Monthly Archives: July 2016

Omicron Sell-Off, Is It Over Yet?

In this 12-03-21 issue of “Is the Omicron Sell-Off Over Yet?”

  • What’s Driving The Omicron Market Sell-Off
  • Did The Omicron Sell-Off Set Up The Santa Rally?
  • Internal Measures Suggest Risk Remains
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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What’s Really Driving The Omicron Market Sell-Off

While the media is running around trying to pin headlines on the market moves from the Fed to the Omicron variant, the reality is that we are in the midst of mutual fund distribution season. As Michael Lebowitz noted:

We believe the rotation is not a sudden change in mindset but, likely the actions of mutual funds rebalancing their portfolios. Frequently at year-end mutual funds sell the winners which have become overweight positions and buy the losers which are below their proper weights. The large returns this year in certain sectors are making these actions more visible than normal.

There is still some sloppiness likely over the next week, but such should theoretically provide investors the entry point for a “Santa Rally.”

Stock market December performance

But such should not be a surprise. In mid-November, we discussed the need to reduce risk against a potential correction. To wit:

Does this mean the market will experience a significant contraction? A pullback to the short-term moving averages would not be surprising and would encompass about a 3-4% drawdown.

What would cause such a correction? I don’t know. However, we are entering the mutual fund distribution season where fund managers need to distribution capital gains, dividends, and interest. Given that most funds are carrying very low cash levels, they will likely have to sell holdings to make those distributions.

Then, on the 23rd of November, we added:

Investors’ “wish lists” are hung by the chimney with care, hopeful the “Santa Claus rally” will soon be there. While they remain “snug in their beds, the historical data dances in the heads.”

It certainly seems there is little to worry about.

Except that dip at the beginning of December.

But is the Omicron sell-off over?

Omicron Sell-Off Tests 100-DMA

In the short term, selling pressure is starting to peak, and downside risk got reduced given the more extreme oversold conditions. As a result, volatility also spiked into excessive overbought levels, and the market held strong support at the 100-dma (orange line) on Friday.

S&P 500 market breadth resistance

We are using the more extreme oversold condition to add trading positions to our portfolio. The upside is likely limited to the bottom of the previous trend channel (blue dashed line) that began in 2020. However, we can take advantage of the rally back to those levels to bolster returns in portfolios.

Notably, any failure at that running lower trend line would be concerning. Such would suggest either a retest of current lows in January or, should that support fail, a very different market in 2022.

As noted above, while the media is frantic to pin sell-off on the “Omicron variant,” it is all quite normal within the context of historical trends. Lastly, another of our technical indicators, the McClellan Oscillator, confirms our analysis of a deeply oversold market.

S&P 500 stock market vs oscillator

Please note that I am consistently speaking of “short-term” opportunities.

While the current decline could strengthen back into a longer-term trend, we treat each increase in equity exposure as a trade until proven otherwise.

One mistake individuals make is trying to “buy the dip” and not respecting the potential for much more significant downside “dipping.”

Always maintain your stop-loss levels.


Daily Market Commnetary

No Guarantees

The current “Omicron sell-off” in the markets, combined with distributions, will leave portfolios “offsides” heading into year-end. As a result, portfolio managers will begin to “window dress” portfolios for year-end reporting around mid-month. As shown in the seasonal chart above, that “buying” is what typically pushes markets higher.

Such was a point I discussed with Charles Payne on Fox Business yesterday.

Is a “Santa Claus” rally guaranteed? Absolutely not.

However, as noted, my Mom said I was a “good boy” this year, so I am hopeful I will get more than a “lump of coal” in my stocking.

Besides, I am not sure Santa Claus can afford coal this year anyway.

Coal Prices

While I am optimistic as we head into year-end, I would be remiss not to point out the obvious risks.

Internal Measures Suggests Risk Remains Present

Over the last few weeks, we have discussed the continuing deterioration of market internals from breadth to volume to expanding new lows. At the same time, while market internals weakened, broad markets continued to rise. As shown, stocks trading above their 50- and 200-dma and the bullish percent index turned down in mid-November. Such suggested the market was at risk of a correction; all that was needed was an event to shift psychology.

That’s how you get the “Omicron sell-off.”

S&P 500 market technical breadth and participation

However, as Sentiment Trader pointed out this week, other internal measures suggest that investors may see lower returns near term. To wit:

“New lows are one of the most critical breadth measures to monitor in a bull market, especially long-duration ones. When they expand to current levels with the market near a high, something is amiss with market participation. The shot across the bow is a warning that we should be alert to rising risks. As always, it’s essential to use a weight-of-the-evidence approach and not rely upon any single indicator.

The previous risk-off signal from October 2018 led to a substantial decline for the S&P 500.”

S&P 500 vs Lows

As they conclude:

“When new lows expand and the market is near a high, something is amiss with market participation, suggesting rising risks. Similar setups to what we’re seeing now have preceded weak returns and win rates on a short and medium-term basis.”

While the market is now very oversold, volume remains relatively weak along with money flows. Such suggests there is a risk of more selling pressure following any short-term bounce. So, as is always the case, be sure to manage your risk exposures accordingly.

There will be a time to become considerably more aggressive, but we need improvement to the underlying technicals first.



Will FANG Wind Up Like BRIC?

My colleague Albert Edwards had an excellent piece out this week answering a question I have had.

“It is the 20th anniversary of the invention of the BRIC acronym. BRICs, for those who need reminding, was dreamt up by the then Chief Economist at Goldman Sachs, Jim (now Lord) O’Neil, who predicted that the emerging economies of Brazil, Russia, India and China would enjoy superior economic growth and investment returns relative to the developed economies. A few days ago Jim O’Neil marked this anniversary with an update in the Financial Times.”

Coincidently it is also exactly the 10th anniversary of my note that ridiculed ‘BRICs’ as an investment idea entitled ‘BRIC = Bloody Ridiculous Investment Concept’ – A. Edwards

We should not overlook the importance of his commentary. In 1999, the “dot.com” bubble was in full swing, and valuations ran at nearly 42x trailing earnings on a CAPE ratio basis. Today, the top-10 stocks of the S&P 500 comprise almost 30% of the entire market capitalization of the index. With valuations once again approaching the dot.com levels of exuberance. (Valuations are just the reflection of investor psychology.)

S&P 500 valuations vs stock market

In Case You Missed It


The Next Crash

As Michael Lebowitz noted in “Is A 2000 Market Crash Possible?”

“P/E valuations are grossly extended, and in both calculations nearing or surpassing levels in 1999. The graph also show valuations are well above those of 1929.”  

The point here is that valuations matter. The growth expectations for the FANG stocks far exceed any conceivable realistic outcome. As Allbert concludes:

“Investors are desperate to believe the EM and BRIC growth story, for they have so little alternative. The story of superior growth for the EM universe is as entirely plausible as it is entirely misleading. Valuation is what matters for investing in EM, not their superior growth story and certainly, EM equities are not relatively cheap. Yet investors persist in the BRIC superior growth fantasy. But it is no different from many of the other investment fantasies I have witnessed over the last 25 years only to see them end in severe disappointment.” BRICs have indeed been terrible investments over the past decade, underperforming both MSCI World and even the EAFE index by a very wide margin.

Put a date in your diary to look out for my Global Strategy Weekly on 2 Dec 2031. For I have a similar feeling that in a decade’s time FAANGs (and US tech generally) will go the way of the BRICs as another example of acronym investing going horribly wrong. Indeed, only recently I noted that despite US IT’s EPS relative now declining sharply, its nosebleed PE valuation at 30x looks vulnerable vs the market’s 22x – the widest gap since the Nasdaq bubble.”

FANG stocks

Valuations always matter, and they matter a lot. The problem is that investors don’t learn this lesson until it is often far too late to matter.



Portfolio Update

Over the last couple of weeks, we stated that after raising cash and reducing hedges, we were “sitting tight” as we got through the Thanksgiving holidays. We worried about a correction during the first couple of weeks of December as mutual fund redemptions took hold. That sell-off came as Omicron headlines sparked the algorithms into sell mode. Now, much of the overbought and extended conditions in the market are reversed.

With that correction, we are now starting to slowly increase our equity risk exposure as we head into year-end. Given the statistical probability of a year-end “Santa Rally,” we want to position portfolios for that potential opportunity.

However, we are maintaining very tight stop-losses on all of our trading positions, as there is NO GUARANTEE that the market will rally into year-end. As with any good “poker player,” we are “playing the odds.”

We added a trading position in the S&P 500 index on Thursday morning and late Friday afternoon. We also nibbled on some energy exposures after the correction in oil prices. Over the next few days, we will opportunistically add exposure to our Technology, Finance, and Healthcare sectors. We are also monitoring Communications and Discretionary for opportunities as well. The goal will be to increase our equity weighting to 60-70% in our 60/40 allocation models. (Yes, we can overweight and underweight equity risk.)

Portfolio model allocation

Lastly, no matter what you decide to do, do it safely. Chasing markets is fine until something goes wrong. So, have stop levels in place, manage your risk exposure relative to your financial objectives, and take unnecessary risk.

There are still plenty of things that can go wrong by year-end. So, don’t screw up an excellent year by making a stupid mistake this close to the end.

See you next week.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

S&P 500 Market Analysis Tear Sheet

Performance Analysis

S&P 500 Market Sector Relative Performance

Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 58.19 out of a possible 100.

Sp500 composite technical gauge.

Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90. The current reading is 66.29 out of a possible 100.

S&P 500 market fear/greed index

Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Sp500 Growth Screen

Low P/B, High-Value Score, High Dividend Screen

Screen Dividend Growth stocks

Fundamental Growth Screen

Screen Fundamental Growth Stocks

Aggressive Growth Strategy

Screen aggressive growth strategy stocks

Portfolio / Client Update

Over the last couple of weeks, we stated that after raising cash and reducing hedges, we were “sitting tight” as we got through the Thanksgiving holidays. We were worried about a correction during the first couple of weeks of December, as mutual fund redemptions took hold. That correction came, as noted above, and corrected much of the overbought and extended conditions in the market.

With that correction, we are now starting to slowly increase our equity risk exposure as we head into year-end. Given the statistical probability of a year-end “Santa Rally,” we want to position portfolios for that potential opportunity.

However, we are maintaining very tight stop-losses on all of our trading positions, as there is NO GUARANTEE that the market will rally into year-end. As with any good “poker player,” we are “playing the odds.”

We added a trading position in the S&P 500 index, as noted below. We also nibbled on some energy exposures after the correction in oil prices. Over the next few days, we will opportunistically add exposure to our Technology, Finance, and Healthcare sectors. We are also monitoring Communications and Discretionary for opportunities as well. The goal will be to increase our equity weighting tactically into year-end.

Portfolio allocation model

We are looking forward to wrapping up a good market year. However, we are not resting on our laurels either. We are very aware of the risk and continue monitoring and managing it accordingly. So make sure and let us know if you have any questions or concerns.

Portfolio Changes

We post all of our trading details as they occur at RIAPRO.NET

We added 2% of SPY to the sector and equity models late this afternoon. We are taking advantage of today’s sell-off to add to our position. The market is holding support at the 100-dma and is deeply oversold. We suspect we will see a tradeable rally into next week.” – 12-03-21

  • Add 2% of the portfolio in SPY to the current holdings. (Position size increases to 4%)

“Over the last couple of weeks, we discussed the potential for some corrective action in the first two weeks of December as mutual funds distribute their annual gains. That selling came a bit sooner than expected, but our previous reduction in equity exposure and hedging reduced our overall volatility. With the deeply oversold condition now present, and the seasonal tendency for a year-end rally, we are now starting to increase our risk exposure accordingly.

We are nibbling at some beaten-up oil stocks, adding a broad market trading position, and continuing to clean up laggards. Over the next week or so, we will look to increase allocations in Healthcare, Technology, Energy, and Financials primarily. Although we will pick up opportunities wherever we find them.” – 12-02-21

Equity Model

  • Sell 100% of Johnson and Johnson (JNJ)
  • Increase XOM to target a weight of 2% of the portfolio.
  • Initiate a 1% position in MRO (Marathon Petroleum)
  • Add a 2% trading position in SPY in the portfolio.

ETF Model

  • Add 1% to XLE bringing the total position weight to 3% of the portfolio.
  • Add a 2% trading position in SPY in the portfolio.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Portfolio Trade Alert – 12-03-21

Portfolio Trade Alert For 12-03-21

Both Equity And ETF Models

We added 2% of SPY to the sector and equity models late this afternoon. We are taking advantage of today’s sell-off to add to our position. The market is holding support at the 100-dma and is deeply oversold. We suspect we will see a tradeable rally into next week.

  • Add 2% of the portfolio in SPY to the current holdings. (Position size increases to 4%)

Daily Market Commnetary

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Technical Value Scorecard Report – Week Ending 12/3/21

Relative Value Graphs

  • Despite what seemed like a bad week for the market, the S&P 500 is only down .35% since last week’s report. The winners are from the traditional safe-haven sectors such as utilities and real estate. Energy and technology also outperformed. The price of crude oil was down 4% this past week and over 20% since mid-November. Despite the weakness in crude prices, energy stocks are holding up well. The sector beat the S&P 500 by .34% this week and by 4% over the last two weeks. Likewise, technology beat the S&P by 1.50% this week, as it continues to be the sector investors flock to when markets are volatile.
  • The standout on the relative charts is the incredibly oversold condition of the communications sector. Its score is -12.41 out of a possible -13.5. It is the lowest sector relative score we have seen since we started this report. Facebook accounts for almost a quarter of the ETFs (XLC) holdings. Over the last week, it is down 7.5%, single handily contributing 1.5% of underperformance versus the S&P 500. Also hurting the sector is NFLX which is down almost 9.0% on the week. It contributes about 5% to the ETF. Google, like FB, accounts for about a quarter of the ETF and was down 1% for the week.
  • In general, the market is leaning back toward a deflationary stance with transports, industrials, financials, and materials all oversold. The flattening yield curve affirms a deflationary market stance. To that point, TLT is very overbought, with a score nearing 75%. Conversely, TIP is approaching a score of -75%.
  • The NASDAQ remains the only overbought index/factor and developed markets the most oversold. With a score of -85%, developed markets are grossly oversold versus the S&P 500 and may also be due for a bounce.

Absolute Value Graphs

  • On Thursday, following Wednesday’s sharp reversal from 2% gains to 1% losses, the S&P 500 was slightly oversold for only the second time this year. It quickly rebounded on Thursday back to overbought territory.
  • The communications sector is weak on an absolute basis, but its -46% score is not nearly as bad as its relative score. If the absolute score were a little lower, we would be more enthused about trying to buy the sector.
  • The absolute scores for all sectors and factor/indexes fell on the week despite a slight decline in the market.
  • Long bonds (TLT) are also overbought on an absolute basis, with a score nearing 75%. This week, the credit sectors, LQD, MBB, and HYG, have higher scores but are clearly underperforming TLT. This situation highlights credit spreads are widening.
  • Developed markets (EFA) which are grossly oversold versus the S&P 500, are only slightly oversold on an absolute basis.
  • The third table shows communications are trading at nearly three standard deviations below its 50dma, arguing for a rebound in its price. All sectors and factors/indexes are trading below their 20dma’s. Communications, small Cap stocks, developed markets, and emerging markets are all trading below their respective 20, 50, and 200 dmas.

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60, the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs,” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

Oil Prices Plummet Then Rally In A Bullish Sign

Oil prices plummeted 5% yesterday morning as OPEC went ahead with a planned output hike of 400k barrels for January. The news disappointed traders expecting OPEC might curtail the increase to 200k barrels. Oil prices quickly came storming back. OPEC helped their cause, saying they may revisit output reductions at its January 4th meeting. Oil prices remain 25% below early November highs, but the hammer candlestick circled below signals a bottom could be in place.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Change in non-farm payrollsNovember (550,000 expected, 531,000 in October)
  • 8:30 a.m. ET: Unemployment rateNovember (4.5% expected, 4.6% in October)
  • 8:30 a.m. ET: Average Hourly Earnings, month-over-month, November (0.4% expected, 0.4% in October)
  • 8:30 a.m. ET: Average Hourly Earnings, year-over-year, November (5.0% expected, 4.9% in October)
  • 9:45 a.m. ET: Markit U.S. Services PMI, November final (57.0 in prior print)
  • 9:45 a.m. ET: Markit U.S. Composite PMI, November final (56.5 in prior print)
  • 10:00 a.m. ET: ISM Services Index, November (65.0 expected, 66.7 in October)
  • 10:00 a.m. ET: Factory Orders, October (0.5% expected, 0.2% in September)
  • 10:00 a.m. ET: Durable Goods Orders, October final (-0.5% in prior print)

Earnings

  • No notable reports scheduled for release

Market Breadth & Resistance

Yesterday, the market rallied sharply off of the 50-dma which was a good sign. However, it was on lighter volume and the negative internals continue to remain exceptionally weak. Furthermore, while we are certainly encouraged by the rally, for now, it remains confined by the downtrend channel.

SP500 market breadth resistance technicals

A breakout above the top of that channel, with an improvement in breadth and participation, would be an encouraging sign to get more aggressively exposed. While we did start building trading positions in portfolios yesterday morning, we are remaining very cautious until we see some improvement.

Do you Feel Lucky?

The tweet and graph below show the bullish percent index on the S&P 500 has dipped below 50%. The last six times that occurred proved to be a good buying opportunity. However, as shown, the first dip below 50% on the graph was a false signal. Do you feel lucky? The index is a measure of breadth that simply counts the percentage of stocks with a point & figure buy signal.

S&P 500 bull

Is There More Selling To Be Done?

S&P 500

Is TLT Ready to Run?

In yesterday’s commentary, we note that heavy short interest in Treasury note futures could propel bond prices higher (yields lower) if those with shorts are forced to cover their positions. The graph below provides a little technical context for what might cause them to do so. As shown, the price of TLT (20 year UST ETF) has bumped up against $152 numerous times since July. Each time it was repelled but to increasingly higher lows. If bonds can break through the current wedge pattern, the 2020 highs may be in sight. Many technical traders who are short bonds are likely to watch how this plays out closely.

TLT bonds

Another $1 Trillion In Equity Demand

And it will all come from the rising beta of hedge funds equity portfolios. JPM Flows & Liquidity:

“We come up with Equity Demand/Supply improvement of around $1.1tr in 2022 relative to 2021. This is similar to the equivalent Demand/Supply improvement this year relative to 2020, when global equities proxied by the MSCI World index have risen by around 15% even after the recent correction”.

Courtesy of @TheMarketEar

Will Inflation Heat Up More?

While many are focused on oil prices, the graph below shows the inverse correlation between rental vacancy rates and owners’ equivalent rent. Not surprisingly, a lower vacancy rental rate results in higher rental prices. With the Fed seemingly getting more serious about inflation, rental prices and owners’ equivalent rent (OER), which account for nearly a third of CPI, become critical data points to follow more closely.

Rental vacancy rates are back to 30+ year lows, pushing rents higher. Adding to the pressure on rents and ultimately CPI is surging home prices. The second graph, courtesy of Fannie Mae, shows their model based on home prices predicts a big jump in OER in 2022. Per the article: “On a year-over-year basis, house price gains historically lead to changes in the CPI shelter cost measures by about 5 quarters.” Home prices started spiking in September of 2020, about 5 quarters ago. If CPI continues higher, the Fed is more apt to remove liquidity quicker. As discussed in Is a Stock Market Crash Like 2000 Possible, liquidity via QE and zero rates are the lifeline of excessive stock valuations.

rental vacancies rents
CPI OER

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Five Stocks to Buy if Santa Comes to Town

Five Stocks for Friday

Five Stocks for Friday uses stock screens to give readers five stocks that we expect to outperform if a particular investment theme plays out in the future. Investment themes may be relevant to the current or expected market, industry and/or economic trends. Investment themes may not always represent our current forecast.  

Risk On Santa Rally

Our inaugural screen seeks companies that may benefit from a Santa Claus rally that pushes markets to new highs at year-end. This screen is largely based on factors that have worked well throughout this year.

Our article “Santa Claus is Coming But Will Markets Correct First?” makes the case that positive seasonality in the last few weeks of December is strong. 

To wit:

Investors’ “wish lists” are hung by the chimney with care, hopeful the “Santa Claus rally” will soon be there. While they remain “snug in their beds, the historical data dances in the heads.” The chart below from @themarketear shows the annual “seasonality” from 1985 through 2019.

S&P 500 seasonality rally

Screening Criteria

We use the following screens and criteria to find the five stocks likely to outperform if Santa Clause comes to town:

  • S&P 500 companies
  • Market Cap >$50 billion
  • Sector = Basic Materials, Consumer Discretionary, Energy, Industrials, and Technology
  • 5-year EPS growth forecast >15%
  • YTD performance > 50% (more than 2x the S&P 500)
  • Beta >1.25
  • Price is above its 50-day and 200-day moving averages

We only looked at large-cap companies in sectors that have generally benefited the most from risk-on rallies in 2021.  While the screen primarily uses price and performance, we chose to add high expected growth rates. This year, expectations for above-average growth rates have fueled narratives that feed price appreciation.

Below is a table comparing key fundamental and technical factors of the five companies that best met our criteria. Beneath the table is a summary of each company.

EOG LOW AMD NVDA TSLA

Company Summaries (all descriptions courtesy Zacks)

EOG

EOG Resources (EOG)- Energy Sector- EOG Resources Inc. is primarily involved in exploring and producing oil and natural gas. The leading upstream energy player’s operations are spread across the United States, China, and Trinidad.

EOG is up 85% this year, tripling the return on the S&P 500 and handily beating XLE, the energy sector ETF. EOG is just turning up on a buy signal using our cash flow model, although its MACD signals more downside is possible. EOG’s stock price is sensitive to oil prices and, therefore, political, and Covid-related headlines that may affect them. While we are not seeking value companies in this screen, it’s worth noting EOG has a relatively low P/E ratio of 16.9.

LOW

Lowes Companies (LOW)- Discretionary Retail – LOW is one of the world’s leading home improvement retailers, offering services to homeowners, renters, and commercial business customers.

LOW is up 400% from its lows in March 2020, including a 65% increase this year. In just the last month, the stock has been on a tear, up 25%. While the stock is trading well, its price is extended, sitting at two Bollinger bands above its 20-day moving average. The P/E ratio is slightly below the market P/E at 21.6.

AMD

Advanced Micro Devices (AMD) Technology – The company has strengthened its position in the semiconductor market on the back of its evolution as an enterprise-focus company from a pure-bred consumer-PC chip provider. AMD has emerged as a strong challenger to NVIDIA’s dominance in the graphic processing unit or GPU market based on its Radeon technology.

AMD is up 160% this year, almost half of which has come since October. The stock and the semiconductor sector are recent investor favorites due to chip shortages and strong chip demand for new technology. The stock price is trading 25% above its 50-day moving average.

NVDA

NVIDIA (NVDA) NVIDIA Corporation is the worldwide leader in visual computing technologies and the inventor of the graphic processing unit, or GPU. Over the years, the company’s focus has evolved from PC graphics to artificial intelligence (AI) based solutions that now support high-performance computing (HPC), gaming, and virtual reality (VR) platforms.

Like AMD and other semiconductor companies, NVDA’s stock is on fire. It is up 150% year to date, with a good chunk of the gains coming since October. Our short-term cash flow model indicates NVDA is turning to a buy signal, but the MACD remains on a sell signal.

TSLA

Tesla (TSLA) -Discretionary/Technology – Tesla is the market leader in battery-powered electric car sales in the United States, owning around 60% of the market share. The company’s flagship Model 3 accounts for about half of the U.S. EV market.

TSLA is a market favorite this year. Its stock price is up 65% year to date, all of which has come since September. The shares are up a whopping ten-fold since the covid crisis lows of 2020. TSLA’s price has consolidated over the last month on the heels of Elon Musk stock sales, potentially setting the stage for another surge higher.

Summary

This screen presents five stocks that are high reward bets in the event of a year-end end rally. One factor to consider with these stocks is they all have tremendous gains for the year. As such, mutual funds may have to sell some shares in them in early December to rebalance. However, the significant gains this year make it a little less likely investors will sell, preferring to push tax gains to next year. This confluence of these events makes timing a purchase of these stocks critical. Further, the prices of the five stocks are extended, making them vulnerable for a steep decline on bad news and or a market decline.

“While we are certainly anxiously anticipating the arrival of the “Santa Claus Rally,” we are also must remember the lesson taught to us in 2018.

Nothing is guaranteed.” –Santa Claus Rally is Coming but will Markets Correct First? 11/23/2021

We currently own AMD and NVDA in the Equity model but have recently trimmed our holdings to lock in profits.

Disclosure

This report is not a recommendation to buy or sell the named securities. The report’s intention is to elicit reader ideas about stocks meeting specific criteria and investment themes. Please read our disclosures carefully and do your own research before investing.

Inflation vs. Deflation – Which Is The Bigger Threat In 2022?

Inflation vs. deflation – while headlines get filled with “inflation” concerns, historical data shows “deflation” remains a threat.

The Financial Times recently had a great piece on Central Bankers and their stance that inflationary pressures remain transient. However, as FT concluded:

“For the first time in many decades, there is the possibility that a significant turning point has arrived, that price rises will be more than a flash in the pan and something more difficult to control.”

It is interesting to hear statements such as the above because inflation has been rising steadily since 1974. The chart below shows the long-term history of inflation going back to 1774.

What the chart shows is that in 1954 the trajectory of inflation changed. However, the annual rate of change indicates the long-term deflationary trend.

Notably, before 1920 the economy was primarily agriculturally based with a dramatically smaller population. Such gave rise to more variability in economic growth. However, the shift to manufacturing and industrialization minimized the big deflationary swings before WWII.

Unfortunately, beginning in 1980, the economy made a shift to financialization and services. While service jobs have a low multiplier effect economically, economic financialization led to a debt explosion. As a result, the combination of debt and lower economic output remains a consistent deflationary pressure.

The Inflation vs. Deflation Conundrum

Currently, the mainstream consensus has latched on the sharp increase in the money supply because a permanent shift to higher inflation is coming. Such was a point we discussed in “Is Hyperinflation A Threat?”

“The measure of money in the system, known as M2, is skyrocketing, which certainly supports that concern. Now, with the Biden administration adding another $1.9 trillion into the economy, those concerns have risen.”

Furthermore, in a previous Bloomberg interview, Larry Summers stated:

“There is a chance that macroeconomic stimulus on a scale closer to World War II levels will set off inflationary pressures of a kind not seen in a generation. I worry that containing an inflationary outbreak without triggering a recession could be even more difficult now than in the past.”

The chart below suggests those points are correct. Given it takes about 9-months for increases in money supply to hit the economy, we see the inflationary spike.

Inflation vs M2 money supply

The sharp decline in money supply suggests deflationary impulses in the economy will become visible around the middle of 2022. Which is roughly when the Federal Reserve plans to hike interest rates. This is significant in the debate of inflation vs. deflation.

However, there are still significant headwinds to inflation over the next decade outside of money supply changes.

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

The 3-D’s

Here are the 3-D’s of inflation vs. deflation. Over the coming decades, three primary factors are supporting deflationary pressures.

  • Debt
  • Demographics 
  • Deflation

These issues are not new. But have been plaguing economic growth for the last 40-years. Given the baby-boomer generation has reached retirement age, they will leave the workforce at an increasing rate, drawing on their accumulated financial assets. As a result, the debts and deficits rose to levels that detracted from economic growth rather than contributed to it.

As shown, the surge in debt and deficits coincides with a peak in the 10-year average economic growth rate.

Debt, Deficits, and GDP

The decline in economic prosperity keeps a deflationary pressure on the economy as the government expands its deficit spending to sustain the demands on the welfare system.

Deficits, GDP and Inflation

The negative impact on the economy is clear. There is a significant negative correlation between the size of the government and economic growth. Rather, debt is the problem, not the solution.

Excessive indebtedness acts as a tax on future growth and it is also consistent with Hyman Minsky’s concept of “Ponzi finance,” which is that the size and type of debt being added cannot generate a cash flow to repay principal and interest. While the debt has not resulted in the sustained instability in financial markets envisioned by Minsky, the slow reduction in economic growth and the standard of living is more insidious.” – Dr. Lacy Hunt

The most direct evidence of the decline of economic prosperity is the rise in social welfare as a percentage of disposable incomes. Recycling tax dollars is a zero-sum game and increases the deflationary pressures on the economy from debt required to fund it.

Social Benefits to citizens

Trump's COVID Market Bounce, Trump’s COVID Infects The Market Bounce. Is It Over? 10-02-20

Debt-Driven Deflation Will Cap Inflation

Furthermore, a recent report from the Mercatus Center at George Mason University studied the effective “multiplier” of government spending.

“The evidence suggests government purchases reduces the size of the private sector and increases the size of the government sector. On net, incomes grow, but privately produced incomes shrink.

There are no realistic scenarios where the short-term benefit of stimulus is so large that government spending pays for itself. In fact, even when government spending crowds in some private-sector activity, the positive impact is small. It is likely much smaller than economic textbooks suggest.” 

With households dependent on governmental assistance, the deflationary “psychology” is difficult 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 such 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.”

Consider the role of wages in the inflation vs. deflation question. When wages fail to keep up with inflation, consumption will contract, contributing to the deflationary bias.

Wages vs Inflation

For the last four decades, when the Fed took action to achieve their goal of “full employment and stable prices,” it led to an economic slowdown, or worse. The relevance of debt versus economic growth is all too evident, requiring an ever-increasing amount of debt to generate $1 of economic growth.

Debt vs GDP Inflation Adjusted

In other words, without debt, there is little to no, organic economic growth.

Don’t Forget The Demographics

The most considerable deflationary pressure will come from the changing demographics. As baby boomers retire and leave the productive workforce, they will cut back on spending and withdraw assets from the financial markets.

Most Central Banks are increasingly convinced high inflation rates might not be so transient after allSuch is why the tightening cycle has now begun. Secular demographics will reach maximum deflationary pressures in the decade ahead.

Such is in stark contrast to the 1970s when demographic trends underpinned the then inflationary surge.

But amid the current inflation panic, Eric Basmajian of @EPBResearch reminds us that the demographic headwinds facing the major economies are intensifying (especially with people dropping out of the workforce).

In the long-term, demographics will be a big shock to Central Banks hopes of higher inflation rates.” – Albert Edwards

Demographics vs inflation

“Demography is destiny.” – Auguste Comte

Economic, 20/20 Economic Projections Will Leave Everyone Disappointed

The Fed’s Liquidity Trap Is Deflationary

“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. Every aspect of a liquidity-trap is in place:

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

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

Monetary Velocity vs the Inflation of the money supply

While many today continue to compare the economic environment to the 1970’s inflationary spike, the impact of demographics and debt are vastly different.

The issue of inflation vs. deflation is likely to continue next year. Will the economy experience a short-term inflationary spike as the stimulus runs through the system? Of course. However, once the “Sugar Rush” wears off, the deflationary pressures will quickly reassert themselves.

The problem for the Fed is they may well make another policy mistake as they hike interest rates at precisely the wrong time. The 3-D’s continue to suggest that inflation will give way to deflation, economic strength will weaken, and over-zealous investors will once again get left holding the bag.

Portfolio Trade Alert – 12-02-21

Portfolio Trade Alert For 12-02-21 – UPDATED

Actions Taken In Both Equity & ETF Models

Over the last couple of weeks, we discussed the potential for some corrective action in the first two weeks of December as mutual funds distribute their annual gains. That selling came a bit sooner than expected, but our previous reduction in equity exposure and hedging reduced our overall volatility. With the deeply oversold condition now present, and the seasonal tendency for a year-end rally, we are now starting to increase our risk exposure accordingly.

We are nibbling at some beaten-up oil stocks, adding a broad market trading position, and continuing to clean up laggards. Over the next week or so, we will look to increase allocations in Healthcare, Technology, Energy, and Financials primarily. Although we will pick up opportunities wherever we find them.

Equity Model

  • Sell 100% of Johnson and Johnson (JNJ)
  • Increase XOM to target weight of 2% of the portfolio.
  • Initiate a 1% position in MRO (Marathon Petroleum)
  • Add a 2% trading position in SPY in the portfolio.

ETF Model

  • Add 1% to XLE bringing the total position weight to 3% of the portfolio.
  • Add a 2% trading position in SPY in the portfolio.

Daily Market Commnetary

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S&P 500 Monthly Valuation & Analysis Review – 11-30-21

S&P 500 Monthly Valuation & Analysis Review: 11-30-21

Also, read our commentary on why low rates don’t justify high valuations.

Daily Market Commnetary



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.

Cartography Corner – December 2021

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


November 2021 Review

E-Mini S&P 500 Futures

We begin with a review of E-Mini S&P 500 Futures (ESZ1) during November 2021.  In our November 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                4911.75

o M3                4896.25

o M1                4658.00

o PMH             4602.75

o Close            4597.00           

o MTrend        4445.47

o PML              4260.00     

o M2                4226.25       

o M5                3972.50

Active traders can use MTrend: 4445.47 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 November 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The option tail wagged the dog again.  Like what occurred in three of the previous five months, the market put in a local high on November 5th (the fifth trading session) and then declined over the next three trading sessions by (1.84%), high-to-low.

Over the following eight trading sessions, the market price rallied 2.49% from the previous low to the intra-day high on November 22ndThat turned out to be the high for the month, as the news surrounding a new strain of the COVID-19 virus began to dissipate.  On November 26th, the United Kingdom announced that it was suspending travel from six African countries.    

The final three trading sessions saw the market price decline by (2.83%), close-to-close.   

Figure 1:

Japanese Yen Futures

We continue with a review of Japanese Yen Futures (6JZ1) during November 2021.  In our November 2021 edition of The Cartography Corner, we wrote the following:  

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

o M4                0.91290

o PMH             0.90275

o MTrend        0.89918

o M1                0.88835

o Close            0.87800

o PML              0.87215                 

o M3                0.85790           

o M2                0.85170

o M5                0.82715

Active traders can use PML: 0.87215 as the initial pivot, maintaining a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for November 2021 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first seven trading sessions in November saw the market price ascend to 0.88735, just shy of our isolated resistance level at M1: 0.88835.  The market price immediately reversed from this level.  Over the following eleven trading sessions, the market price declined by (2.28%).

Starting with the “risk-off” event of November 26th, the yen rallied over the final three trading sessions by 2.08%, close-to-close.  

Figure 2:

December 2021 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESZ1).  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Weekly Trend         4667.67        

o Daily Trend             4621.14

o Current Settle         4566.25        

o Monthly Trend        4495.83        

o Quarterly Trend      4135.58

The relative positioning of the Trend Levels is starting a bearish transition.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are “Trend Up”, having settled above Quarterly Trend for six quarters.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures are “Above Trend: 2 Months”.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are “Below Trend: 1 Weeks”.

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.  The signal was given the week of November 22nd to anticipate a two-week high within the next four to six weeks.  That high can be achieved this week with a trade above 4740.50.

Support/Resistance:

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

o M4                5221.00

o M1                4878.25

o M2                4854.00

o PMH             4740.50

o Close            4566.25           

o PML              4557.00

o M3                4535.50     

o M5                4511.25       

o MTrend        4495.83

Active traders can use MTrend: 4495.83 as the pivot, maintaining a long position above that level and a flat or short position below it.

Coffee Futures

For December, we focus on Coffee Futures.  We provide a monthly time-period analysis of KCH2.  The same analysis can be completed for any time-period or in aggregate.

Trends:  

o Daily Trend           237.16           

o Current Settle       232.30

o Weekly Trend       228.74           

o Monthly Trend      207.63           

o Quarterly Trend    154.41

The relative positioning of the Trend Levels is bullish.  Think of the relative positioning of the Trend Levels like you would a moving-average cross.  As can be seen in the quarterly chart below, coffee is “Trend Up”, having settled four quarters above Quarterly Trend.  Stepping down one time-period, the monthly chart shows that coffee is “Trend Up”, having settled eight months above Monthly Trend.  Stepping down to the weekly time-period, the chart shows that coffee is “Trend Up”, having settled above Weekly Trend for five weeks.

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.  The signal was given in 1Q2021 to anticipate a two-quarter high within the next four to six quarters (now one to three).  That high can be achieved this quarter with a trade above 0.930900.  The signal was given the week of October 11th to anticipate a two-week high within the next four to six weeks (now one to three).  That high can be achieved this week with a trade above 0.8832500.

Speculative positioning, structural momentum, and trend persistence are all in the extreme right tail of their distributions.  We encourage clients to review those graphs on the website.

Support/Resistance:

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

o M4                305.10

o M1                281.25

o M3                260.11

o PMH             248.20

o Close            232.20

o M2                211.60                    

o MTrend        207.63             

o PML              201.45

o M5                187.75

Active traders can use PMH: 248.20 as the initial pivot, maintaining 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.

 

The Omicron Variant Flips Stocks From Green To Red

News of the Omicron Variant showing up in California shook investors and pushed stocks from significant intra-day gains into the red. The u-turn in stock prices came as the S&P 500 was up nearly 2% from Tuesday’s close. The combination of the Omicron variant and increasingly hawkish language from Chairman Powell result in large swings in prices. Further pressuring stocks are mutual fund activities. As we wrote a week ago in Santa Claus Rally is Coming, but Will Markets Correct First: “Before “Santa Claus” comes to visit “Broad and Wall” mutual funds distribute their capital gain, dividends, and interest income for the year. These distributions start in late November, but a large number of distributions occur in the first two weeks of December.”

Yesterday’s 3.19% intraday swing from high to low is the largest in over a year.

S&P 500
Daily Market Commnetary

What To Watch Today


Economy

  • 7:30 a.m. ET: Challenger job cuts, November (-71.7% in October)
  • 8:30 a.m. ET: Initial jobless claims, week ended Nov. 27 (240,000 expected, 199,000 during prior week)
  • 8:30 a.m. ET: Continuing claimsNov. 20 (2.003 million expected, 2.049 million during prior week)

Earnings

Pre-market

  • 6:55 a.m. ET: Dollar General (DG) to report adjusted earnings of $2.01 on revenue of $8.47 billion
  • 8:00 a.m. ET: Kroger (KRto report adjusted earnings of 67 cents on revenue of $31.18 billion

Post-market

  • 4:05 p.m. ET: Ulta Beauty (ULTAto report adjusted earnings of $2.49 on revenue of $1.88 billion


Politics

  • President Biden visits the National Institutes of Health today for a speech on the Omicron variant and the next steps in his administration’s response. He’s promised to respond “not with shutdowns or lockdowns.”

Trading Update

While the media is running around trying to pin headlines on the market moves from the Fed to Omicron variant, the reality is that we are in the midst of mutual fund distribution season. Such is a theme we repeated over the two weeks prior to Thanksgiving and has now arrived.

In the short-term, selling pressure is getting close to peaking and downside risk is most likely limited over the next few days as markets are now extremely oversold. Volatility has spiked up to overbought levels, and the market has strong support at the 100-dma (orange line) currently.

SP500 market technical chart

While we are starting to look for trading positions to add to our portfolio, the upside is likely limited to the bottom of the previous trend channel that began in 2020. A failure at that trend line will set the markets up for either a retest of current lows in January, or we are going to start talking about a very different market in 2022.

ARKK Sprung A Leak

“ARRK is down another 3.7% as of this writing. It is now approaching the panic lows we saw in May. 100 is the must hold level. The questions we continue asking ourselves: Is innovation dead if the queen of innovation is underperforming by this much? Is the overall market about to catch up and ARKK is just early or has Cathie just lost her mojo? Almost tempting to start catching a few falling ARKK knives, or?” – @TheMarketEar

National Manufacturing Surveys

The PMI manufacturing survey was weaker than expectations at 58.3 versus 59.1. Per the report- “November PMITM data from IHS Markit signaled the second-weakest rise in production recorded over the past 14 months as producers reported further near-record supply delays and a slowing of new order inflows to the softest so far this year. Jobs growth also waned amid difficulties filling vacancies.” Further- “While average selling price inflation eased as firms sought to win customers, the rate of input cost inflation hit a new high, hinting at a squeeze on margins.”

The ISM survey came in at expectations of 61.1. While below levels from earlier this year, the survey remains near 20-year highs. The much-followed prices paid index fell slightly. Supply line disruptions remain a big problem. Over half of the respondents report slower delivery times. The normal range is 10-20%. The table below annotated by Zero Hedge shows six of the ten ISM components were lower this month.

ISM PMI manufacturing

Is the Sell-Off Over?

Stock market S&P 500

The Fed Matters

“Bank of America estimates that corporate earnings used to explain half of equity market returns up to the financial crisis, but since then they only explain 21%. Meanwhile, changes to the Fed’s balance sheet explain 52% of market returns since 2010, it estimates. Buy what the FED buys. Sell what the FED stops buying.” – @TheMarketEar

Fed balance sheet vs market cap

Have Oil Prices and Energy Stocks Bottomed?

The chart below provides fodder for oil bulls and bears. The price of oil tends to rally strongly following periods when the OVX (oil volatility index) is above 65. Currently, the index is at 75. While the reading entails oil may rise in price once volatility declines, we must consider the volatility index can stay elevated, resulting in further declines. For example, the index was above 65 from October 2008 to March 2009. In 2020, the index was above 65 from early March until late May. Currently, the index is only on its third day above 65. Bulls are waiting on a sub-65 reading, and bears are hoping volatility remains elevated. We caution; the index can fall slightly below 65 for a day or two before rising back above 65. In such prior cases, the price of oil continued lower.

The second graph below compares the price of the popular energy sector ETF, XLE, to the OVX index. As shown, like oil prices, XLE tends to do well once the index falls back below 65. However, XLE bucked the trend in 2020 as it rose when the index was above 65 and fell once it dropped back below 65.

oil prices
crude oil volatility

Everyone Hates Bonds- Is That Bullish?

Per Reuters, the net bearish bets on U.S. Treasury ten-year note futures is now the largest since February 2020. In January and February 2020, bond prices were rising, and yields were falling as the economy slowed and the Fed had begun cutting rates late in 2019. The advent of Covid in early March sent bond prices soaring, fueled in part by traders forced to cover their short bets. Today, like then, net shorts are extreme, and some traders are starting to buy to cover their shorts as the Omicron variant and hawkish tones from Powell pressure stocks. History may not repeat itself, but it often rhymes.

Cyber Monday Disappoints

According to Adobe Analytics, sales for Cyber Monday were disappointing. Online sales for last Monday totaled $10.7 billion, a 1.4% decline from last year. While it is the first decline for Cyber Monday, one must factor that last year’s data was an anomaly due to Covid and consumers’ reluctance to go to stores. To wit, foot traffic is up 48% versus last year, but it is still down 28% from pre-pandemic years. Personal consumption accounts for approximately two-thirds of GDP. As such, holiday spending is an essential component of growth. This year we must be careful reading too much into retail sales data. Inflation and shortages of many goods result in timing and spending behaviors that are not comparable to years prior.


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Powell Retires “Transitory” Inflation and the Market’s Fret

Jerome Powell has been using the words “transitory inflation” to characterize the recent bout of inflation as temporary. Such verbiage pacified the stock markets as it entailed the Fed would not stop the printing presses too soon. The markets showed their displeasure as Powell retired “transitory inflation.” In Senate testimony Tuesday, he stated: “It’s time to say goodbye to the term “transitory” when it comes to inflation.” During his testimony, he had a concerning tone about inflation leading markets to believe the Fed will be more aggressive in tapering QE. The graph below from our ‘coming soon’ version of RIAPro, shows that there were only six winners in the S&P 500 yesterday.

S&P 500 aapl apple
Daily Market Commnetary

What To Watch Today


Economy

  • 7:00 a.m. ET: MBA Mortgage Applications, November 26 (1.8% during prior week)
  • 8:15. a.m. ET: ADP Employment Change, November (525,000 expected, 571,000 in October)
  • 9:45 a.m. ET: Markit U.S. Manufacturing PMI, November final (59.1 during prior month)
  • 10:00 a.m. ET: Construction Spending, month-over-month, October (0.4% expected, -0.5% in September)
  • 10:00 a.m. ET: ISM Manufacturing, November (61.2 expected, 60.8 in October)
  • 2:00 p.m. ET: Federal Reserve releases Beige Book

Earnings

  • 4:15 p.m. ET: PVH Corp. (PVH) to report adjusted earnings of $2.07 on revenue of $2.41 billion

Consumer Confidence Continues to Weaken

The Conference Boards Consumer Confidence Index fell to 109.5, down from 111.6. Both the present situation index and the expectations index were lower. Driving consumers’ moods are concerns about rising prices and income prospects.

weak consumer confidence

The Chicago PMI, a precursor to national manufacturing surveys, fell more than expected to 61.8 from 68.4. After hitting a high of 75 in April, the index has been trending lower. The slowing of new orders and employment were partially responsible for this month’s decline. The ISM and PMI manufacturing surveys will be released tomorrow. Both are expected to show slight increases from last month.

Sounding The Inflation Alarms

Chairman Powell was vocal about inflation and is finally backing off using the word “transitory” to describe it. Per his testimony to the Senate: “time to retire the term”transitory” regarding inflation.” He followed, “the risk of persistently higher inflation has increased. We will use our tools to make sure higher inflation does not become entrenched.”  The inflation comments are an upgrade to his recent descriptions of inflation.

However,  he countered the discussion by mentioning the weak labor participation rate and covid related factors affecting economic growth. On balance, his statement was a little more hawkish than usual.

The market did not like that “hawkish” tilt.

Market technical chart

The 50-dma is now the most logical support where an increase in the previous volume-at-price resides. Also, the market is now approaching decent oversold levels. While we could see another day or two of volatility, we are continuing to set up for a potential year-end rally.

End In Sight?

santa claus rally

Powell Warns About Omicron

Chairman Powell spoke late on Monday. While his economic assessment was in line with other recent speeches, he did offer pause about the new Omicron variant.

The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation. Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.

Buckle Up – The Debt Ceiling is Upon us Again

The last debt ceiling debate ended with an extension to mid-December. December starts tomorrow, and the debt ceiling headlines are starting back up. Bloomberg reports that Congress needs to pass a stopgap funding bill to keep the government open beyond this week. The graph below, from Zero Hedge, shows Treasury Bills maturing in mid/late December yield 4bps more than they should. The kink in the curve is due to investors requiring a premium to take the risk that principal payments on maturing bills are delayed.

Debt ceiling us treasury

A Bull Market For the Ages

The chart below, courtesy of Fidelity, shows all of the cyclical bull markets since 1920. The rally starting in 1932, following the crash of 1929 and subsequent 89% drawdown, is the only rally steeper than the post-March 2020 rally.

stock market bull cycle

FANG Outlier

Money has been hiding in some unusual places. As of late that hiding place is Apple. The chart below, courtesy of @themarketear, shows Apple relative to the rest of the FANG stocks.

FANG stock market

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Is A Stock Market Crash Like 2000 Possible?

Is A Stock Market Crash Like 2000 Possible?

Say say two thousand zero zero party over, oops, out of time
So tonight I’m gonna party like it’s nineteen ninety-nine”
-Prince 1999

Prince wrote the song “1999” in 1982, 18 years before the clock ran out on the 20th century and possibly the greatest stock market run in American history.

In 1999, equity valuations stood at unprecedented peaks, even dwarfing those of 1929. At the time, investors were euphoric as if the rally were eternal. Newbies were killing it, and veterans were cleaning up like never before. Some stocks were rising 10, 20, and even 30% or more in a day. Companies adding dot com to their name or discussing new internet technology saw huge pops in their share prices. Investors bought the narrative with little to no due diligence.

Sound familiar? Not only is today’s speculative environment eerily similar to the late 90s, but valuations, in many cases, are frothier than that period.

Comparing valuations from separate periods is inaccurate as economic and earnings environments can be different. This article contrasts the valuations and environments to consider if it’s time to leave the party or stay and rock on. To help you decide we provide a statistical analysis showing the potential downside risk facing the S&P 500.  

First, however, let’s look at a few valuation measures to provide context between today and 1999.

S&P 500 Price to Earnings

Price to earnings (P/E) is the most often used method to value stocks. It’s common for investors to use the trailing 12 months (ttm) of earnings in the P/E denominator, as shown in the first graph.

Some investors, including ourselves, prefer using the CAPE P/E. Robert Shiller’s CAPE method uses the last ten years of earnings to better factor in secular earnings trends and avoids one-off events that distort valuations.

Price to earnings S&P 500

P/E valuations are grossly extended, and in both calculations nearing or surpassing levels in 1999. The graphs also show valuations are well above those of 1929.  

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Price To Sales

The benefit of using the ratio price to sales (P/S) versus P/E is that sales, or revenue, are not easy to manipulate by executives.

The graph below shows the price to sales ratio (P/S) is now 50% above where it was in 1999.

price to sales S&P 500

The charts below, courtesy of the Leuthold Group, provide further context. The top chart shows 15% of the S&P 500 stocks have a P/S ratio greater than ten. That compares to 8% in 1999. The bottom graph shows the median P/S ratio is nearly double the 1999 level.

stock market valuation

To highlight what a P/S ratio of ten entails, we quote Scott McNeely, the CEO of Sun Microsystems, from 1999.

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. It assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are?”

More Valuation Metrics

The following graph is purportedly Warren Buffet’s favorite valuation technique. The measure compares the inflation-adjusted market cap of the S&P 500 as a ratio to the economy. Given that earnings and economic growth correlate well over time, the ratio effectively points out valuation extremes. Currently, the ratio is at 2.50, well above the 1.95 from 1999 and 1.40 leading into the Financial Crisis.

buffet indicator

The Q-ratio takes the S&P 500 market cap and divides it by the aggregate replacement costs of the assets held by the companies in the index. It effectively quantifies how much an investor is paying for the underlying corporate assets. As shown below, courtesy of Advisor Perspectives, the ratio is now over 3.5 standard deviations above its norm. It is also higher than it was in 1999 and multiples of any other prior peak.

advisor perspectives Q ratio
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Compared to What?

Conservatively speaking, current valuations are on par or greater than those in 1999 and any other period. Such a statement is statistically factual, but it ignores the economic environments of both periods. For instance, if you think the economy and corporate earnings will grow at double-digit rates for years, we can make the case valuations are fair today.

The table below compares economic environments from both periods.

gdp, cpi and Fed

Economic and earnings growth rates today are weaker than 20 years ago. Further, debt levels, measured as a ratio to GDP, are much higher today. Productivity growth and demographics, two significant factors determining economic growth, are weighing on economic growth today. In the 90s, they were strong economic tailwinds.  

The last three indicators show the amount of monetary stimulus via low-interest rates, and the Fed’s enlarged balance sheet is much more accommodative than in 1999.

Fundamentals and the economic/earnings outlook are weaker today than in 1999. As a result, investors were better off paying higher valuations in 1999 than today.

However, the Fed is, directly and indirectly, bolstering asset prices and, therefore, valuations via their excessive actions. Low-interest rates promote the use of leverage and encourage buybacks which fuel stock prices. Additionally, investors shun low-yielding bonds to chase stocks to pick up needed returns. For more, please read The Fed is Juicing Stocks.

The Fed is the Fundamentals

The bottom line is investors are paying more and getting less compared to 1999. The graph below shows numerous measures of valuations are at extremes except three. Those three in green shading use comparisons of stock prices to interest rates. They are “fairly valued.”

valuations S&p 500

Whether they know it or not, investors are betting the Fed continues to levitate the market. Can stocks remain at extremely lofty valuations while lacking fundamental backing if the Fed continues to reduce QE purchases and ultimately raises interest rates?

Essentially the real gamble investors are taking is that inflation will be transitory.  If high inflation is persistent and not transitory, the Fed will find it increasingly challenging to continue current policy.

Without the Fed’s enormous liquidity, valuation gravity will reassert itself.

Statistics Warn of 2650

The graph below shows the strong correlation between CAPE valuations and future 20-year returns. At current levels, highlighted in yellow, we should expect annualized returns ranging from 2-4% for the next 20 years.  

Shiller P/E S&P 500

You may be thinking 2-4% doesn’t sound too bad considering how high valuations are. The problem, however, with such a long-range forecast is there may be periods with negative growth and others with double-digit growth within the twenty years.

While the regression allows us to form 20-year expectations, it also gives us the ability to forecast shorter periods.

Eighteen years ago, in October 2003, the S&P stood at 1019.50. Based on the regression above, investors could expect 4.90% annualized returns at that time. At such a growth rate, the S&P would rise to 2655 in October 2023. Currently, the S&P 500 is around 4700. Assuming the regression holds and history has favorable odds of that occurring, we should expect the S&P 500 to fall to 2650 in the next two years. A 43% decline is harsh, but it will only leave the index at fair value based on the last 40 years of CAPE levels. Quite often, markets revert below their means.

Before you dismiss our statistical analysis, let’s look back to 1999.

Prince wrote “1999” in 1982. When he wrote it, the S&P was at 111. Using the same math, investors could have expected 12% annualized returns, putting the S&P 500 at 1068 on New Year’s Eve 1999.  The S&P, at the end of 1999, was 1450, offering investors a two-year expected return of -26%. Statistics delivered right on cue, and just two years later, the S&P hit 1068. The index ultimately fell to the low 800s before the stock market crash ended.

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Summary

Every era of speculation brings forth a crop of theories designed to justify the speculation, and the speculative slogans are easily seized upon. The term “new era” was the slogan for the 1927-1929 period. We were in a new era in which old economic laws were suspended.” -Dr. Benjamin Anderson – Economics and the Public Welfare

Investors are making a big bet on the Fed and a “new era.”

On the eve of the stock market crash in 1929, Irving Fisher erroneously declared that stocks hit “what looks like a permanently high plateau.” Fisher could not have been more wrong. Same with investors in the “new era” of the internet of the late 90s.

Do you have faith the “new era” of Fed-managed markets can levitate stocks well above historical norms and prevent a stock market crash? Or will this “new era” resolve itself like prior “new eras” with a stock market crash?

Portfolio Trade Alert – 11-29-21

Portfolio Trade Alert For 11-29-21

Top 10-Buys and Sells From TPA Research

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

, Portfolio 11/22/2021

November 22, 2021

*** Portfolio Trading Alert ***  – Equity Model Only

We sold Verizon (VZ) in the equity model this morning for tax-loss harvesting. We have a lot of gains to offset this year from profit-taking.  While we like Verizon fundamentally, particularly the 4% yield, we think it could continue to trade weaker over the next couple of weeks as mutual funds and professional managers do the same. We will likely buy it back in a month as it should benefit from the infrastructure bill and a potential shift to value next year.

  • Sell 100% of Verizon (VZ)

Cyber Monday Stock Sales Entice Investors

Cyber Monday stock gains erased a good chunk of Black Friday’s losses. Fear of another high-powered Covid variant was tempered over the weekend, and investors, like shoppers, bought into Cyber Monday deals. Oil recovered some of its Friday meltdown rising 2.5%.

Despite the renewed optimism, there remains a little trepidation in the market. We can best see it in the travel and lodging sectors. For example, Bookings.com (BKNG) only picked up 1.25% of its 7% decline from Friday. Many of the largest resorts and casinos were red on the day. Technology led the way higher, as shown below, while healthcare and financials barely eked out gains.

S&P 500 sector performance stocks
Daily Market Commnetary

What To Watch Today

Economy

  • 9:00 a.m. ET: FHFA House Price Index, month-over-month, September (1.2% expected, 1.0% in August)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite Index, month-over-month, September (1.20% expected, 1.17% in August)
  • 9:00 a.m. ET: S&P CoreLogic Case-Shiller 20-City Composite Index, September (19.30% expected, 19.66% during prior month)
  • 9:45 a.m. ET: MNI Chicago PMI, November (67.0 expected, 68.4 in October)
  • 10:00 a.m. ET: Conference Board Consumer Confidence Index, November (110.0 expected, 113.8 in October)

Earnings

  • 4:05 p.m. ET: Salesforce.com (CRM) to report adjusted earnings of 92 cents on revenue of $6.80 billion

Technical Backdrop Still Questionable

Yesterday’s “Cyber Monday” rally was not surprising given the depth of the decline on “Black Friday.” However, while the rally was strong enough to put the market back above broken support, it failed resistance at the 20-dma. Also, with major “sell signals” still intact, we could see some volatility in the days ahead.

This morning fears are resurfacing over the omicron variant and futures are sliding lower once again. But that is just the excuse to explain the sell-off we have been discussing for the last two weeks.

However, with the market getting decently oversold on a short-term basis, such should set investors up for the seasonal “year-end” rally. Therefore, it is a good idea to start “making your list, and checking it twice,” and using opportunistic entry points to add equity exposure heading into 2022.

S&P 500 Technical Chart

A Historic Cluster Of Warnings

“Single warning signs, like we saw in March, are less of a worry. It’s a more significant issue when we see multiple days of warnings and on more than a single exchange.

This is a problem now because they’ve been firing consistently lately, ahead of Friday’s carnage. In just 5 days, a combined 12 warning signs have triggered between the NYSE Hindenburg Omen, Nasdaq Hindenburg Omen, NYSE Titanic Syndrome, and Nasdaq Titanic Syndrome.” – Sentiment Trader

Titanic Hindeburg Warnings

“It’s been rare to see such a big cluster of warnings across both exchanges over the past 25 years. The handful of times these clusters popped up, the S&P 500 had a tough time holding any upside momentum.”

Titanic and Hindeburg Warnings vs the stock market.

Powell Pivots Gets Excuse To Slow Taper

We have wondered how long it would be before Jerome Powell came up with some excuse to delay tapering of the balance sheet and hiking the Fed funds rate. We now know the answer according to Zerohedge:

But for one market participant in particular, it’s a great excuse (especially after his re-nomination) as Fed Chair Powell’s prepared remarks ahead of The Coronavirus and CARES Act hearing before the Committee on Banking, Housing, and Urban Affairs, offered some insight into his next actions (after a token shift to more hawkish positions by some Fed speakers).

Here is the key paragraph:

“The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation.

Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.

That uncertainty can mean only one thing when it comes from The Fed… backing away from the taper’s current trajectory (and any guesses at when takeoff may occur).

Of course, this is truly amusing because only 10% of Wall Street respondents to a flash DB poll thing Omicron will be a big issue at year end…

Twitter Rollercoaster

On “Cyber Monday,” Twitter’s stock jumped almost 10% at the market open on news that CEO Jack Dorsey will be stepping down. The gains were short-lived, as shown in the graph below. Twitter has become a large social media brand, but its stock price is flat since IPO’ing in 2013. After the initial rush of enthusiasm, it appears investors are concerned that promoting a long-time Twitter veteran (current CTO – Parag Agrawal) to replace Dorsey will not result in the types of changes investors are asking for.

Twitter stock

Omicron Variant Shakes Wall Street

Omnicron Variant cyber monday

What’s Wrong with Foreign Stocks?

The graph below compares two widely followed foreign stock ETFs and the S&P 500, from the beginning of the Covid outbreak through today. EEM holds emerging market stocks, and EFA developed market stocks. As shown, all three ETFs performed similarly during the decline in early 2020 and the recovery afterward. However, starting in the spring of 2021, the foreign market ETFs peaked while the S&P 500 continued to new highs. Over the last nine months emerging markets (EEM)s have given up about 25% of their post-Covid gains, while developed markets (EFA) have essentially flatlined. The following factors help account for some of the U.S. equity outperformance:

  • Since June 2021, the USD index is up about 8%.
  • The economic recovery in the U.S. has been stronger than in most nations.
  • The Fed is slightly more hawkish than other central banks.
  • China’s economic activity has slowed significantly, weighing heavily on many emerging markets.
emerging and developed stock markets

The Week Ahead

The week’s significant events will be the ADP employment report on Wednesday and the BLS report on Friday. Currently, the forecast is for a gain of 550k jobs in the November BLS jobs report. Investors are likely to focus on the labor participation rate as Fed Chairman Powell claims the lower rate is a sign of labor weakness. The current estimate is for the participation rate to uptick 0.1% to 61.7%.

Investors will also watch the ISM manufacturing and services surveys on Wednesday and Friday, respectively. Current indications are that both numbers will remain at their current levels. We will follow the price gauges in both surveys closely.

The next Fed meeting will be in two weeks on the 15th of December. Assuming the new covid variant does not become problematic for global economic activity, we might see some Fed members encouraging a faster tapering pace in speeches and comments this week. Voting Fed members go into their self-imposed media blackout period next week, so this week may be their last chance to speak up publically before the meeting.

Investors will be looking for retail results from Black Friday and Cyber Monday to help assess holiday sales.


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Market Correction Before The Santa Rally Has Started

Last week, we asked if there would be a market correction before “Santa visits Broad and Wall?”

Investors’ ‘wish lists’ are hung by the chimney with care, hopeful the ‘Santa Claus rally’ will soon be there. While they remain ‘snug in their beds, the historical data dances in the heads.’ The chart below from @themarketear shows the annual “seasonality” from 1985 through 2019.

It certainly seems there is little to worry about. However, notice that dip at the beginning of December.

Seasonality for santa claus rally.

We made the case that mutual fund distributions would provide additional selling pressure on a market already plagued by weak internals. To wit:

However, there is potentially a negative impact on the market. Such is particularly the case when volumes are weak, liquidity is low, and breadth is poor. As shown, during the entire advance from the September lows, the volume declined. Importantly, over the last week, breadth deteriorated.

All that was missing was a catalyst to create a market correction.

“Over the last couple of weeks, the market has been warning to the risk of a downturn, all that was needed was a catalyst to change sentiment.” – The Real Investment Report

Chart updated through Friday.

The Lack Of Liquidity

On Friday, news of a new “Covid” variant broke, and stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows.

“Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.”Real Investment Report

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

As you will note, the market correction was swift. Such is because of the “lack of liquidity” in the markets.

As discussed previously, the stock market is a function of buyers and sellers agreeing to a transaction at a specific price. Or rather, “for every seller, there must be a buyer.”

The chart from last week’s discussion showed there was a lack of volume a lower prices. As I wrote:

“Buyers appear to be ‘living’ closer to the 50-dma (orange dashed line.) As the Wall Street axiom goes: ‘Sellers live higher. Buyers live lower.'”

Sp500 technical chart volume at price

These “gaps” between buyers and sellers lead to sharp price reversions in markets.

Breadth Suggests There May Be More Work To Do

While the market correction last Friday was sharp and did push several of our short-term indicators into oversold territory, any bounce this week could lead to more selling pressure near term. While we previously noted our concerns about the “bad breadth” of the market, SentimenTrader also suggests such may lead to a pause in the rally. To wit:

“For only the 6th time since 1926, declining issues outnumbered advancing issues for 7 consecutive days when the S&P 500 closed 2% or less from its 252-day high. If I eliminate the distance below the high condition, the study returns 123 instances when screening out repeats. Almost half of those signals occurred when the S&P 500 was down 10% or more from its 252-day high.”

“This signal triggered 5 other times over the past 96 years. After the others, future returns and win rates were weak in the 2-to-8-week time frame. If I optimize a short signal, the test returns 27 days as the best time frame to hold a negative view of the market. And, the S&P 500 closed down in 5 out of 6 instances. The sample size is small.”

Notably, weak breadth, light volumes on rallies, and speculative behaviors make the market vulnerable to sharp reversals. Moreover, as noted last week, with mutual funds adding to the selling pressure over the next two weeks, there is a risk of further downside.

However, such will provide a trading opportunity for year-end “window dressing.”

Trading The Santa Rally

I agree with Doug Kass’ recent comment:

While I am not bullish, I am less bearish. On a (tactical) trading and investing basis, markets probably overreacted to the Omicron news on Friday, It is likely time to consider being a bit more greedy when others are fearful. Many stocks, away from “The Nifty Seven,” have fallen dramatically and may represent both shorter and longer-term value“

We agree. After previously taking profits in overbought and extended equities, we are now looking for discounted positions in technology, energy, consumer, and financial-related sectors.

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

One other comment is that the “Omicron variant” could provide “cover” for the Federal Reserve to slow their monetary tightening. The majority of the rally on Monday was likely bulls coming around to this idea. As such, it was no surprise to see Jerome Powell already pivoting towards a more dovish stance in prepared remarks for the CARES Act Hearing.

“The recent rise in COVID-19 cases and the emergence of the Omicron variant pose downside risks to employment and economic activity and increased uncertainty for inflation.

Greater concerns about the virus could reduce people’s willingness to work in person, which would slow progress in the labor market and intensify supply-chain disruptions.” – Powell

Of course, this is the excuse Powell needs to slow tapering of the balance sheet and delay hiking interest rates.

For now, that keeps the bullish bias in stocks. But as we head into 2022, I would not be surprised to see a pick up in volatility as liquidity flows decline along with economic growth.

As an investor, always remember that making money in the market is only one-half of the job. Keeping it is the other.

“We can not direct the wind, but we can adjust the sail.” – Anonymous

Viking Analytics: Weekly Gamma Band Update 11/29/2021

We share the Weekly Gamma Bands Update by Viking Analytics. The report uses options gamma to help you better manage risk and your equity allocations.

Gamma Band Update

The S&P 500 (SPX) fell sharply on Friday, closing on the lows and below the end-of-day gamma flip level near 4,620.  Our model cut SPX exposure to 30%.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,460), the model will reduce the SPX allocation to zero.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years 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.

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.


Could The Fed Trigger The Next “Financial Crisis”

Could the Fed trigger the next “financial crisis” as they begin to hike interest rates? Such is certainly a question worth asking as we look back at the Fed’s history of previous monetary actions. Such was a topic I discussed in “Investors Push Risk Bets.” To wit:

“With the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” is the most significant risk.

The ‘stability/instability paradox’ assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push ‘the big red button.’

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

The problem, as shown below, is that throughout history, when the Fed begins to hike interest rates someone inevitability pushes the “big red button.”

Fed funds rates crisis

The behavioral biases of individuals remain the most serious risk facing the Fed. While they may hope that individuals will act rationally as they hike rates and tighten monetary policy, investors tend not to act that way.

Importantly, each previous crisis in history was primarily a function of extreme excesses in one area of the market or economy.

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy

What about currently?

A Bubble In “Everything”

No matter what corner of the market or economy you look there are excesses.

  • Real estate,
  • FANG-NATM (Facebook, Apple, Netflix, Google, Nvidia, Amazon, Tesla and Microsoft)
  • EV’s – Tesla is a $1 Trillion dollar company.
  • Corporate debt,
  • Credit,
  • Private equity,
  • SPAC’s,
  • IPO’s,
  • “Meme” stocks; and,
  • Options speculation

The list could go on, but you get the idea.

There is a correlation between the Fed’s interventions and the surge in speculative risk-taking. As shown, household equity ownership is highly correlated to the Fed’s balance sheet.

Equity ownership to Feds balance sheet

Unfortunately, in order to invest in the financial markets, individuals must have disposable income with which to invest. However, while the massive interventions by the Fed inflated the most prominent financial bubble in history, it did little to boost economic growth or prosperity. As a result, the top 10% of income earners own roughly 90% of the financial market assets.

Breakdown of equity ownership

Not surprisingly, after more than a decade of ultra-accommodative monetary policies, risk appetites surged as participants came to believe the Fed eliminated all “risk.”

Of course, if there is “no risk of loss,” why not take on more risk? Such is exactly what everyone did.

A Bubble In Leverage

In Seth Klarman’s famous book, “A Margin Of Safety,” he discussed the 1980’s bond mania before it imploded. At that time, many companies issued bonds even though they could not afford to pay the interest expenses. Today, we call such companies “zombie companies,” as they must feed on cheap debt to stay alive. Currently, the market capitalization of these zombie firms is at a record.

Total EV of firms with EBIT less than interest expense on debt
Chart courtesy of Kailash Concepts

The obvious problem is what happens when they cannot refinance their debt. Unfortunately, as Kailash Concepts explains, debt itself is a significant risk.

Currently, the world is awash in financial alchemy. There is currently a record number of companies unable to cover their interest expense from profits.

Since 2007, a big part of America’s debt crisis has moved from the financial sector to non-financial stocks with too much debt. We believe the mix of record debt and record equity valuations is likely a side effect of real rates approaching lows last seen in 1973. Whether we are right or wrong on the causality, the facts are intimidating in our view.

Our research has documented that the world has never been less prepared or less equipped to deal with a possible outbreak of inflation or pull-back in Federal largesse.

Total Debt of Non-Financial Firms To GDP

However, it isn’t just a corporate leverage bubble. It is also a bubble in investor leverage as individuals take on debt to chase markets.

Margin Debt and Free Crash Balances

Of course, the critical thing about “margin debt” is that it fuels the bullish advance. But, unfortunately, it also accelerates the market’s eventual decline as leverage reverses. Such is always a brutal and mauling event, which is why Wall Street calls it a “bear market.”

The Risk Of A Policy Mistake Is Enormous

In “Rising Interest Rates Matter” we discussed how if interest rates rise, the Fed tightens monetary policy, or the economic recovery falters, a financial crisis is possible.

“In the short term, the economy and markets (due to current momentum) can  DEFY the laws of financial gravity as interest rates rise. However, they act as a ‘brake’ on economic activity as rates NEGATIVELY impact a highly levered economy:”

  • Rates increases debt servicing requirements reducing future productive investment.
  • Housing slows. People buy payments, not houses.
  • Higher borrowing costs lead to lower profit margins.
  • The massive derivatives and credit markets get negatively impacted.
  • Variable rate interest payments on credit cards and home equity lines of credit increase.
  • Rising defaults on debt service will negatively impact banks.
  • Many corporate share buyback plans and dividend payments are done through the use of cheap debt.
  • Corporate capital expenditures are dependent on low borrowing costs.
  • The deficit/GDP ratio will soar as borrowing costs rise sharply.

Most importantly, over the last decade, the primary rationalization for overpaying for equity ownership is that low rates justify high valuations. Unfortunately, with inflation surging, which shrinks profit margins, and the Fed set to hike rates, valuations are likely a bigger issue than most suspect.

Equity ownership vs Valuations

As Mohammed El-Erian stated in a recent interview:

“Investors should keep an eye on the risk of an abrupt shift from a relative valuation market mindset to an absolute valuation one. If that happens, you should stop worrying about the return on your capital and start worrying about the return of your capital.” 

However, for now, there is no reason to worry about the next “financial crisis.”

Well, that is unless someone pushes the “big red button.”

Black Friday Sales Hit The Markets As Omicron Emerges

The typical uneventful post-Thanksgiving Friday trading session was anything but that. Black Friday market discounts are now in effect as the stock market, cryptos, and many commodities fell sharply. Black Friday investors fear a repeat of the lockdowns, and economic weakness may be upon us again. Crude oil is among the biggest loser, down over 12% and below $70 a barrel. Bond yields fell sharply as the bond markets are pricing in slower economic growth and more dovish policy.

The graphs below, a sneak peek of our soon-to-be-released new version of RIAPro, show the day’s biggest gainers and losers. Moderna and Pfizer lead the winners. The ten worst stocks are primarily airlines and cruise ship companies.

S&P 500 winners and losers
+

Not surprisingly, market futures are pointing higher this morning. The question will be whether they are sustainable.

Daily Market Commnetary

What To Watch Today

Economy

  • 10:00 a.m. ET: Pending home sales, month-over-month, October (0.8% expected, -2.3% in September)
  • 10:30 a.m. ET: Dallas Federal Reserve Manufacturing Activity Index, November (17.0 expected, 14.6 in October)

Earnings

  • No notable reports scheduled for release

Reflex Rally After “Black Friday” Plunge

As news of a new “Covid” variant broke, stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows. Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.

With mutual fund distributions running through the first two weeks of December, there is additional downside pressure on stocks near term. However, our “money flow sell” signal is firmly intact and confirmed by the MACD signal. Such suggests we continue to maintain slightly higher levels of cash.

"Black Friday" Plunges, “Black Friday” Plunges As Covid Variant Rattles Markets

Notably, the market is getting oversold near-term, with the money-flow signal depressed. Such suggests that any further weakness will provide a short-term trading opportunity. As discussed last week, the statistical odds are high that we will see a “Santa Rally” as most professional managers will position for year-end reporting.

We expect a short-term bounce, but there is more risk of selling over the next few days.

Green in a Sea of Red on Black Friday

The Finviz heat map below shows that many stocks are down 2-3% on the day, but a few stocks are bucking the trend. In most cases, the green on the map is in businesses that benefit from the lockdowns. In addition to the obvious winners in the healthcare industry are Verizon, NetFlix, and Clorox. Moderna and Pfizer are up significantly. The restaurant and travel business are faring the worst. Notice losses are approaching 10% for Marriot, Las Vegas Sands, and Booking.com in the upper right corner.

Stocks Down S&P 500 omicron

B.1.1.529 Variant is Roiling Markets

Stocks are declining worldwide due to a new variant of covid detected in South Africa. Per CNBC:

“South African scientist Tulio de Oliveira said in a media briefing held by the South Africa Department of Health on Thursday that the variant contains a “unique constellation” of more than 30 mutations to the spike protein, the component of the virus that binds to cells. This is significantly more than those of the delta variant.

Many of these mutations are linked to increased antibody resistance, which may affect how the virus behaves with regard to vaccines, treatments and transmissibility, health officials have said.”

The bond market is assuming the new strain will force the Fed into a more dovish policy stance. 2-year yields are down 12 bps this morning, essentially taking out half of a 25bps Fed rate hike over the next two years.

Many traders are out for the holiday, so liquidity will be poor and trading may likely be volatile.

Black Friday Disappointment

The good news: Black Friday retail traffic was up 47.5% over last year. The bad news: It was still 28.3% lower vs. 2019 levels, according to CNBC, citing preliminary data from Sensormatic Solutions.

The peak time for Black Friday shopping in stores was 1 p.m. to 3 p.m., similar to trends in past years, Sensormatic said. Black Friday is still predicted to be the busiest in-store shopping day of the season, according to Sensormatic.

On Thanksgiving day, visits to brick-and-mortar stores cratered 90.4% from 2019 levels, Sensormatic found. Retailers including TargetWalmart and Best Buy opted to keep their doors closed to customers on the holiday. Target has said it will be a permanent shift. -CNBC

Online spending fell from 2020 levels, meanwhile, with e-retailers ringing up $8.9 billion in Black Friday sales – down from $9 billion last year, according to Adobe Analytics, which noted that this is the first year that growth reversed from the prior year as long as records have been kept. The company analyzes over 100 million items in 18 product categories spanning 1 trillion visits to US retail sites.

Thanksgiving day online sales were flat from one year ago at $5.1billion, according to Adobe.

The numbers provide even greater evidence that the holiday season got stretched out as more Americans began their shopping as early as October. Retailers have been spreading out their promotional offers, too. According to a survey from the National Retail Federation, the retail industry’s leading trade group, 61% of consumers had already started purchasing holiday gifts before Thanksgiving. -CNBC

Courtesy of Zerohedge

The Dollar is on Fire

Other than Friday, the dollar has been strong. The impetus behind the dollar continues to be economic data that the market believes will push the Fed to become more hawkish. Many corporate and sovereign borrowers that borrow in dollars for use in their home country get exposed to currency risk. Essentially, a stronger dollar increases their net borrowing costs as they have to convert to dollars at a higher rate to pay interest and principal. As such, a strong dollar tightens liquidity for the rest of the world and will inhibit global economic growth if the dollar continues upwards. The graph below shows the dollar index is up over 7% year to date.

U.S. Dollar

Defining “Prolonged” and “Substantially Exceeds”

The Fed recently informally updated its price stability policy. Under the new inflation averaging regime, they will allow inflation to run higher than 2% for short periods to compensate for periods when it was below average. The graph below shows the three-year average inflation rate is now 2.7%. Further, the annual inflation rate is 6.2%. Fed members are increasingly getting nervous that inflation is running hot for a prolonged period and the current rate substantially exceeds the Fed’s target on both a short-term and longer-term averaging basis. We expect to see various Fed members discussing their thoughts on how to adjust monetary policy to manage inflation better.

cpi inflation

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“Black Friday” Plunge As Market Rattled By Covid Variant

In this 11-26-21 issue of “Black Friday” Plunge As Market Rattled By Covid Variant

  • “Black Friday” As Market Plunges
  • Time To Buy Oil
  • Yes, Interest Rates Will Matter
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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“Black Friday” As Market Plunges

Last week, we discussed the weakness of the underlying market as “FOMO” had returned to the market.

“The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.”

Chart updated through Friday.

S&P 500 technical update

Over the last couple of weeks, the market has been warning to the risk of a downturn, all that was needed was a catalyst to change sentiment.

That occurred as news of a new “Covid” variant broke, stocks marked “Black Friday” by plunging firmly through the 20-dma and support at recent lows. Notably, that downside break broke the consolidation pattern (blue box in the chart below) that began in early November. While there is some minor support around 4550, critical support lies at the 50-dma at 4527. That support level also corresponds to the September peak.

With mutual fund distributions running through the first two weeks of December, there is additional downside pressure on stocks near term. However, our “money flow sell” signal is firmly intact and confirmed by the MACD signal. Such suggests we continue to maintain slightly higher levels of cash.

S&P 500 money flow signal RIAPRO

Notably, the market is getting oversold near-term, with the money-flow signal depressed. Such suggests that any further weakness will provide a short-term trading opportunity. As discussed last week, the statistical odds are high that we will see a “Santa Rally” as most professional managers will position for year-end reporting.

Just remember, nothing is guaranteed. We can only make educated guesses.

Will The Fed Slow Their Roll

While “Black Friday” usually marks the beginning of the retail shopping season, the question is whether the new “variant,” which is flaring concerns of additional lock-downs, will reverse the current economic recovery. As Barron’s notes, it will be worth watching the Fed closely.

“Fixed-income markets are signaling that the Federal Reserve will have to increase interest rates sooner than expected, which could put a dent in the stock market.

The yield on the 2-year Treasury note has gone from 0.5% in early November to 0.64% as of Wednesday. The move suggests that investors expect the Fed to raise interest rates to combat inflation that remains higher than expected because of soaring consumer demand and supply chains that are struggling to match demand.

Indeed, minutes released Wednesday from the Fed’s meeting earlier this month show that members of the central bank are prepared to increase rates sooner than previously anticipated if inflation remains high.”

Of course, this was before “Black Friday” sent yields plunging 10% lower in a single day. Suddenly, the bond market is starting to question the sanity of hiking rates in the face of an ongoing pandemic.

Bonds technical update

While many pundits have suggested higher interest rates won’t matter to stocks, as we will discuss momentarily, they do matter and often matter a lot.

The surge in the new variant gives the Fed an excuse to hold off tightening monetary policy even though inflationary pressures continue to mount. But, what is most important to the Fed is the illusion of “market stability.”

What “Black Friday’s” plunge showed was that despite the Fed’s best efforts, “instability” is the most significant risk to the market and you.

More on this in a moment.


Daily Market Commnetary

Time To Buy Oil?

Once a quarter, I review the Commitment Of Traders report to see where speculators place their bets on bonds, the dollar, volatility, the Euro, and oil. In October’s update, I looked at oil prices that were then pushing higher as speculators were sharply increasing their net-long positioning on crude oil.

We suggested then that the current extreme overbought, extended, and deviated positioning in crude will likely lead to a rather sharp correction. (The boxes denote previous periods of exceptional deviations from long-term trends.)

Oil Rates Dollar, Traders Are Pushing Oil, Rates & The Dollar. Are They Right?

The dollar rally was the most crucial key to a view of potentially weaker oil prices. Given that commodities are globally priced in U.S. dollars, the strengthening of the dollar would reduce oil demand. To wit:

The one thing that always trips the market is what no one is paying attention to. For me, that risk lies with the US Dollar. As noted previously, everyone expects the dollar to continue to decline, and the falling dollar has been the tailwind for the emerging market, commodity, and equity ‘risk-on trade.” – June 2021

Portfolio, Rates, S&P 500, energy, yield

Since then, as expected, the dollar rally is beginning to weigh on commodity prices, and oil in particular.

oil dollar technical chart.

While the dollar could certainly rally further heading into year-end, oil prices are becoming much more attractive from a trading perspective. The recent correction did violate the 50-dma, which will act as short-term resistance. However, prices are beginning to reach more attractive oversold levels.

There are also reasons to believe higher oil prices are coming.



Higher Oil Prices Coming

The Biden administration released oil from the “Strategic Petroleum Reserve,” attempting to lower oil prices. He also tasked the DOJ to “investigate oil companies for potential price gouging.” These actions are thinly veiled attempts to regain favor with voters but will not lower oil prices.

Oil prices are NOT SET by producers. Instead, speculators and hedgers set oil prices on the NYMEX. Think about it this way:

  • If oil companies are setting prices to “reap profits,” why did oil prices go below ZERO in 2020?
  • Furthermore, would producers need to “hedge” current production against future delivery?

There are two drivers reflecting positioning by speculators and hedgers:

  1. The expected supply and demand for oil; and,
  2. The value of the dollar.

The more critical problem comes from the Administrations’ attack on production over “climate change” policies. As noted in Crude Investing: Energy Stocks & ESG (kailashconcepts.com):

This isn’t rocket science.  Look at the sharply lagging rig response to the rise in energy prices post the Covid crash. This is an anomaly. 

According to history, there should be ~1,300 rigs in operation today based on current oil prices. With only ~480 rigs running today, oil’s prospects may be bright over the long haul.”

Portfolio, Rates, S&P 500, energy, yield

With output at such low levels, OPEC+ refusing to increase production, and “inefficient clean energy” increasing demand on “dirty energy,” higher future prices are likely.

If the economy falls into a tailspin, oil prices will fall along with demand, so nothing is assured. However, the ongoing decline in CapEx in the industry suggests production will continue to contract, leaving it well short of future demand.

Portfolio, Rates, S&P 500, energy, yield
Chart courtesy of Kailash Concepts

That is the perfect environment for higher prices.


In Case You Missed It


Higher Interest Rates Will Lead To Market Volatility

Did “Black Friday’s” plunge send a warning about rates? Last week, we discussed that it isn’t a question of if, but only one of when.

I showed the correlation between interest rates and the markets. With the sharp drop in rates, it is worth reminding you of the analysis. It is all about “instability.”

The chart below is the monthly “real,” inflation-adjusted return of the S&P 500 index compared to interest rates. The data is from Dr. Robert Shiller, and I noted corresponding peaks and troughs in prices and rates.

interest rates vs S&P 500

To try and understand the relationship between stock and bond returns over time, I took the data from the chart and broke it down into 46 periods over the last 121-years. What jumps is the high degree of non-correlation between 1900 and 2000. As one would expect, in most instances, if rates fell, stock prices rose. However, the opposite also was true.

Interest rate changes vs S&P 500

Rates Matter

Notably, since 2000, rates and stocks rose and fell together. So bonds remain a “haven” against market volatility.

As such, In the short term, the markets (due to the current momentum) can DEFY the laws of financial gravity as interest rates rise. However, as interest rates increase, they act as a “brake” on economic activity. Such is because higher rates NEGATIVELY impact a highly levered economy:

  • Rates increases debt servicing requirements reducing future productive investment.
  • Housing slows. People buy payments, not houses.
  • Higher borrowing costs lead to lower profit margins.
  • The massive derivatives and credit markets get negatively impacted.
  • Variable rate interest payments on credit cards and home equity lines of credit increase, reducing consumption.
  • Rising defaults on debt service will negatively impact banks which are still not as well capitalized as most believe.
  • Many corporate share buyback plans and dividend payments are done through the use of cheap debt.
  • Corporate capital expenditures are dependent on low borrowing costs.
  • The deficit/GDP ratio will soar as borrowing costs rise sharply.

Critically, for investors, one of the main drivers of assets prices over the last few years was the rationalization that “low rates justified high valuations.”

Either low-interest rates are bullish, or high rates are bullish. Unfortunately, they can’t be both.

What “Black Friday’s” plunge showed was the correlation between rates and equity prices remains. Such is due to market participants’ “risk-on” psychology. However, that correlation cuts both ways. When something changes investor sentiment, the “risk-off” trade (bonds) is where money flows.

The correlation between interest rates and equities suggests that bonds will remain a haven against risk if something breaks given exceptionally high market valuations. The market’s plunge on “Black Friday” was likely a “shot across the bow.”

It might just be worth evaluating your bond allocation heading into 2022.



Portfolio Update

We made no substantive changes to portfolio allocations this past week given due to the holidays. Generally, the week of Thanksgiving is a poor indicator of market sentiment given the “inmates are running the asylum.”

Therefore, despite the market swinging around a good bit this past week, we will re-evaluate our positioning and holdings when institutional traders return to their desks next week.

However, as a reminder:

“Over the last two weeks, we took profits in overbought and extended equities. We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.”

Portfolio allocation model.

Despite the sell-off on Friday, the bullish bias remains strong. We also remain in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

However, as discussed most of this week, mutual fund distributions will begin in earnest and continue through the second week of December. Such suggests we could see some additional volatility and potential weakness in the market as those distributions get made.

Critically, any correction will provide a decent entry point for the year-end “Santa Claus” rally and the first week of January, which tend to be strong. Therefore, we will try and take advantage of that.

While Friday’s plunge likely shocked you out of your “tryptophan-induced” coma, I hope you had a Happy Thanksgiving.

See you next week.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

SP500 Tear Sheet

Performance Analysis

Market Sector Relative Performance

Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 65.83 out of a possible 100.

Technical gauge RIAPRO

Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90. The current reading is 80.55 out of a possible 100.

Fear Greed Gauge

Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.
Risk Range Report

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Market index growth screen

Low P/B, High-Value Score, High Dividend Screen

dividend growth screen

Fundamental Growth Screen

fundamental growth screen

Aggressive Growth Strategy

aggressive growth screen

Portfolio / Client Update

This past week, we took no substantive actions in portfolios. Such is because Thanksgiving week usually trades on very light volume.

“Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities (F, NVDA, AMD). We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

Santa Claus Rally, Santa Claus Rally Is Coming, But Will Markets Correct First?

The best opportunity to increase equity would come from a correction in early December as mutual funds distribute their annual gains. Such would provide a better entry point for the year-end “Santa Claus Rally.”

As we move closer to the end of the year, I will review our annual performance in both primary models and discuss what we expect as we head into 2022. With the Fed on course to taper their balance sheet, and the market forecasting 3-rate hikes, next year will likely be an entirely different “ball game.”

Portfolio Changes

There were no changes this past week.

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Jobless Claims Plunge To 52 Year Lows

As we show below, Initial Jobless Claims plunged to a level last seen in 1969. This indicator is yet another signal the jobs market is fully or near fully recovered. San Francisco Fed President Mary Daly took notice. She commented: “It would not surprise me if in the least there were one or two rate increases next year.” The bottom line is that plunging jobless claims add to the pressure on the Fed to speed up the taper process and begin the discussion to raise interest rates.

Jobless Claims

Despite, plunging jobless claims, futures are tumbling this morning.


S&P 500 futures (
ES=F): 4,623.25, -75.75 (-1.61%)

Dow futures (YM=F): 34,973.00, -776.00 (-2.17%)

Nasdaq futures (NQ=F): 16,224.50, -141.50 (-0.86%)

Daily Market Commnetary

What To Watch Today

There are no major economic releases scheduled for Friday. The stock market will close at 1 p.m. ET on Friday due to the holiday weekend. 

Economic Data Recap

Jobless Claims plunged to 199k in the latest week, marking a low going back to November 1969. Keep in mind that the population is 65% larger today than in 1969, so today’s number is off the charts on a population-adjusted basis. This is yet another piece of data that affirms the labor market is robust. Having an inflation problem and strong labor market is more evidence the Fed needs to speed up tapering QE and start contemplating rate hikes.

Durable Goods fell 0.5% versus expectations for a 0.3% gain and a prior month reading of -0.4%. Excluding transportation, the number was positive at 0.5%. Accounting for the difference is the auto sector, which struggles to produce cars due to the chip shortage.

Wholesale inventories rose 2.2% versus 1.4% last month. This is a positive sign that supply line problems and shortages are abating. However, Retail Inventories only increased by 0.1% versus falling 0.2% last month. Either many retailers are not fully stocking up on goods to help justify higher prices, or trucking problems are making it difficult to deliver goods. It is likely a combination of both factors.

The $1.25 Tree

“In 1986 the first five locations opened of a new retail outlet, which had a simple premise for what it would sell, and an even simpler name — “Only $1.00”. Although not the first of its kind, “Only $1.00” would grow into what today is Dollar Tree, which is a $33bn giant with more than 15,900 retail locations throughout the US, split between its two biggest brands Dollar Tree and Family Dollar.

This week Dollar Tree had some big news, announcing that most of its prices will rise from $1 to $1.25. That’s a change that the company has been putting off for some time, dropping some products over the years that it could no longer afford to stock for just $1.” – Chartr

Dollar Tree

When the company started $1 could get you a fair amount. Today it buys you much less. In fact, $1 in 1986 is more like $2.50 in today’s money once you account for inflation over those 35 years.

If you bought $1 worth of Dollar Tree shares in 1995, your $1 would be worth, ironically, roughly $125 today

Junk Bonds Sending A Signal

The graph below shows the strong correlation between JNK and the S&P 500. JNK is a popular junk bond ETF. The ETF just hit lows going back to July, while the S&P is nearly 10% above its July levels. JNK is also back to its 200dma, something the S&P hasn’t done since it broke through the 200dma in June 2020. Higher yields for junk bond issuers can lead to financial hardship and bankruptcy in some cases as they tend to be overleveraged. Are inflation and the possibility of the Fed raising rates finally concerning JNK investors? Maybe the better question is, is the recent price action of JNK foreshadowing problems for the equity markets?

jnk junk bonds S&P 500

More Details on the SPR Oil Release

Of the 50 million barrels being released from the Strategic Petroleum Reserve, 32 million will be under the exchange program.  Companies that receive oil under the program must pay it back and with interest, so to speak. The winning bidders take delivery starting December 16th from one of four sites. They will have to return the oil with a premium. Each site has a different premium and return date. For example, Bryan Mound will offer 10 million barrels. The oil has three return dates, with the first starting January 2023. If the oil is returned at that time, the winning bidder must return an additional 3.9% of oil. The premium increases to 5.3% and 8.6% if they choose the second or third delivery dates, respectively. In the short run, the release will add supply to the market but reduce it starting in July of 2022.

The graph below, courtesy of Bianco Research, provides context for the size of the SPR and recent withdrawals from the reserves.

oil reserves SPR

Tesla Is Traded More Than Any Other Stock On The Market

Tesla is truly the stock of the times. Having more than doubled in value in the last year, the company has become a magnet for the full range of investors from retail traders to hedge funds and institutions.

Data from Koyfin reveals that ~$40bn of Tesla shares changed hands yesterday — more than twice as much as the next most-traded stock, and way more than other mega-cap giants like Apple, Amazon and Microsoft. Put another way, the amount traded in Tesla yesterday was equivalent to the volume traded in 307 members of the S&P 500 Index (which is a group of 500 of the largest companies).

A great piece in the FT reveals that the story goes much deeper. We’ve charted just the vanilla equity trading volume, but the volume traded in financial derivative markets (options) is even more off the charts, with more than $240bn a day recently being bet on Tesla by its army of fans, or detractors (who presumably think the company is overvalued).” – Chartr

Tesla Stock Trading

Who knows, with jobless claims plunging to historically low levels, maybe more people can afford to buy a Tesla?

Snapchat – Investors Are Overly Optimistic

“Snapchat’s primary source of revenue is advertising based on the use of its camera platform capable of taking “snaps” or short videos and images.  SNAP shares have soared on the euphoria around rising levels of “daily active users.” With 83% of the 41 analysts covering SNAP being bullish, Wall Street’s financial advice is “BUY”.  For those interested, we have discussed how groupthink is a risk in prior missives.

Our team believes that Snapchat may have been an outsized beneficiary of herding.  In our view, many investors are creating narratives to justify a valuation we believe is simply untenable. The stalling of the stock in the last few months may point to an opportune time to sell.”Kailash Concepts

Snapchat Investos Stock

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Technical Value Scorecard Report – Week Ending 11-26-21

Relative Value Graphs

  • Most sectors and factors/indexes remain oversold versus the S&P 500. As we noted last week, the analysis continues to pick up on the market’s bad breadth. Of note, communications are grossly oversold and are due for a bounce on a relative basis versus the index.
  • Financials beat the S&P 500 by over 2.5% last week, bringing its score from moderately oversold to fair value. Powell’s renomination, and the likely continuation of bank-friendly monetary policy, seem to be driving the outperformance. Energy beat the S&P 500 by over 5%, but its score only modestly improved to fair value. Why did financials improve so much but not energy? The technical analysis in this study uses multiple periods. Accordingly, while the past week of price activity matters, the prior weeks also significantly influence, especially the periods that drop out of the underlying analysis comprise the score.
  • Discretionary and technology took it on the chin over the past few days, and their scores fell slightly, albeit they remain overbought.
  • Developed international markets are grossly oversold versus the S&P 500 and likely due for a relative bounce.
  • The third table below highlights the consistent poor relative performance of the communications sectors over the last six months and the solid relative outperformance for discretionary over the same period.

Absolute Value Graphs

  • While most sectors are oversold on a relative basis, they remain overbought on an absolute basis. Communications is the only sector in oversold territory. Discretionary and technology, with scores over 75% last week, both fell to more moderate overbought levels.
  • Real estate (XLRE) is now the most overbought sector, followed closely by many sectors with similar scores.
  • Emerging markets and developed international markets are the two most oversold sectors. Developed markets are only slightly oversold compared to its very oversold relative score.
  • The bond scores show mortgages (MBB), corporate junk (HYG), and investment-grade corporates (LQD) are all oversold. Credit has been underperforming, which is another type of bad market breadth. The fourth graph below shows the concerning divergence between junk and the S&P 500. Whether or not you are interested in bonds, credit spreads at times foreshadow equity weakness.
  • The S&P score in the bottom right graph is overbought, but in line with where it has been the majority of the last year.  

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60, the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs,” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

The NASDAQ Is On A Losing Streak

The NASDAQ was lower by over one percent at lunchtime but cut its losses in half toward the end of Tuesday’s trading. Had it held on to its losses, mimicking Monday’s 1% decline, it would be only the third time such a losing streak occurred in 2021. The black vertical lines below show the two times the NASDAQ fell by more than 1% in two consecutive days. The technology bull market of 2021 is a force to be reckoned with.

The NASDAQ and technology stocks are putting pressure on the S&P 500, yet most other stocks kept the S&P 500 in the green. Sound familiar? Last week the S&P was higher with a large majority of stocks lower, except the technology sector.

NASDAQ
Daily Market Commnetary

What To Watch Today

Economy

  • 7:00. a.m. ET: MBA Mortgage Application, week ended Nov. 19 (-2.8% during prior week)
  • 8:30 a.m. ET: Initial jobless claimsweek ended Nov. 20 (260,000 during prior week)
  • 8:30 a.m. ET: Continuing claims, week ended Nov. 13 (2.033 expected, 2.080 million during prior week)
  • 8:30 a.m. ET: Advance Goods Trade Balance, October (-$95 billion expected, -$96.3 billion during prior week)
  • 8:30 a.m. ET: Wholesale Inventories, month-over-month, October preliminary (1% expected, 1.4% expected)
  • 8:30 a.m. ET: GDP annualized, quarter-over-quarter, 3Q second estimate (2.2% expected, 2.0% in 2Q)
  • 8:30 a.m. ET: Personal consumption, 3Q second estimate (1.6% expected, 1.6% in 2Q)
  • 8:30 a.m. ET: Core PCE, quarter-over-quarter, 3Q second estimate (4.5% expected, 4.5% in 2Q)
  • 8:30 a.m. ET: Durable goods orders, October preliminary (0.2% expected, -0.3% in September)
  • 8:30 a.m. ET: Durable goods orders excluding transportation (0.5% expected, 0.5% in September)
  • 8:30 a.m. ET: Capital goods orders, non-defense excluding aircraft, October preliminary (0.5% expected, 0.8% in prior print)
  • 8:30 a.m. ET: Capital goods shipments, non-defense excluding aircraft, October preliminary (0.5% expected, 1.4% in prior print)
  • 8:30 a.m. ET: Personal income, October (0.2% expected, -1.0% in September)
  • 8:30 a.m. ET: Personal spending, October (1.0% expected, 0.6% in September)
  • 8:30 a.m. ET: PCE Deflator, month-over-month, October (0.7% expected, 0.3% in September)
  • 8:30 a.m. ET: PCE Deflator, year-over-year, October (5.1% expected, 4.4% in September)
  • 8:30 a.m. ET: PCE Core Deflator, month-over-month, October (0.4% expected, 0.2% in September)
  • 8:30 a.m. ET: PCE Core Deflator, year-over-year, October (4.1% expected, 3.6% in September)
  • 10:00 a.m. ET: University of Michigan Sentiment, November final (67 expected, 66.8 in October)
  • 10:00 a.m. ET: New home sales, October (800,000 expected, 800,000 in September)
  • 2:00 p.m. ET: FOMC meeting minutes, November meeting

Earnings

  • 6:45 a.m. ET: Deere & Co. (DE) to report adjusted earnings of $3.88 on revenue of $10.48 billion 

Is A Jerome Powell Second Term A Bad Thing For Markets?

Jerome Powell Fed

Nasdaq Correction In Progress

We discussed over the last week or so that while investors were exceedingly bullish on the potential for a year-end “Santa Claus” rally, a correction was likely first. That correction is likely starting in the Nasdaq. As shown, with Nasdaq volatility rising, there is a risk of a deeper correction in Technology stocks near term as mutual funds sell to distribute large gains for the year.

The War on Oil Prices

President Biden is ordering the Department of Energy to release 50 million barrels of oil from the Strategic Petroleum Reserve. The action is in unison with China, India, Japan, Korea, and the U.K. Per the announcement:

“The President stands ready to take additional action, if needed, and is prepared to use his full authorities working in coordination with the rest of the world to maintain adequate supply as we exit the pandemic.”

What’s Wrong With Gold?

A reader asked us why gold fell over $40 an ounce on Monday. While some media outlets ascribe it to Powell’s nomination, the real answer lies in the two charts below. The first chart, from our article The Fed’s Ever-Growing Footprint, shows the strong correlation between the price of gold and real interest rates (nominal interest rates less the implied inflation rate). Gold prices often rise when real rates fall and vice versa. The second graph, courtesy of Zero Hedge, shows real rates (green) have risen about 20bps (from -1.20% to -1.00%) from midday Friday through Monday. The sharp increase is due to the 10-year break-even inflation rate (red) falling and bond yields rising.

gold real yields
real yields inflation

Will Bond Bears Be Proven Wrong, Again?

Short interest in bond futures is currently at or near record highs. Given the inflation outlook and the Fed’s lethargic response to combatting inflation, shorting bonds may seem like a nice trade. It may be, but context is valuable in this case. The graph below from Jim Bianco shows professional forecasters have been consistently wrong in predicting the path of bond yields. Those short bond futures better hope this time is different.

Treasury interest rates

Reminiscent of 1999

We stumbled upon the table below highlighting market performance by sector in the months leading to the NASDAQ crash in 2000. It looks awfully familiar to the poor breadth of the last few days of trading.


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Did Jerome Powell Just Mark The Market Top?

President Biden renominated Fed Chairman Jerome Powell for another four years as the head of the Federal Reserve. Jerome Powell is proving to be one of the more dovish members of the Fed, so his leadership warrants investor optimism that the Fed will continue to run exceedingly easy monetary policy. Despite a red day in the markets, JP Morgan, Goldman Sachs, and Bank of America are all up around 2% on the news. The Fed’s actions under Powell have and will likely continue to be bank-friendly.

Just as a reminder, in case you forgot, there is a high correlation between the Fed’s easy money policies and the market. With Jerome Powell on course to taper the balance sheet and hike rates, will his renomination mark the peak?

Daily Market Commnetary

What To Watch Today


Economy

  • 9:45 a.m. ET: Markit U.S. Manufacturing PMI, November preliminary (59.1 expected, 58.4 in October)
  • 9:45 a.m. ET: Markit U.S. Services PMI, November preliminary (59.0 expected, 58.7 in October)
  • 10:45 a.m. ET: Richmond Fed Manufacturing Index, November (11 expected, 12 in October)

Earnings

Pre-market

  • 6:45 a.m. ET: Burlington Stores (BURLto report adjusted earnings of $1.30 on revenue of $2.23 billion
  • 7:00 a.m. ET: Best Buy (BBY) to report adjusted earnings of $1.96 on revenue of $11.69 billion
  • 7:30 a.m. ET: Dick’s Sporting Goods (DKSto report adjusted earnings of $2.00 on revenue of $2.51 billion
  • 7:30 a.m. ET: Dollar Tree (DLTR) to report adjusted earnings of 95 cents on revenue of $6.44 billion
  • 8:00 a.m. ET: American Eagle Outfitters (AEOto report adjusted earnings of 61 cents on revenue of $1.23 billion

Post-market

  • 4:05 p.m. ET: Nordstrom (JWNto report adjusted earnings of 55 cents on revenue of $3.48 billion
  • 4:05 p.m. ET: Autodesk (ADSKto report adjusted earnings of $1.26 on revenue. of $1.12 billion
  • 4:05 p.m. ET: HP Inc (HPQ) to report adjusted earnings of 88 cents on revenue of $15.43 billion
  • 4:15 p.m. ET: VMWare (VMW) to report adjusted earnings of $1.54 on revenue of $3.12 billion
  • 4:15 p.m. ET: The Gap (GPS) to report adjusted earnings of 50 cents on revenue of $4.42 billion
  • 4:25 p.m. ET: Dell Technologies (DELLto report adjusted earnings of $2.23 on revenue of $26.81 billion

Economic Surprises Are Improving Which Supports The “Santa Rally”

The Citi Economic Surprise index finally turned positive after a very long stretch of disappointment. Such should be supportive, near term, of a market advance. (Such does not rule out short-term corrections along the way.) However, the improvement could be short-lived as we get into 2022 and liquidity begins to slow globally.

Citi Economic Surprise Index vs SP500 6mo ROC

Jerome Powell’s “Consigliere” Tells The World The Dollar Is Going Up

Below is an excerpt from TS Lombard on the implications from Richard Clarida’s last speech. (Courtesy of @themarketear)

  • Readies world for tightening by reminding all the Fed is the US central bank
  • Only way for policy to slow inflation is through strong dollar first
  • Deflation from China stayed the Fed in 2015/16, we see a repeat in 2022

The only way for the Fed to counter this inflation, without damaging the recovery and, more importantly, the equity market, is to ramp up the dollar. Rhetoric about raising the Fed funds rate, supported by accelerating the taper, accomplishes this goal.” – @themarketear

US Dollar

“China matters a lot to the 2022 outcome, and the downside risk is greater than what markets are pricing. Last, but not least, while ramping the dollar is the only route for the Fed to counter current inflationary risks, a strong dollar policy is not aligned with Administration aims.” – Steve Blitz

By the way, remember that the previous rationalization for buying overvalued equities was the WEAKNESS of the dollar.

dollar vs stocks

Rivian Is Falling Out of Favor

Last week’s favorite EV automobile company, Rivian (RIVN), is taking it on the chin. Today shares are down more than 10% as its plans to develop cars jointly with Ford (F) have been canceled. The stock has lost a third of its value in the last few days, yet is still up 14% since its November 11th IPO. Ford is up over 5% today on the news. Also helping Ford’s shares are rumors they may split off their electric car division.

rivian rivn

Is There Any Upside Left?

S&P 500 bull market

Powell Renominated

U.S. Federal Reserve Chair Jerome Powell is being renominated by President Biden for a second four-year term. The runner-up for the seat, Lael Brainard, is the new Vice-Chair. The initial reaction from the stock futures market is bullish. The asset markets and betting markets had high odds for his renomination.

Gamma Band Update

stock options gamma

Leverage At The Largest Pension Fund

As we write below, the use of leverage by retail investors is up sharply. Similar behaviors are occurring by many institutional investors, including the more conservative types. The following comes from David Robertson and Almost Daily Grant’s

“Facing a high bar to generate necessary returns within the confines of public markets, the largest pension fund in the United States tweaks its own strategy in the opposite direction.  The California Public Employees Retirement System (Calpers) voted in a board meeting yesterday to upsize its allocation to private equity holdings to 13% from 8% and bump private credit holdings to 5% from less than 1%, while adding $25 billion in leverage (equivalent to just over 5% of assets) to help juice returns. Without those changes, Calpers estimates that its portfolio would generate a 20-year return of 6.2% annually, lagging the 6.8% annual bogey established this summer, which was itself lowered from 7%.”

David’s summation- “To sum up, the largest pension fund in the country is not only increasing allocations to the riskiest assets at the most expensive valuations in history, but it is also taking on debt to boost returns even more.”

Leverage Galore

The graph from Top Down Charts below shows that investors’ participation in leveraged long ETFs has tripled since the pandemic. Due to zero interest rates, the cost of leverage has never been cheaper for the ETF managers and ultimately the investors. However, if the Fed gets closer to raising interest rates the cost of leverage will rise in anticipation. This may be a fly in the bull market’s ointment, but likely a story for next year, not this year.

Leveraged ETFs

The Week Ahead

Despite the Thanksgiving holiday, it will be a busy week for economic data releases. Of note are Existing and New Home Sales, PMI Manufacturing Survey, Durable Goods, GDP Price Index, and Personal Income and Spending. The Fed will also release the minutes from its November meeting on Wednesday.

Economic calendar

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Santa Claus Rally Is Coming, But Will Markets Correct First?

Investors have high hopes for the annual “Santa Claus” rally. But, could there be a correction before “Santa visits Broad and Wall?”

At the moment, investors are “making their list, and checking it twice.” Sure, prices remain near all-time highs, but the Fed is remaining accommodative (at least for now.) Earnings remain very “nice,” and the market largely views “pandemic” related risks largely priced in.

Yes, inflation is “naughty,” but the market seems convinced it will be transient. Furthermore, companies seem to be able to pass costs along to consumers, at least for now. Hopes are high that profit margins will continue to be strong, and eventually, earnings will catch up to valuations.

Investors’ “wish lists” are hung by the chimney with care, hopeful the “Santa Claus rally” will soon be there. While they remain “snug in their beds, the historical data dances in the heads.” The chart below from @themarketear shows the annual “seasonality” from 1985 through 2019.

Seasonality for santa claus rally.

It certainly seems there is little to worry about.

However, notice that dip at the beginning of December.

Mutual Fund Distributions Come First

Before “Santa Claus” comes to visit “Broad and Wall” mutual funds distribute their capital gain, dividends, and interest income for the year. These distributions start in late November, but a large number of distributions occur in the first two weeks of December.

Every year, I get large numbers of emails from individuals confused by the sharp decline in their funds. To wit:

“Lance, I don’t understand what happened to my fund. Yesterday, the fund was trading at $10.54 per share, and today it is at $9.78. There is no news to account for decline.

There is nothing wrong with the mutual fund. They made their annual distribution. In this case, it was capital gains and dividend income.

When the distribution occurs, the fund price is immediately impacted. However, in a day or so, you will receive either additional fund shares or a cash deposit. Such depends on how you have elected to take your distributions. Yes, on the date of distribution you will see your portfolio value decline by the amount of the distribution. But when that distribution is received and credited, your value will return to normal.

There is no need to panic.

However, there is potentially a negative impact on the market. Such is particularly the case when volumes are weak, liquidity is low, and breadth is poor. As shown, during the entire advance from the September lows, the volume declined. Importantly, over the last week, breadth deteriorated.

sp500 technical chart breadth

The problem is that “for every seller, there must be a buyer.” The chart below shows where volume exists at various price levels.

Sp500 technical chart volume at price

When mutual funds start making distributions, buyers appear to be “living” closer to the 50-dma (orange dashed line.)

As the Wall Street axiom goes: “Sellers live higher. Buyers live lower.”

Let The Market Tell You

There are more than just a few caveats to this analysis, both bullish and bearish.

  • From the bullish perspective, sentiment remains optimistic, momentum is strong, and speculation is rampant. Such can certainly keep stocks elevated in the near term.
  • From a bearish view, valuations, inflation, and the Fed remain challenges. However, while these broader factors tend to play out over longer periods, they provide the “fuel” for an exogenous catalyst. Such could be a spike in interest rates, a more hawkish Fed, or an expected battle over the “debt ceiling.”

However, picking one side over the other leaves you exposed to the unexpected. Therefore, the best approach is to let the market “tell you.”

Such is our approach. As noted in this past weekend’s newsletter:

“Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities (F, NVDA, AMD). We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

Portfolio allocation

The RIAPro Technical Chart, suggests caution. The market is well extended above its 50-dma, is overbought, and the MACD “sell signal” suggests the risk is elevated.

sp500 technical chart

If the market breaks above the current consolidation, a move higher is likely, suggesting an increase in equity exposure. However, from current levels, any advance would remain limited.

The best opportunity would come from a correction in early December providing a better entry point for the “Santa Claus Rally.”

There Are No Guarantees

Does any of this mean the market will correct with absolute certainty? Of course, not. The one thing the market does well is doing exactly the opposite of what you would expect.

However, there is a strong likelihood with the market trading weak already, any additional selling pressure from mutual fund distributions could pressure prices short-term. It is a risk at least worth considering if you are looking for a better entry point.

The good news is that if “Santa does visit Broad and Wall,” the January effect has a greater degree of potential success. Of course, there is no guarantee of that either, but historical odds are strong that momentum will carry through

However, beyond that in 2022, I don’t have a clue. Currently, Wall Street analysts are optimistic with Goldman Sachs predicting the S&P to hit 5100 next year. Anything is possible, but when looking at the market on a longer-term basis, with earnings and economic growth likely peaking, I am a bit more sanguine on outcomes.

A Stocking Stuffer

Since we have our “stockings hung by the chimney with care,” we can stuff them with a few essential investment guidelines to navigate as we head into year-end.

  • Investing is not a competition. There are no prizes for winning but there are severe penalties for losing.
  • Emotions have no place in investing.You are generally better off doing the opposite of what you “feel” you should be doing.
  • The ONLY investments that you can “buy and hold” are those that provide an income stream with a return of principal function.
  • Market valuations (except at extremes) are very poor market timing devices.
  • Fundamentals and Economics drive long-term investment decisions – “Greed and Fear” drive short-term trading. Knowing what type of investor you are determines the basis of your strategy.
  • “Market timing” is impossible– managing exposure to risk is both logical and possible.
  • Investment is about discipline and patience. Lacking either one can be destructive to your investment goals.
  • There is no value in daily media commentary– turn off the television and save yourself the mental capital.
  • Investing is no different than gambling– both are “guesses” about future outcomes based on probabilities.  The winner is the one who knows when to “fold” and when to go “all in”.
  • No investment strategy works all the time. The trick is knowing the difference between a bad investment strategy and one that is temporarily out of favor.

While we are certainly anxiously anticipating the arrival of the “Santa Claus Rally,” we are also must remember the lesson taught to us in 2018.

Nothing is guaranteed.

Viking Analytics: Weekly Gamma Band Update 11/22/2021

The S&P 500 (SPX) reached all-time highs again on Friday, and the gamma flip level at the end of the week rose to 4,650. As long as we remain above this level, this model will maintain a 100% allocation to SPX. Monthly option expiration days are shown below by the vertical dashed lines.

The Gamma Band model[1] is a simplified trend following model that is designed to show the effectiveness of tracking various “gamma” levels. This can be viewed conceptually as a risk management tool. When the daily price closes below Gamma Flip level, the model will reduce exposure to avoid price volatility and sell-off risk. If the market closes below what we call the “lower gamma level” (currently near 4,460), the model will reduce the SPX allocation to zero.

The main premise of this model is to maintain high allocations to stocks when risk and corresponding volatility are expected to be low.  For investors who have been conditioned to “buy low and sell high,” it is counter-intuitive to increase allocations when the market rises, but this approach has shown to increase risk-adjusted returns in the back-test.  

The Gamma Band model is one of several indicators that we publish daily in our SPX Report (click here for a sample report).  

With stocks climbing to historically high valuations, risk management tools have become more important than ever to manage the next big drawdown. We incorporate many options-based signals into our daily stock market algorithms. Please visit our website to learn more about our trading and investing tools.

The Gamma Flip – Background

Many market analysts have noted that daily volatility in the S&P 500 will change when the value of the SPX moves from one gamma regime to another.   Some analysts call this level the “gamma flip.”  The scatterplot below shows how price volatility (on the y-axis) is increasingly lower as the value of SPX rises higher above the Gamma Neutral level (on the right side of the chart).  When the value of the S&P closes lower than Gamma Neutral (to the left of the chart), volatility increases. 

Gamma Band Model – Background

The purpose of the Gamma Band model is to show how tail risk can be reduced by following a few simple rules.  The daily Gamma Band model has improved risk-adjusted returns by over 60% since 2007.  The graph below demonstrates how this approach can limit drawdowns while maintaining good returns.  A quick video introduction of the Gamma Band model can be seen by following this link

Disclaimer

This is for informational purposes only and is not trading advice.  The information contained in this article is subject to our full disclaimer on our website.

[1] The Gamma Band model in our SPX Market Report adjusts position size DAILY based upon the daily closing levels of SPX value and calculated Gamma Neutral.  The Weekly Gamma Band model is shown for illustrative purposes only.

Authors

Erik Lytikainen, the founder of Viking Analytics, has over twenty-five years 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.

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 Euro Tumbles as Covid Cases Surge

The Euro continues to tumble versus the dollar as Covid cases in Europe are spiking. Austria declared they are going into lockdown and mandating vaccines. Other nations will likely follow. The euro was already struggling versus the dollar as their central bank seems much less willing than the Fed to reduce monetary stimulus. The resulting stronger dollar will help temper inflation, especially on imported commodities. Crude oil is lower by another $2 while bond yields fall, partially as a result of the stronger dollar.

Fed Vice Chair Richard Clarida echoed other Fed members calling for the Fed to discuss a “faster taper” at the December FOMC meeting. While he had a softer tone than some other Fed members, Clarida is clear the economy is robust and the Fed should consider speeding up the removal of monetary stimulus.

Daily Market Commnetary

What To Watch Today

Economy

  • 8:30 a.m. ET: Chicago Federal Reserve National Activity Index, October (-0.13 in September)
  • 10:00 a.m. ET: Existing home sales, October (6.20 million expected, 6.29 million in September)

Earnings

  • 4:05 p.m. ET: Agilent Technologies (A) to report adjusted earnings of $1.18 on revenue of $1.66 billion
  • 4:05 p.m. ET: Zoom Video Communications (ZMto report adjusted earnings of $1.10 on revenue of $1.02 billion

Market Consolidates Gains Near Highs

The FOMO is back. Previously, we discussed the speculative nature of the market, from record call option activity to historical highs in equity allocations. However, such occurs when the Fed is tapering bond purchases, futures are predicting three rate hikes, and inflation is surging.

There seems to be nothing that can derail this “freight train.” Consequently, such is usually about the time something happens. For now, we are maintaining our equity exposure as the consolidation of October’s advance continues. As shown, our biggest concern has been the absolute lack of volume during the recent advance.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

Notably, downturns in breadth were previously often aligned with market corrections. It is the flood of money into FAANG stocks keeping the markets elevated. So, while the lack of breadth in the short-term may not seem problematic, in the longer term, it likely will be.

As Bob Farrell quipped:

“Investors tend to buy the most at the top, and the least at the bottom.”

More Bad Breadth

The graph below shows that despite the NASDAQ hitting new highs, the number of new lows is now the highest since March of 2020.

nasdaq bad breadth

Faster Taper

The more hawkish Fed members are finally expressing their views and it seems they want to speed up tapering. For instance, Fed President Chris Waller said:

“The rapid improvement in the labor market and the deteriorating inflation data have pushed me towards favoring a faster pace of tapering and a more rapid removal of accommodation in 2022.”

A “more rapid removal of accommodation” implies raising interest rates. He also mentions the Fed should consider “contracting its balance sheet“, aka selling bonds. As noted in this past weekend’s newsletter:

“The “stability/instability paradox” assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

Unfortunately, such has never been the case.

The "FOMO", The “FOMO” Rises As Investors Push Risk Bets 11-19-21

What’s Ailing Europe?

Covid infections are on the rise in Europe and we are now learning Austria is going on a full lockdown. We suspect other European nations may follow their lead. The Euro has traded poorly over the last week, in part due to the rising number of infections and their economic implications. As we show below, the Euro/USD is down about 4% since the start of the month. More importantly, it has fallen about 10% versus the dollar since early June. Europe’s economy is not rebounding as strongly as the U.S. which helps explain part of the underperformance. As a result, the ECB has been more dovish (if that’s possible) than the Fed.

This morning ECB President Christine Lagarde essentially ruled out rate hikes in 2022. Per her speech- “conditions to raise rates are very unlikely to be satisfied next year.” Currently, the Fed’s “dot plots” call for one rate hike next year. The markets see as many as three hikes.

Euro USD dollar

Technical Value Scorecard

S&P 500 sector analysis

Buybacks > Investments

The Bloomberg graph below shows that the stocks spending the most on buybacks (orange) are outperforming the S&P 500 (white). The chart also shows that companies investing the most in R&D and Capex are considerably lagging the market. Investors should be concerned that the companies investing the most into their future are essentially being punished. Slowing productivity growth is a big factor limiting future economic growth. This chart highlights the personal incentive for most executives with equity-based salaries to buy back stock instead of engaging in productive investments.

stock buybacks capex

Covid Infections are Spiking Again in Europe

The graph below from Longview Economics shows that Covid infections in many European countries are rising rapidly and in some cases at the highest levels since the pandemic began. The sharply increasing number of cases will likely result in lockdowns in Europe, which will stunt economic activity in Europe and to a much lesser degree worldwide. The big question for U.S. investors is will the high rate of infections spread across the Atlantic? Further, the euro versus the dollar has been declining rapidly. If the high rate of infections continues and European economic growth suffers, will the dollar continue to appreciate versus the euro?

Covid europe

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Fed “Taper” Is Good News For The Bond Market

Investors are fretting over the prospect of a “Fed Taper,” but history shows such will likely be good news for the bond market. Currently, it doesn’t seem that way, with rates rising post-announcement. As noted by CNBC:

“While the Fed has gone into policy retreat before, it has never pulled back from such a dramatically accommodative position. For the past eighteen months, it bought at least $120 billion of bonds each month, Such provided unprecedented support to financial markets that it now will walk back.

The bond purchases have added more than $4 trillion to the Fed’s balance sheet which now stands at $8.5 trillion. Roughly, $7 trillion of which is the assets bought up through the Fed’s quantitative easing programs. The purchases helped keep interest rates low. Such provided support to markets that malfunctioned badly during the pandemic, and fueled a powerful run for the stock market.”

Previously, when the Fed began to taper their bond-buying programs, the market buckled as the “risk-on” trade reversed.

Fed taper balance sheet market

As was the case previously, Wall Street analysts quickly assumed that this time would be different despite the previous debacles.

“When Federal Reserve officials talked about pulling back on accommodative policies in 2013, anxious investors sent markets into a tizzy.

The opposite is happening now: The Fed signaled it started discussions of reducing bond-purchase programs. Investors, however, remain placid. The markets, in short, are taking everything in stride.” – WSJ

That is the case for now. Now let’s take a look at how the potential impact of the Fed’s announcement to taper may possibly be good news for the bond market.

Global Liquidity Is Slowing

While Wall Street is eternally optimistic, there are two problems with the view the Fed can cut liquidity without consequence.

To begin with, it isn’t just the Fed cutting liquidity. Liquidity globally, from both Central Banks and Governments, has started reversing heading into 2022.

The hope, of course, is the economy is now strong enough to “stand on its own” without ongoing support. But, as discussed in “Reversion To The Mean,” economic growth is already falling well below expectations.

Over the next few quarters, the year-over-year comparisons will become much more challenging. Q2-2021 will likely mark the peak of the economic recovery.

GDP annual change

During each previous QE cycle, as soon as the liquidity flows slowed or stopped, undesired outcomes were close by.

Awaken The Bond Bull

The recent “pop” in rates, when the Fed announced they will taper bond purchases, was not surprising. Such is the expectation if one of the primary sources of bond-buying is getting removed.

“In theory, tapering should lead to higher interest rates. By tapering its bond purchases, the Fed is increasing the supply that must get absorbed by the market. Such signals that policy is becoming less accommodative.” – Schwab

However, over the last decade, a reversal in Fed policy has repeatedly provided bond-buying opportunities. In the past, rates rose during QE programs as money rotated out of the “safety of bonds” back into equities (risk-on.).

When those programs ended, rates fell as investors reversed their risk preferences.

Fed Taper QE and Interest Rates bond market

As the Fed begins tapers, investors’ risk preferences will change as liquidity wanes. There are three reasons such will be the case.

  1. All interest rates are relative. With trillions in global debt globally sporting negative interest rates, the assumption that rates in the U.S. are about to spike higher is likely wrong. Higher yields in U.S. debt attracts flows of capital from countries with negative yields which push rates lower in the U.S.
  2. The coming budget deficit balloon. Given the lack of fiscal policy controls, and promises of continued largesse, the budget deficit will swell beyond $4 Trillion in coming years. Such will require more government bond issuance to fund future expenditures.
  3. Central Banks will continue to be a buyer of bonds to maintain market stability, but will become more aggressive buyers during each recession.”

With the current Administration and the Treasury pushing the idea of more government spending, the budget deficit is already rising, with economic growth running well below expectations. Such will foster more, not less, demand for bonds in the future and this is potentially good news for the bond market. 

Bonds May Outperform

Here is the primary point. While market punditry continues to push a narrative that “stocks are the only game in town,” such will likely turn out to be poor advice. But that is the nature of a media-driven analysis with a lack of historical experience or perspective.

From many perspectives, the absolute risk of the heavy equity exposure in portfolios gets outweighed by the potential for further reward. The realization of “risk,” when it occurs, will lead to a rapid unwinding of the markets pushing volatility higher and bond yields lower. Such is why we continue to acquire bonds on rallies in the markets to hedge against a future market dislocation.

Household equity ownership versus stock market and fed taper

In other words, we get paid to hedge risk, lower portfolio volatility, and protect capital. Bonds aren’t dead. In fact, they are likely going to be your best investment in the not too distant future.

In the short term, the market could surely rise further, especially if the Fed continues reinvesting the proceeds from their balance sheet. Such is a point I will not argue as investors are historically prone to chase returns until the very end. But over the intermediate to longer-term time frame, the consequences are entirely negative.

As my mom used to say:

“It’s all fun and games until someone gets their eye put out.”

FOMO Rises As Investors Push Risk For Gains

In this 11-19-21 issue of “FOMO Rises As Investors Push Risk For Gains.”

  • Market Consolidates Gains Near Highs
  • FOMO Is Evident As Investors Chase Returns
  • The Next Financial Crisis
  • Portfolio Positioning
  • Sector & Market Analysis
  • 401k Plan Manager

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Market Consolidates Gains Near Highs

FOMO is back. Previously, we discussed the speculative nature of the market, from record call option activity to historical highs in equity allocations. However, such occurs when the Fed is tapering bond purchases, futures are predicting three rate hikes, and inflation is surging.

There seems to be nothing that can derail this “freight train.” Consequently, such is usually about the time something happens. For now, we are maintaining our equity exposure as the consolidation of October’s advance continues. As shown, our biggest concern has been the absolute lack of volume during the recent advance.

Short-term technical chart

Furthermore, the MACD “sell signal” remains; however, the money flow signal is nearing oversold. Such suggests the market will likely remain weak near-term. As noted in Friday’s Daily Market Commentary (click the banner below to subscribe):

“Seasonality is strong this year as stocks push higher. However, note the first two weeks of December tend to sport a correction as Mutual Funds distribute capital gains for the year. That pullback would set up for the traditional rally to close out the year.”

FOMO keeps prices in seasonal trends.

The only concern we have is the lack of breadth as of late. As shown, the number of stocks above the 50-dma turned sharply lower this week. Furthermore, they are well below levels when markets typically make new highs. The same goes for the number of stocks trading above their 200-dma’s.

FOMO has bad breadth

Notably, downturns in breadth were previously often aligned with market corrections. It is the flood of money into FAANG stocks keeping the markets elevated. So, while the lack of breadth in the short-term may not seem problematic, in the longer term, it likely will be.

As Bob Farrell quipped:

“Investors tend to buy the most at the top, and the least at the bottom.”

But as stated, for now, it’s all about FOMO.


Daily Market Commnetary

FOMO Rises As Investors Chase Gains

Last week, we touched on some of the excesses building in the market as investors continue to pile into risk. To wit:

 The chart shows us that the S&P 500’s annualized return when the composite model was above 80% was a miserly -9.2%. When the model was above 85%, accounting for about 2% of all days since 1998, that return was a horrid -15.6%.”

Four major sentiment models show FOMO

With the market up 25% in 2021, investors have a more significant “Fear Of Missing Out,” or FOMO, than they do of losing money. Such speculative activity is apparent in the volume of inflows into leveraged ETFs to bolster market returns.

Levered ETF flows and FOMO investors.

During very late-stage bull markets, the speculative frenzy of investors to chase returns is not uncommon. At the peak of every bull market cycle in history, we witnessed the same. Furthermore, in recent decades, we can measure such exuberance by the magnitude of “leverage” individuals take on to chase markets.

margin debt versus free cash balances shows FOMO

Of course, the critical thing about “margin debt” is that it fuels the bullish advance. But, unfortunately, it also accelerates the market’s eventual decline as leverage reverses. Such is always a brutal and mauling event, which is why it is called a “bear market.”

The only question is what causes investor sentiment to switch from FOMO to GTFO (Get The $*^# Out!)



The Next Financial Crisis

While investors remain engulfed in FOMO, serious issues are brewing within the fundamental underpinnings of the market. In Seth Klarman’s famous book, “A Margin Of Safety,” he discussed the 1980’s bond mania before it imploded. That book today will cost you dearly.

Margin of safety Seth Klarman

At that time, many companies issued bonds even though they could not afford to pay the interest expenses. Today, such a company gets nicknamed a “zombie.” Such is when a company must feed on cheap debt to stay alive. Currently, the market capitalization of these zombie firms is at a record.

Total enterprise value with EBIT less than interest expense.
Chart courtesy of Kailash Concepts

The obvious problem is what happens if interest rates rise to a level where they cannot refinance their debt.

Unfortunately, as Kailash Concepts explains, debt itself is the problem.

“We don’t understand why others are not alarmed by an ‘anything goes’ attitude towards record levels of leverage where interest expense cannot be paid for by profits. Currently, the world is awash in financial alchemy.

Since 2007, a big part of America’s debt crisis has moved from the financial sector to non-financial stocks with too much debt. We believe the mix of record debt and record equity valuations is likely a side effect of real rates approaching lows last seen in 1973. Whether we are right or wrong on the causality, the facts are intimidating in our view.

Our research has documented that the world has never been less prepared or less equipped to deal with a possible outbreak of inflation or pull-back in Federal largess.

Debt crisis in American equities. A big shock to investors.

If interest rates rise, the Fed tightens monetary policy, or the economic recovery falters, the seeds for the next financial crisis have already gotten sown.


In Case You Missed It

Rising interest rates matter blog post

The Stability / Instability Paradox

Over the last decade, the Fed’s monetary policy trained investors to take on increasing levels of risk. Each crack in the “financial foundation” got met with monetary injections. Moreover, the “stability” provided by the Fed’s interventions bolstered investors’ FOMO.

Interestingly, the Fed is dependent on market participants believing in this idea. As noted above, with the entirety of the financial ecosystem more heavily levered than ever, the “instability of stability” is the most significant risk.

The “stability/instability paradox” assumes all players are rational and implies avoidance of destruction. In other words, all players will act rationally, and no one will push “the big red button.”

The Fed is highly dependent on this assumption. After more than 12-years of the most unprecedented monetary policy program in U.S. history, they are attempting to navigate the risks built up in the system.

Simply, the Fed is dependent on “everyone acting rationally.”

Unfortunately, such has never been the case.

Federal Reserve Funds Rate

The behavioral biases of individuals remain the most serious risk facing the Fed. Throughout history, the Fed’s actions have repeatedly led to adverse outcomes despite the best of intentions.

  • In the early 70’s it was the “Nifty Fifty” stocks,
  • Then Mexican and Argentine bonds a few years after that
  • “Portfolio Insurance” was the “thing” in the mid -80’s
  • Dot.com anything was a great investment in 1999
  • Real estate has been a boom/bust cycle roughly every other decade, but 2007 was a doozy
  • Today, it’s real estate, FAANNGT, debt, credit, private equity, SPAC’s, IPO’s, “Meme” stocks…or rather…”everthing.”

After the Fed inflated the most prominent financial bubble in history, they now want to reduce liquidity and hike interest rates.

They are hoping no one pushes the “big red button.”

“Only those that risk going too far can possibly find out how far one can go.” – T.S. Eliot



Portfolio Update

Given the more exceeding levels of FOMO in the market currently, we remain weighted towards equity risk. Therefore, from a portfolio management standpoint, we must continue to press for portfolio returns for clients. However, don’t mistake that as a disregard for the underlying risk.

Over the last two weeks, we took profits in overbought and extended equities. We also shortened our bond duration by trimming our longer-duration holdings. Such actions rebalanced portfolio risk short-term. In addition, we run a 60/40 allocation model for our clients; such left us slightly underweight equities and bonds and overweight cash.

As noted last week,

“In the meantime, we remain a bit more bullishly biased than we like. However, sometimes, being ‘uncomfortable’ is just part of the investment process.”

Such remains the case this week. For now, the bullish bias is strong. We are also in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

Those forces are powerful, and trying to fight them has been a futile and costly exercise. Such was a point made this past week as Michael Burry closed out all of his bearish positions. Furthermore, Russell Clark of Russell Clark Investment Management tagged the world’s most bearish hedge fund, shut down entirely.

We remain focused on the risk of what can, and will, eventually destroy unimaginable amounts of capital. However, we will continue to participate in markets while they are rising.

Just be aware we are sitting very close to the exit of this particular theatre.

“May The FOMO Be With You.”

Have a great weekend.

By Lance Roberts, CIO


Market & Sector Analysis

Analysis & Stock Screens Exclusively For RIAPro Members


S&P 500 Tear Sheet

SP500 Tear Sheet 112119

Performance Analysis

Index Sector Relative Performance Sheet 111921

Technical Composite

The technical overbought/sold gauge comprises several price indicators (RSI, Williams %R, etc.), measured using “weekly” closing price data. Readings above “80” are considered overbought, and below “20” are oversold. The current reading is 85.65 out of a possible 100.

Technical overbought sold composite FOMO

Portfolio Positioning “Fear / Greed” Gauge

Our “Fear/Greed” gauge is how individual and professional investors are “positioning” themselves in the market based on their equity exposure. From a contrarian position, the higher the allocation to equities, to more likely the market is closer to a correction than not. The gauge uses weekly closing data.

NOTE: The Fear/Greed Index measures risk from 0-100. It is a rarity that it reaches levels above 90. The current reading is 92.00 out of a possible 100.

FOMO Allocation Based Fear/Greed Index

Sector Model Analysis & Risk Ranges

How To Read This Table

  • The table compares each sector and market to the S&P 500 index on relative performance.
  • “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. (Ranges reset on the 1st of each month)
  • Table shows the price deviation above and below the weekly moving averages.
Risk Reward Ranges 111921 Show FOMO

Weekly Stock Screens

Currently, there are four different stock screens for you to review. The first is S&P 500 based companies with a “Growth” focus, the second is a “Value” screen on the entire universe of stocks, and the last are stocks that are “Technically” strong and breaking above their respective 50-dma.

We have provided the yield of each security and a Piotroski Score ranking to help you find fundamentally strong companies on each screen. (For more on the Piotroski Score – read this report.)

S&P 500 Growth Screen

Screen Growth Stocks SP500

Low P/B, High-Value Score, High Dividend Screen

Value based dividend screen

Fundamental Growth Screen

Fundamental Growth Screen

Aggressive Growth Strategy

Aggressive growth screen

Portfolio / Client Update

FOMO is in the air. As noted last week:

“It has been a stellar few weeks in the market. The speculative frenzy quickly returned to the market, and the fear of a correction has “gone with the wind.” However, as noted, the market is now back into more extreme overbought levels. Therefore, we have started taking profits in egregiously overbought positions.”

That process continued this week as we continued to rebalance risk accordingly. As noted in the main body of this week’s missive:

“The bullish bias is strong. We are in the “seasonally strong” period of the year, and the seemingly endless supply of money continues to flood into equities.

Those forces are powerful and trying to fight them has been a futile and costly exercise. Such was a point made this past week as Michael Burry closed out all of his bearish positions. Furthermore, Russell Clark of Russell Clark Investment Management, tagged the world’s most bearish hedge fund, shut down entirely.

We remain focused on the risk of what can, and will, eventually destroy unimaginable amounts of capital. However, we will continue to participate in markets while they are rising.”

Over the next few weeks, there are a couple of risks worth watching. Furthermore, Thanksgiving is traditionally a light trading week, which increases market volatility. However, the first two weeks of December will see the bulk of mutual fund distributions and rebalancing. Such could put downward pressure on the market.

Therefore, any decline will set the market up for the traditional “Santa Claus” rally over the next couple of weeks. Accordingly, we will look to position portfolios while still focusing on our risk controls.

Next year will likely be an entirely different “ball game.”

Portfolio Changes

During the past week, we made minor changes to portfolios. In addition, we post all trades in real-time at RIAPRO.NET.

*** Trading Update – Equity and Sector Models ***

“We previously put on a small volatility hedge in light of the record number of call options outstanding. At that time we said we would close out that hedge when those options expired. This more we sold the entire hedge of VXX at a small loss. Given that next week is Thanksgiving, and trading volumes will be exceptionally light, we are leaving the portfolios with a heavier weighting of cash to offset risk.” – 11/18/21

Equity & ETF Models

  • Sell 100% of the Volatility Index (VXX)

This morning news hit that Amazon (AMZN) would not be accepting Visa (V) credit cards issued in the U.K.  That news sent the stock immediately lower this morning violating all of our stop-loss levels. While we still have a small gain in the stock, we are selling the remaining shares in our portfolio. We are looking for a replacement in the space and are evaluating some candidates to add.” – 11/17/21

Equity Model

  • Sell 100% of Visa (V)

As always, our short-term concern remains the protection of your portfolio. Accordingly, we remain focused on the differentials between underlying fundamentals and market over-valuations.

Lance Roberts, CIO

Have a great week!

Technical Value Scorecard Report – Week Ending 11-19-21

Relative Value Graphs

  • On Thursday, the S&P 500 was up .40%, yet every sector was lower except technology. Such was not just a one-day anomaly. The breadth of the market has been poor for a couple of weeks. The third graph below shows that over the last ten days, technology is the only sector to outperform the S&P 500.
  • The top graph shows most sectors have negative/oversold scores. Financials, communications, and healthcare are the most oversold sectors. Technology with a score nearing 75% is moving into strongly overbought territory. As discussed below, its absolute score of 80% argues it is due for consolidation at best and more likely a period of underperformance.
  • The inflationary sectors tended to give up ground. As a result, our inflation-deflation index is again favoring growth and deflationary beneficiaries. The deflationary sectors, defined in the footnotes below, have given up over 5% to the growth sectors. Surprisingly, this is occurring as inflation readings, and expectations hit new highs.
  • All but two factors and indexes are oversold. Technology (QQQ) has a strong score (51%), although it certainly has room to become more overbought versus the S&P. After a nice run, small caps have given back 2.7% versus the S&P pushing its score back to fair value.

Absolute Value Graphs

  • Technology and discretionary are extremely overbought from an absolute perspective. We are not surprised as the FAANG stocks have led the market higher with significant contributions to the S&P 500. Communications is the only oversold sector yet not far from fair value.
  • The S&P 500 has a score of around 50%, putting it in overbought territory but not yet offering a strong sell signal.
  • The momentum factor (MTUM) has been improving as of late. The ETF has a curious mix of holdings. Tesla contributes over 8% to the ETF. The stock, which is recently lower, was on a tear. Next up are three financials (JPM, BAC, and BRK/B). As we noted earlier, financials, along with communications, are the most relatively oversold sectors. Financials are at fair value on an absolute basis with the second-lowest absolute score. We suspect holdings in the FAANG stocks will increase as a percentage of the ETF in the days ahead. In such a market where sector and style preferences rotate so quickly, can MTUM truly capture momentum? Our concern is that the holdings do not change fast enough and tend to reflect yesterday’s high momentum stocks.  

Users Guide

The technical value scorecard report is one of many tools we use to manage our portfolios. This report may send a strong buy or sell signal, but we may not take action if other research and models do not affirm it.

The score is a percentage of the maximum score based on a series of weighted technical indicators for the last 200 trading days. Assets with scores over or under +/-70% are likely to either consolidate or change the trend. When the scatter plot in the sector graphs has an R-squared greater than .60, the signals are more reliable.

The first set of four graphs below are relative value-based, meaning the technical analysis is based on the ratio of the asset to its benchmark. The second set of graphs is computed solely on the price of the asset. At times we present “Sector spaghetti graphs,” which compare momentum and our score over time to provide further current and historical indications of strength or weakness. The square at the end of each squiggle is the current reading. The top right corner is the most bullish, while the bottom left corner is the most bearish.

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
  • Inflation Index- XLB, XLE, XLF, and Value (IVE)
  • Deflation Index- XLP, XLU, XLK, and Growth (IWE)

FAANG Stocks Keep The S&P 500 Afloat

Thanks to the FAANG stocks, the S&P 500 and NASDAQ were higher on the day. AMZN (+4.15%), AAPL (+2.85%), and GOOGL (+1.22%) led the charge for the FAANG stocks. Most other stocks were not so lucky. The Dow, equal-weighted S&P (RSP), and the Russell 2000 closed in the red. As we show below, the market’s breadth was poor. 10 of the 11 S&P sectors were lower, and five of them fell by about half a percent or more. Further, two-thirds of S&P 500 stocks are down on the day despite a .35% gain. Bad breadth in an upward trending market can signal weakness ahead, so stay tuned.

S&P sectors FAANG
Daily Market Commnetary

What To Watch Today

Economy

  • No notable reports scheduled for release

Earnings

  • No notable reports scheduled for release

Seasonality Is Strong But Watch The First Two Weeks Of December

Seasonality has certainly held strong this year as stocks continue to push higher. As shown in the chart below, such bodes well for an end-of-the-year “Santa Claus Rally.” However, before we get these, note that the first couple of weeks of December tend to sport a correction as Mutual Funds distribute their capital gains, interest, and dividends for the year. That pullback will set the market up for the traditional rally to close out the year on a strong note.

Stock market seasonality

APPLE (AAPL) Surges To New Highs

Apple surged to new highs yesterday on the news they would enter the Electric Vehicle market by 2025. Of course, given the recent performance chase of other EV automakers, the surge was of no surprise.

Apple stock chart

However, the following note from @TheMarketEar brings up an interesting point about what has been supporting Apple’s stock price in recent years. Of course, this holds true for all of the FAANG stocks in particular.

Apple buyback commentary

In other words, Apple would not be trading at current levels, without the benefit of its massive stock buyback programs. Of course, given that 40% of the S&P 500’s advance since 2011 is from buybacks along, such should not be a surprise.

NVIDIA (NVDA) Earnings

NVDA GAAP EPS of $0.97 easily tops the consensus estimate of $0.86, thanks to strong demand and favorable product mix. Gross margins increased +2.6% YoY to reach 65.2% in the third quarter. Revenue of $7.1B (+50.1% YoY) modestly beat expectations of $6.8B. Revenue is driven by record sales in the Gaming (+42% YoY) and Data Center (+55% YoY) segments.

Management set guidance for Q4 revenue at $7.4B plus or minus 2%, above expectations of $6.9B. In addition, they guide for gross margin to remain steady at 65.3% plus or minus 50 bps. Investors love the report as the stock is trading +10%. We hold a 1.75% position in the Equity Model and have taken profits in it twice in the last month. NVDA is not a FAANG stock but certainly acted like one!

Charts courtesy of RIAPRO.NET

Nvidia NVDA technical study.
Nvidia NVDA analyst analysis

Higher Prices in Philly

The Philadelphia Fed Economic Survey, showing current economic conditions in the mid-Atlantic, points to robust activity. The index rose to 39, its highest level since April. Prices also continue to rise with the prices paid index rising to 80, just a hair below 80.7 in June, a 42 year high. A score of 80 means that 80% of those surveyed witnessed higher prices in November than October. Price received rose as well to its highest reading since 1974. The bottom line is that companies are paying more for input goods but can pass the higher costs to consumers.

The most important part of this survey is this month’s special question. Per the Fed:  In this month’s special questions, the firms were asked to forecast the changes in the prices of their own products and for U.S. consumers over the next four quarters. Firms are bracing for more inflation in the prices of goods they sell and higher wage expenses. More telling, their longer-term inflation forecast rose by half a percent to 3.5%.

Philadelphia Fed Philly

Are We Due For A Santa Claus Rally?

santa claus rally

Stocks are Expensive

The chart below from the Leuthold Group shows that stocks are extremely expensive by all measures except those that compare valuations to interest rates. The Fed model and the two equity risk premium valuations are relatively cheap because interest rates are so low. The problem we have with those models is that interest rates are so low in part because future economic growth and therefore earnings growth are also trending lower.

stocks are expensive

Infrastructure Spending Forecasts

The graph below from Moody’s shows net spending from the recently passed infrastructure bill and the current proposal for the social infrastructure bill. Currently, nominal GDP is over $23 trillion. If we assume the social bill passes, as it is currently written, additional government spending from both bills will peak in 2025 at about $150 billion. That amount would add approximately .60% to GDP. While somewhat meaningful, we must also consider net government spending from the two bills in aggregate decline in the years 2028 and beyond.

infrastructure spending bill

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