesting a slow-motion accident in Turkey. It is also part of a broader pattern of what at least appears to be a routine of either desperation or incompetence rather than effective leadership in response to the pandemic.

Commercial real estate

Almost Daily Grant’s, July 30, 2020

“According to the Manhattan Chamber of Commerce, overall foot traffic across the Big Apple is down 46% from its pre-pandemic levels.  As of last week, only 8% of employees at downtown office buildings managed by CBRE Group had physically returned to work.” 

“The buyer and seller expectations are not aligned,’ Simon Mallinson, an executive managing director at RCA, told Bloomberg last week. ‘Sellers aren’t being forced to the market because there’s no realized distress and buyers are sitting on the sidelines thinking there’s going to be distress’.”

“It’s becoming clearer, especially with the resurgence in [virus] cases across the country, that a three-month forbearance is not really going to satisfy the situation.”

There are several great insights in this one note from Grant’s. One is yet another indication of how much activity has declined in New York City, which seems to be bearing disproportionate harm from the pandemic.

Another is the state of limbo in commercial real estate nationwide. The data show “commercial real estate transactions fell 68% in the second quarter compared to a year ago”. Grant’s explains why: Three-month forbearance policies have delayed the realization of distress. Not only does this obfuscate metrics for monitoring current conditions, but also as I pointed out last week, “is a latent deflationary force.

The third point is a broader one. When the pandemic first started taking hold, it was reasonable to believe that it could be managed in a way that involved severe but short-lived constraints on activity. For a number of different reasons, this did not work and therefore transformed what could have been an acute challenge into a chronic one. This means different policies will now be required and expectations for a return to normalcy will also need to adjust. John Dizard explains this very clearly …

Hope will not save US commercial properties

“So CMBS sponsors and holders are killing time by creating two fictions for everyone to believe. The first is that the US only needs a month or two to get back to a V-shaped boom.”

“Commercial real estate will have to be entirely restructured in the US. More equity and less . . . hope. Starting next year.” 

Systemic risk

Ex-BoE deputy governor fears ‘utter mayhem’ from clearing house reform

“Their vital role, standing between parties trading trillions of dollars a day and dealing with defaults, has raised concern that they are ‘too important to fail’.”

One of the big problems in the GFC was transmission of risk through the financial system. One institution would become weak or collapse and suddenly several other organizations were also infected. As a result, a core effort by regulators since then has been to reign in systemic risk.

Many of the areas – bank capital, interconnected organizations – have been addressed if not completely resolved. However, in the efforts to shift risk from banks to capital markets, the sources of systemic risk have also shifted in the direction of clearing houses.

It is true that they “are absolutely at the centre of the modern financial system” and it is also true that “there would be utter mayhem” if one collapsed. Although this story has not made headlines, it has not escaped the notice of astute market observers either. Four years ago, for example, John Dizard raised the issue in the FT where he recognized: “The problem is that in volatile or discontinuous markets, clearing houses do not eliminate risks, but rather concentrate them on the clearing house’s own balance sheets.”

Inflation

The graph at the right from the DailyShot.com does a nice job of capturing where inflation is in the mindset of the general public. Clearly, the amalgam of public policy initiatives and increasing commentary on the subject have done more than just restore concerns about inflation to earlier levels, but have raised them to even higher levels.

While this is certainly consistent with what Russell Napier has been saying (see Public policy), another eminent economist, Gary Shilling, is emphasizing the short-term impact from the pandemic. He thinks a “second wave” of deflationary forces are in store. While the two views are not necessarily very far apart, it will be interesting to watch the tug-of-war between inflationary and deflationary forces in upcoming months.

Gary Shilling: Stocks May Start Sliding About 7 Weeks From Now

“The recent Treasury bond rally fits with our forecast that the recession has a second, more serious leg that will extend well into 2021, despite massive monetary and fiscal stimulus.”

Public policy

Central Banks have Become Irrelevant

“But let me be precise: It will be governments who will act to stop bond yields from going up. They will force their domestic savings institutions to buy government bonds to keep yields down. The bit of your statement I disagree with is that central banks will put a cap on bond yields. They won’t be able to.”

One of the things about Russell Napier is that he is such a good thinker and careful communicator that his presentations are often so rich as to demand a couple of passes to fully appreciate. In my latest blog post I focused on Napier’s belief that control of the money supply is shifting to governments – and that shift will eventually cause inflation.

What I didn’t have room to expand on in the blog are the subtle implications of how financial repression will be implemented. As Napier states, “governments … will act to stop bond yields from going up”. Governments, not central banks. This is a key distinction. Politicians, not central bankers.

The way governments will act to suppress bond yields will be to “force savings institutions to buy government bonds”. In other words, these institutions will be forced to provide so much demand for Treasuries to overcome flat demand from outside the US and still sufficient to suppress yields.

Mind you, these are the very same savings institutions that have been struggling to even come close to meeting their return targets that will allow them to satisfy their liabilities. Their futile effort to earn higher returns by investing in riskier assets like private equity, hedge funds, and real estate will be further obstructed by obligations to own even more low yielding Treasuries.

It is interesting to observe all of this. While most investors seem laser-focused on what the Fed is doing, which ultimately is not going to matter much, they also seem to completely overlook what the government is doing, which will matter a lot. It is almost like a magic act that employs intentional misdirection. Regardless of intent, it will be important to maintain attention on what counts.

Implications for investment strategy

Russell Napier: The coming credit crisis will be outside the U.S., MacroVoices, January 23rd, 2020

“So I think we can all go back and look at that period in history [1945-1980] as a sort of guide to what to do and how to invest and where to make money. Maybe I can just leave you with one idea of what some of the real winners of that period of history in equities, were companies with very large fixed assets.”

One of the broadly successful investment themes of the last forty years has been high duration because it benefits from declining interest rates. Stocks that have high growth and big potential payoffs far into the future fit the profile well. Platform companies that can scale quickly also fit the bill. Indeed, good times have been rolling for “asset-light” companies.

As the landscape transitions to a more inflationary one, however, “the winners and the losers are likely to be very different in this new world”. The new beneficiaries will be “asset-heavy” companies, especially ones that do not have substantial ongoing reinvestment needs.

Napier says this change in investment environment “couldn’t be more profound”. That sounds about right. Look across the largest stocks in the S&P 500 and how many have substantial fixed assets? Conversely, look at the asset-heavy companies and most of them are small and midcap names now.

Another interesting implication will be on the ESG field. Some strands of ESG rate asset-light companies highly because they inherently have less impact on the environment by having fewer tangible assets. If these types of companies begin to significantly underperform asset-heavy companies, it could cause a major re-evaluation of ESG principles.

One of the implications I am most confident of is that there will be a massive reordering process that will wreak havoc on passive portfolios that have no way to respond.

Feedback

This publication is an experiment intended to share some of the ideas I come across regularly that I think might be useful. As a result, I would really appreciate any comments about what works for you, what doesn’t work, and what you might like to see in the future. Please email comments to me at drobertson@areteam.com. Thanks!        – Dave

Principles for Areté’s Observations

  1. All of the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

#MacroView: Fed Wants Inflation But Their Actions Are Deflationary

A recent CNBC article states the Fed will make a major commitment to ramping up inflation. How is this different than the past decade of promises for higher inflation? More importantly, while the Fed may want inflation, their very actions continue to be deflationary.

The Fed Has A Plan

“In the next few months, the Federal Reserve will be solidifying a policy outline that would commit it to low rates for years as it pursues an agenda of higher inflation and a return to the full employment picture that vanished as the coronavirus pandemic hit. 

Recent statements from Fed officials and analysis from market veterans and economists point to a move to “average inflation” targeting in which inflation above the central bank’s usual 2% target would be tolerated and even desired. 

To achieve that goal, officials would pledge not to raise interest rates until both the inflation and employment targets are hit.” – CNBC

Such certainly sounds familiar.

“The Federal Reserve took the historic step on Wednesday of setting an inflation target that brings the Fed in line with many of the world’s other major central banks.

In its first-ever ‘longer-run goals and policy strategy’ statement, the U.S. central bank said an inflation rate of 2 percent best aligned with its congressionally mandated goals of price stability and full employment.”– Reuters Reporting On Ben Bernanke’s Fed Policy Statement January 26, 2012

The Unseen

Over the last decade, the Federal Reserve has engaged in never-ending “emergency measures” to support asset markets and the economy. The stated goal was, and remains, such actions would foster full employment and price stability. There has been little evidence of success.

The table and charts below show the Fed’s balance sheet’s expansion and its effective “return on investment” on various aspects of the economy. For example, since 2009, the Fed has expanded its balance sheet by 612%. During that time, the cumulative total growth in GDP (through Q2-2020) was just 34.83%. In effect, it required $17.58 for every $1 of economic growth. We have applied that same measure across various economic metrics.

No matter how you analyze it, the “effective ROI” has been lousy.

These are the unseen consequences of the Fed’s monetary policies.

Momentum Fundamentals, Technically Speaking: Chase Momentum Until Fundamentals Matter

The Seen

The only reason Central Bank liquidity “seems” to be a success is when viewed through the lens of the stock market. Through the end of the Q2-2020, using quarterly data, the stock market has returned almost 135% from the 2007 peak. Such is more than 12x the growth in GDP and 3.6x the increase in corporate revenue. (I have used SALES growth in the chart below as it is what happens at the top line of income statements and is not AS subject to manipulation.)

Unfortunately, the “wealth effect” impact has only benefited a relatively small percentage of the overall economy. Currently, the Top 10% of income earners own nearly 87% of the stock market. The rest are just struggling to make ends meet.

While in the short-term ongoing monetary interventions may appear to be “risk-free,” in the longer-term, the Fed has now reached the “end game” of monetary policy.

Fed’s Actions Are Deflationary

What the Federal Reserve has failed to grasp is that monetary policy is “deflationary” when “debt” is required to fund it.

How do we know this? Monetary velocity tells the story.

What is “monetary velocity?” 

“The velocity of money is important for measuring the rate at which money in circulation is used for purchasing goods and services. Velocity is useful in gauging the health and vitality of the economy. High money velocity is usually associated with a healthy, expanding economy. Low money velocity is usually associated with recessions and contractions.” – Investopedia

With each monetary policy intervention, the velocity of money has slowed along with the breadth and strength of economic activity.

However, it isn’t just the expansion of the Fed’s balance sheet which is undermining the strength of the economy. It is also the ongoing suppression of interest rates to try and stimulate economic activity.

In 2000, the Fed “crossed the Rubicon,” where lowering interest rates did not stimulate economic activity. Instead, the “debt burden” detracted from it.

To illustrate the last point, we can compare monetary velocity to the deficit.

To no surprise, monetary velocity increases when the deficit reverses to a surplus. Such allows revenues to move into productive investments rather than debt service.

The problem for the Fed is the misunderstanding of the derivation of organic economic inflation

It’s The Debt

It isn’t just the Federal debt burden that is detracting from economic growth. It is all debt. As stated, the belief that lower interest rates would spur more economic activity was correct, to a point. However, as shown, once the debt burden because to consume more than it produced, the lure of debt turned sour.

You will notice that in 1998, monetary velocity peaked and began to turn lower. Such coincides with the point that consumers were forced into debt to sustain their standard of living. For decades, WallStreet, advertisers, and corporate powerhouses flooded consumers with advertising to induce them into buying bigger houses, televisions, and cars. The age of “consumerism” took hold.

However, while corporations grew richer, households got poorer, as growth in the economy and wages remained nascent.

The problem for the Federal Reserve, is that due to the massive levels of debt underlying the meager economic activity it generates, interest rates MUST remain low. Any uptick in rates quickly slows economic activity, forcing the Fed to lower rates and support it.

Economic Inflation

For the last several years, the Fed’s belief has been inflating asset prices would lead to a rise in economic prosperity and inflation. As noted, the Fed did achieve “asset inflation,” which led to a burgeoning “wealth gap.”

What monetary policy did not do was lead to “general fluctuations in price levels.” 

Despite the Fed’s annual call of higher rates of inflation and economic growth, the realization of those goals remains elusive.

The problem for the Fed is that monetary policy creates “bad” inflation, without supporting the things that lead to “good” inflation.

Momentum Fundamentals, Technically Speaking: Chase Momentum Until Fundamentals Matter

Good Inflation

The Fed believes the rise in inflationary pressures is directly related to an increase in economic strength. However, as I will explain: Inflation can be both good and bad.

Inflationary pressures can be representative of expanding economic strength if reflected in the more robust pricing of imports and exports. Such increases in prices would suggest stronger consumptive demand, which is 2/3rds of economic growth and increases in wages allowing for the absorption of higher prices.

That would be “the good.”

Bad Inflation

The bad would be inflationary pressures in areas which are direct expenses to the household. Such increases curtail consumptive demand, negatively impacting pricing pressure, by diverting consumer cash flows into non-productive goods or services.

If we look at import and export prices, there is little indication that inflationary pressures are present. 

This lack of economic acceleration is seen in the breakdown of the Consumer Price Index below, which shows where inflationary pressures have risen over the last 5-months.

(Thank you to Doug Short for help with the design)

As is clearly evident, the surge in “healthcare” related costs, due to the surging premiums of insurance, pushed both consumer-related spending measures and inflationary pressures higher. Unfortunately, higher health care premiums do not provide a boost to production but drain consumptive spending capabilities.

[Housing costs, a very large portion of overall CPI, is also boosting inflationary pressures. But like “health care” costs, rising housing costs and rental rates also suppress consumptive spending ability. It is the same for Other Goods and the cost of “food,” which is stripped out of the core calculation, but eat away at disposable incomes.]

For the middle-class and working poor, which is roughly 80% of households, rent, energy, medical and food comprise 80-90% of the aggregate consumption basket.” – Research Affiliates

The Fed’s problem is that by trying to push inflation higher, which will also drive interest rates higher to compensate, will immediately curtail increases in economic activity.

Such is why the Fed remains caught in a liquidity trap.

The Liquidity Trap

Here is the definition:

“When injections of cash into the private banking system by a central bank fail to lower interest rates or stimulate economic growth. A liquidity trap occurs when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war.

Signature characteristics of a liquidity trap are short-term interest rates remain near zero. Furthermore, fluctuations in the monetary base fail to translate into fluctuations in general price levels.

Pay particular attention to the last sentence.

As discussed through the entirety of this article, every aspect of a liquidity-trap has been checked:

  • Lower interest rates fail to stimulate economic growth
  • People hoard cash because they expect an adverse event (economic crisis).
  • Short-term interest rates near zero.
  • Fluctuations in monetary base fail to translate into general price levels.

Importantly, the issue of monetary velocity and saving rates is critical to defining a “liquidity trap.”

Confirmation

As noted by Treasury&Risk:

“It is hard to overstate the degree to which psychology drives an economy’s shift to deflation. When the prevailing economic mood in a nation changes from optimism to pessimism, participants change. Creditors, debtors, investors, producers, and consumers all change their primary orientation from expansion to conservation. Creditors become more conservative, and slow their lending. Potential debtors become more conservative, and borrow less or not at all.

As investors become more conservative, they commit less money to debt investments. Producers become more conservative and reduce expansion plans. Likewise, consumers become more conservative, and save more and spend less.

These behaviors reduce the velocity of money, which puts downward pressure on prices. Money velocity has already been slowing for years, a classic warning sign that deflation is impending. Now, thanks to the virus-related lockdowns, money velocity has begun to collapse. As widespread pessimism takes hold, expect it to fall even further.”

Momentum Fundamentals, Technically Speaking: Chase Momentum Until Fundamentals Matter

Deflationary Spiral

Such is the biggest problem for the Fed and one that monetary policy cannot fix.

Deflationary “psychology” is a very hard cycle to break.

“In addition to the psychological drivers, there are structural underpinnings of deflation as well. A financial system’s ability to sustain increasing levels of credit rests upon a vibrant economy. A high-debt situation becomes unsustainable when the rate of economic growth falls beneath the prevailing rate of interest owed.

As the slowing economy reduces borrowers’ ability to pay what they owe. In turn, creditors may refuse to underwrite interest payments on the existing debt by extending even more credit. When the burden becomes too great for the economy to support, defaults rise. Moreover, fear of defaults prompts creditors to reduce lending even further.”

For the last four decades, every time the Fed has taken action trying to achieve their goals of “full employment and stable prices,” it has led to an economic slowdown, or worse.

The relevance of debt growth versus economic growth is all too evident. Over the last decade, it has taken an ever-increasing amount of debt to generate $1 of economic growth.

In other words, without debt, there has been no organic economic growth.

While the Fed has been diligently working on its next program to achieve the long-elusive 2% inflation target, it will result in the same outcome as the last decade. 

The problem is the debt, and you can’t solve a debt problem with more debt. 

At some point, you have to stop digging.

Relative Value Report 8/7/2020

The Relative Value Report provides guidance on which sectors, factors, indexes, and bond classes are likely to outperform or underperform its appropriate benchmark.

Click on the Users Guide for details on the model’s relative value calculations as well as guidance on how to read the graphs. 

This report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary

  • Over the last few weeks, we have noticed that the standard deviation score we use has been muted as compared to scores from a month or two ago. This is logical given the reduced market volatility and the way we normalize data to calculate the score. The takeaway is that extreme scores may now be between +/-1 to 2 versus +/-3 to 4.
  • The last graph shown below, titled “S&P Sector Relative Value- SCORE”, shows the raw relative value scores (before normalizing). Note the greater divergence in scores versus the normalized graph we lead with below.
  • Materials and Discretionary appear the most overbought sectors this week, while Healthcare and Real estate the most oversold.
  • Most of the factor/indexes are hovering near fair value versus the S&P or their appropriate benchmark. Small and Mid-cap are overbought, while value versus growth continues to languish.
  • Bonds continue to remain stable as yields trade in a tight range.
  • We have been working on a new version of this report using the same technical scoring methodology but on an absolute, not relative basis. We do not assess the ratio of one index to another, instead just the index outright. This is comparable to what we put out in the Weekend Newsletter.
  • On an absolute basis, every sector is overbought but Energy. The graph shows the score, which is not normalized. Not surprisingly, Technology and Communications are the most overbought.
  • The chart to the right graphs the absolute score (orange line) of the S&P with its price in gray. While its extremely overbought score fell slightly this past week, the S&P 500 is still more overbought today than at the prior record highs in February.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP

#WhatYouMissed On RIA This Week: 08-07-20

What You Missed On RIA This Week Ending 08-07-20

It’s been a long week, and you probably didn’t have time to dive into all the headlines that scrolled past you on RIA. Don’t worry, we’ve got you covered. Just in case you haven’t already, be sure to opt-in and to get our newsletter and technical updates.

Here is this week’s rundown of what you missed. A collection of our best thoughts on investing, retirement, markets, and your money.

Webinar: Retirement Right Lane

Got questions regarding your retirement strategy, social security, medicare, the markets, and how to achieve your financial dreams.

You are in luck. This is the webinar for you. Everything you need to know to stay in the “Right Lane” for your retirement.

Join Us: Saturday, August 8th, from 9-11 am.

What You Missed This Week In Blogs

Each week, the entire team at RIA publishes the research and thoughts behind the portfolio management strategy for our clients. The important focus are the risks which may negatively impact our client’s capital. If you missed our blogs last week, these are the risks we are focusing on now.

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What You Missed In Our Newsletter

Each week, our newsletter covers important topics, events, and how the market finished up the week. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how to trade it.

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What You Missed: RIA Pro On Investing

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free) Just in case you are a DIY investor, this is the site for you. Furthermore, RIAPRO has all the tools, data, and analysis you need to build, monitor and manage your own money.

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The Best Of “The Real Investment Show”

Just in case, you didn’t tune in last week. That’s okay. Here are the best moments from the “Real Investment Show.” Every week, we cover the topics that mean the most to you from investing, to markets, and your money.

Best Clips Of The Week Ending 08-07-20

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What You Missed: Video Of The Week

Markets Are Headed To All Time Highs

I discuss the markets heading to all-time highs, and what’s driving it. Furthermore, I dig into the issue of the Fed’s “new plan” to create inflation with Michael Lebowitz, CFA. For instance, we discuss why is the new plan the same as the old plan?

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What You Missed: Our Best Tweets

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. You may also enjoy the occasional snarky humor.

Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Nick Lane: The Value Seeker Report- AT&T (T)

In this edition of the Value Seeker Report we analyze an investment opportunity in AT&T (NYSE: T) using fundamental and technical analysis.

Overview

  • We utilize RIA Advisors’ Discounted Cash Flow (DCF) valuation model to evaluate the investment merits of AT&T (NYSE: T). Our model is based on our forecasts of free cash flow over the next ten years.
  • Using what we view as conservative forecasts, we arrive at an intrinsic value of $38.09 per share for T’s Stock. The stock is currently trading at $29.82.

Pros

  • T declined in line with the market in March, but its performance has lagged the market since the bottom. As a result, the dividend yield on this stock is currently hovering around 7%.
  • T has increased its dividend for 15 consecutive years. In each of the last 11 years, they have increased the dividend by $0.04 per share.
  • According to our forecasts, T will produce enough cash flow to continue this trend for the next ten years.
  • T trades at a Price to Earnings (P/E) of 8.45, which is near the lowest it has been in at least 20 years.

Cons

  • As shown below, the market feels a lack of enthusiasm towards T’s recent acquisitions of DirecTV in 2015 and Time Warner in 2018. Due to these acquisitions, the market is concerned that T will continue to make less-than-optimal investments and fall further behind in the race to deploy nationwide 5G coverage. This could lead to price stagnation for the stock until Investors see a reason to believe the firm can successfully roll out its 5G network.

Key Assumptions

  • Despite revenue growth of 5+% on an annualized basis over periods of the last 5-years and last 20-years, we conservatively assume negative growth in FY20 and muted growth in the following 9 years. The chart below compares our forecasts to a linear projection (green dotted line) based on historical revenue.
  • T will have depressed profit margins in 2020, which should recover gradually. As the market for 5G coverage begins to mature, margins should trend down to our long-term forecast.
  • Over the forecasted 10-year period, the firm will make the capital investments necessary to support the nationwide expansion of its 5G network.

Technical Snapshot

  • T is about $4 a share above a critical support line going back over a decade. This is an important support and provides investors with a reasonable stop-loss if it is materially violated.
  • On a short-term basis, T is set up to test resistance at the 50-day moving average. At the same time, we see money flow buy signals. We would need to see a sustained price move above the 50-day moving average before the uptrend is confirmed.

Value Seeker Report Conclusion On (T)

  • According to our forecasts, T is currently 27.7% undervalued by the market.
  • In an environment with high equity valuations and bonds yielding little, T represents a valuable investment opportunity due to its dividend yield and potential price appreciation. While there are certainly some pitfalls, we believe the discounted stock price and high dividend offer a margin of error that makes the investment worthwhile.

Eric Lytikainen: Do You Have The “Monday Market Blues”

Monday Market Blues

Most people hate Mondays.  The reason is perhaps obvious: it is the end of a two-day rest for many, and the beginning of another work week.

Monday is the first step up a long, steep hill, and apparently most people don’t like to climb hills.

In 2005, Gallup conducted a poll which sought to discover people’s favorite seasons, months, and days of the week.  The most significant result in the survey – not surprisingly – was that people listed Monday as their least favorite day of the week.

Source: Gallup

Some people believe that the stock market is a barometer of investor emotion, and we believe that there is merit to this statement.

One thing is for sure.  The stock market hates Mondays just as much as you do.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

History of Returns

We study the markets and look for repeatable patterns that we put into our investment models.  Recently, we came across a pattern that has persisted from 1927 to the present: historically, Monday is by far the worst performing day in the S&P 500.

Every other day in the S&P 500 has a positive return, and Monday is decidedly negative.  Turn-around Tuesday really is a thing.

Monday Performance During Sell-offs

Further, in addition to modeling day-of-the-week returns for the entire history, we also looked at data during the recent sell-offs of 2008, 2018 and 2020.  In all cases, Monday under-performed[1].  During 2008, the Monday trade was a slow grind lower, and Tuesday was a slow grind higher.

In late 2018, Monday returns began to drift lower, and were a significant source of the spike lower in March 2020.

Risk-Adjusted Return

Eliminate Monday returns from the S&P for the last 93 years and you will dramatically increase total risk adjusted return[2].  This model sells the S&P Friday at the close and buys the S&P 500 Monday at the close.

[1] A “Monday” return consists of buying at the Friday close and selling the Monday close.  A Tuesday return comes from buying at the Monday close and selling the Tuesday close.

[2] Sharpe ratio is the realized return divided by the standard deviation of the return.

Why has this pattern persisted for almost 100 years?  We don’t know for sure.  Is it about weekend news?  Is it about order flow?  Maybe it’s because most people hate Mondays.

Whatever the causes, this pattern may be something to keep in mind when buying and selling stocks.

Authors

Viking Analytics is a quantitative research firm that develops tools to help navigate complex markets.  If you would like to learn more, please visit our website, or download a complimentary report.

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years of experience as a financial analyst, entrepreneur, business developer, and commodity trader. He holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Rob McBride has 15+ years of experience in the systematic investment space and is a former Managing Director at a multi-billion dollar hedge fund. He has deep experience with market data, software and model building in financial markets.  Rob has a M.S. in Computer Science from the South Dakota School of Mines and Technology.


The Difference Between Good Economics And Bad

The Difference Between Good Economics and Bad

“Real protection means teaching children to manage risks on their own, not shielding them from every hazard.” ― Wendy Mogel, The Blessing of a Skinned Knee

In the five weeks from February 19 to March 26, 2020, the S&P 500 fell 33.9%. Because of all the bizarre things we have seen since then, that seems like such a long time ago. Despite serious questions about how quickly the economy will ultimately rebound from the global shutdown, investors are pricing the stock and bond markets for perfection. Many individual stocks sit at new all-time highs, and credit spreads are tighter today than before the COVID-19 outbreak.

Meanwhile, Treasury yields have fallen to levels well below those seen before the pandemic. Mortgage rates for a 30-year term are below 3.00%. Eerily, equity volatility remains quite elevated suggestive of investor anxiety and illiquidity.

As investors, we tend to draw conclusions based on market behavior. When Treasury yields fall, for example, it is not unreasonable to think it portends undetected economic weakness. If credit spreads tighten, it is plausible to believe that the cause is strengthening corporate revenue and earnings.

What if, however, signals are misleading as described above? What if the market’s traffic lights are green and red at the same time? Dare we ask, what happens when good economics become bad.

The Visible Hand

Beginning in February, the Federal Reserve (Fed) initiated several policy programs resulting in massive surge of their balance sheet. In just 13 weeks, the Fed provided over $3 trillion of liquidity to financial markets. The Fed’s efforts in 2008 pale in comparison.

While such a policy did not forestall a recession, the objective is clearly to mitigate damage in risky asset markets. Actions of this sort are becoming increasingly routine for frightened policymakers. In the name of expedience, they aim to “rescue” financial markets.

On the other hand, in Congressional testimony (those with whom oversight of the Fed resides) and in media appearances, Fed members apply vacuous counter-factual arguments. “Had we not taken forceful action, things would be much worse,” always goes uncontested by elected officials. Uncontested because wealthy individuals and corporations are their primary source of campaign funds. Re-election odds for incumbents correlate well with market direction.

Secondary Consequences

The other issue, the one we write about here, is how that policy response sets the table for other problems. Henry Hazlitt, in his profound book, Economics in One Lesson, describes it this way.

“…a main factor that spawns new economic fallacies everyday…is the persistent tendency of men to see only the immediate effects of a given policy, or its effects only on a special group, and to neglect to inquire what the long-run effects of that policy will be not only on that special group but on all groups. It is the fallacy of overlooking secondary consequences.”

Hazlitt immediately continues-

“In this lies the whole difference between good economics and bad.”

The Federal Reserve’s pragmatism is driven by the influence of wealthy men, corporate executives, and political donors. By insisting that every action be taken with no regard for long-term effects makes certain the influencers’ wealth is protected.

Using the opening quote as an analogy, the Fed has become a notoriously overprotective helicopter parent to the stock market since the financial crisis, shielding it from every hazard. Just as in the case of child-rearing, their actions are responsible for producing an extraordinarily petulant and fragile system.

Drawing again from Wendy Mogel –

“If a child is distressed and sees Mom react with panic, he knows he should wail; if she’s compassionate but calm, he tends to recover quickly.”

This long-term “parental” panic pattern results in a variety of adverse consequences. The worst of them may be the extreme surge in passive investing. As we wrote in a Passive Fingerprints are all over This Crazy Market, the influence of passive investing on the current market is extreme.

Other Factors

In 2014 Steve Bregman at Horizon Analytics, enlightened us to what he calls the ETF (exchange-traded fund) divide. His argument highlights the passive, indiscriminate nature of ETF investors. The monumental shift away from discretionary (active) value-oriented strategies was well underway but not yet diagnosed in a way that Bregman astutely observed.

Since then, the wave of passive investing has become a tsunami. Passive, or index strategies, attract massive capital at the expense of discretionary or active mutual fund managers.

That re-allocation means two things:

  1. Money is leaving active managers who regularly hold 5% cash on average and is going into passive ETFs which hold less than 0.10% cash
  2. Active managers have historically been the cops on the beat patrolling overvalued stocks and selling them when those conditions are clear. Those cops are being systematically “defunded,” and there is no consideration of “value” in the passive index world.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

Seismic Shift

Why are these issues so important?

First, when $3 or 4 trillion dollars move from funds managed with 5% cash  to funds with near-zero cash, $150 to $200 billion of “new money” leads to an explosive upside effect on individual stocks targeted in passive funds.

Second, when money is removed from discretionary hands and reallocated to index funds, there is no consideration for price, ever. When a passive S&P 500 or NASDAQ 100 fund receives one dollar to invest, it immediately invests in all of the underlying stocks. It does so at whatever price is available. The top decile, ranked by market cap, perpetually benefits the most as the inflows occur. The bottom decile also benefits via overvaluation, but to a lesser extent.

Stocks that do not benefit are those not in passive ETF/indexes. Those are stocks that enjoy none of the indiscriminate flows of capital and frequently become undervalued.

Blame Game

The Fed is responsible for market inefficiencies in the same way a parent is responsible for the demeanor of an entitled child. If policymakers repeatedly rush to the care of markets anytime difficulties arise, then investors never see problems. Prudence and risk management are put aside and neglected.  The buy-the-dip mentality goes beyond a humorous meme, it becomes a doctrine.

Over time and with plenty of Fed parenting, passive investors outperform the prudence and diligence of discretionary value managers. When the pattern repeats for a decade, then the chart above of net flows is the result. The concentration of passive investing becomes acute, and its effects on valuations extreme.

As Bregman pointed out in 2014, a proliferation of the ETF divide had, even then, begun to reveal itself in unhealthy ways. Those circumstances persist. The strong correlation of large S&P 500 components to the S&P 500 is now stark. The table below adds recent data from 2020 to Bregman’s original table.

The dramatic rise in correlation means there is less benefit to diversification than historically has been the case. Owning a variety of stocks and being well-diversified makes sense unless the benefits of that strategy no longer exist. Based on current data, diversification using index funds is futile.

Summary

Central bankers are prone to applying a convenient narrative to justify their actions. Their dialogue is usually laced with contempt for those who cast doubt. That is not a sign of confidence; it is a sign of deep insecurity. A sign of confidence would be humility, a characteristic one never sees out of Fed leadership.

Markets are more fragile today because of a hovering Fed parent, shielding investors from every hazard. The second and third-order effects continue to evolve, but the volatility in the first quarter offered a glimpse of disturbing possibilities.

Sector Buy/Sell Review: 08-04-20

HOW TO READ THE SECTOR BUY/SELL REVIEW: 08-04-20

Each week we produce a “Sector Buy/Sell Review” chart book of the S&P 500 sectors to review where money is flowing within the market as whole. This helps refine not only decision making about what to own and when, but what sectors to overweight or underweight to achieve better performance.

You can also view sector momentum and relative strength daily here.

There are three primary components to each chart below:

  • The price chart is in orange
  • Over Bought/Over Sold indicator is in gray in the background.
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise when the buy/sell indicator is above the ZERO line investments have a tendency of working better than when below the zero line.

We added 2- and 3-standard deviation extensions from the 50-dma this week. We are back to “stupid” overbought on many levels. Caution is advised.

SECTOR BUY/SELL REVIEW: 08-04-20

Basic Materials

  • As we noted previously, XLB was too overbought and a correction was likely. That correction started over the last couple of days.
  • The buy signal is now at the highest level on record. It WILL revert at some point soon.
  • Short-Term Positioning: Bullish
    • Last Week: No Positions
    • This Week: No Positions
  • Stop-Loss moved up to $57
  • Long-Term Positioning: Bearish

Communications

  • XLC has pushed up on extremes with a large deviation from the 200-dma, and is pushing the most extreme overbought condition in its history. 
  • A correction is coming. It is just a function of time.
  • Take profits and reduce risk. Move up stop levels.
  • We moved our stop to $53.
    • Short-Term Positioning: Bullish
    • Last Week: Hold positions
    • This Week: Hold positions
  • Long-Term Positioning: Neutral

Energy

  • Energy continues to push up on its 50-dma from an oversold condition.
  • Energy is not overbought, and there is room for energy to improve on the upside if we see a rotation to value occur. 
  • However, that has not occurred and energy failed at the 50-dma. It needs to hold support at the recent lows of $35.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
  • Stop loss adjusted to $34.00
  • Long-Term Positioning: Bearish

Financials

  • Financials continue to underperform and remain a sector to avoid currently.
  • As noted previously, the initial support was at $24, which was violated. Now that level is being tested as “resistance.” 
  • There may be a bit of pickup on a rotation plan, but banks remain out of favor for now.
  • Short-Term Positioning: Neutral
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Bearish

Industrials

  • Industrials bounced of support at the 50% retracement level and triggered a buy signal.
  • That buy signal is very extended and the 200-dma is acting as tough resistance. 
  • We are watching the dollar as a counter-trend rally could impact the sector due to international exposure.
  • We took profits in our position last week. 
    • Short-Term Positioning: Neutral
    • Last week: No position.
    • This week: Reduced XLI to 2% 
  • Long-Term Positioning: Bearish

Technology

  • Technology continues to push higher as the “momentum chase” continues. On Monday there was a sharp advance in the sector following our increase of XLK last Thursday and strong earnings from tech giants later that night. 
  • Technology stocks, and the Nasdaq, are extremely overbought with the buy signal at a higher level now than in February before the crash. (It’s the highest level EVER.)
  • We are holding our positions currently, but took profits in AAPL on Monday after adding to it  last Thursday. 
  • The deviation above the moving averages will be resolved likely sooner than later. In other words, a correction is coming. 
  • Short-Term Positioning: Bullish
    • Last week: Reduced positions slightly. 
    • This week: Took profits in AAPL.
    • Long-Term Positioning: Bullish

Staples

  • XLP triggered a buy signal after adding slightly to our positions previously. The buy signal is now extremely extended. 
  • XLP is overbought and is trading at 3-standard deviations above the mean. A correction is coming, timing is the only question.
  • Rebalance holdings and tighten up stop-losses.
  • We are moving our stop-loss alert to $59 as our stop-level.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions
    • Long-Term Positioning: Bullish

Real Estate

  • Like XLP, XLRE has triggered a buy signal.
  • XLRE broke above its consolidation wedge and the 200-dma. I would like to see XLRE hold the 200-dma before adding exposure to the sector. 
  • Move stops up to $34.
  • Short-Term Positioning: Neutral
    • Last week: No holdings.
    • This week: No holdings
    • Long-Term Positioning: Bullish

Utilities

  • XLU has been lagging but has triggered a very early BUY signal. With XLRE also on a buy, it suggests we may see a rotation from risk starting. It’s early, so we will see.
  • On Monday, Utilities badly underperformed so we need to see some improvement.
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Hold positions
  • Long-Term Positioning: Bullish

Health Care

  • As noted previously, XLV is trading 3-standard deviations above the moving average, a correction is likely short-term. 
  • With the buy signal now getting more extremely overbought, corrections should be contained back to support where holdings can be added. 
  • The 200-dma is now important support and needs to hold, along with the previous tops going back to 2018. 
  • We are moving our stop to $96
  • Short-Term Positioning: Bullish
    • Last week: Hold positions
    • This week: Hold positions.
  • Long-Term Positioning: Bullish

Discretionary

  • AMZN is still driving this sector and XLY is trading at extremes.
  • With the buy signal at the highest level on record a correction is coming. It is just a function of time and a catalyst. (Common theme in this missive.)
  • Hold current positions but maintain your stop levels. We recommend taking profits.
  • Stop loss is set at $122.50
  • Short-Term Positioning: Bullish
    • Last week: No position
    • This week: No position
  • Long-Term Positioning: Neutral

Transportation

  • The rally in XTN is losing traction and failed at resistance again at the 200-dma.
  • The sector is performing weakly so caution is advised. 
  • If the economy begins to show signs of deterioration, we will likely see the recent rally in transportation fail. Risk is elevated.
  • Stop loss set at $50
  • Short-Term Positioning: Neutral
    • Last week: Hold positions
    • This week: Reduced position in IYT.
  • Long-Term Positioning: Bearish

Technically Speaking: COT Positioning – Back To Extremes: Q2-2020

As discussed in Is It Insanely Stupid To Chase Stocks, the market has gotten quite ahead of the fundamentals as money continues to chase performance. In the Q2-2020 review of Commitment Of Traders report (COT,) we can see how positioning has moved back to extremes.

The market remains in a bullish trend from the market lows but is very overbought short-term. Despite valuations reaching more extreme levels, economic growth very weak, and a risk of a reduction in stimulus; investors continue to chase markets.

While the S&P 500 is primarily driven higher by the largest 5-market capitalization companies, it is the Nasdaq that has now reached a more extreme deviation from its longer-term moving average.

Moving averages, especially longer-term ones, are like gravity. The further prices become deviated from long-term averages, the greater the “gravitational pull” becomes. An “average” requires prices to trade above and below the “average” level. The risk of a reversion grows with the size of the deviation.

The Nasdaq currently trades more than 23% above its 200-dma. The last time such a deviation existed was in February of this year. The Nasdaq also trades 3-standard deviations above the 200-dma, which is another extreme indication. 

Such does not mean the market is about to crash. However, it does suggest the “rubber band” is stretched so tightly any minor disappointment could lead to a contraction in prices.

But it isn’t just the more extreme advance of the market over the past 8-weeks which has us a bit concerned in the short-term, but a series of other indications which typically suggest short- to intermediate-terms corrections in the market.

The “Greed” Factor

Market sentiment is back to more “extreme greed” levels. Unlike a pure “sentiment” based indicator, this gauge is a view of what investors are doing, versus what they are “feeling.”

The rapid acceleration in price has sent our technical composite gauge back towards extreme overbought levels as well. (Get this chart every week at RIAPRO.NET)

What we know is that markets move based on sentiment and positioning. Such makes sense considering that prices are affected by buyers and sellers’ actions at any given time. Most importantly, when prices, or positioning, become too “one-sided,” a reversion always occurs. As Bob Farrell’s Rule #9 states:

“When all experts agree, something else is bound to happen.” 

So, how are traders positioning themselves currently?

Positioning Review

The COT (Commitment Of Traders) data, which is exceptionally important, is the sole source of the actual holdings of the three key commodity-trading groups, namely:

  • Commercial Traders: this group consists of traders that use futures contracts for hedging purposes and whose positions exceed the reporting levels of the CFTC. These traders are usually involved with the production and/or processing of the underlying commodity.
  • Non-Commercial Traders: this group consists of traders that don’t use futures contracts for hedging and whose positions exceed the CFTC reporting levels. They are typically large traders such as clearinghouses, futures commission merchants, foreign brokers, etc.
  • Small Traders: the positions of these traders do not exceed the CFTC reporting levels, and as the name implies, these are usually small traders.

The data we are interested in is the second group of Non-Commercial Traders.

This is the group that speculates on where they believe the market is headed. While you would expect these individuals to be “smarter” than retail investors, we find they are just as subject to “human fallacy” and “herd mentality” as everyone else.

Therefore, as shown in the charts below, we can look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. 

Volatility 

The extreme net-short positioning against the volatility index was an excellent indicator of the February peak. The sharp sell-off in March, not surprisingly, sharply reduced the short-positions outstanding.

With the markets continuing to rally from the March lows, investors are again becoming encouraged to take on risk. Currently, net shorts on the VIX are rising sharply and are back to more extreme levels. While not as severe as seen in 2017 or 2020, the positioning is large enough to fuel a more significant correction. The only question is the catalyst.

Investors have gotten used to extremely low levels of volatility, which is unique to this market cycle. Due to low volatility, the complacency has encouraged investors to take on greater levels of risk than they currently realize. When volatility eventually makes it return, as we saw in March, the consequences will not be kind.

Crude Oil Extreme

The recent attempt by crude oil to get back above the 200-dma coincided with the Fed’s initiation of QE-4. Historically, these liquidity programs tend to benefit highly speculative positions like commodities, as liquidity seeks the highest rate of return.

While prices collapsed along with the economy in March, there has been a sharp reversion on expectations for a global economic recovery. Interestingly, with the economic recovery showing signs of slowing, crude oil has stalled below its 200-dma. As we discussed recently with our RIAPRO subscribers:

  • The rally in oil has stalled at the 200-dma and the 50% Fibonacci retracement level.
  • Importantly, the lower pane “buy/sell” signal is the most overbought in 25-years. (We see the same in many other areas of the market as well like Technology, Materials, Discretionary, Communications, Etc.) A correction is coming, and it will likely be large.
  • There is currently little support for oil and a break of $35 will lead to a retest in the $20’s. 
  • Long-Term Positioning: Bearish

Despite the decline in oil prices earlier this year, it is worth noting crude oil positioning is still on the bullish side with 543,826 net long contracts. While not the highest level on record, it is definitely on the “extremely bullish” side.

Oil Leads Stocks & The Economy

Importantly, there is a decent correlation to the rise, and fall, of oil prices and the S&P 500 index. If oil begins to correct again, it will be in conjunction with an economic downturn. Stocks will follow suit.

As we wrote back in February:

“The inherent problem with this is that if crude oil breaks below $48/bbl, those long contracts will get liquidated. Such will likely push oil back into the low 40’s very quickly. The decline in oil is both deflationary and increases the risk of an economic recession.”

The rest, as they say, is history.

U.S. Dollar Extreme

Another index we track each week at RIAPRO.NET is the U.S. Dollar.

Speaking of hedges, we began to accumulate a long-dollar position in portfolios this past week. There are several reasons for this:

  1. When the financial media discusses the dollar’s demise, such is usually a good contrarian signal. 
  2. The dollar has recently had a negative correlation to stocks, bonds, gold, commodities, etc.
  3. The surging exuberance in gold also acts as a reliable contrarian indicator of the dollar.  
  4. The dollar is currently 3-standard deviations below the 200-dma, which historically is a strong buy signal for a counter-trend rally. 

Insanely stupid, “Insanely Stupid” To Chase Stocks As Economy Plunges? 07-31-20

Given our portfolios are long weighted in equities, bonds, and gold currently, we need to start hedging that risk with a non-correlated asset. We also trimmed some of our holdings in conjunction with adding a dollar hedge.

  • As noted previously: “The dollar has rallied back to that all-important previous support line. IF the dollar can break back above that level, and hold, then commodities, and oil, will likely struggle.
  • That is precisely what happened over the last two weeks. The dollar has strengthened that rally as concerns over the “coronavirus” persist. With the dollar close to testing previous highs, a break above that resistance could result in a sharp move higher for the dollar.
  • The rising dollar is not bullish for oil, commodities or international exposures.
  • The “sell” signal has begun to reverse. Pay attention.

Much of the bulls rallying cry has been based on the dollar weakening with the onset of QE. However, over the last couple of months, the long-dollar bias has reverted to a net “short” positioning. Historically, these reversals are markers of more important peaks in the market, and subsequent corrections. 

Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. In March of last year, I wrote “The Bond Bull Market” which was a follow up to our earlier call for a sharp drop in rates as the economy slowed. We based that call on the extreme “net-short positioning” in bonds which suggested a counter-trend rally was likely.

Since then, rates fell to the lowest levels in history as economic growth collapsed. Importantly, while the Federal Reserve turned back on the “liquidity pumps” in March, juicing markets back toward all-time highs, bonds have continued to attract money for “safety” over “risk.” 

Not surprisingly, despite much commentary to the contrary, the number of contracts “net-short” the 10-year Treasury, while reduced, remains at levels that have preceded further declines in rates. Such suggests we are “not out of the woods” yet, economically speaking.

Importantly, even while the “net-short” positioning in bonds has reversed, rates have failed to rise correspondingly. The reason for this is due to rising levels of Eurodollar positioning. Such is due to foreign banks pushing reserves into U.S. Treasuries for “safety” and “yield.”

There is a probability for rates to fall in the months ahead coinciding with further deterioration in economic growth. 

Conclusion

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that financial markets can only rise further. The arguments supporting those beliefs are based on comparisons to previous peak market cycles. Unfortunately, investors tend to be wrong at market peaks and bottoms.

With retail positioning very long-biased, the implementation of QE-4 has once again removed all “fears” of a correction, recession, or bear market. Historically, such sentiment excesses form around short-term market peaks.

Such is a excellent time to remind you of the other famous “Bob Farrell Rule” to remember: 

“#5 – The public buys the most at the top and the least at the bottom.”

What investors miss is that while a warning doesn’t immediately translate into a negative consequence, such doesn’t mean you should not pay attention to it.

As I concluded in our recent newsletter:

“There remains an ongoing bullish bias that continues to support the market near-term. Bull markets built on ‘momentum’ are very hard to kill. Warning signs can last longer than logic would predict. The risk comes when investors begin to ‘discount’ the warnings and assume they are wrong. 

It is usually just about then the inevitable correction occurs. Such is the inherent risk of ignoring risk.'”

The cost of not paying attention to risk can be extraordinarily high.

TPA Analytics: Top 10 Buys & Sells: 08-03-20

Note from the RIAPro Team:

We are proud to offer TPA Analytics to you at a deeply discounted price. TPA has been serving institutional clients with their trading ideas and strategies. Now you can add the same long-short strategies and ideas to your portfolio as well.

Click on RIAPro+ today to add TPA Research to your subscription for just $20/month. 

As a subscriber you will receive real-time alerts of trading activity by TPA and a minimum of 2-reports each week.

Turning Point Analytics utilizes a time-tested, real-world strategy that optimizes the clients entry and exit points and adds alpha. TPA defines each stock as Trend or Range to identify actionable inflection points.


Top 10 Buys & Sells As Of 08-03-20

These are high conviction stocks that TPA has recommended recently. They are technically positive for “buys,” or negative for “sells.” They are also trading at, or near, the recommended action price levels.

Cartography Corner – August 2020

J. Brett Freeze and his firm Global Technical Analysis (GTA) provides RIA Pro subscribers Cartography Corner on a monthly basis. Brett’s analysis offers readers a truly unique brand of technical insight and risk framework. We personally rely on Brett’s research to help better gauge market trends, their durability, and support and resistance price levels.

GTA presents their monthly analysis on a wide range of asset classes, indices, and securities. At times the analysis may agree with RIA Pro technical opinions, and other times it will run contrary to our thoughts. Our goal is not to push a single view or opinion, but provide research to help you better understand the markets. Please contact us with any questions or comments.  If you are interested in learning more about GTA’s services, please connect with them through the links provided in the article.

The link below penned by GTA provides a user’s guide and a sample of his analysis.

GTA Users Guide


July 2020 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESU0) during July 2020. In our July 2020 edition of The Cartography Corner, we wrote the following:

In isolation, monthly support and resistance levels for July are:

  • M4                 3693.65
  • M1                 3388.40
  • PMH              3226.95
  • M3                 3138.50
  • Close            3090.25      
  • M2                3087.25
  • MTrend        2933.44
  • PML              2923.75      
  • M5               2782.00

Active traders can use M2: 3087.25 as the pivot, maintaining a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for July 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The month of July began with the market price overcoming early-session weakness to settle above our isolated pivot level at M2: 3087.25.  Over the following two trading sessions, the market price ascended to and settled above our first isolated resistance level at M3: 3138.50.  The three-session cumulative gain, relative to June’s settlement price, totaled 2.65%.  Collective patriotism is not limited to fireworks and barbeques.

The following six trading sessions saw the market price trade in a range, bound on the upside by our next isolated resistance level at PMH: 3226.95 and on the downside by M3: 3138.50 now acting as support.  Despite some long upper and lower shadows on the candles, the market price settled above M3: 3138.50 on five of six trading sessions by an average of 0.64%.  Energy was building for the next move.   

Figure 1:

Starting on July 15th, the market price experienced a mini “phase-shift” higher, with our next isolated resistance level at PMH: 3226.95 acting as a magnet.  The final thirteen trading sessions were spent with the market price oscillating in a 3.01% range around that level.

Market participants following our analysis ended the month, on a mark-to-market basis, with a 5.7% gain on their positions.

Silver Futures

We continue with a review of Silver Futures (SIU0) during July 2020.  In our July 2020 edition of The Cartography Corner, we wrote the following:

In isolation, monthly support and resistance levels for July are:

  • M4         23.140
  • M2         19.610
  • M1         19.365
  • PMH       18.950
  • M3         18.775
  • Close       18.637
  • PML        17.185             
  • MTrend  16.868                         
  • M5           15.835

Active traders can use 18.950 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for July 2020 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first five trading sessions of July saw the market price ascend to, and settle above, our isolated pivot level at PMH: 18.950.  First hurdle cleared.

The following seven trading sessions saw the market price ascend towards and surpass our next isolated clustered-resistance levels at M1: 19.365 / M2: 19.610.  Last hurdle cleared.

The following three trading sessions saw the market price make a quick ascent to our isolated Monthly Upside Exhaustion Level at M4: 23.14.  Monthly objective achieved.

With seven trading sessions remaining in the month, our analysis had one level remaining to be achieved.  On June 30th, our analysis isolated the 3Q2020 Quarterly Upside Exhaustion Level at Q4: 26.215.  On July 28th, the high price for the month was achieved at 26.275.  Quarterly objective achieved.

We anticipate a two-month low AND a two-quarter low over the following four to six periods, respectively.

At a minimum, market participants following our analysis realized a 22.0% gain.   

Figure 2:

August 2020 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESU0).  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Current Settle         3263.50       
  • Daily Trend             3240.47
  • Weekly Trend         3219.36       
  • Monthly Trend        3079.94       
  • Quarterly Trend      2913.69

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross; the Trend Levels are higher as the time-periods decrease.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”, after having been “Trend Up” for four quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled for three months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled for five weeks above Weekly Trend.

One rule we have is to anticipate a two-period high (low), within the following four to six periods, after a Downside (Upside) Exhaustion level has been reached.  Recall, these two-period highs may occur at higher levels but can also occur from lower levels.  We now anticipate a two-period high in the quarterly time-period over the next three to five quarters.  If this were to be achieved in 3Q2020, a trade to a new all-time high is required. To reiterate, it can also be achieved in another quarter at lower levels.

Our timing-cycle work reaches its local apex, meaning it is most supportive of the market price, on August 16, 2020.  It then declines rapidly, reaching its local trough on January 7, 2021.

The 1929 analog is also reaching its apex.

Support/Resistance:

In isolation, monthly support and resistance levels for August are:

  • M4                 3645.25
  • M3                 3436.75
  • M1                 3342.05
  • PMH              3284.50
  • Close            3263.50      
  • M2                3201.75
  • MTrend        3079.94
  • PML              3062.75      
  • M5               2898.55

Active traders can use PMH: 3284.50 as the pivot, maintaining a long position above that level and a flat or short position below it.

Euro FX Futures

For August, we focus on Euro FX Futures (“the Euro”).  We provide a monthly time-period analysis of 6EU0.  The same analysis can be completed for any time-period or in aggregate.

Trends:

  • Daily Trend           1.1807           
  • Current Settle       1.1800
  • Weekly Trend       1.1593           
  • Monthly Trend      1.1305           
  • Quarterly Trend    1.1135

The relative positioning of the Trend Levels is as bullish as possible.  Think of the relative positioning of the Trend Levels like you would a moving-average cross; the Trend Levels are higher as the time-periods decrease.  As can be seen in the quarterly chart below, the Euro is in “Consolidation”.  Stepping down one time-period, the monthly chart shows that the Euro is “Trend Up”, having settled above Monthly Trend for three months.  Stepping down to the weekly time-period, the chart shows that the Euro is “Trend Up”, having settled above Weekly Trend for four weeks.

Support/Resistance:

In isolation, monthly support and resistance levels for August are:

  • M4         1.2736
  • M1         1.2397
  • M3         1.2346
  • PMH       1.1920
  • Close      1.1800
  • MTrend   1.1305
  • M2         1.1301             
  • PML        1.1202                         
  • M5           1.0962

Active traders can use 1.1920 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Summary

The power of technical analysis is in its ability to reduce multi-dimensional markets into a filtered two-dimensional space of price and time.  Our methodology applies a consistent framework that identifies key measures of trend, distinct levels of support and resistance, and identification of potential trading ranges.  Our methodology can be applied to any security or index, across markets, for which we can attain a reliable price history.  We look forward to bringing you our unique brand of technical analysis and insight into many different markets.  If you are a professional market participant and are open to discovering more, please connect with us.  We are not asking for a subscription; we are asking you to listen.


Major Market Buy Sell Review: 08-03-20

HOW TO READ THE MAJOR MARKET BUY SELL REVIEW 08-03-20

There are three primary components to each Major Market Buy/Sell chart in this RIAPro review:

  • The price chart is in orange
  • The Over Bought/Over Sold indicator is in gray
  • The Buy / Sell indicator is in blue.

When the gray indicator is at the TOP of the chart, there is typically more risk and less reward available at the current time. In other words, the best time to BUY is when the short-term condition is over-sold. Likewise, when the buy/sell indicator is above the ZERO line, investments have a tendency of working better.

With this basic tutorial, let’s review the major markets.

Major Market Buy/Sell Review 08-03-20

S&P 500 Index

  • SPY is overbought short-term, but continues to run along its bullish uptrend from the lows. For now, the bulls remain in control of the upside.
  • While there is immediate support below Friday’s close, there is limited upside due to the overbought condition.
  • As noted above, the buy signal at the highest level in 25-years, a correction is more likely than not over the next month. 
  • Caution is advised. 
  • Short-Term Positioning: Bullish
    • Last Week: No holdings.
    • This Week: No holdings
    • Stop-loss set at $300 for trading positions.
    • Long-Term Positioning: Bullish

Dow Jones Industrial Average

  • The Dow continues to underperform other major indices due to its lack of the 5-major FANG stocks.
  • With the buy-signal extremely extended, and underperforming other assets, we are going to focus our attention elsewhere for now.
  • Short-Term Positioning: Bearish
    • Last Week: No position..
    • This Week: No position.
    • Stop-loss moved up to $260
  • Long-Term Positioning: Bullish

Nasdaq Composite

  • QQQ’s outperformance of SPY turned up a bit last week as expected. We added to our tech exposure on Thursday.
  • The QQQ’s remain massively overbought, the buy signal is extremely extended, and QQQ is still pushing 3-standard deviations above the 200-dma. 
  • However, for now, tech really is about the “only game in town.”
  • Take profits and rebalance as needed.
  • Short-Term Positioning: Bearish – Extension above 200-dma.
    • Last Week: No positions
    • This Week: Added to tech holdings (MSFT, AAPL, NFLX, AMZN, ADBE, CRM, XLK)
    • Stop-loss moved up to $240
  • Long-Term Positioning: Bullish

S&P 600 Index (Small-Cap)

  • Small-caps attempted a very weak rally but remain below the 200-dma.
  • With the buy-signal extremely extended, and the market under-performing, the risk is still too high.
  • With small-caps very susceptible to weak economic growth, we are still avoiding this area of the market. 
  • Support is critical at the $58 level.
  • Short-Term Positioning: Bearish – Market Risk Is High
    • Last Week: No positions
    • This Week: No positions.
    • Stop-loss reset at $58
  • Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

  • The relative performance remains poor as with SLY. However, MDY is trying once again to break above the 200-dma resistance. It failed the last attempt.
  • We are also avoiding mid-caps for the time being until relative performance improves.
  • The $320 stop-loss remains. Use this rally to reduce if needed. 
  • Short-Term Positioning: Bearish
    • Last Week: No holding
    • This Week: No holding
    • Stop Loss reset at $320
  • Long-Term Positioning: Bearish

Emerging Markets

  • Emerging markets have performed better on a relative basis but are now extremely extended. As with all other markets, the buy signal is at the highest level on record.  
  • Look for a correction that does not violate the 200-dma to add a trading position. Target is $41. 
  • There dollar decline, responsible for EEM performance, is well overdone. Look for a counter-trend rally which will push EEM lower. 
  • Short-Term Positioning: Bullish
    • Last Week: No position
    • This Week: No position.
    • Stop-loss remains at $40 for trading positions.
  • Long-Term Positioning: Bearish

International Markets

  • EFA was holding up better but took a sharp dive on Friday with the bounce in the dollar.  
  • It will be important for EFA to hold support at the 200-dma, but the overbought condition puts this at risk. 
  • We had previously added a 3% trading position previously, but we sold that position last Tuesday which worked out well. on an expectation of a dollar rally. 
  • As with EEM, EFA is dollar sensitive, so we also added a dollar hedge. 
  • Short-Term Positioning: Bearish
    • Last Week: No position.
    • This Week: Sold position in EFA.
    • Stop-loss set at $62
  • Long-Term Positioning: Bearish

West Texas Intermediate Crude (Oil)

  • Oil prices are struggling to move higher and are running into the 200-dma resistance. 
  • We suggested last: “Look for a correction to reverse some of the extreme overbought.” That correction may have started last week, we will see.
  • Oil is also subject to a reversal in the dollar, another reason we are adding a dollar hedge.
  • Energy stocks are underperforming oil prices currently which suggests more trouble in the sector. However, there remains relative value in some energy companies which may perform better than oil prices in the near-term. 
  • Oil should hold support between $30 and $35 and we will look to increase our holdings on pullbacks.
  • Short-Term Positioning: Bearish
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop for trading positions at $32.50
  • Long-Term Positioning: Bearish

Gold

  • We remain long our current position in IAU, but did take some profits last week due to the risk of a counter-trend rally in the dollar. 
  • Gold is extremely overbought and starting to push 4-standard deviations above the 200-dma. 
  • We suggest taking some profits for now and look for a pullback to increase our sizing. 
  • We believe downside risk is fairly limited, but as always maintain stops.
  • Short-Term Positioning: Bullish
    • Last week: Hold positions.
    • This week: Hold positions
    • Stop-loss moved up to $165
    • Long-Term Positioning: Bullish

Bonds (Inverse Of Interest Rates)

  • Two weeks ago we noted that “there is more room for TLT to rally this next week.” That occurred over the last two weeks, and the “sell signal” continues to head towards a “buy signal.”
  • While bonds are overbought short-term, with every other market extremely extended into overbought territory, if a correction occurs, TLT should hedge risk to some degree as rates push towards zero. 
  • The is potentially some short-term risk of a short-term correction, but given the extreme extension of the equity markets, dips should be bought. 
  • There is still upside potential in bonds if there is a dollar rally or a correction in equities as we move into August. 
  • Short-Term Positioning: Neutral
    • Last Week: Hold positions
    • This Week: Hold positions
    • Stop-loss moved up to $155
    • Long-Term Positioning: Bullish

U.S. Dollar

  • Previously we stated, “While the dollar has sold off, and helped fuel a rather torrid stock and commodity rally, we are likely closer to a bottom. That is still the case this week with the dollar pushing 3-standard deviations oversold.
  • The dollar bounced off support on Friday, so we will see if we get some follow through next week.
  • Given the large number of analysts with “bearish” forecasts on the dollar the probability of a dollar rally has risen. We have started building a trading position for such a counter rally and to hedge our international, energy and gold holdings.
  • Trading positions can be added to hedge portfolios but there is not a huge move available currently given the current market dynamics. 
  • Stop-loss adjusted to $93

 

Safety, Liquidity, Or Return. Why Cash Is An Important Hedge.

Safety, Liquidity, Or Return. Why Cash Is An Important Hedge.

Over the past few months, we have been writing a series of articles highlighting our concerns of increasing market risk.  Here is a sampling of some of our more recent posts on the issue.

The common thread among these articles was to encourage our readers to evaluate the current market “risks” and take some relevant actions. To wit:

“There remains an ongoing bullish bias that continues to support the market near-term. Bull markets built on “momentum” are very hard to kill. Warning signs can last longer than logic would predict. The risk comes when investors begin to “discount” the warnings and assume they are wrong.

It is usually just about then the inevitable correction occurs. Such is the inherent risk of ignoring risk.

In reality, there is little to lose by paying attention to “risk.”

sellable rally risk, Technically Speaking: Looking For A Sellable Rally To Reduce Risk.

The current deviation between the stock market, the economy, corporate profits, and earnings suggests something isn’t quite right.

“While the rally off the March lows has been substantial, there is still a vast disconnect between the markets and the underlying economic fundamentals. Given the divergence was driven by unprecedented monetary policy, the eventual reversion could be climatic.”

sellable rally risk, Technically Speaking: Looking For A Sellable Rally To Reduce Risk.

Equity prices are currently outpacing expectations for near-term profits, forming a price-earnings melt-up akin to what was seen in the late 1990s. Furthermore, the S&P 500’s price-sales ratio is also flashing a similar warning.

The Difficult Part

Despite many clear warnings that suggest that current risk outweighs the reward, investors fail to act due to the “Fear Of Missing Out.” (aka FOMO) I recently received an interesting email which makes this point clearly:

“The market is going higher and will continue to do so indefinitely, as long as the Fed is injecting liquidity into the market. If you are removing risk, you are missing out.”

As stated above, the most significant risk to investor capital is “ignoring the risk”

Just because you see a bear in the woods, and choose to ignore it, doesn’t mean it will ignore you. 

“The reason we suggest selling any rally is because, until the pattern changes, the market is exhibiting all traits of a ‘topping process.’ As the saying goes, a market-top is not an event; it’s a process.” – RIA

It’s Your Brain

There are several psychological factors which make managing risk extremely difficult:

  • Investors are slow to react to new information (they anchor), which initially leads to under-reaction but eventually shifts to over-reaction during late-cycle stages.
  • The “herding” effect ultimately drives investors. A rising market leads to “justifications” to explain over-valued holdings. In other words, buying begets more buying.
  • Lastly, as the markets turn, the “disposition” effect takes hold, and winners are sold to protect gains, but losers are held in the hopes of better prices later. 

In our portfolio management practice, technical analysis is a critical component of the overall process. It carries just as much weight as the fundamental analysis. As I have often stated:

“Fundamentals tell us WHAT to buy or sell. Technicals tell us WHEN to do it.”

Currently, our analysis suggests there is a deteriorating technical backdrop, combined with our outlook for continued disappointment in earnings and corporate profits recovery.

Such suggests that we reduce equity risk modestly, and further increase our cash hedge, until there is more “clarity” with respect to where markets are heading next.

This brings me to the most important point.

The 3-Components Of All Investments

In portfolio management, you can ONLY have 2-of-3 components of any investment or asset class:  Safety, Liquidity & Return. The table below is the matrix of your options.

The takeaway is that cash is the only asset class which provides safety and liquidity. Obviously, the safety comes at the cost of return. This is basic.

But what about other options?

  • Fixed Annuities (Indexed) – safety and return, no liquidity. 
  • ETF’s – liquidity and return, no safety.
  • Mutual Funds – liquidity and return, no safety.
  • Real Estate – safety and return, no liquidity.
  • Traded REIT’s – liquidity and return, no safety.
  • Commodities – liquidity and return, no safety.
  • Gold – liquidity and return, no safety. 

You get the idea. No matter what you chose to invest in – you can only have 2-of-the-3 components. Such is an important, and often overlooked, consideration when determining portfolio construction and allocation. The important thing to understand, and what the mainstream media doesn’t tell you, is that “Liquidity” gives you options. 

I learned a long time ago that while a “rising tide lifts all boats,” eventually, the “tide recedes.” I made one simple adjustment to my portfolio management over the years, which has served me well. When risks begin to outweigh the potential for reward, I raise cash.

The great thing about holding extra cash is that if I’m wrong, I simply make the proper adjustments to increase the risk in my portfolios. However, if I am right, I protect investment capital from destruction and spend far less time ‘getting back to even.’ Despite media commentary to the contrary, regaining losses is not an investment strategy. 

8-Reasons To Hold Cash

1) We are speculators, not investors. We buy pieces of paper at one price with hopes of selling at a higher price. Such is speculation in its purest form. When risk outweighs rewards, cash is a good option. 

2) 80% of stocks move in the direction of the market. If the market is falling, regardless of the fundamentals, the majority of stocks will decline also.

3) The best traders understand the value of cash. From Jesse Livermore to Gerald Loeb, each believed in “buying low and selling high.” If you “sell high,” you have raised cash to “buy low.”

4) Roughly 90% of what we think about investing is wrong. Two 50% declines since 2000 should have taught us to respect investment risks.

5) 80% of individual traders lose money over ANY 10-year period. Why? Investor psychology, emotional biases, lack of capital, etc. Repeated studies by Dalbar prove this. 

6) Raising cash is often a better hedge than shorting. While shorting the market, or a position, to hedge risk in a portfolio is reasonable, it also merely transfers the “risk of being wrong” from one side of the ledger to the other. Cash protects capital and eliminates risk. 

7) You can’t “buy low” if you don’t have anything to “buy with.” While the media chastises individuals for holding cash, it should be somewhat evident that without cash you can’t take advantage of opportunities.

8) Cash protects against forced liquidations. One of the biggest problems for Americans  is a lack of cash to meet emergencies. Having a cash cushion allows for handling life’s “curve-balls,” without being forced to liquidate retirement plans.Layoffs, employment changes, etc. are economically driven and tend to occur with downturns that coincide with market losses. Having cash allows you to weather the storms. 

Retirement, Retirement Confidence Declined Despite A Surging Market

Conclusion

Importantly, I want to stress that I am not talking about being 100% in cash.

I am suggesting that holding higher levels of cash during periods of uncertainty provides both stability and opportunity.

With the political, fundamental, and economic backdrop becoming much more hostile toward investors in the intermediate term, understanding the value of cash as a “hedge” against loss becomes much more important. 

Given the length of the current market advance, deteriorating internals, high valuations, and weak economic backdrop, reviewing cash as an asset class in your allocation may make some sense.

Chasing yield at any cost has typically not ended well for most.

Of course, since Wall Street does not make fees on investors holding cash, maybe there is another reason they are so adamant that you remain invested all the time.

S&P 500 Monthly Valuation & Analysis Review – 8-01-2020

S&P 500 Monthly Valuation & Analysis Review – 08-01-20


J. Brett Freeze, CFA, founder of Global Technical Analysis. Each month Brett will provide you their valuable S&P 500 Valuation Chart Book. This unique analysis provides an invaluable long term perspective of equity valuations. If you are interested in learning more about their services, please connect with them.

Do Investors Know They Are Skiing In An Avalanche Zone?

Do Investors Know They are Skiing in an Avalanche Zone?

2020 has been quite a year for the stock and options markets. We have witnessed a gut-wrenching roller coaster ride from highs to lows and back to highs. The volumes of both stock and options trading have ballooned as discount brokers offer zero commission trading.

What few seem to realize is that the proliferation of options trading has created a new market dynamic. This dynamic can create feedback loops that could generate significant volatility. If we compare a feedback loop to a snowball rolling downhill, one can view the recent spike in options trading as a snowfall leading to a potential avalanche.

To make our case, we provide a simplified option hedging example to show how this practice can affect order flow in the underlying markets. Specifically, options delta hedging can lead to amplified upward and downward price pressure. With options trading at record volumes, one should not overlook this point.

Options Hedging Example

To illustrate the effects of delta hedging, let’s consider an example. A bank or broker that writes options will usually construct and manage a delta neutral portfolio to manage this risk[1].  For this example, we consider a delta hedger in SPY that ended a recent trading day with a delta-neutral hedged position. We show this in the first table below.

The closing price of SPY is $321/share. The market participant sold 100 call options at the $340/share strike price, with options expiration 28 days away.  To hedge this position close to delta-neutral, the participant sold 57 puts at a strike price of $300/share. There are many ways to hedge the position, and the method we present is common among market makers.

To arrive at 57 puts, the participant calculated how many options are needed to bring the total delta of the position to near zero. As shown below, the call and put delta in the two right columns are essentially equal. However, that will cease to be the case once SPY moves in one direction or the other.

[1] Delta measures how the option price will change as the underlying stock or index changes.

The Next Day

The next day, we assume the value of SPY increases by $4/share to $325/share. The price changes also change the delta values for both the puts and calls. This participant wants to maintain a delta neutral position. To do so, they can buy 8-shares of SPY[1] to neutralize delta (we show the changes to the position in red in the tables below).

The important thing to emphasize is that maintaining a delta neutral hedge requires the participant to buy SPY shares when the price of SPY increases.

To illustrate the same case when the market declines, consider the case where SPY falls by $4/share the next day. In this example, the participant would sell 7-shares of SPY to maintain a delta-neutral portfolio.

Again, the important thing to emphasize is that maintaining a delta neutral position requires the participant to sell SPY shares when the price of SPY decreases.

Therefore, one outcome of delta hedging is that options market makers will buy shares when the market is rising and sell shares when it is falling.

When liquidity is weak and hedging requirements are large, a feedback loop can materialize and amplify price moves. Such occurs when hedge related buying pushes prices higher. As prices rise, hedgers must buy more, which then pushes prices even higher. The same loop can occur on the downside as well.

[1] Since 1-option in the stock markets is for 100 shares, the delta neutral position would require 800 shares of SPY. We are simplifying the calculations for reader understanding.

fundamentals, The Death Of Fundamentals & The Future Of Low Returns

Risk of Cascading Declines

In the simple example above, we did not consider changes in volatility to adjust our delta hedge. In reality, implied volatilities change rapidly, particularly in a sharply declining market.

When volatility spikes, then the values, deltas, and gammas of options also spike.

Volatility is most likely to rise in falling markets and remain stable to falling in rising markets. The amount of hedging required to hedge downward moves is typically greater than upward moves.

A sharply falling market can result in a cascading feedback loop. Such occurs as delta hedgers must sell increasing numbers of shares to maintain their delta-neutral hedge. Importantly, most of this delta hedging is done by computers, which can further amplify the move as all of the delta hedgers can act simultaneously.

Stock market selling can beget more selling, and in some cases, this can result in a market that looks like a snowball heading downhill.

Gamma Triggers

In studying the options markets, one of our primary goals is to protect your retirement savings from these cascading downward events that can debilitate long term wealth.

To better assess the situation we calculate and share with our subscribers the so-called Gamma Neutral level. This level can be a trigger for follow-on selling and higher volatility in the stock market. As such, it allows us to better understand how options traders are positioned and discover market levels that could trigger a feedback loop.

The chart below shows the historical volatility of the SPX above and below Gamma Neutral levels.

Conclusion

We have provided a simple delta hedging example to emphasize that delta hedging has significant follow-on effects in the stock market. In times of questionable liquidity and record options trading, these implications become magnified. In particular, delta hedging can result in a feedback loop where stock market increases are bought, and systematic delta hedgers sell stock market decreases.

As options trading gains popularity via low or zero-commission trading, the effects of this feedback loop are gaining in importance.

The feedback loop in a market sell-off is proven to be more pronounced as volatility, delta, and gamma all spike. Such results in even larger follow-on selling by machine delta hedgers. The greatest risk of the increase in options trading is the potential for a large, cascading downward move, similar to what we saw earlier this year.


If you would like to learn more, please visit our website, or download a complimentary report.

Author

Erik Lytikainen, the founder of Viking Analytics, has over 25+ of experience as a financial analyst, entrepreneur, business developer, and commodity trader. Erik holds an MBA from the University of Maryland and a BS in Mechanical Engineering from Virginia Tech.

Is It “Insanely Stupid” To Chase Stocks As The Economy Plunges?


In this issue of, “Is It Insanely Stupid To Chase Stocks As The Economy Plunges.”

  • Stocks Hug The Bullish Trend
  • The Gold/Dollar Conundrum
  • The GDP Crash 
  • Is It “Insanely Stupid” To Chase Stocks
  • Managing Into The Unknown
  • MacroView: Universal Basic Income Is Not An Economic Savior
  • Sector & Market Analysis
  • 401k Plan Manager

Follow Us On: Twitter, Facebook, Linked-In, Sound Cloud, Seeking Alpha


WEBINAR: Retirement Right Lane Workshop

Register today for our most popular class covering everything you need to know about retirement, Medicare, Medicaid, Social Security, Roth conversions, RMD’s, investing, markets, and more. 

WHEN: Saturday, August 8th, 9-11 am  


Catch Up On What You Missed Last Week


Stocks Hug The Bullish Trend

As discussed previously in “The Cobra Effect,” we noted the market remained confined to its consolidation channel.

“Unfortunately, the market failed to hold its breakout, which keeps it within the defined trading range. The market did hold its rising bullish uptrend support trend line, which keeps the “bullish bias” to the market intact for now. “

That remained the case again this week and keeps our allocation models primarily on hold at the moment. 

While the market has not been able to push above the recent July highs., support is holding at the rising bullish trend line. With the short-term “buy signals” back in play, the bias at the moment is to the upside. However, as we have discussed over the last couple of weeks, July held to its historical trends of strength. With a bulk of the S&P 500 earnings season behind us, we suspect the weakening economic data will begin to weigh on sentiment in August and September. 

Such is why we are keeping our hedges in place for now. 

The Gold / Dollar Battle

Speaking of hedges, we began to accumulate a long-dollar position in portfolios this past week. There are several reasons for this:

  1. When the financial media discusses the dollar’s demise, such is usually a good contrarian signal. 
  2. The dollar has recently had a negative correlation to stocks, bonds, gold, commodities, etc.
  3. The surging exuberance in gold also acts as a reliable contrarian indicator of the dollar.  
  4. The dollar is currently 3-standard deviations below the 200-dma, which historically is a strong buy signal for a counter-trend rally. 

Given our portfolios are long weighted in equities, bonds, and gold currently, we need to start hedging that risk with a non-correlated asset. We also trimmed some of our holdings in conjunction with adding a dollar hedge. 

Our friends at Sentiment Trader also picked up on the same idea and published the following charts supporting our thesis. As shown, hedge fund exposure to the dollar has reached more bearish extremes. 

As noted previously, the dollar has a non-corollary relationship to gold. Whenever there is extreme negative positioning in the dollar, forward returns are negative across every time frame. 

The vital thing to note here is that opportunity generally exists as points of extremes. When stocks, gold, and bonds are stretched beyond normal bounds (200-dma), reversions tend to occur. The only question is timing. 

However, with that said, the disconnect between the economy and the market remains a conundrum. 

The GDP Crash

On Friday, we got the first official estimate of GDP for the second quarter. It many ways it was just as bad as we had feared. As shown in the chart below, the print of a nearly 38%, inflation-adjusted decline was stunning. 

However, the “return to economic normality” faces immense challenges. High rates of unemployment, suppressed wages, and elevated debt levels, make a “V-shaped” recovery unlikely. Nonetheless, the current estimates for Q3 forward suggest record-setting rates of GDP growth. 

Such is where the “math” becomes problematic. A 38% drawdown in Q2, requires about a 67% recovery to return to even. In the more optimistic recovery scenario detailed above, three-quarters of record recovery rates still leave the economy running in a deep recession.

Even if the economy achieves high recovery rates, it won’t change the recession. The resulting 2.7% economic deficit will remain one of the deepest in history. While we would welcome such a recovery, it is not enough to support more substantial employment, wage growth, or corporate earnings.

A Whole New (Lower) Trend

Here is the issue missed by the majority of mainstream economists.

Before the “Financial Crisis,” the economy had a linear growth trend of real GDP of 3.2%. Following the 2008 recession, the growth rate dropped to the exponential growth trend of roughly 2.2%. Instead of reducing the debt problems, unproductive debt, and leverage increased.

The “COVID-19” crisis led to a debt surge to new highs. Such will result in a retardation of economic growth to 1.5% or less. As discussed previously, while the stock market may rise due to massive Fed liquidity, only the top-10% of the population owning 88% of the market will benefit. Going forward, the economic bifurcation will deepen to the point where 5% of the population owns virtually all of it.

“That is not economic prosperity. It is a distortion of economics.”

All Hat, No Cattle

Importantly, these are all extremely optimistic assumptions based on massive interventions by the Federal Government. While the economic plunge was terrible, had it not been for the massive infusions of Government stimulus, it would have been far worse. 

The chart below shows the annual percentage change in Federal expenditures and the rate of GDP growth less Fed expenditures. Essentially, there was ZERO economic growth, ex-federal expenditures. 

However, that is also why the stock market has done so well. 

The problem is the Government’s ability to continue spending at increasing rates to support economic growth and the markets. 

As they say in Texas, the current rally has been “all hat and no cattle.” 

Such is the most significant risk for the bulls.

Insanely Stupid

This past week, we discussed with our RIAPro Subscribers (Try Risk-Free for 30-days) the dangers of chasing markets, which have deviated extremely from their long-term means. The risk, of course, is that markets always, without exception, revert to the mean. The only question is the “timing” of the event. 

Such was a point recently discussed by Sarah Ponczek and Michael Regan at Advisor Perspectives:

“People buying bubble assets will make money until they don’t. If they don’t have a view of what it will take for me to say, ‘OK, enough already, I’m going to get out,’ then they are doomed to ride the roller coaster over the top and down. So without a sell discipline, buying bubble assets is insanely stupid.” – Rob Arnott, Research Affiliates

As we have discussed in this missive previously, you can’t have a stock market that remains detached from fundamentals indefinitely. 

Reversions Happen Fast

Importantly, throughout history, it is not fundamentals that catch up with the market, but the opposite. The only question is, what causes that reversion?

Unfortunately, we don’t, and won’t, know what the catalyst will eventually be. It won’t be COVID, bad economic data, or even weak earnings. All those issues have been factored into the market and “rationalized” by investors using earnings 3-years into the future. 

 

While that is also insanely stupid, investors will get away with it until some exogenous, unexpected event catches the market off-guard. When it happens, like it did in March, it will take investors by surprise and the damage will be just as consequential. 

There are a tremendous number of things that can go wrong in the months ahead. Such is particularly the case of surging stocks against a depressionary economy. While investors cling to the “hope” that the Fed has everything under control, there is more than a small chance they don’t.

Regardless, there is one truth about stocks and the economy.

“Stocks are NOT the economy. But the economy is a reflection of the very thing that supports higher asset prices – corporate profits.”

Such is why we continue to manage risk, adjust exposures, and hedge accordingly. 

Is it “insanely stupid” to chase stocks here? Probably. But as Keynes once quipped, “the markets can remain irrational longer than you can remain solvent.”

We understand the risk we are taking in this market, and we have a risk management discipline we follow. Or rather, as Rob Arnott suggests, a rigorous “sell discipline.” 

Will it absolve us of any downside risk in portfolios?

Absolutely not.

But it will definitely reduce the risk to our capital more than not having one at all. 

Managing Into The Unknown

As discussed above, we are heading into seasonally two of the weakest market months of the year. Such comes at a time when Congress is battling over the next relief bill, the Federal Reserve is slowing weekly bond buying, and the economic recovery is faltering. There is also the risk of a Presidential election that goes completely awry. 

With the market currently extended, overbought, and overly bullish, we suggest the following actions to manage portfolios over the next couple of months. 

  • Re-evaluate overall portfolio exposures. We will look to initially reduce overall equity allocations.
  • Use rallies to raise cash as needed. (Cash is a risk-free portfolio hedge)
  • Review all positions (Sell losers/trim winners)
  • Look for opportunities in other markets (The dollar is extremely oversold.)
  • Add hedges to portfolios.
  • Trade opportunistically (There are always rotations which can be taken advantage of)
  • Drastically tighten up stop losses. (We had previously given stop losses a bit of leeway due to deeply oversold conditions in March. Such is no longer the case.)

The Risk Of Ignoring Risk

There remains an ongoing bullish bias that continues to support the market near-term. Bull markets built on “momentum” are very hard to kill. Warning signs can last longer than logic would predict. The risk comes when investors begin to “discount” the warnings and assume they are wrong.

It is usually just about then the inevitable correction occurs. Such is the inherent risk of ignoring risk.

In reality, there is little to lose by paying attention to “risk.”

If the warning signs do prove incorrect, it is a simple process to remove hedges and reallocate back to equity risk accordingly.  

However, if these warning signs do come to fruition, then a more conservative stance in portfolios will protect capital in the short-term. A reduction in volatility allows for a logical approach to making further adjustments as the correction becomes more apparent. (The goal is not to get forced into a “panic selling” situation.)

It also allows you the opportunity to follow the “Golden Investment Rule:” 

 “Buy low and sell high.” 

So, now you know why we are looking for a “sellable rally.”


The MacroView

If you need help or have questions, we are always glad to help. Just email me.

See You Next Week

By Lance Roberts, CIO


Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders


S&P 500 Tear Sheet


Performance Analysis


Technical Composite


Sector Model Analysis & Risk Ranges

How To Read.

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • The “MA XVER” is determined by whether the short-term weekly moving average crosses positively or negatively with the long-term weekly moving average.
  • The risk range is a function of the month-end closing price and the “beta” of the sector or market.
  • The table shows the price deviation above and below the weekly moving averages.


Sector & Market Analysis:

Be sure and catch our updates on Major Markets (Monday) and Major Sectors (Tuesday) with updated buy/stop/sell levels.

Sector-by-Sector

Improving – Financials (XLF), Industrials (XLI), and Energy (XLE)

Previously we noted that Financials moved into the improving quadrant of the rotation model. Still, performance continues to be poor but has improved relative to the S&P 500 this past week. There is some value in the sector, but we are still avoiding banks for now. The same goes for Energy performance, which remains inadequate but is improving on the value trade. We previously added Industrials to our portfolio as performance has improved.

Current Positions: XLE, XLI

Outperforming – Materials (XLB), and Discretionary (XLY)

Over the last couple of weeks, we continued to suggest profit-taking in these holdings. These sectors remain extremely extended and overbought. Take profits and rebalance accordingly. 

Current Positions: XLK, XLC

Weakening – Technology (XLK), and Communications (XLB)

We took profits previously in Technology due to the extreme extension and warned a correction was likely. That correction came, and we added back to our holdings after taking profits. Technology is weakening in terms of relative performance, but we may see a return to outperformance short-term.

Current Position: XLK, XLC

Lagging – Healthcare (XLV), Utilities (XLU), Real Estate (XLRE), and Staples (XLP)

Previously, we added to our core defensive positions Healthcare. We continue to hold Healthcare on a longer-term basis as it tends to outperform in tougher markets and hedges risk. Healthcare was sitting on support and oversold, and the counter-trend rally in Healthcare has come to fruition.

Our defensive positioning in Staples and Utilities continues to lag, but performance is improving. Utilities and Staples remain part of the “risk-off” rotation trade. Real Estate is also improving and coming back on our radar.

Current Position: XLU, XLV, XLP

Market By Market

Small-Cap (SLY) and Mid Cap (MDY) – Both of these markets continue to underperform. Both markets are flirting with overhead resistance. We maintain no holdings currently.

Current Position: None

Emerging, International (EEM) & Total International Markets (EFA)

Emerging and International Markets have performed better recently. Last week, we closed our position in EFA as the dollar is setting up for a counter-trend rally. We will look to add international back to portfolios once the dollar reversal occurs.

Current Position: None

S&P 500 Index (Exposure/Trading Rentals) – We currently have no “core” holdings.

Current Position: None

Gold (GLD) – Last week, we trimmed our exposure to IAU. Gold is a bit overbought short-term, so we are looking for a pullback to rebuild exposures. The Dollar is extremely oversold; we have added a small position in UUP to hedge downside risk in Gold. 

Current Position: IAU, UUP

Bonds (TLT) –

We continue to hold our bond holdings as a hedge against market risk. However, those positions are starting to get very extended, so we will likely rebalance soon. No change this week.

Current Positions: TLT, MBB, & AGG

Portfolio / Client Update

With July now behind us, we are heading into two of the seasonally weak months of the year. Last week, we made changes to portfolios to rebalance risk, add a hedge, and shift exposures into protected areas against economic weakness.

We had taken profits previously in our technology holdings. We brought those holdings back up to size and reduced International, Industrials, and Transportation, which are subject to a weaker economy and rising dollar.

As noted in the main body of the newsletter this week, we also started building a position in the Dollar to hedge against a market decline. With stocks, bonds, gold, and commodities all very extended, a reversion is likely.

We suspect we may have a bit more “choppiness” ahead of us. Still, with the technical indicators more bullish than bearish, we are maintaining our equity exposure. Nonetheless, we also keep moving our “stops” up, just in case. 

Changes

In both models, we added a small hedge in the Dollar (UUP) as it is extremely oversold. The purpose of this position is to hedge risk in our Energy, Gold, and International positions. 

We also readjusted some weightings in both portfolios by adding a small amount of money to sectors we were underweight on relative to the S&P 500.

Equity Model:

  • Added to our positions in AAPL, AMZN, MSFT, NFLX, ADBE, CRM.  
  • Sold our positions in EFA, RTX, and NSC.

ETF Model:

  • Added to our position in XLK
  • Sold our positions in EFA and EFG.
  • Reduced positions in XLI, IYT

The purpose of these changes is to provide a bit more relative performance without markedly increased risk. 

We had a good test of our portfolios on Thursday and Friday as portfolios provided outstanding relative performance versus the benchmark. Our hedges continue to work as expected, even with increased equity exposure.

In the meantime, we are doing our best to maintain some risk controls. We do not want to be forced to sell emotionally. Please don’t hesitate to contact us if you have any questions or concerns.

Lance Roberts

CIO


THE REAL 401k PLAN MANAGER

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Model performance is a two-asset model of stocks and bonds relative to the weighting changes made each week in the newsletter. Such is strictly for informational and educational purposes only and should not be relied on for any reason. Past performance is not a guarantee of future results. Use at your own risk and peril.  


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Arete’s Observations 7/31/2020

Market observations

Goldman Spots A Historic Inversion In The Market

“The average daily value of options traded has exceeded shares for the first time, with July single stock options volumes currently tracking 114% of shares volumes.”

Three things strike me from this report. One is when activity in a derivative surpasses activity in the underlying asset, it is often a sign of excess. When the number of mutual funds overwhelmed the number of stocks, mutual funds endured a long period underperformance. Same with hedge funds.

Another thing is that since options represent leveraged positions in underlying stock, the increased activity represents increased speculation.

The third thing is this phenomenon demonstrates why the policy of lowering volatility is ultimately counterproductive. There will always be people who want to do better. Indeed, the active money management industry is predicated on it. Plus, some people are just inclined to speculate. Regardless, any efforts to reduce short-term or idiosyncratic risk only do so at the expense of increasing longer-term systemic risk. It looks like we just got another indicator systemic risk is increasing.

Jim Chanos: ‘We are in the golden age of fraud’

“Chanos describes the current environment as ‘a really fertile field for people to play

fast and loose with the truth, and for corporate wrongdoers to get away with it for a

long time’.”

“This market is setting up to be one of the great short opportunities of all time … Trouble’s coming, I don’t know when, but it’s coming.”

Jim Chanos pockets $100m from Wirecard short

“’If you’re a fundamental short seller, the Wirecard story was a classic,’ Mr Chanos said in a Lunch with the FT interview. ‘The buzzwords, the numbers that didn’t make sense, the business model that seemingly didn’t make sense’.”

“When people ask us, who were the auditors, I always say ‘Who cares?’ … Almost every fraud has been audited by a major accounting firm.” 

The first point to make is that from everything I have observed over the years, Jim Chanos is a class act and someone worth listening to. He is an elite analyst and benefits from doing hard analytical work rather than from spreading sensational stories. I heard him present at a CFA conference and his lessons are those of forensic accounting combined with practical experience.

So, when Chanos describes the current environment as “a really fertile field for people to play fast and loose with the truth”, this is something to pay attention to. I have been observing the same behaviors myself in going through financial statements and valuing companies and reported what I saw most recently in a blog post entitled, “The bursting bubble of BS”. What I can say is that it is hard to capture in words how flimsy the financial foundations of many public companies are.

Earnings adjustments, non-gaap earnings, aggressive reporting assumptions and other deceptive practices have always been part of the investment landscape; it happens. What seems different this time is that is has been going on for so long that many deceptive practices have essentially become institutionalized. This creates a feedback loop: Deceptive reporting practices become commonplace, investors habituate to the reality, aggressive managers and fraudsters learn that there is room to push things even further.

An interesting observation on this phenomenon came out of a podcast with Marc Cohodes hosted by Grant Williams and Bill Fleckenstein. Cohodes and Fleckenstein, both accomplished short sellers, agreed that “shorting frauds is almost impossible any more – there is almost no enforcement”. In other words, you can be absolutely right on the facts and still face an uphill battle because there is so little effort to prosecute the case or to defend you from retaliation. Who needs it?

Another consequence is that an environment with weak enforcement creates challenges for people and businesses just trying to do their thing. For example, as a major producer of N95 masks, 3M was in a position to benefit from the pandemic response. Indeed, according to its second quarter earnings release, the company was able to produce “nearly 800 million respirators in the first half of 2020”.

Along with those benefits, however, also came important challenges. In its efforts to “fight fraud and price gouging”, the company also reported that it “Secured removal of more than 7,000 counterfeit websites and more than 10,000 false or deceptive social media posts to date”. Of course, this takes time and money and effort to accomplish. 3M was able to do it; many smaller companies are not and succumb to such nefarious behavior.

I strongly suspect Chanos is right in his assessment that “trouble is coming”.

Economy

The second quarter GDP number came out on Thursday and at -32.9% it revealed a truly massive decline. Also on Thursday, new jobless claims came out and affirmed a troubling pattern of reversed progress. The graph at the right seems to capture the trajectory fairly well.

While we have clearly rebounded off the lows from late March and early April, the recovery has clearly flattened out – and at levels much lower than they were before the Covid shutdowns. Needless to say, it is essential to get activity levels back on the rise to return to any semblance of normalcy.

In order to get some sense of where the economy is headed, I will be watching the trajectory of infections across different states and the country as a whole as a primary indicator. I will also be watching to see how the expirations of various policies (such as moratoria on evictions of renters) filter through into real economic impact. That said, I also expect new relief policies to be implemented that will partly replace expired ones and further obscure the true underlying strength of the economy.

Emerging markets

I have mentioned Turkey a few times and most recently two weeks ago discussing how “little snippets” can make their way through the news without ever hitting the radar of “importance”. Nonetheless, such snippets can also quietly reveal how more important happenings unfold.

In the last few days we have seen news of an escalating conflict between Turkey and Greece and of further depreciation of the Turkish lira. Unimportant coincidence? Yeah, I don’t think so either.

Commercial real estate

Although a portfolio of five office buildings is hardly a representative sample of New York City, the fact that these buildings in aggregate have only 3% occupancy in the most densely populated city in the country truly is “staggering”.

One takeaway is what is happening in NYC is, as Grant’s Interest Rate Observer puts it, on more of a “depression” scale than a “recession” one.

Another takeaway is that this magnitude of downturn may be fairly unique to NYC. Most other areas seem to be doing better.

Also on the commercial real estate front, a brief evaluation of the market from Annaly Capital Management in its second quarter earnings presentation captures the environment well: “Commercial property investment remains muted as sellers and buyers differ on price expectations given the change in economic environment.”

This is code for, “the two sides are so far apart on price that no deals are getting done”. This means there are virtually no clearing prices from which to establish values. We will have no idea how bad things are until deals start getting done. This is a latent deflationary force.

Public policy

As debate is heating up regarding a follow up pandemic relief program, Republicans want credit supports for their cronies and Democrats want to funnel money to unemployment benefits and to states and municipalities. In other words, arguments are going in their typical partisan directions. Neither party, however, seems particularly concerned about spending a lot of money.

Forget the Income Cliff for a Moment. The U.S. Is About to Go Over a Child-Care Cliff.

“The current fiscal debate is off-key, says Betsey Stevenson, professor of public policy and economics at the University of Michigan. A lack of child care, she says, is a much bigger disincentive than the extra $600 when it comes to decisions not to work.”

Two things strike me about the debate. One is despite obvious differences between Republicans and Democrats in terms of where additional money should go, both seem to believe that more money is the solution to the problem.

The second is that Stevenson is on to something when she calls the debate “off-key”. What is missing is consideration of all the other elements that are important for a family’s livelihood. Sure, money matters, but so does child care and education and safety and some degree of stability. Failure on many of these fronts is crippling the ability of parents to take care of their families AND return to work in the same capacity.

Shadow banking

I’ve written several times over the years about shadow banking because I think it is both important and under-appreciated. Based upon much of the commentary I come across regarding monetary policy and assessments of it, it is clear much of the commentary comes from outdated mental models of the financial system. This piece from the Economist serves as a useful primer …

Banks lose out to capital markets when it comes to credit provision

“But capital markets have played a mighty role [in economic development], too. Today that is truer than ever, which in turn helps explain the stunning scope of the Federal Reserve’s response to the latest economic crisis.”

“Worldwide the exercise [to identify firms most susceptible to liquidity or solvency panics] identified $51trn (or 59% of gdp) in ‘narrow’ shadow investments, almost three-quarters of which are held in instruments ‘with features that make them susceptible to runs’. This slice has grown rapidly, from $28trn in 2010 (or 42% of gdp).”

This background helps evaluate and interpret central bank actions. For one, central banks are designed to oversee banks, not capital markets. As a result, “policymakers have once again found their customary tools do not work as well as they might like.”

For another, the panoply of initiatives the Fed has announced since March make a lot more sense in the context of the rising role of credit markets. As the Economist summarized, “Rather than acting as a lender of last resort to the banking system, therefore, the Fed has been forced to act as a marketmaker of last resort.” In other words, the Fed has had to redirect attention to the shadow banking system because that is where the greater liquidity and solvency risks reside.

US dollar/gold/inflation

One of the biggest stories over the last few weeks has been the incredible runup in gold. A related story that has also gotten a lot of attention is the weakening of the US dollar since the end of May.

A simple and common argument is with the Fed printing so much money, it will ignite inflation and significantly devalue the dollar. The trend in gold reinforces this belief. This has also come at a time when there has been some excitement about the euro after the EU agreed on a pandemic relief program.

There is truth to the argument, but as with many narratives, it oversimplifies things in a way that can be really confusing and counterproductive for long-term investors. In the short-term, the selloff in the dollar is probably overdone as is the runup in gold.

That said, it is important to understand the longer-term forces. For the dollar, clearly its status as the world’s reserve currency is an essential consideration. This means there is always demand for US dollars. People who are concerned about fiscal profligacy in the US (and I am one of them) need to weigh those concerns relative to fiscal conditions in other countries (which are as bad or worse).

What? Default? Where? Dollar?

“But the US has borrowed so much money!, you say. Yes, but so have Europe, and Japan, and China, everyone has who could.”

“I don’t see anything there that would make me think the dollar is collapsing, no more than the euro is. What I see is gold and silver rising.”

So, the dollar is unlikely to collapse against other fiat currencies but it is fair to be concerned about the loss of value in the dollar relative to gold over the longer-term. That said, if the dollar is oversold here, which I believe it is, then a rebound in the dollar will cause a decrease in the price of gold in dollar terms. This could create a nice opportunity for investors seeking to increase their exposure to gold.

Implications for investment strategy

I came across Russell Napier during the GFC when I read his book, Anatomy of the Bear, which is a deep study of the four major bear markets of the last 100 years. Napier is an independent thinker and is one of the few analysts with a deep appreciation of history as evidenced by his founding and directing The Practical History of Financial Markets course.

Napier has been right about persistent deflationary forces, but now he sees something that is changing his mind …   

https://www.ft.com/content/a7663749-179f-4194-ab89-0f8d7f0158ed

“During the Covid-19 crisis, control of the supply of money has quietly passed from central banks to governments. As a result, investors need to prepare for a new era of inflation.”

“Savers, through government-mandated bond holdings, will have to bear the burden of capped yields and will watch a portion of their savings eaten away through inflation.”

Inflation expectations are always a complex and dynamic mix of monetary policy, fiscal policy, and level of public acceptance. The key change Napier identifies is government guaranteed loans. These have all the makings of evolving into what he calls the “magic money tree”. I agree with Napier that these arrangements undermine any kind of accountability for growth in money supply, but am more uncertain as to the timing.

The second point is an important one for investors to fully embrace. Here’s the deal: the government is not there to allow you to comfortably earn returns to fund your retirement. No. You are a source of wealth that can be exploited to help the government manage its debt. Through the tool of inflation, your wealth will be gradually, but persistently, taxed and transferred. So, this will be a real challenge.

Napier’s final point is also an important one. In the context of strong tailwinds for stocks and bonds over the better part of forty years, the big investment call hasn’t been whether to be 40% or 50% invested in bonds but simply to be exposed to stocks and bonds. Conversely, in an inflationary environment, the key is to preserve purchasing power. Government debt will undermine that objective; gold will help:

“In this new age of repression, the secret to preserving the purchasing power of savings lies not in the mix of assets that are held but in the quantities they are held. Investors should hold as much gold, and as little government debt, as they feel comfortable with.”

Feedback

This publication is an experiment intended to share some of the ideas I come across regularly that I think might be useful. As a result, I would really appreciate any comments about what works for you, what doesn’t work, and what you might like to see in the future. Please email comments to me at drobertson@areteam.com. Thanks!        – Dave

Principles for Areté’s Observations

  1. All of the research I reference is curated in the sense that it comes from what I consider to be reliable sources and to provide meaningful contributions to understanding what is going on. The goal here is to figure things out, not to advocate.
  2. One objective is to simply share some of the interesting tidbits of information that I come across every day from reading and doing research. Many of these do not make big headlines individually, but often shed light on something important.
  3. One of the big problems with investing is that most investment theses are one-sided. This creates a number of problems for investors trying to make good decisions. Whenever there are multiple sides to an issue, I try to present each side with its pros and cons.
  4. Because most investment theses tend to be one-sided, it can be very difficult to determine which is the better argument. Each may be plausible, and even entirely correct, but still have a fatal flaw or miss a higher point. For important debates that have more than one side, Areté’s Takes are designed to show both sides of an argument and to express my opinion as to which side has the stronger case, and why.
  5. With the high volume of investment-related information available, the bigger issue today is not acquiring information, but being able to make sense of all of it and keep it in perspective. As a result, I describe news stories in the context of bodies of financial knowledge, my studies of financial history, and over thirty years of investment experience.

Note on references

The links provided above refer to several sources that are free but also refer to sources that are behind paywalls. All of these are designed to help you corroborate and investigate on your own. For the paywall sites, it is fair to assume that I subscribe because I derive a great deal of value from the subscription.

Disclosures

This commentary is designed to provide information which may be useful to investors in general and should not be taken as investment advice. It has been prepared without regard to any individual’s or organization’s particular financial circumstances. As a result, any action you may take as a result of information contained on this commentary is ultimately your own responsibility. Areté will not accept liability for any loss or damage, including without limitation to any loss of profit, which may arise directly or indirectly from use of or reliance on such information. 

Some statements may be forward-looking. Forward-looking statements and other views expressed herein are as of the date such information was originally posted. Actual future results or occurrences may differ significantly from those anticipated in any forward-looking statements, and there is no guarantee that any predictions will come to pass. The views expressed herein are subject to change at any time, due to numerous market and other factors. Areté disclaims any obligation to update publicly or revise any forward-looking statements or views expressed herein.

This information is neither an offer to sell nor a solicitation of any offer to buy any securities. Past performance is not a guarantee of future results. Areté is not responsible for any third-party content that may be accessed through this commentary.

This material may not be reproduced in whole or in part without the express written permission of Areté Asset Management.

Relative Value Report 7/31/2020

The Relative Value Report provides guidance on which sectors, factors, indexes, and bond classes are likely to outperform or underperform its appropriate benchmark.

Click on the Users Guide for details on the model’s relative value calculations as well as guidance on how to read the graphs. 

This report is just one of many tools that we use to assess our holdings and decide on potential trades. Just because this report may send a strong buy or sell signal, we may not take any action if it is not affirmed in the other research and models we use.

Commentary

  • Technology (XLK) is now the most relatively oversold sector. However, on an absolute basis XLK is close to fair value. We explain this divergence a little further down. Because of XLK’s relative weakness, we rotated slightly from industrials and transportation to the technology sector.
  • Staples, Utilities, Healthcare, Realestate, Financials, and Discretionary barely moved over the last five days.
  • Despite poor performance, energy is just slightly relatively oversold. We attribute this to its weak relative performance over the last 5 months. While it has a very low score (-9), the score is inline with prior low scores. In other words, on a standard deviation basis, the low score is well within the recent norm.
  • Conversely, XLK is decently oversold despite a score of near zero. Zero is not a bad score but it is well below its prior elevated scores.
  • QQQ and DIA are both oversold, attesting to relative strength in SPY. In the same vein, the bulk of the market outperformed the recent market leaders. These include small cap, mid cap, and even value. Note RSP, equally weighted S&P, is now one standard deviation overbought.
  • Bonds are dead. With record low volatility in bonds we should not expect to garner much value in this analysis.
  • Included below is a graph showing the Excess Performance of the Sectors and Markets/Factors versus SPY. Note that over the last 20 days, XLK ranked 19th out of 22 in relative performance. XLE has been the worst performer across almost all time frames.

Graphs (Click on the graphs to expand)

The ETFs used in the model are as follows:

  • Staples XLP
  • Utilities XLU
  • Health Care XLV
  • Real Estate XLRE
  • Materials XLB
  • Industrials XLI
  • Communications XLC
  • Banking XLF
  • Transportation XTN
  • Energy XLE
  • Discretionary XLY
  • S&P 500 SPY
  • Value IVE
  • Growth IVW
  • Small Cap SLY
  • Mid Cap MDY
  • Momentum MTUM
  • Equal Weighted S&P 500 RSP
  • NASDAQ QQQ
  • Dow Jones DIA
  • Emerg. Markets EEM
  • Foreign Markets EFA
  • IG Corp Bonds LQD
  • High Yield Bonds HYG
  • Long Tsy Bonds TLT
  • Med Term Tsy IEI
  • Mortgages MBB
  • Inflation TIP

TPA Analytics: Stick With Nasdaq To Avoid Sad Performance In 2020

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How To Avoid Sad Performance For The Rest Of 2020

For the past 4 months, TPA has been telling clients to stick with the winners. It has been a good strategy, riding the wave of those stocks that either benefit or are less harmed by Covid-19 and its ramifications. In this World Snapshot, we will get more granular.

Yesterday’s GDP number was horrendous, underscoring the profoundly difficulty of the current situation. The 70-year GDP chart below shows the worst GDP drop on record.

The dilemma: Opening the economy too fast means more sickness and death, but a careful, slow opening is historically painful. TPA continues to believe that this problem will take a long time to resolve and, therefore, the same conditions that led to winners and losers for most of the year will be with us for many more months. The smart and logical strategy has been and will continue to be to stick with the winners.

Stick With Nasdaq For Performance

The relative performance chart below of the Nasdaq 100 and the S&P500 shows that the right place to be has been the TECH-heavy NDX.  The NDX is up 22.70% YTD, while the S&P500 is up 0.48% YTD.

TPA clients should focus on the NDX 100 to find stocks to won. TPA ranked all stocks in the NDX 100 in the table at the bottom of this report. The average YTD performance for the top half of the NDX was 54.09%, while the average YTD performance for the bottom half of the NDX 100 was -6.04% (less than the S&P500).  The logical conclusion, in a world that must live with the pandemic for months to come, is to focus on the top ½ of the NDX 100.

Happy Stocks

The table below shows the prevalent sub-industries for the Happy stocks in the NDX 100 (top half) and the Sad stocks in the NDX 100 (the bottom half). Again, the Happy groups are where TPA clients should focus for their longs.

The stocks below are high conviction longs for TPA clients. These are stock that:

  • have already proven themselves in the Pandemic environment
  • either benefit from or are less harmed by the economic shutdown
  • are in a consistent, well-formed technical uptrend

Not only are these stocks proven 2020 winners, they are also less risky in the current environment.

#MacroView: Universal Basic Income Is Not An Economic Savior

According to a new study by the left-leaning Roosevelt Institute, a universal basic income could permanently make U.S. economy trillions of dollars larger. While such socialistic policies sound great in theory, history, and data, show it isn’t the economic savior it is touted to be.

What Is A Universal Basic Income (UBI)

To understand why the theory of universal basic incomes (UBI) is heavily flawed, we need to understand what UBI is.

Basic income, also called universal basic income (UBI), is a public governmental program for a periodic payment delivered to all citizens of a given population without a means test or work requirement. Basic income can be implemented nationally, regionally, or locally, and is an unconditional income sufficient to meet a person’s basic needs (i.e., at or above the poverty line).

The idea of guaranteed income is not a new thing. According to Wikipedia:

“The concept of a state-run basic income dates back to the early 16th century when Sir Thomas More’s “Utopia” depicted a society where every person receives a guaranteed income. 

In the late 18th century, English radical Thomas Spence, and American revolutionary Thomas Paine, declared their support for a welfare system that guaranteed an assured basic income. Nineteenth-century debate on basic income was limited, but during the early part of the 20th century, a basic income called a “state bonus” was widely discussed. 

In 1946, the United Kingdom implemented unconditional family allowances for every family’s second and subsequent children. In the 1960s and 1970s, the United States and Canada conducted several experiments with negative income taxation, a related welfare system. From the 1980s and onward, the debate in Europe took off more broadly, and since then, it has expanded to many countries around the world. “ 

While the idea of a UBI sounds good in theory, as discussed previously, they fail to work in reality. 

UBI Won’t Increase Economic Growth

“More money in people’s pockets will lead to stronger economic growth.” – J.M. Keynes

Such is the underlying sentiment behind a universal basic income and its impact on economic growth. Unfortunately, it simply isn’t true.

Let’s run a hypothetical example using GDP from 2007 to the present. (I am using estimates of -4.3% for 2020 GDP growth) In 2008, in response to the “Financial Crisis,” Congress passes a bill providing $1000/month ($12,000 annually) to 190 million families in the U.S. 

The chart below shows the economy’s annual GDP growth trend assuming the entire UBI program shows up in economic growth. For those supporting programs like UBI, it certainly appears as if GDP is permanently elevated to a higher level. 

When you look at the annual rate of change in economic growth, which is how we measure GDP for economic purposes, a different picture emerges. In 2008, when the $12,000 arrives at households, GDP spikes, printing a 17% growth rate versus the actual 1.81% rate.

However, beginning in 2009, the benefit disappears. The reason is that after UBI is injected into the system, the economy normalizes to the new level after the first year. Also, notice that GDP grows at a slightly slower rate as dollar changes to GDP at higher levels print a lower growth rate.

UBI’s Dark Side

Of course, the money to provide the $12,000 UBI benefit had to come from somewhere.

According to the Center On Budget & Policy Priorities, in 2019, roughly 75% of every tax dollar went to non-productive spending. 

“In the fiscal year 2019, the Federal Government spent $4.4 trillion, amounting to 21 percent of the nation’s gross domestic product (GDP). Of that $4.4 trillion, federal revenues financed only $3.5 trillion. The remaining $984 billion came from debt issuance. As the chart below shows, three major areas of spending make up most of the budget.”

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

Think about that for a minute. In 2019, 75% of all expenditures went to social welfare and interest on the debt. Those payments required $3.3 Trillion of the $3.5 Trillion (or 95%) of the total revenue collected.

That was BEFORE the shutdown of the economy due to COVID-19. Given the subsequent decline in economic activity occurring this year, those numbers become markedly worse. Given this bit of data, all universal basic income payments would have had to come solely from debt.

The table below shows the increase in total Federal Debt adjusting for the annual UBI payment. 

The chart below takes our hypothetical example and compares the impact of the additional debt on the Federal deficit from the implementation of UBI.

While the “theoretical models” assume that UBI will create enough economic growth and prosperity to “offset” the increase in debt, 40-years of history suggest otherwise.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

UBI Won’t Increase Economic Growth

As discussed previously, there is a high correlation between debts, deficits, and economic prosperity. 

“The relevance of debt growth versus economic growth is all too evident, as shown below. Since 1980, the overall increase in debt has surged to levels that currently usurp the entirety of economic growth. The growth in debt continues to divert more tax dollars away from productive investments into the service of debt and social welfare.”

, #MacroView: The Fed Can’t Fix What’s Broken

However, simply looking at Federal debt levels is misleading.

It is the total debt that weighs on the economy.

Under the current economic situation, it currently requires nearly $4.00 of debt to create $1 of economic growth. However, if you added UBI into the equation, it would require roughly $5 per $1 of growth. (Unfortunately, at the current spending rate, the U.S. will be approaching the $5 mark by the end of 2020)

If you don’t understand the implications of debt on economic growth, let me rephrase the analysis for you.

For instance, in the 30-years from 1952 to 1982, the economy ran at a surplus. That surplus fostered rising economic prosperity in the U.S. which averaged roughly 8%. 

Since 1980, the economic deficit has continued to erode economic prosperity. As shown, there has been no organic growth without increases in debt. Due to the need to increase debt to fund it, UBI would only succeed in exacerbating the situation.

, #MacroView: Is The “Debt Chasm” Too Big For The Fed To Fill?

The UBI Test Has Already Failed

The United States already has a semi-UBI plan. It is an effectively bankrupt system called “Social Security.” 

The collapse in economic growth has resulted in a collapse in Federal Tax revenue needed to pay for the massive social welfare schemes in the U.S.

Retirement, Retirement Confidence Declined Despite A Surging Market

It now requires more than of 100% of tax receipts just to meet the mandatory spending of social welfare and interest on the debt. In other words, we are now going into debt more just to provide social assistance.

How bad is it?

Social Security will be insolvent and unable to pay the full value of promised benefits by 2035. Social Security’s costs will exceed its income by 2020, according to a new report published Monday by the program’s trustees.

At the end of 2018, Social Security was providing income to about 67 million Americans. About 47 million of them were over age 65, and the majority of the rest were disabled. If nothing changes, the Social Security Trust Fund will be fully depleted by 2035. If such occurs, the program will impose across-the-board cuts of 20 percent to all beneficiaries.”

Getting Worse

That report, dire in its warning already, was issued before the “Pandemic” and “economic shutdown.”

Meanwhile, demographics are blowing up the basic premise of the funding of Social Security. There were 2.8 workers for every Social Security recipient in 2017. That’s down from 3.3 in 2007, and that’s way down from the 5.1 workers per beneficiary that existed in 1960.

Furthermore, the two programs function mostly as a giant conveyor belt to transfer wealth from the young and relatively poor to the old and relatively rich. Such allows the average person (who now lives to be 78) more than a decade of taxpayer-funded retirement.

Welfare now makes up the highest percentage of disposable personal incomes in history despite record low unemployment, rising wage growth, and the longest economic expansion in U.S. history.

Retirement, Retirement Confidence Declined Despite A Surging Market

During the “Great Depression,” the economically devastated masses would form “breadlines.” Today, those “breadlines” form at the mailbox. Without government largesse, many individuals would be living on the street.

The chart above shows all the government “welfare” programs and current levels to date. The black line represents the sum of the underlying sub-components. Since the onset of the “pandemic,”  both unemployment insurance and “other benefits” have surged by $3 trillion. Those increases are in excess of the continued increases in all other benefits, like social security, Medicaid, and Veterans’ benefits.

Importantly, for the average person, these social benefits are critical to their survival. Government assistance now makes up ~38% of real disposable personal incomes. With more than 1/3rd of incomes dependent on Federal assistance, it should not be surprising the economy continues to struggle. Recycled tax dollars used for consumptive purposes, has virtually no impact on increasing economic activity.

Conclusion

In its essential framework, a universal basic income sounds excellent. Everyone has their basic needs covered. Then they can go out and produce and not worry about covering critical bills. In reality, the additional income is quickly absorbed into the economy as prices rise (inflation) to compensate for the extra spending. After the first year, the UBI has to be increased or no longer has any benefit. 

Therein lies the trap with all socialistic programs.

While UBI, along with free healthcare, education, childcare, etc., sounds great, they are NOT productive investments that have a higher return than the carrying cost of the debt. In actuality, history suggests these welfare supports have a negative multiplier effect in the economy.

Most telling is the inability of the current economists, who maintain our monetary and fiscal policies, to realize the problem of trying to “cure a debt problem with more debt.”

The Keynesian view that “more money in people’s pockets” will drive up consumer spending, with a boost to GDP being the result, has been wrong. It hasn’t happened in 40 years.

We fear that these socialistic programs, which promises “free everything” with no consequences, instead delivers inflation, generates further income inequality, and ultimately higher social instability and populism. Such has been the result in every other country which has run such programs of unbridled debts and deficits.

While UBI sounds excellent at the conversational level, so does “communism” and “socialism.” In practice, the outcomes have been vastly different than the theory.

As Dr. Woody Brock aptly argues:

“It is truly ‘American Gridlock’ as the real crisis lies between the choices of ‘austerity’ and continued government ‘largesse.’ One choice leads to long-term economic prosperity for all; the other doesn’t.”

Take your pick. 

#WhatYouMissed On RIA This Week: 07-31-20

What You Missed On RIA This Week Ending 07-31-20

It’s been a long week, and you probably didn’t have time to dive into all the headlines that scrolled past you on RIA. Don’t worry, we’ve got you covered. Just in case you haven’t already, be sure to opt-in and to get our newsletter and technical updates.

Here is this week’s rundown of what you missed. A collection of our best thoughts on investing, retirement, markets, and your money.

Webinar: Retirement Right Lane

Got questions regarding your retirement strategy, social security, medicare, the markets, and how to achieve your financial dreams. This is the webinar for you. Everything you need to know to stay in the “Right Lane” for your retirement.

Join Us: Saturday, August 8th, from 9-11 am.

What You Missed This Week In Blogs

Each week, the entire team at RIA publishes the research and thoughts which drive the portfolio management strategy for our clients. The important focus are the risks which may negatively impact our client’s capital. If you missed our blogs last week, these are the risks we are focusing on now.

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What You Missed In Our Newsletter

Each week, our newsletter covers important topics, events, and how the market finished up the week. Our technical review provides the basis of how we are positioning our client portfolios, what we expect to happen, and how to trade it.

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What You Missed: RIA Pro On Investing

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free) If you are a DIY investor, this is the site for you. RIAPRO has all the tools, data, and analysis you need to build and manage your own money.

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The Best Of “The Real Investment Show”

Just in case, you didn’t tune in last week. That’s okay. Here are the best moments from the “Real Investment Show.” Every week, we cover the topics that mean the most to you from investing, to markets, and your money.

Best Clips Of The Week Ending 07-31-20

https://youtu.be/yB5-fzQeZos

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What You Missed: Video Of The Week

Interview With Dr. Don Rich

Dr. Don Rich, CIO of Esoterica Capital dig into the financial markets, valuations, the Fed and just about everything you need to know about investing in this market and the outlook for future returns. This is one of the best things you will listen to this weekend.

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What You Missed: Our Best Tweets

If you don’t follow us on Twitter, that is where we drop some quick market, investing, and financial thoughts. However, just in case you missed it, here are a few from this past week you may enjoy. Follow us on twitter @lanceroberts and @michaellebowitz.

See you next week!

Shedlock: 62-Million People Had No Pay Last Week

Over 62 million not-retired people had no pay last week.

Household Pulse Charts

For reference, I used the data from Household Pulse Surveys by the Census Bureau to create this series of charts.

This is week #12. The collection of the data ran between July 16, 2020 to July 21, 2020.

Here are some additional charts from the survey data.

No Pay 

Household Pulse Survey - No Pay Jul 21

Nearly 100 million people reported no pay in the reference week. Of those, 37,744,514 had retired. 

62.173 million people are not retired and received no pay. 4.293 million said they did not want to work. 

Those with no pay, but not retired, bottomed on June 23 at 55.780 million. 

Some people who are retired still want to work at least some hours. 

Number Employed

Household Pulse Survey - Number Employed  Jul 21

130.003 million people received pay in the reference week. The number of people employed peaked at 134.855 million for the survey ending June 16.

Did Not Work

Household Pulse Survey - Did Not Work  Jul 21

117.952 million people did not work in the reference week.

Those that are technically retired still want to work at least some hours. 

Expect Income Loss

Household Pulse Survey - Expect Income Loss Jul 21

87.333 million people expect an income loss in the next four weeks. Income loss is by household, not individually.

Clock Ran Out 

As noted on Sunday, the Clock Just Ran Out on $600 in Weekly Unemployment Benefits.

Roughly 130 million people are receiving some form of pandemic aid. 

Those with little or no pay will get hammered this week.

“So Far Apart on Covid Deal That We Don’t Really Care”

These are huge numbers, especially the 62 million who received no pay at all.

Nonetheless, Trump says “We are So Far Apart on a Covid Deal That We Don’t Really Care”

Will Consumers Bailout The Economy?

Will Consumers Bailout the Economy?

“Absent any policy and behavioral changes…most likely (will lead) to an overall GDP contraction for 2020 in the 8% to 12% range, assuming no second round of infections in improving states such as New York. Moreover, the recovery of lost output would not be completed in 2021. And the uncertainty surrounding these predictions would notably increase, with the balance of risk tilted to the downside.”

                                                Mohammed El-Erian, Allianz, Chief Economic Advisor, 6/30/20

The nation faces the worst economy since the Great Depression. The National Bureau of Economic Research – NBER has declared that a recession started last February.  Uncertainty is increasing as there are signals that the recovery is stagnating and the recession worsening not improving.

Over 35M workers are receiving unemployment assistance with 1 in 5 workers receiving government financial support.  Corporate debt to GDP is at the highest level on record.  The federal deficit is now at nearly the same ratio to GDP as the record federal deficit during WWII.  Analysts look to the consumer to ‘start spending again to jumpstart the recovery’ in the hopes of bailing out the economy. 

Will consumers bailout the economy?  As consumer spending is 70% of GDP, resumption of robust consumer buying is crucial to shift the economy back onto a growth track.  In this post we examine the status of the consumer, factors that are affecting spending and possible policy initiatives to ensure increased spending resumes.

We will offer an analysis of the following points to understand the likelihood of the consumer bouncing back and spending at pre-pandemic levels:

Psychological and Social Factors Affecting Consumer Behavior

  • Two Key Megatrends – Driving Consumer Spending
    • Health & Spending – virus driving fear
    • Financial Insecurity – fear throttles spending
  • Outlook for Consumer Spending – Stalled Today, Future Decline Likely
  • Initiatives for Long Term Recovery – shift from relief transfer payments to investing in: long term infrastructure and job creation, economic bridges to increase trade, new business economic centers, and sick leave and child care

Consumer buying is composed of many factors, yet the core factor is confidence based on security.  Let’s look at consumer psychology and how uncertainty is eroding confidence. Understanding the emotional and social factors buffeting consumers will inform our analysis of how their behavior has already changed and may change in the future.

Psychological and Social Factors Affecting Consumer Behavior 

The pandemic has shocked people, changing almost everything and everyone in their lives. Workers lost their jobs. Shops closed their doors. Schools were closed leaving children at home. Children at home has created a dilemma for essential worker parents who must decide either to go to work and find scarce child care or stay home and lose income. If parents had a job that allowed them to work remotely, they could work online and stay home with their children.  In a just a week or two, families had to learn how to live 24 hours a day at home, buy groceries, and manage children learning online while working at home. Most health services were suspended except emergency rooms and coronavirus treatment. Anxiety and stress increased for all workers but especially for first responders, healthcare workers, grocery clerks, gas station attendants, meat processing workers, and farm laborers. 

Large crowd social activities that could reduce stress like sports events, concerts, church meetings, movie shows, and parties were closed or prohibited.  Entertainment shifted into ‘at home’ versions of talk shows or variety shows.  Production stopped in mid-season for some television programs and movies. Subscriptions to streaming services were substituted but are not the same as in person events.

Many things have changed in our lives.  A continuous stream of out-of-the-ordinary things increase anxiety including: signs at stores telling us ‘to keep 6 ft apart and wear a mask’, wearing masks, store closures, shelves empty of basic paper goods and some meat products, lines of people in front of stores, social distancing Xs on sidewalks and in stores, plastic screens installed at counters, and roads being almost empty of cars and trucks. In addition areas where groups and crowds used to meet are closed for example: stadiums, movie theaters, churches, meeting rooms in bars and restaurants.

Added to these visual reminders are changes to social interactions such as:  not traveling to visit friends or family, not hugging, or no handshakes, Face Time calls or Zoom chats replaced in person visits.  Online multi-player games offered game enthusiasts 24 hour access to play day or night.

It is as if some tsunami of social change flooded our nation transforming every aspect of our life all at once. The social change from the virus pandemic has created deep psychological changes: for some, injuries and for others a loss of a family member or job. The psychological stress maybe similar to strains and losses of a generation during the Great Depression. The Great Depression changed attitudes, beliefs and values for decades afterward. The ‘greatest generation’ felt the need for increasing job security, having savings, working hard, and paying off debt.  Plus, they saw the need to help each other, work as a team and dig in with self-sacrifice to turnaround their lives. Unfortunately, many of these values are submerged in the divisive narrative of our present society.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

The pandemic is already changing how we interact, buying patterns, work attitudes, health and financial security.  It will take time for people to get over the shock, the visual reminders of the threat to their health and job loss creating financial insecurity. The uncertainty surrounding all these emotional and social forces will undermine consumer confidence until they are mitigated or removed.

There are two key megatrends triggered by the virus that are driving the changes in our society and spending patterns. We look at these trends next.

Megatrends

Health & Spending – Virus Driving Fear

The threat of virus infection is driving uncertainty and fear to new heights as new infections and deaths continue to accelerate while still in the first wave.  Yet, other countries like Germany and European Union members implemented national strategic containment programs which have successfully contained the infection’s first wave.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: EU Center for Disease Prevention and Control, Bloomberg – 7-20-20

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Johns Hopkins Center for Systems Science & Engineering – The Wall Street Journal – 7-20-20

Consider where the U.S. would be today if the virus was contained like the EU has done.  Schools would resume classes, businesses reopen, workers return to their offices. More importantly, consumers would have confidence to begin spending, not at pre-pandemic levels but buying more. Plus, increased consumer spending gives executives’ confidence to reopen and begin recalling staff. While the EU has still prohibited super spreader events like sports games, concerts and conferences, for the most part social life is returning to some semblance of normal. 

In the U.S. fear of becoming infected has transformed consumer behavior causing steep declines in retail location shopping, in-restaurant dining (in many areas is still closed) and travel in spite of reopening in many states.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Deep Macro, Veraset, US Census Bureau, The Wall Street Journal, The Daily Shot – 7/14/20

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Source: Statista – 7/20/20

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Source: TSA, Wolfstreet.com, The Wall Street Journal, The Daily Shot, 7/22/20

The lack of mobility means consumers are staying home due to fear about becoming infected, regardless of officials relaxing social distancing policies.

Consumer spending in some industry sectors has increased during the pandemic as fear of the virus created new demand.  Used car sales increased by 16% from May to June, though the sales level was still 20% below the same month last year, according to ALG Inc. Many of these vehicle purchases were likely made by drivers looking for private transportation as public transit use has dropped by 80% nationwide.  In a possible permanent shift in buying patterns most car purchases were made online, so dealerships had skeleton staffs. As families made plans for summer trips recreational vehicle sales have soared. Airstream sales increased by 11% in May compared to the same month last year with sales ‘going through the roof’ in June.  In the stay-at-home market Netflix increased subscriptions in the first quarter by 16.1M and in the second quarter by 6.8M. Yet, the company forecasts a flattening of sales to 2.5M for the third quarter as the market for streaming services becomes saturated. The pandemic lockdown forced people to buy groceries versus going out to dinner. Thus, location grocery sales increased by 20% during the first three months of the lockdown with online grocery sales spiked by 35%.

Online shopping for general merchandise soared by 18% in the first 6 months of this year. However, general retail sales including auto and fuel categories is expected to drop by 10.5% for all of 2020, reports eMarketer.  Home prices have increased in suburban markets as city dwellers leave the city permanently to get away from the densely populated cities where the virus was rampant. Also, some employers have allowed workers to permanently move out of the area and work from home. For example, San Francisco with the highest pre-pandemic rents in the country has experienced a 6.4% drop in rental prices from May to June as residents leave for the suburbs, or Sacramento where housing is 25 – 30% cheaper. In New York, the prices of homes in the Hamptons outside of New York City have soared to a 13 year high. Once resettlement has been completed for workers with income and wealth, we expect rental prices to fall. In the future we expect home prices to flatten or even decline as the number of qualified buyers dwindles. Many virus triggered consumer segments are likely to flatten or decline slowly as the virus comes under control.

Finally, a key consumer segment, Baby Boomers are uncomfortable with the economy.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Bloomberg, The Wall Street Journal, The Daily Shot – 7/10/20

Boomers provide 31% of all consumer spending, according to Visa.  Boomers are highly vulnerable to catching the corona virus and have a much higher mortality rate than other age groups. Most seniors are sheltering in place even in those areas that are reopening. Their reluctance to go out shopping, go to restaurants, take trips and just general sense of anxiety will cap spending until the virus is contained. 

Even with some increases in spending in a few sectors, overall consumer spending is down about 10% from pre-pandemic levels. The lack of a national containment program has led states to develop containment programs of their own. New York has announced a quarantine requirement for all travellers from 31 states in the U.S. as officials become concerned about travellers from states causing increased infections. The quarantine requirement will significantly reduce tourism revenue. A few other states are considering quarantine requirements as well further restricting mobility and income from visitors. As long as virus infections rates are out of control, consumer fears will grow and spending will be throttled.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Financial Insecurity – Fear Throttles Spending

Consumers in the bottom 80% in income were struggling financially prior to the pandemic hitting theircommunities. Most workers in this segment were borrowing at record levels to sustain their standing of living and a Federal Reserve study showed many do not have $400 in saving even to pay for an emergency.  The pandemic hit causing widespread layoffs and furloughs at rates not seen since the Great Depression. The Department of Labor reports that 36.4 million workers are on unemployment or have applied and are waiting for benefits.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Department of Labor, Economic Policy Institute, The Wall Street Journal, The Daily Shot – 7/17/20

The virus infection rate continues to drive initial unemployment claim increases in many hotspots including Texas, Arizona, Florida and California.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Department of Labor, Morgan Stanley, The Wall Street Journal, The Daily Shot – 7/14/20

Rising virus infection rates will continue to drive unemployment claims as more workers are laid off permanently due to declining sales or companies closing. For the week ending July 18, the Department of Labor reports an increase of 109,000 initial claims to 1.4M. This is the first increase since March.  This uptick in initial claims is another indication of increasing weakness in the labor market.

Consumers receiving unemployment insurance funds are anxious about whether their unemployment benefits will continue while they manage tight budgets. Making budgets tighter for households is the fact that states are slow in actually sending checks to unemployed workers.  Bloomberg reports that over $100 billion of approved checks have not been sent to claimants as of July 24th. When the pandemic hit in March state unemployment departments were under staffed, using old computer systems and experienced funding cuts. The states were not ready for millions of claims to be filed in just days.

Over 31M Americans are receiving unemployment benefits or 1 of every 5 workers.The unprecedented lack of employment prospects drives extreme worker anxiety and stress.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Department of Labor, Wolfstreet.com, The Wall Street Journal, The Daily Shot – 7-24-20

Recent employment reports show the effects of the reversal of reopening efforts. The Census Household Pulse Survey between mid-June through mid-July showed there was a drop of 6.7M jobs due to jobs losses becoming permanent and possible shifting to white collar workers. Analysts are now expecting an increase in the number of initial unemployment claims in the coming weeks. 

The status for many of 31M small businesses is fragile. A July survey by Alignable of 13,600 small businesses showed that without further aid 40% of business owners had only 30 days of cash left – even with Payroll Protection Program (PPP) funds and other pandemic loans. Confirming the small business predicament, a Goldman Sachs small business survey found 84% of business owners said they would not have enough money to keep paying staff after August 8th when the PPP loans end.  In addition, 15% of small businesses or 4.65M businesses have shut down their operations either temporarily or permanently. These business owners and their employees could become the next wave of unemployed if they don’t receive relief fast.

Based on health and financial security trends we have developed an outlook for consumer spending based on present programs and ideas for new relief funding being discussed in Congress.

Outlook for Consumer Spending – Stalled Today, Future Decline Likely

The Federal Reserve moved swiftly when the stock market hit a low in late March and has continued to flood the economy with 12 different business relief loan and credit programs totaling nearly $4 trillion including QE cash injections. The federal government provided relief funding to businesses and consumers including: on-time direct payments of $1,200, Payroll Protection Program funding to small businesses, and enhanced unemployment of additional $600 with coverage for contract workers and sick leave benefits all totaling $2.1 trillion. To monitor the results of this $6.1 trillion relief effort Oxford Economics has developed the following recovery tracker:

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Oxford Economics – et al, The Wall Street Journal, The Daily Shot – 7/247/20

The economy fell by 50% in all six categories from the January 31st baseline, and has come back about 25%. Though the tracker is still 25% below January’s level.  Of immediate concern, the Recovery Tracker shows three declines in the last five weeks. As we have noted recent indicators show a stall in consumer spending.

In the following chart, consumer spending bounced back from a dive of 35% and has begun to stall at minus 10%. The present 10% decline in spending below pre-pandemic levels is in line with the forecast we quoted in the introduction to this post by Mohammed El-Erian of a contraction of 8 – 12 % in GDP for 2020.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Source: Scotiabank, Opportunity Insights – 7/10/20

Consumer confidence levels track spending and shows how consumers have become a little more confident after March when the pandemic first hit. But recently, their economic concerns have grown. In the lower section of the chart, the magnitude of the drop is beyond the levels in the 2002 – 2003 recession.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: University of Michigan, Lehman Economics, Bloomberg – 7/21/20

The confidence decline illustrates the heightened level of fear we noted related to the psychological and social fears the pandemic has triggered.

Congress is now considering a range of relief programs from the House proposal of $3.1 trillion to a Senate initiative for $1.1 trillion.  The issue is that without effectively containing the virus these relief programs to keep consumers spending will likely fail to jumpstart a recovery. There are two fears: becoming sick and losing their job. The relief efforts will not in and of themselves overcome fear of virus driven job losses. Consumers and businesses will hoard cash until they feel the virus is contained and it is safe to resume normal activity. The emerging danger is that the lack of a strategic dedicated focus on virus containment will cause continued temporary spending which precludes the ability to invest in long term recovery initiatives.

Congress can help to alleviate the job loss issue with unemployment funding and related programs.  The Federal Reserve can keep businesses operating with relief loan and credit programs. Yet, building a thriving economy will require a five to ten year perspective by making innovative investments today to meet the economic challenges of tomorrow.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Initiatives for Long Term Recovery

The way to grow the economy is through investment leading to productive investment that supports wage growth. Wage growth will lead to increased consumer spending.  Investment will lead to building a solid foundation for a recovery.

Covid-19, COVID-19 Triggers Transformation into a New Economy – Part 2

Sources: Deutsche Bank – et al, The Wall Street Journal, The Daily Shot – 7/24/20

To spur wage growth here are a few investment ideas to build a solid foundation for recovery.

Shift From Relief To Investing

Relief programs only buy time to get the virus under control.  Relief programs will support workers, employment and consumer spending only on a temporary basis.  Companies and consumers are hoarding cash now due to the high level of uncertainty.  To break this cycle, both executives and consumers need to see that our policy makers are serious about investing with a long term perspective.  Initiatives like infrastructure spending have bipartisan support, but will need the political will to implement.  Funding job training on a national scale to match unemployed workers with new jobs in information services, renewables, automation software, and health services. We need to build on vision that brings all workers into the mainstream of the economy, benefiting from a capitalist system.

Safety Net To Support Workers

Returning workers to their jobs will be challenging as child care may not be available during the day when parents are working. For example, in California the University of California surveyed child care centers and found 25% were closed and many others were losing money due to caring for fewer children. Reopening restrictions on ‘same groups’ and social distancing force care centers to care for fewer children. As a nation we need to support child care businesses and non-profits as part of the critical infrastructure for a solid recovery. Sick leave has become a major issue during the pandemic where workers were forced to decide between working and taking sick leave even though they had virus symptoms.  We need our policy leaders to ensure that all worker have sick leave to make the right choice in a pandemic situation and stay home until they are not infectious.

New Business Innovation Infrastructure

Silicon Valley and other areas of the country have developed strong innovation ecosystems.  These ecosystems establish a comprehensive supportive environment for new businesses to start and thrive. We can adapt the model by the federal government providing seed funding for innovation centers throughout the country as a priority. Center development should be focused on economically hard hit Midwest and Southern rural communities and low income neighborhoods in our cities. These centers provide a nexus of training, university sponsorship and expertise, venture capitalists, local government and development of incubation centers to build new businesses.  Please see our post: COVID – 19 Triggers Transformation into a New Economy – Part 2 for more details on how this initiative could be implemented. The goal of these centers is to jumpstart economically depressed areas to create thousands of new businesses and employ millions of workers.

Build Trade Bridges

Over the past three years trade tensions, strident policies and tariffs have built a labyrinth of obstacles for executives to operate and build their markets overseas.  For S & P 100 companies 50-55% of their revenues and 60-75% of their profits come from offshore operations. World trade is forecast to decline by 10% or more over the next few years unless we make changes in our approach to international trade. That statistic is before any COVID related trade complications are accounted for. We need to rebuild our social and economic relationships again in a bipartisan manner that Democratic and Republican administrations have supported since WWII.  The goal was to build an international structure of cooperation, trade and shared social systems to manage an existing crisis or prevent a new crisis from erupting. We need to do our part as well with U.S. consumers providing 30% of worldwide consumption spending. By building economic bridges we ensure that nations have a vested interest in peace over war.  These multi-lateral relationships need to be built on partnerships that are equal and a win-win for both the U.S. and our overseas neighbors.  Our recovery will happen much faster by reopening international markets, and selling our products to their consumers.

We have the most diverse, innovative society on earth. Intelligent and innovative people from around the world want to be here to contribute and build a future that solves problems of our country and other countries.  To foster more growth we need to welcome immigrant innovators to our shores, particularly as our population ages.  The ratio of the number of workers to retirees is declining quickly, causing more dependency on government transfer payments. Instead, we need to boost the number of immigrant prime age workers in the labor force.

Our recovery initiatives must focus on Main Street. In a capitalist democracy Wall Street and Washington exist to serve all the people not a privileged few.  In this time of crisis, we are quickly discovering how inequitable our economic and social support systems are. Our capitalist democracy can do better.  Will consumers bailout the economy?  Yes .Consumers will begin buying again when they feel safe and feel financially secure. But, we need to pull together as a nation, focus on workers by investing in them, creating opportunities and ensuring a fair economic playing field for all.

___________________________________________________________________

Patrick Hill is the Editor of The Progressive Ensignhttps://theprogressiveensign.com/ writes from the heart of Silicon Valley, leveraging 20 years of experience as an executive at firms like HP, Genentech, Verigy, Informatica, and Okta to provide investment and economic insights. Twitter: @PatrickHill1677

4-Value/Dividend Stocks For An Uncertain Market

4-Value/Dividend Stocks For An Uncertain Market


This article was written for RIA PRO subscribers by Matthew (Cole) Robertson who is an analyst with RIA Advisors in Houston, Tx. 


MetLife, Inc. (MET)

MetLife, Inc. (MET), a provider of insurance and financial services based in New York is an intriguing stock yielding high dividends. The common stock currently generates an annual dividend of $1.84 (4.80%).

  • MET has ramped up dividends every year in the past five years by 20% ($0.38 in 2015 $0.48 in 2020)
  • MetLife has beat earnings estimates in the past two quarters of 2020 amidst the coronavirus pandemic
  • 30% revenue growth in the first two quarters in 2020
  • P/E ratio of 4.03 compared to competitor’s average of 9.87
  • Price-to-book value of 0.49
  • Positive outlook of with a diversified business model in insurance and financial services across the world including emerging markets

B&G Foods, Inc, (BGS)

B&G Foods, Inc, (BGS), is a frozen foods company based in Parsippany, New Jersey employing over 2,706 full-time employees. The company hosts brands such as Green Giant, Old London, and Ortega.

  • Currently maintains a 7.13% dividend yield
  • BGS has maintained a 5.7% average in the past five years
  • B&G projects to post revenue growth of 37.7% from Q2 2019 and a $0.64 earnings per share according to Zacks
  • Price-to-book value of 2.11
  • Profit margin of 5.11%

The food conglomerate outlook has upside due to uptick of household cooking by millennials and financial strain on individuals due to the coronavirus pandemic. B&G Foods continues to be a company that provides value to investors while keeping an upside for future growth.

AT&T Corp. (T)

The Dallas based telecom company of AT&T (T) has been a cornerstone dividend stock among investors. However, the giant’s current value should be appealing to both value and dividend investors alike.

  • AT&T has share price has rebounded ~10% compared to ~40% rebound for the rest of the S&P 500 since March lows
  • AT&T’s rebound lag provides investors with an opportunity for growth
  • 5G technology and an increase in subscription services will facilitate AT&T’s growth
  • ~25% decrease in stock price YTD
  • Maintains a dividend yield of 7.03% ($2.08 per share)
  • P/E ratio of 15.02
  • Price to book value of 1.19

Chevron Corporation (CVX)

Chevron Corporation (CVX), the oil and gas giant is the final stock in this list. CVX has enjoyed a sharp rebound compared since the crash in March 2020 compared to its competitors such as Exxon (XOM) and Occidental Petroleum (OXY). Chevron’s acquisition of Noble Energy and significant reserves in the Permian should allow for the giant to generate cash flow in the future. Chevron currently operates with a dividend of $5.16 (5.73%) and should be expected to increase dividends as oil prices continue to rebound from COVID-19 lows in addition to the following reasons:

  • CVX has raised its dividend for 32 straight years
  • Increased its dividend by 8.4% in February 2020
  • 49% return on assets
  • Profit margin of 2.86%
  • Chevron plans on cutting 33% of its workforce in 2020
  • 33% reduction on its capital expenditures
  • Increased its dividend by 8.4% in February