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Monthly Archives: September 2016

I get lots of questions from readers regarding the various technical indicators discussed in our “Technically Speaking” posts and in our weekly Real Investment Reports. While we often discuss the signals these technical signals are indicating, there are often questions involving exactly what these indicators are measuring.

Technical analysis is often dismissed by investors for three reasons:

  1. A lack of understanding of exactly what technical analysis is,
  2. An inability to properly apply technical analysis to portfolio management, and;
  3. The media narrative that “technical analysis” doesn’t work.

There is no “one method” of technical analysis that works for everyone. Every technician uses different methods, indicators, and time-frames for their own analysis. Much depends on your personal investment time frame, risk tolerance and investing behavior.

This article will be the first of several in an attempt to clearly define some of the more common technical indicators we use in our own portfolio management practice and how we apply them.

(Note: we will be providing our specific methods of technical analysis, indicators, etc., in our forthcoming premium section of Real Investment Advice. Click here for pre-subscription information.)

We are going to start our journey with the Relative Strength Index.

What Is RSI

Over the last few weeks, there have been numerous postings about the S&P 500 index and how it has hit a historically high reading on the RSI index. My friend Adam Koos recently posted:

“The first picture below is a weekly chart (or intermediate-term) look at momentum in the S&P 500. Just one week ago, I was posting on social media and explaining that there had only been two times in the last 6-plus decades that the market had been this overbought. Thanks to the second week of January, the market is more overheated today than it has been in more than 67 years!”

But actually, I will “one-up” Adam on this. This is not only the highest level for RSI on a “weekly” basis but also one of the highest levels on a “4-year quarterly” basis as well.

But exactly what is RSI and how is it calculated?

The relative strength index (RSI) is a “price” momentum indicator that measures the magnitude of recent gains and losses over a specified period of time. It is essentially a measurement of the “speed” of price gains, or losses. 

Why do we care about that?

As I have written previously:

Market crashes are an ’emotionally’ driven imbalance in supply and demand. You will commonly hear that ‘for every buyer, there must be a seller.’ This is absolutely true. The issue becomes at ‘what price.’ What moves prices up and down, in a normal market environment, is the price level at which a buyer and seller complete a transaction.

The problem becomes when the ‘buyer at a higher price’ fails to appear.”

The same goes for “buying stampedes” as well.

At some point, buyers and sellers reach a point of “exhaustion” or more commonly termed “overbought” or “oversold” conditions. This is simply the point at which buyers are unwilling to pay “higher” prices, or sellers are unwilling to accept “lower” prices. Historically, these “overbought” and “oversold” conditions have represented better “entry” or “exit” points for investment capital.

The relative strength index, or RSI, is calculated using the following formula:

RSI = 100 – 100 / (1 + RS)

Where RS = Average gain of up periods during the specified time frame / Average loss of down periods during the specified time-frame

RSI values range from 0 to 100.

Here is a table of the calculation used for the chart above.

The “average” number of periods, usually 14-days, can be any length of period chosen by the investor. The longer the “average” the “slower” the movement of the index. This is where it becomes important to “marry” the duration of the index to your investment horizon. Since our portfolios are “long-term” in nature, our example uses a 16-period quarterly chart (4-years).

Regardless of the “period” used, RSI values of 70 or above indicate that a security is becoming overbought or overvalued, and therefore may be primed for a trend reversal or corrective pullback in price. On the other side of RSI values, an RSI reading of 30 or below is commonly interpreted as indicating an oversold or undervalued condition that may signal a trend change or corrective price reversal to the upside.

RSI is a “tool” that can be used to help identify better entry or exit points for investor capital. However, like any tool, if used improperly it will provide poor results. It is for this specific reason that most investors deem “technical analysis” to be nothing more than “voodoo” and disregard it entirely. But should you?

The reason that technical analysis fails most investors is that their investment time horizon exceeds time-frame of the analysis. For example, most investors are investing capital to perform with the market over the forthcoming year which is why benchmarking” is so widely adopted. However, they then use very short-term, daily, technical analysis to manage their portfolio. This “duration mismatch” leads to technical signals that create “bad” entry/exit points for investors more commonly known as “whipsaws” or “head fakes.” 

In our own practice, our portfolios are designed for longer-term holding periods. Therefore, outside of short-term trading opportunities, we are more interested in the overall “trend” of the market. Our major concern is a more “major” change in the overall trend that could lead to large losses of capital during the portfolio investment horizon. This is why our focus is primarily on monthly and quarterly measures which provide a better “match” to our overall investment goals.

There Is Not Just One

There is no indicator that is an “absolute.” Since markets are driven largely by emotion, large price movements can create “false” buy or sell signals in the RSI, or any “price” based indicator. As Adam stated in his article:

“One can’t simply use a single metric to manage risk in their retirement portfolio. It takes a suite of indicators, observing them all in unison, and making buy and sell decisions based on the weight of the evidence at hand.”

This is why all indicators perform the best when:

  • Used in conjunction with other, confirming technical indicators,
  • Periods and duration are matched to investment horizons,
  • Combined with the overall investment discipline (buy/sell strategy), and;
  • Utilizes the K.I.S.S. principle (Keep It Simple, Stupid)

The two biggest problems, in my opinion, that investors run into when trying to implement technical analysis into their portfolio management are:

  1. They try and use too many different indicators which create contradicting signals which leads to investment “paralysis.”  Keep it simple. 
  2. A lack of a “buy” and “sell” discipline which corresponds to the technical signals being given. Any portfolio management process is only as good as the investor discipline to adhere to it. 

Currently, the RSI index is registering a level that has only been seen a few times previously throughout history. However, given the longer-term time frames of the indicators we use, these “warning” signals can take some time to “play out” within the markets.

I agree with Adam’s assessment that we are most likely headed for a 5-10% correction sometime this year which would be “healthy” for the markets and provide a “buying” opportunity for the time being. The problem is that it has been so long since investors have even seen a 2-3% correction, a correction of 5%, or more, will “feel” much worse than it actually is which will lead to “emotionally driven” mistakes.

But therein lies the real “value” of technical analysis.

Technical analysis IS NOT some “black box” approach to portfolio management. However, what technical analysis does provide is a method to extract “emotion” from the “buy/sell” process. For us, the fundamentals dictate WHAT we “buy” and “sell” in portfolios, but it is the technicals that drive the WHEN those decisions are implemented.

Over the coming months, we will exploure Bollinger Bands, Williams %R, Trendlines, and more. You may not agree with our methods, but it is what works for us in our process. I hope you find it useful to yours.

Over the past 18-months or so, I have written several articles on the potential for a “market melt-up,” which I updated in last week’s post “Market Bulls Target S&P 3000.” 

“With investors now betting on a sharp rise in earnings to reduce the current levels of overvaluation, there seems to be little in the way of the next major milestones for 30,000 on the Dow and 3000 on the S&P 500.”

Note: For more on earnings and expectations read this past weekend’s newsletter.

I made the point specifically that “bull-runs” are a one-way trip. 

Throughout history, overbought, excessively extended, overly optimistic bull markets have NEVER ended by going “sideways.”

Not surprisingly that article elicited quite a few emails and comments asking “what would be the ‘pin’ that pricks the current bubble.”

The true answer is I don’t know exactly what the catalyst will be.


However, while much of the media is currently suggesting that interest rates are about to surge higher due to economic growth and inflationary pressure, I disagree.

Economic growth is “governed” by the level of debt and deficits as I discussed this past weekend. Tax cuts only make that problem worse in the long-term. But as shown above, it isn’t JUST the government that is heavily leveraged – it is every single facet of the economy.

Debt has exploded.

(The chart below shows the combined totals of Government, Corporate, Household,  Margin and Bank debt – in BILLIONS.)

Which leads us to our chart of the day.

Chart Of The Day (COTD)

Each time rates have “spiked” in the past it has generally preceded a mild to severe market correction.

However, when the economy is as heavily leveraged as it is today, higher borrowing costs rapidly slow economic growth as rising interest burdens divert capital from consumption. As I laid out previously, interest rates impact everything.

1) The Federal Reserve has been buying bonds for the last 9- years in an attempt to push interest rates lower to support the economy. The recovery in economic growth is still dependent on massive levels of domestic and global interventions. Sharply rising rates will immediately curtail that growth as rising borrowing costs slows consumption.

2) The Federal Reserve currently runs the world’s largest hedge fund with over $4 Trillion in assets. Long Term Capital Mgmt. which managed only $100 billion at the time nearly brought the economy to its knees when rising interest rates caused it to collapse. The Fed is 45x that size.

3) Rising interest rates will immediately kill the housing market, not to mention the loss of the mortgage interest deduction if the GOP tax bill passes, taking that small contribution to the economy away. People buy payments, not houses, and rising rates mean higher payments.

4) An increase in interest rates means higher borrowing costs which lead to lower profit margins for corporations. This will negatively impact the stock market given that a bulk of the “share buybacks” have been completed through the issuance of debt.

5) One of the main arguments of stock bulls over the last 9-years has been the stocks are cheap based on low interest rates. When rates rise the market becomes overvalued very quickly.

6) The massive derivatives market will be negatively impacted leading to another potential credit crisis as interest rate spread derivatives go bust.

7) As rates increase so does the variable rate interest payments on credit cards.  With the consumer are being impacted by stagnant wages, higher credit card payments will lead to a rapid contraction in income and rising defaults. (Which are already happening as we speak)

8) Rising defaults on debt service will negatively impact banks which are still not adequately capitalized and still burdened by large levels of bad debts.

9) Commodities, which are very sensitive to the direction and strength of the global economy, will plunge in price as recession sets in.

10) The deficit/GDP ratio will begin to soar as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new forecasts begin to propel higher.

I could go on but you get the idea.”

Since interest rates affect “payments,” increases in rates quickly have negative impacts on consumption, housing, and investment which ultimately deters economic growth.

With “expectations” currently “off the charts,” literally, it will ultimately be the level of interest rates which triggers some “credit event” that starts the “great unwinding.”  

It has happened every time in history.

Given the current demographics, debt, pension and valuation headwinds, ten-year rates much above 2.6% are going to start to trigger an economic decoupling. Defaults and delinquencies are already on the rise and higher rates will only lead to an acceleration.

The problem with most of the forecasts for the end of the bond bubble is the assumption that we are only talking about the isolated case of a shifting of asset classes between stocks and bonds. However, the issue of rising borrowing costs spreads through the entire financial ecosystem like a virus. The rise and fall of stock prices have very little to do with the average American and their participation in the domestic economy.

Interest rates, however, are an entirely different matter.

Could rates go higher from here first? Absolutely.

But bonds will likely once again spend another decade, or so, outperforming stocks.

Want to exceed your financial goals? Understand your hurdle rate

The ringing in of a New Year brings a sense of hope for the future and closure of the past. It’s a time of reflection of past goals and habits and the ushering in of new, better behaviors.

In the financial planning and investment world, it’s very much the same. Advisors, wealth managers and clients are looking back at what went right or wrong and determining the next actionable steps for the new year.  Advisors and money managers should be doing this daily, but for most, unless you’re in the day-to-day dealings of the markets, this may be difficult. There is so much information out there, and the incessant talk of new highs can easily cloud one’s judgement.

As we’re meeting with clients and updating financial plans, a big part of assessing the prior year is looking at calendar year returns.

“How did we do versus the market?” is one of the most common questions. BUT, is it the right question?

I’d venture to say no unless your overall goal is to beat the market. For most, that’s not the case, and comparing your portfolio to the Dow is like comparing apples to bananas or oranges unless you’re only investing in a large cap blended portfolio.

We set hurdle rates.

A hurdle rate is the minimum return you need for a successful financial plan. In the majority of our cases, many clients’ hurdle rates are far below the actual average rate of return they experience in their portfolios. However, it’s not the market’s rate of return nor should it be. You see, if you want the market’s rate of return, you must take the good with the bad unless you employ a buy/sell discipline.  Most don’t have a strategy to exit the market, but we’ll save that for another time. When investing in an index fund you can’t get the actual index’s return with those pesky things called expense ratios or fees. We can’t forget there will also be times of prolonged poor performance. For example, if you invested in the S&P 500 from 2000-2010, it took you 10 years to get even, (we call it ‘the lost decade’.) You went in with $10,000 and you came out with $10,000.

When markets are this fully valued, there is bound to be something bad in the future, meaning prior years’ returns have pulled returns from the future. Yes, there will be a reversion to the mean, but knowing your hurdle rate will allow you to rebalance or take risk off the table after having a good year. Hence, prepare for a rainy day. I think we can all agree that’s not a bad idea.

When you’re determining your hurdle rate, there are many considerations to make. What type of sequence of returns are used? Is bad timing included, meaning what if you retire and the market drops the first two years? Does the plan inflate your expenses annually? What is the rate of return used? Sometimes advisors will make things look a lot better than they are simply to earn your business. That is not the way we conduct business, but it occurs.

What type of risk can you handle?

This is extremely important, but often glazed over with a “look at these long-term returns” says the broker.

That’s great, but what if you retire right before or in the middle of a downturn? Can you push through and work longer? Will your company keep you around? Will your health hold up? Can you wait out the recession? The last big recession took many investors 4-6 years just to get back to even without considering any fees or distributions from your portfolio.

What type of risk will not keep you up at night, but still give you the returns you need to maintain your lifestyle? Returns that “beat the market” sound great, but keeping more of your hard-earned money sounds even better. Did you answer an 8-question questionnaire on your market experience and your intestinal fortitude that are typically based on ‘recency bias’?

Deep down you know yourself and the limits you can stand in the midst of turmoil, but a good financial plan shows what type of loss your wealth can withstand and still enable you to have a successful retirement.

The higher the hurdle rate the less likely your plan will be successful—meaning, a major lifestyle change may be coming your way.

When we are building or reviewing a financial plan we do several things:

  1. Use realistic returns. (Yes, I’m talking to all of those 12 percenters out there, media pundits and planners who use those numbers). We revise our numbers annually based on market cycles and current valuations.
  2. Use variable rates of return; no one makes a flat 7% each year.
  3. Inflate your expenses annually. I have never yet had one client give themselves an annual raise-but remember we’re stress testing
  4. Provide income tax alpha. We’re not CPAs, but we can help you determine the best way to take distributions to help you keep more of your funds.
  5. Make smart decisions regarding Social Security benefits and Medicare.
  6. Provide risk management that is not accounted for with financial planning software to portfolios. And no, it’s not with annuities or insurance products, it’s through having a very defined buy and sell discipline.
  7. Evaluate portfolios to ensure they aren’t built for the past, but prepared for the future. We have no crystal ball, but we can make very educated decisions by using fundamental and technical analysis and evaluating the current economic landscape. No portfolio should be built simply on the prior year returns.  Unfortunately, this happens way more often than you might think.
  8. Use a realistic life expectancy. We have our clients go to This gives us a better idea on life expectancy; we understand everyone doesn’t live to 103.
  9. Look at long term care and insurance policies. Many of the couples I meet with are self-insured. It’s usually the wife I’m most concerned with as it’s likely she’ll outlive her spouse.
  10. Ensure client has an estate plan. It doesn’t have to be fancy or sophisticated, but it should always include a will, power of attorney and medical directives.

These are just a few tips to help you evaluate your own financial plan. Numbers are everywhere these days. We know our credit score, social security number, checking account number, debit card pin and alarm code like the palm of our hands, but how many of you know your hurdle rate? I’d bet more of you know the Dow Jones return for 2017 than your minimum rate of return (hurdle rate.) Get acquainted with it, know it. It will change annually depending on markets, impacts of withdrawals and your overall life situation. Financial plans aren’t meant to be static, they’re as fluid as our lives. Things change quickly in our lives and so should your plan. Don’t let one thing bog you down.

Ask your advisor for your hurdle rate, he or she should know it. Also, be sure to follow the 10 rules of the road above to ensure your family is getting the most out of your plan.

A financial plan or investment strategy isn’t something to rush through or skimp over because it is only your financial security we’re talking about.

Today’s equity market valuations have only been eclipsed by those of 1929, and 1999.”

In March of 2017, we examined traditional equity valuations in a new light to help better compare today’s valuations versus those of past business cycles. In particular, we adjusted the popular price-to-earnings (P/E) ratio for economic growth trends. The logic backing the analysis is that investors should be willing to pay a larger premium if economic growth is strong, and therefore corporate earnings are higher, and vice versa if economic growth is comparatively weak. The premise is similar to the popular price-to-earnings growth (PEG) ratio commonly used by equity investors. While P/E assesses the value of a stock on the basis of trailing earnings, PEG is more forward-looking using the expected growth of earnings. Essentially, the ratio tells us how much a current investor is willing to pay for a unit of expected earnings.

This re-publication of Second to None is intended to revisit a variety of key points as a base of understanding for an upcoming article. Given the extent to which markets have moved over the past several months, updating this analysis is timely. Further, the upcoming article will broaden the discussion to include a second important driver of corporate earnings and therefore provide fresh perspectives on valuations. We are confident you will find it compelling, so stay tuned.

Given the continuing equity market rally and multiple expansion, the quote above from prior articles, had to be modified slightly but meaningfully. As of today, the S&P 500 Cyclically Adjusted Price to Earnings ratio (CAPE) is on par with 1929. It has only been surpassed in the late 1990’s tech boom.

A simple comparison of P/E or other valuation metrics from one period to another is not necessarily reasonable as discussed in Great Expectations. That approach is too one-dimensional.   This article elaborates on that concept and is used to compare current valuations and those of 1999 to their respective fundamental factors.  The approach highlights that, even though current valuation measures are not as extreme as in 1999, today’s economic underpinnings are not as robust as they were then. Such perspective allows for a unique quantification, a comparison of valuations and economic activity, to show that today’s P/E ratio might be more overvalued than those observed in 1999.

Secular GDP Trends

Equity valuations are a mathematical reflection of a claim on the future cash flows of a corporation. When one evaluates a stock, earnings potential is compared to the price at which the stock is offered. In most cases, investors are willing to pay a multiple of a company’s future earnings stream. When the prospects for earnings growth are high, the multiple tends to be larger than when growth prospects are diminished.

To forecast earnings growth for a company, one needs to do an in-depth analysis of the corporation, the economy and the markets in which it operates. However, evaluating earnings growth for an index comprising many companies, such as the S&P 500, is a relatively straight-forward task.

Corporate earnings are a byproduct of economic activity. Earnings growth can differ from economic growth for periods of time, but in the long run aggregate earnings growth and GDP growth are highly correlated.  The two graphs below offer an illustration of the durability of this relationship. The graph on the left plots three-year average GDP growth and its trend since 1952, while the graph on the right highlights the correlation of GDP to corporate profits.

Data Courtesy: St. Louis Federal Reserve (FRED), Bureau of Economic Analysis (BEA) and Bloomberg

Given the declining trend of GDP and the correlation of earnings to GDP, it is fair to deduce that GDP and earnings growth trends were healthier in the late 1990’s than they are today. More specifically, the following table details key economic and financial data comparing the two periods.

Data Courtesy: St. Louis Federal Reserve (FRED), and Robert Shiller

As shown, economic growth in the late 1990’s was more than double that of today, and the expected trend for economic growth was also more encouraging than today. Trailing three- five- and ten-year annual earnings growth rates contrast the current stagnant economic growth versus the robust growth of the 90’s. Additionally, various measures of debt have ballooned to levels that are constricting economic growth and productivity. Historically low interest rates are reflective of the current state of economic stagnation.

The graph below charts price-to-earnings (CAPE) divided by the secular GDP growth (ten-year average), allowing for a proper comparison of valuations to fundamentals.

Data Courtesy: Robert Shiller

The current ratio of CAPE to GDP growth of 19.77 has far surpassed the 1999 peak and all points back to at least 1950. At the current level, it is over three times the average for the last 66 years.  Further, based on data going back to 1900, the only time today’s ratio was eclipsed was in 1933. Due to the Great Depression, GDP at that time for the preceding ten years was close to zero. So, despite a significantly deflated P/E multiple, the ratio of CAPE to GDP was extreme. Looking forward, if we assume a generous 3% GDP growth rate, CAPE needs to fall to 18.71 or 35% from current levels to reach its long term average versus GDP growth.


Equity valuations of 1999, as proven after the fact, were grossly elevated. However, when considered against a backdrop of economic factors, those valuations seem relatively tame versus today. Some will likely argue with this analysis and claim that Donald Trump’s pro-growth agenda will invigorate the outlook for the economy and corporate earnings. While that is a possibility, that argument is highly speculative as such policies face numerous headwinds along the path to implementation.

Economic, demographic and productivity trends all portend stagnation. The amount of debt that needs to be serviced stands at overwhelming levels and is growing by the day. Policies that rely on more debt to fuel economic growth are likely not the answer. Until the disciplines of the Virtuous Cycle are understood and followed, we hold little hope that substantial economic growth can be sustained for any meaningful period. Given such a stagnant economic outlook, there is little justification for paying such a historically steep premium for what could likely be feeble earnings growth for years to come.

It’s a record.

As of yesterday’s market close, the Dow crushed its previous record milestone time frame by adding 1000 points to the index in just 8-trading days. The S&P also rose to 2800 at a record pace adding 100-points in just 10-days.

It is starting to go parabolic.

While the record-breaking pace is certainly breathtaking, it shouldn’t be surprising as we discussed in the June 9th, 2017 edition of the weekly newsletter:

Let me state this VERY clearly. The bullish bias is alive and well and a move to 2500 t0 3000 on the S&P 500 is viable. All that will be needed is a push through of some piece of legislative agenda from the current administration which provides a positive surprise. However, without a sharp improvement in the underlying fundamental and economic backdrop soon, the risk of something going ‘wrong’ is rising markedly. The chart below shows the Fibonacci run to 3000 if “’everything goes right.’” 

Of course, that piece of legislative agenda was “tax reform.”

With investors now betting on a sharp rise in earnings to reduce the current levels of overvaluation, the seems to be little in the way of the next major milestones for 30,000 for the Dow and 3000 for the S&P 500.

The above chart has been updated for that momentum.

Just remember, bull-runs are a one-way trip. 

Currently, there are just 200 points of upside until the S&P 500 hits a majority of its Wall Street targets of 3000.

I have taken the chart above and calculated several possible corrections and mean reversions to different levels.

When comparing the probable levels of even a mild correction, 200-points of upside currently hardly justifies the risk being undertaken by investors.

This is particularly the case given one of the most extreme overbought conditions of the market in its history.

I know. I know.

It’s easy to get wrapped up in the bullish advance, however, it is worth remembering that making up a loss of capital is not only hard to do, but the “time” lost cannot.

The point is while the media and bulk of the commentary continue to “urge you to ride the bull,” they aren’t going to tell you when to get off.

And when the ride does come to an end, the media will ask first “why no one saw it coming?”

Then they will ask “why YOU didn’t see it coming when it so obvious.” 

In the end, being right or wrong has no effect on the media as they are not managing your money nor or they held responsible for consistently poor advice. However, being right, or wrong, has a very big effect on you.

Let me repeat for all of those who continue to insist I am bearish and somehow am missing out on the “bull market” advance:

“While our portfolios remain long currently, we do so with hedges and stops in place, a thorough methodology of analysis and a strict investment discipline we follow to mitigate the risk of long-biased exposure. In other words, whenever the market does turn, we will sell and move to cash.”

If you are going to “ride this bull,” just make sure you do it with a strategy in place for when, not if, you get thrown.

Tending The Garden

The combined overbought, over-leveraged condition of the financial markets is of extreme risk to investors currently. While the bullish trend remains intact currently, it is extremely prudent to perform some risk management in portfolios.

It is worth remembering that portfolios, like a garden, must be carefully tended to otherwise the bounty will be reclaimed by nature itself.

  • If fruits are not harvested (profit taking) they ‘rot on the vine.’ 
  • If weeds are not pulled (sell losers), they will choke out the garden.
  • If the soil is not fertilized (savings), then the garden will fail to produce as successfully as it could.

So, as a reminder, and considering where the markets are currently, here are the rules for managing your garden:

1) HARVEST: Reduce “winners” back to original portfolio weights. This does NOT mean sell the whole position. You pluck the tomatoes off the vine, not yank the whole plant from the ground.

2) WEED: Sell losers and laggards and remove them from the garden. If you do not sell losers and laggards, they reduce the performance of the portfolio over time by absorbing “nutrients” that could be used for more productive plants. The first rule of thumb in investing “sell losers short.”

3) FERTILIZE AND WATER: Add savings on a regular basis. A garden cannot grow if the soil is depleted of nutrients or lost to erosion. Likewise, a portfolio cannot grow if capital is not contributed regularly to replace capital lost due to erosion and loss. If you think you will NEVER LOSE money investing in the markets…then STOP investing immediately.

4) WATCH THE WEATHER: Pay attention to markets. A garden can quickly be destroyed by a winter freeze or drought. Not paying attention to the major market trends can have devastating effects on your portfolio if you fail to see the turn for the worse. As with a garden, it has never been harmful to put protections in place for expected bad weather that didn’t occur. Likewise, a portfolio protected against “risk” in the short-term, never harmed investors in the long-term.

With overall market trend still bullish, there is little reason to become overly defensive in the very short-term. However, I have this nagging feeling that the “spring” is now wound so tightly, that when it does break loose, it will likely surprise most everyone.

Just something to think about.

Consider the following:

  1. The current U.S. economic expansion has lasted 103 months and counting. Based on data since 1945 covering 11 business cycles, the average is 58 months and the longest was 120 months (1991-2001).
  2. The unemployment rate is at 4.1%, the lowest level since January 2001.
  3. For the first time on record, the S&P 500 produced positive total returns in each month of last year.
  4. The S&P CoreLogic Case-Shiller 20-City Home Price Index is at 203.84, the highest level since December 2006 and less than 3 points shy of the all-time high seen at the peak of the housing bubble in July 2006.
  5. Small Business Optimism is at the highest level since September 1983 and the Michigan Current Consumer Sentiment gauge is at 17-year highs.
  6. Recent corporate earnings growth is strong at 9-10% and running above the historical average (6%).
  7. Tax reform legislation reduces taxes for corporations from a statutory rate of 39% to 21%.
  8. The current U.S. Consumer Price Index is 2.1% and 1.8% excluding-food and energy.
  9. The Federal Reserve is planning to adhere to a gradual series of rate hikes and balance sheet reduction over the coming year.
  10. The market currently expects 2 to 3, 25 basis point rate hikes in 2018, which would bring the Fed Funds rate to just over 2.00%.
  11. The Federal Reserve loses 44 years of policy-making experience with the departures of Yellen, Fischer, Dudley and Lockhart.
  12. Geopolitical risks are more extensive than any year in recent memory. Problems include instability in Sub-Saharan Africa, Southern Asia and the United Kingdom as well as friction between the U.S. and North Korea, Iran, Mexico and China.

After what we observed in 2017, another year of complacency measured by record low volatility and high valuations cannot be ruled out. That said, mean reversion remains part of the natural order and every day that elapses brings us another day closer to the eventuality of a regime shift. Changes in monetary policy, fiscal policy and Fed leadership have historically been quite volatile for markets, although the term of Janet Yellen was an exception. Also, according to Eurasia Group’s Ian Bremmer, “The markets don’t recognize it. They’re hitting records on a regular basis. The global economy feels pretty good, but geopolitically we are in the midst of a deep recession.” Heightened geopolitical risks have the potential to stir up the volatility pot and markets are not priced for any of those probabilities.

Markets have remained remarkably stable despite numerous geopolitical concerns throughout the past year. Based on the information provided above, it appears as though markets may be underpricing expectations for interest rate moves given the obvious dynamics between global growth, low rates, swollen balance sheets and market valuations. Yet the paradigm of the Fed as inflation fighters has long since passed, and the concern now remains defending against the evil windmills of deflation. The new Federal Open Market Committee (FOMC) will try to remain vigilant, but any unexpected uptick in inflation may spook them into moving back toward their natural inclination as inflation fighters. Given the shifting winds of Fed policy from easier to less easy, the markets’ failure to acknowledge the risks of a quicker tightening pace and the sensitivities of the debt-bloated economy to higher interest rates, our concerns remain in the arena of some difficult changes occurring sooner rather than later.

The same divergent dynamic exists on the geopolitical side of the equation. Often characterized as exogenous risks, they can be especially combustible when markets become as complacent as they apparently are today. The important message for investors is to remain vigilant about assessing risks and avoid being lulled into the groupthink trap. This is especially true as the consensus perspective becomes increasingly one-sided. Risks and consensus have both reached extremes and should be given proper consideration.

Cause when life looks like easy street, there is danger at your door.”  – Grateful Dead

Take It Personally

It was a real electronic beauty. One of the finest CB radios on the market.

Metal smooth around the edges. Simulated woodgrain; swirly, rich blends of chestnut brown and tan leather-hide. Shiny chrome knobs and a backlit power and modulation meter with a needle-like instrument that swung like a pendulum from red to green depending on whether you were receiving or transmitting.

In 1976, my paternal grandmother handed a new model over to a diminutive gray-haired man with a face etched in permanent scowl. The goal was to convince him, the manager, to consider her grandson (me) for a job as a “stock boy,” at the urban supermarket “C-Town,” that was located near Kings Highway and McDonald Avenue in Brooklyn.

Ironically, I work with stocks today; as a pre-teen, stock meant long supermarket aisles choked with piles of cardboard cartons, and wooden (yes wood), crates that stored metal coffee containers, boxes of Kellogg’s cereal, white, red labeled Campbell’s soup, and cans of cat and dog food. Granted, it was strenuous physical work, but I was responsible for two long aisles – from pasta to coffee, pet food to canned soup, and took pride in how neat (all labels uniform, facing out), and well-stocked my shelves were. I guess you can say I was obsessed.

My father owned two CB radios/car stereo stores then, “The Communication Hut,” in Merrick and Bellmore, New York. Grandma was able to cajole dad into the CB radio bribery caper. My love for all things radio began with Citizen’s Band and pre-dawn New York AM radio.

At the time, the CB, a defunct brand named Teaberry, sold for $189. Compute for today’s dollars? $838 bucks. A lofty sum. You can pick up a new CB radio for $59. Listen, except for collectors like me, the demand for CB radios is weak to say the least. Although, I lament often how much fun CB radio was compared to social media outlets like Facebook, today.

Well, what about color televisions? We all love television, right?

In 1977, a Sylvania with a 25-inch screen sold for $850 (a whopping $3,581 today adjusted for inflation).

At Best Buy, I can pick up a 32” LED for $180.

Inflation is a popular and personal topic. Whether it’s low or high, to most of us inflation is always the elephant in the room or the boogieman in the closet. A real sore point for consumers for as long as I can recall.

In the 1970s, inflation was indeed a formidable foe for many American families and a real standard-of-living destroyer for my financially-stressed household, as you can see in the chart.

Money velocity or the turnover of the money supply, has collapsed post-financial crisis, confounding economists; in the 70s, it was a different story. Generally, an increase in the money supply should lead to price increases as more money chases the same level of or less goods.

In the 70s, there were two or three varieties of soup and a couple of brands of paper towels. This afternoon I can walk through Kroger’s and be flummoxed by the competition and variety of choices available. It makes me wonder how consumers don’t freeze up from confusion and walk out of a store with nothing. I’ve done it.

Now, discussions about inflation are heating up again (pun intended). As the U.S. economy experiences record levels of low unemployment, the unemployment-inflation trade-off as demonstrated by the Phillip’s Curve, or the relationship between unemployment and especially wage inflation, is a re-surfacing debate.

The U.S. Labor Department reported a December increase in core prices of .3% which exclude volatile food and energy – The biggest jump in 11 months.

Unfortunately, housing, transportation and medical care costs were inflation culprits for December which is detrimental for many households.

To piggyback off Michael Lebowitz’s article The Only Benchmark of Wealth, it’s important for investors when it comes to financial planning, to understand how inflation affects not only their wealth, but their emotions and behavior.

Here are several points to consider.

Inflation is personal to and differs for every household.

My household’s inflation rate may differ from yours.

Thanks to an inflation project undertaken by the Federal Reserve Bank of Atlanta, there’s now a method to calculate a personal inflation rate. A smart idea is to compare the results of their analysis to the inflation factor your financial professional employs in retirement and financial planning. Instruct your adviser to complete an additional planning scenario which incorporates your personalized consumer price index and see how it affects your end results or outcomes.

The bank has undertaken a massive project to break down and study the elements of inflation along with the creation of a myCPI tool which captures the uniqueness of goods that individuals purchase.

Researchers estimate average expenditures using a calculation which incorporates various cross-demographic information including sex, age, income, education and housing status. The result is 144 different market baskets that may reflect a closer approximation to household’s personal cost of living vs. the average consumer. It’s easy to use and sign up for updates. Try it!

My personal CPI peaked in July 2008 at an annualized rate of 5.2%. Currently, it’s closer to 1.2%. For retirement planning income purposes, I use the average over the last decade which comes in at 2.1%.

The tool can help users become less emotional and gain rational perspective about inflation. Inflation tends to be a touchy subject as prices for everything must always go higher (which isn’t the case). I’ve witnessed how as a collective, we experience brain drain when we rationalize how inflation impacts our financial well-being. It’s a challenge to think in real (adjusted for inflation) vs. nominal terms.

I hear investors lament about the “good old days,” often where rates on certificates of deposit paid handsomely. For example, in 1989, the year I started in financial services, a one-year CD yield averaged 7.95%. Inflation at the time was 5.39%. After taxes, investors barely earned anything, but boy, those good old days were really somethin’ weren’t they?

We’re inflation experts because it co-exists with us. It’s an insidious financial shadow. It follows us everywhere. We just lose perspective at times as the shadow ebbs and flows, shrinks and expands depending on our spending behavior. Interestingly, as humans, we tend to anchor to times when inflation hit us the hardest.

At C-Town, one of my responsibilities was to update prices (usually higher), on canned items. Not an easy task. You see, back then, every stock boy (not trying to be a Neanderthal here, stock girls weren’t a thing as they were employed mostly as cashiers at checkout in front of the store), was equipped with a heavy metal “stamper,” that was holstered by leatherette holders, attached to our belts when not in use. I kid you not. We resembled urban-western gunslingers with those contraptions.

A stamper was equipped with a long handle to ensure a firm grip. Forged to the handle was a self-contained printing mechanism that held a soaked pad of deep-purple ink and a row of 6 horizontal rubber strips of numbers and symbols that a user was able to manipulate with a couple of fingers, sort of like a series of ink-laden dials.

A stocker set the price he wanted, followed by the symbol for dollars or cents, applied downward pressure on the handle which forced down the mechanism’s rubber numbers to hit the ink and stamp the top of a can or whatever we wanted to stamp.

Frankly, it was a messy ordeal. My left thumb and middle finger were stained purple at least through 1980! In the mid-70s, pages of price changes came in weekly. It was the inevitable nature of the ominous inflation beast. Every can of tuna, cat & dog food, coffee (and some cans were 3 times the size of what’s available today), had to be wiped clean of current prices and stamped with fresh numbers that made the elderly patrons in the neighborhood groan loudly from the aisles. Several customers possessed an eerie inflation spider sense and knew to stock up before price-change day.

So, I understand the intimate journey with inflation.

On the other side of the spectrum, deflation was an outcome of the Great Depression. Simply, the overall price levels of goods and services collapsed by 25% with commodity or farm goods-related product prices declining more to compete for whatever aggregate consumer demand remained. If you were lucky enough to remain employed and not leveraged into the stock market, it was like receiving a 25% increase in pay.

Several economists argue that the lingering effects of the Great Depression including 25% unemployment, could have been assuaged if employed workers were receptive to a decrease in wages to match prices.

In other words, workers had a difficult time comprehending that in real, inflation-adjusted terms, a cut in pay would not have affected their ability to purchase goods and services. Obviously, this is an overly simplistic explanation to illustrate a point. There were multiple factors negatively affecting labor such as the deflation of risk asset valuations (like stocks), and the negative impact of deflation as it increased the cost of servicing household debts.

The goal is to think rationally when it comes to inflation. MyCPI is a good start to understanding how pricing pressure can affect a household. The comparison of personalized CPI to your broker’s financial planning input should at least spark enlightening discussion between you and your adviser.

Plan for inflation in retirement, but you may be surprised by what affects your spending.

I love westerns, especially “The Big Valley.” Rich story lines and robust acting by Barbara Stanwyck as the matriarch of the Barkleys, along with Lee Majors and Richard Long as members of a California ranching family, have captivated me for years.

Your spending in retirement is mostly a big valley. I’ll explain.

I partner with clients who have been in retirement-income distribution mode for over a decade.  In other words, they are re-creating paychecks through systematic portfolio withdrawals and Social Security retirement benefits. Although we formally planned for an annual cost-of-living increase in withdrawals, rarely if at all does this group contact me every year to increase their distributions!

There’s a time series in retirement where active-year activities, big adventures conclude, and retirees enter the big valley of level consumption. I call it the “been there done that,” stage where a retiree has moved on; the overseas trips have been fulfilled and enrichment lives a bit closer to home.

Retirees move from grandiose bucket list spending to a long period or valley of even-toned, creative, mindful endeavors. It’s a sweet spot, an extended time of good health; so, healthcare is not so much an inflationary or heavy spending concern. The big valley stage is just a deeper, relaxed groove of a retirement lifetime.

A thorough analysis I refer to often because it reflects the reality I witness through clients, was conducted by David Blanchett, CFA, CFP® and Head of Retirement Research for Morningstar. The research paper, “Estimating the True Cost of Retirement,” is 25 pages and should be mandatory reading for pre-retirees and those already in retirement.

David concludes:

“While research on retirement spending commonly assumes consumption increases annually by inflation (implying a real change of 0%), we do not witness this relationship within our dataset. We note that there appears to be a “retirement spending smile” whereby the expenditures actually decrease in real terms for retirees throughout retirement and then increase toward the end. Overall, however, the real change in annual spending through retirement is clearly negative.”

David eloquently defines spending as the “retirement spending smile.” As a fan of westerns, I envision the period as a valley bracketed by the spending peaks of great adventures on one side, healthcare expenditures on the other. Hey, I live in Texas. This analogy works better for me.

In comprehensive financial planning, it’s prudent to be conservative and incorporate an inflation rate to annual spending needs.

Medical costs affect retirees differently. Unfortunately, it’s tough as we age to avoid healthcare costs and the onerous inflation attached to them. Thankfully, proper Medicare planning is a measurable financial plan expense as a majority of a retiree’s healthcare costs will be covered by Medicare along with Medigap or supplemental coverage.

Unfortunately, many retirees are ill-prepared for long-term care expenditures which are erroneously believed to be covered by Medicare. Generally, long-term care is assistance with activities of daily living like eating and bathing. At Clarity, we use an annual inflation factor of 4.5% for additional medical expenses (depending on current health of the client), and the cost of long-term care.

David suggests an alternative inflation proxy for older workers. The Experimental Consumer Price Index for Americans 62 Years of Age and Older or the CPI-E, reflects contrast of category weightings when compared to CPI-U or CPI-W, the CPI for urban consumers and urban wage earners, respectively.

It makes tremendous sense for the CPI-E to attach greater weightings to medical care and housing. Generally, the share of expenditures on medical care is double that of the CPI-U or W populations.

Your financial partner should be adjusting healthcare inflation accordingly in your financial plan.

As the U.S. economy heats up and pricing pressures ensue, the topic of inflation is going to gain traction and grab headlines when compared to recent years. As we have a difficult time processing the topic objectively (there’s always purple ink on our fingers so to speak), it’ll be crucial for financial partners to be pragmatic and assist you with the interpretation of inflation on your household’s terms.

Because inflation is indeed personal.

The objective is to manage “inflation-phobia,” accordingly to ensure that financial planning reflects reality. Your reality.

  • * Beware of investment fads and the experts that deliver endorsing pablum in the business media
  • * They are not your allies in delivering good investment returns — they are harmful to your investment well being

“Thus hath the candle singd the moath.”
– William Shakespeare, The Merchant of Venice

This morning the price of bitcoin is down by another 10%: the price is flirting with $10,000 after trading at around $20,000 a few months ago.

The phrase “like a moth to a flame” is an allusion to the well known attraction that moths have to bright lights.

The word moth was used in the 17th century to refer to someone who was apt to be tempted by something that would lead to their downfall.

So it is with many in the business media, who too often, like Wall Street offering up conflicted research recommendations, seek audience over intelligence by parading experts (in the latest fad, like cryptocurrencies) and, too wittingly become the enemy of the average and uninformed investor. These experts, with memorized sound bytes, will always sound confident and rarely express the notion of risk. But, many of that audience will learn, like The Wizard of Oz, that they’re simply delivering an odious pablum –bland or insipid intellectual fare and entertainment.

Those outlets that are inundated by crypt talk know who they are — like Warren Buffett, I prefer to criticize by category (and praise by name). (As evidence to the preoccupation, just take a quick look at the Twitter threads of some of the leading business media shows — they are overwhelmed by crypto chatter and nonsensical and hyperbolic opinions.)

Popular investment fads often too quickly become unprofitable investment endeavors — stocks in 1999 and housing/banking stocks in 2007 come to mind.

Ultimately the frequency of media coverage will diminish coincident with the fads’ price declines (and investors/traders lost interest). While the business media may shamelessly move on (unlike research firms and money managers who deliver poor investment advice, will face little retribution), your portfolio could be permanently impaired by what Joe Granville used to call “the bagholders’ blues.”

I may be wrong in my ursine view of bitcoin, et al, and though I no longer have any position (See Tales of the Crypt (Issue IX), I have written tens of thousands of words on the subject, discussing both the potential rewards but also, importantly, the risks as I saw them:

* There’s A Sucker Born Every Minute
* Res Ipsa Idiot

Many in the business media may ultimately forget their current preoccupation with crypto and drop coverage if my negative forecasts continue to be realized — but not until lots of money is lost in the process.


Not to worry, when enough time transpires, the same experts will be trotted back onto the business media with another investment idea in hand — just as the case is now, some nine years after The Great Recession and near 80% drops in their portfolios.

Some may say “time heals all wounds.”

But I disagree, as this elephant never forgets.

“The market does not know you exist. You can do nothing to influence it. You can only control your behavior.”

– Alexander Elder

It is up to each trader/investor to evaluate reward vs. risk of each investment — as many in the business media and the talking heads and commentators will not necessarily address upside compared to downside particularly in the trade du jour.

These days I am too often reminded of Benjamin Disraeli’s quote:

“What we have learned from history is that we haven’t learned from history.”

“Did you hear the news that was driving the markets to new records this morning?

No? Yeah, me either. But such is the nature of a speculative driven frenzy.”

Since the markets were closed yesterday, there is nothing to update from this past weekend’s newsletter.

While that missive was primarily directed at why “bond bears will likely be wrong again,” I did state the following about the market:

“That extension, combined with extreme overbought conditions on multiple levels, has historically not been met with the most optimistic of outcomes.

Importantly, such extensions have NEVER been resolved by a market that moved sideways. But, ‘exuberance’ of this type is not uncommon during a market ‘melt-up’ phase.

Nothing changed this past week as the “melt-up” phase gains momentum. We are on track currently to ratchet the both the fastest and most numerous sequential milestone advances for the Dow in history.

You can barely print ‘Dow 2X,000’ hats fast enough.”

Well, as the market opened this morning, the Dow and the S&P both set the fastest pace of a milestone advance in U.S. history as the Dow crested 26000 and the S&P touched 2800.

The surge in market exuberance in terms of both individual and professional investors is generally indicative of the “capitulation phase” of an advance which is when the last of the “holdouts” finally jump back into a market which “can seemingly never go down.”

From “QE” to “Low Rates Justify High Valuations” to “Tax Cuts,” the unfettered rise in asset prices has been underpinned by a shifting narrative backing bullish sentiment.

The latest, of course, is that “tax cuts” will boost bottom line earnings giving investors a reason to bid asset prices up further.

But have the markets already fully “priced in” the tax cuts even before they arrive?

It’s All About “Effective”

Just recently, Shawn Langlois penned an interesting article for MarketWatch:

“Zach Scheidt of the Daily Reckoning blog detailed his thoughts in a post Wednesday warning that anybody who’s investing based on these predictions is in for a big surprise as we move through 2018. 

‘I’ve seen analysts make some bad calls before, but this one really takes the cake. Wall Street’s best and brightest are massively underestimating how much the new tax law will benefit companies’ bottom lines.”

As Shawn states, a company that posted $5.00 in pretax profits would have an after-tax profit of $3.25 in 2017. Under the new law, that after-tax profit would rise to $3.95 — a big 21% improvement.

I don’t disagree with the analysis at face value.  However, there are two important issues that need to be addressed.

The first is the difference between the statutory rate of 35% versus the “effective” tax rate that corporations actually pay. This is crucially important and a point recently addressed by my partner, Michael Lebowitz:

“The statutory tax rate is the legally mandated rate at which corporate profits are taxed. As shown above, the rate has been consistent over the last 75 years except for one significant change as a result of the Tax Reform Act of 1986.

“The effective corporate tax rate is the actual tax rate companies’ pay. One can think of the statutory rate as similar to the MSRP sticker price on a new car. It provides guidance on cost but consumers always pay something less.

From 1947 to 1986 the statutory corporate tax rate was 49% and the effective tax rate averaged 36.4% for a difference of 12.6%. From 1987 to present, after the statutory tax rate was reduced to 39%, the effective rate has averaged 28.1%, 10.9% lower than the statutory rate.”

So, back to the math.

In reality, a company that earned $5.00 pretax only paid $1.41 in taxes in 2017 on average, leaving an after-tax profit of $3.59, and not $3.25. Under the new tax law that after-tax profit would come in at the $3.95 as stated in the article and the gain would be 10%, or half, of the gain the author forecasted.

There is a good bit of difference between a statutory increase of $0.70 profit per share the author assumed, versus the reality of $0.36 per share which is nearly a 50% reduction from the estimated benefit.

All Priced In

Secondly, investors didn’t just start estimating the impact of the “tax reform” bill when it was passed in December of 2017.

Far from it.

The rally that begins in November 2016 was the beginning of the “Trump Rally” in anticipation of regulatory reform, the repeal of the Affordable Care Act, infrastructure spending, and tax reform. It is worth noting that “tax reform” was the easiest of the four to calculate the beneficial impacts from passage. Therefore, a large portion of the post-election gains are reflective of those expected benefits.

The chart below shows the S&P 500 from 2014 to present with Wall Street projections through 2020.

The rise in the index is not surprising given cheaper valuations following the “Financial Crisis” combined with more than $33 Trillion in monetary accommodations. Considering reported earnings were deeply negative in 2008, the initial recovery in earnings was quite strong. However, since 2014 earnings growth has been weaker. Despite, minimal growth since 2014, Wall Street believes currently that earnings will rise strongly through the end of this decade.

Just remember two things.

First, while asset prices have surged to record highs, reported earning, estimates for the S&P 500 through the end of 2018 are currently only slightly above where 2017 was expected to end in 2016. Wall Street ALWAYS over-estimates earnings and by about 33% on average. That overestimation provides a significant amount of headroom for Wall Street to be disappointed by year end, particularly once you factor in the “effective” rate issue noted above. 

Secondly, Wall Street has never foreseen a recession or an earnings reversion until well after the fact.

It is quite likely that once again Wall Street is extrapolating the last few quarters of earnings growth ad infinitum and providing even more fodder for the market rally. It is also quite likely Wall Street will be proven wrong on earnings as so often has occurred in the past.

All Dressed Up

As I have addressed over the last few weeks, investors, both individual and professional, are overly exuberant and confident about the future of the market.

However, as I recently noted in “Bob Farrell’s 10-Investment Rules” – Rule #9 is pretty clear

“When all the experts and forecasts agree – something else is going to happen.”

Or even as Sam Stovall, the investment strategist for Standard & Poor’s once stated:

“If everybody’s optimistic, who is left to buy? If everybody’s pessimistic, who’s left to sell?”

Of course, Wall Street is notorious for missing the major turning of the markets and leaving investors scrambling for the exits.

This time will likely be no different.

Will tax reform accrue to the bottom lines of corporations? Most assuredly.

However, the bump in earnings growth will only last for one year. Then corporations will be back to year-over-year comparisons and will once again rely on cost-cutting, wage suppression, and stock buybacks to boost earnings to meet Wall Street’s expectations.

The risk of disappointment is extremely high.

Simply – the markets are “all dressed up with nowhere to go.” 

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

When the financial media continuously repeat an opinion as fact, it spawns a mainstream narrative, which produces a powerful effect on investor psychology. One mainstream narrative, repeated with certainty, is low interest rates cause high stock market valuations, which is supported by the public statements of investment luminaries such as Warren Buffett.

A related mainstream truth is rising rates will cause high stock market valuations to fall. In fact, recently, both Bill Gross and Jeffrey Gundlach have commented on the level of 10-year Treasury rates and why they are destined to go higher. Gundlach even went further, suggesting that if 10-year rates were to rise above 2.63% (currently 2.55%), stock prices would begin to fall.  While Gundlach possesses a sterling track record, and his comment captures a prominent fear among investors, his comment also seems to define the term “spurious precision.” Can it be true that stocks are a safe investment at 2.62% but not 2.63%?

Are the two “truths” in bold above supported by the historical record? Believe it or not, the answer is no, as we will explain.

Let’s begin by examining stock market valuations. Most professional observers of financial markets would agree that stocks valuations are high compared to their historical range. This fact is demonstrated in the chart of the Shiller CAPE ratio (Cyclically-Adjusted PE ratio) below.

Source:  Robert Shiller,  Data through January 9, 2018.

While no single statistic perfectly describes reality, the CAPE ratio highlights how cheap or expensive the stock market is relative to its historical average. Indeed, comparing the current CAPE ratio of 33.38 to its median value of 16.15, stocks would have to fall by more than 50% to be in line with historical norms.

The CAPE chart is more than a historical chart of valuation. It is also a chart of investor psychology compared to historical norms, because the chart measures the investing public’s fear or mania to “buy” a dollar’s worth of stock market earnings at any point in time. For example, a long bull market began in August 1982, when stocks were cheap (CAPE = 7) based on the fearful consensus reasoning of the day. The subsequent 18-year rally mushroomed into the internet stock craze that peaked in March 2000, when stocks were expensive (CAPE = 45), based on manic consensus reasoning of the day.

Excluding the tech mania of 2000, today stocks are more highly-valued than at any other time during the past 140 years, even including the peak at the end of the Roaring 1920s. If high valuations are a sign of investor psychology, then investors today are about as optimistic as at any time in the past.  Put another way, today’s high valuations indicate that investors see more future upside (reward) than future downside (risk).

The psychological effect on stock prices can also be seen in the chart below, which breaks down the PE ratio into P (price) and E (earnings). When the gap between price (blue line) and earnings (green line) is high, investors are willing to pay high a price to buy a dollar of earnings.  A glance at the chart shows the same eras of peak valuations occurring in the 1920s, the 1960s, and again over the past two decades. Most recently, during the past few years earnings have been flat while stocks were rising dramatically. While bidding up stock prices during this period, it appears investors were expecting a big jump in earnings. If so, they didn’t receive what they expected.  So, if earnings didn’t drive stock prices higher, what did? The inquiring minds of the financial punditry need another narrative.

Source:  Robert Shiller,  Data through June 2017

Regardless of the common sense embedded in the CAPE chart, doubters of the CAPE methodology would probably make arguments driven by “relative value,” not “absolute value.” Relative value arguments state that one asset is valued at price X because another asset is valued at price Y.

Let’s substitute stocks for price X and interest rates as price Y. When interest rates (Y) are extremely low, it makes intuitive sense that stock prices (X) would be high, because interest rates are a main theoretical factor in the valuation of stocks. Another sensible argument is that prevailing interest rates provide competition for an investor’s dollar relative to an investment in the stock market. For these reasons, when rates (Y) are low, stocks (X) are perceived to be more attractive, relatively.

Indeed, the two charts presented so far only show the relationship between the price of stocks and the earnings of the underlying companies; the charts say nothing about the level of interest rates.  Interest rates are the crucial input into the theoretical valuation of stocks. In addition, interest rates are thought to drive the prices of all other assets such as real estate, privately operated businesses, commodities, and currencies.

To analyze the relative value argument, let’s look at the interaction of interest rates and stock valuations over the broad sweep of time. As shown below, extremely high stock market valuations occurred in 1929, 2000, and recently. But interest rates were extremely low only once (recently) during those three occurrences. If low interest rates coincide with extremely high stock valuations only one time out of three, then it is obvious that low interest rates cannot cause high stock valuations. Yet “low interest rates cause high stock valuations” is one of the certainties of the current mainstream narrative.

Source:  Robert Shiller,  Data through June 2017.

Isolating the times when interest rates were extremely low, that has occurred twice; in the 1940s and again in recent times. But in the 1940s, stock valuations were low. So, the statement that low interest rates cause high stock valuations is supported by a .500 batting average in the historical record, which is the equivalent of a coin-flip.

A better batting average is achieved by the relative value argument that extremely high interest rates coincide with extremely low stock market valuations, which occurred in 1921 and 1981.  Although a sample size of two observations is not enough from which to draw a statistically-significant conclusion, at least the batting average is 1.000.

Summarizing the historical relationship between extremes in stock market valuations with extremes in interest rates:

  • Extremely high interest rates, which have occurred twice, coincided with low stock market valuations. This fact does not prove that high interest rates “cause” low stock valuations. But at least the historical record is consistent with such a statement.
  • Extremely low interest rates, which have occurred twice, have coincided with high stock market valuations only once; today. The historical record (1/2 probability) does not validate the highly-confident mainstream narrative that low interest rates “cause” or extremely high stock market valuations.
  • Extremely high stock valuations have occurred three times. Only once (1/3 probability) did high stock valuations coincide with low interest rates; today.
  • If extremely low interest rates do not cause extremely high stock market valuations, then a rise in rates should not necessarily cause a decline in stocks. That is, the historical record does not support the near-certain mainstream narrative that a rise in rates will torpedo stock prices.
  • To demonstrate the ability of a consensus narrative to overwhelm analysis of historical facts and even current reality, consider that the Fed has hiked short-term interest rates five times since December 2015. Also, long-term rates bottomed in mid-2016 and have moved more than a full percent higher. Yet the S&P 500 index has risen more than 30% since the lows in short-term and long-term rates. 

Beware the investment advisor, pundit, or superstar investor who is certain that extremely low rates cause extremely high stock valuations, or that a rise in rates from extremely low levels will cause a decline in stock prices. Stocks may fall, and interest rates may rise, but the historical record disagrees that one causes the other.

Confidence is soaring…everywhere.

In last weekend’s newsletter, we showed multiple charts of surging investor confidence all at, or near, record levels. But while investors are indeed confident about the markets over the coming year, business and manufacturing surveys (sentiment) have also surged to near record levels. The National Federation Of Independent Businesses (NFIB) just released their December survey which showed a near record level of confidence for business owners.

One thing to notice is that spikes in optimism have generally occurred near peaks in the market.

Why should that be the case?

The reason is simple, exuberance tends to be disappointed by reality. When you dig down into the NFIB survey what small business owners are “saying,” and “doing,” are two different things.

For example, while business owners “SAY” they are optimistic about the economy currently, when it comes to committing their capital they are not nearly as brash. In fact, their level of planned capital expenditures continues to run at levels more normally associated with weak, or recessionary, environments.

What about consumers? They are optimistic as well.

Well, maybe not as much as you think. The survey shows that while business owners “SAY” sales should be improving, their biggest concern, which is spiking higher, is “poor sales.” 

Furthermore, notice that while there has been an immense amount of “chatter” about how the recent tax reform has lowered the burden on business which will lead to a surge in economic growth, etc., the level of concern over the amount of taxes being paid has budged from post-recessionary levels. While taxes were recently lowered, the “cost” of labor is rising which will absorb, for small business owners, much of the impact of any tax cut received. 

There is also a big difference between what the “hope” sales will be and what “actually” occurs. With such high levels of expectations currently, the risk of disappointment in future sales volumes is elevated.

While there is much “hope” that economic growth will boom this coming year due to regulatory and tax changes, history suggests the current levels of “economic optimism” are also likely to be disappointed.

Ultimately, for the markets and for investors, it is what you DO that matters the most.

Investors are currently set up for disappointment on many fronts over the next 12-24 months. While “exuberance” currently reigns, and investors are piling into risk equity with reckless abandon, the markets will continue to push higher.

Just be aware that “reality” will eventually set in.

Here is your weekend reading list.

Economy & Fed


RIA Chart Book: Q4-2017 Most Important Charts

Cryptocurrency Mania

Research / Interesting Reads

“Risk comes from not knowing what you are doing.” – Warren Buffett

Questions, comments, suggestions – please email me.

My end of the year newsletter generated the following comment at Seeking Alpha:

“I look at last year’s numbers and I feel all warm and content. I read articles like this and all that comfort disappears like it was never there. Reading this author is like taking your medicine, it’s good for your investing prowess, but it sure is not much fun. I guess folks find it bracing to write such things, ‘It’s for your own good.’ Ugh.The sad thing is that is likely a reasonable forewarning of disaster to come. Shoot the messenger, I say, let me bask in the sun of my success to date. Tomorrow we die, don’t you know, eat drink and be merry. It is good until it is no more.”

He’s right.

It’s the same thing as having to pass on a big, juicy hamburger and opt for the salad with low-fat dressing. It is not nearly as satisfying, but we do it because we don’t want to die from cardiac arrest.

The same thing with “working out.”  We trudge to the gym to grind away on a stair-climber so we don’t drop dead from a heart attack. (Maybe, if they called it something more fun sounding, like “sex prepping,” people might be more inclined to actually do it.)

But when it comes to the investment world, doing something for the “health and welfare” of your portfolio, especially when regard for risk is at historic lows, is a “buzzkill.”

Hey, I get it.

In fact, right now, the view of hedging a portfolio is virtually non-existent. The chart below is the 50-dma of the CBOE SKEW Index (which is derived from the price of S&P 500 tail risk and is calculated from the prices of S&P 500 out-of-the-money options) divided by the volatility index (VIX).

With the “lack of fear” index at near record highs, who wants to hear about why things may not stay that way?

But, isn’t this exactly the reason that we SHOULD be worrying about what comes next? 

We diet, exercise and do all things we hate to try and live a healthier life. We buy life insurance to hedge off the risk of dying too soon. Yet, we don’t want to give the same concern toward the “health” of the one thing we are going to be MOST dependent upon in retirement – OUR SAVINGS.

This is why my missives most often discuss the “risk” of what could go wrong with the market and your money.

No one wants to hear their doctor tell them to stop eating all that delicious fattening food. Nor do they want some fitness guru telling them they need to get to the gym. However, when the diagnosis is dire enough, it is the push needed for us to focus on what is important.

Of course, in the investment world, since such a view is considered “bearish,” it is immediately assumed that I am all in cash and have been sitting idly on the sidelines awaiting the next crash.

That is simply not the case.

In fact, in each weekly missive, I make a conscious effort to reinforce the fact that we are remain fully allocated in portfolios currently. I also discuss what we are doing within our client-centric portfolios. As noted this past weekend:

“As I noted last week, we did add some defensive positions to our portfolio allocations while we still retain a fully allocated long-position as well. These defensive ‘shock absorbers’ are simply in place to reduce a volatility shock when, not if, one occurs.” 

“Again, our portfolios remain on the long-side for now. However, as I will discuss below, we are also starting to add hedges and looking for additional opportunities to de-risk portfolios as prices continue their exuberant press higher.”

Here is the point.

I could easily become a “market cheerleader.” 

But there are already a multitude of those from the mainstream media to Wall Street.

Since I am already fully allocated to markets in our models, focusing on reasons why the markets will continue to rise seems a bit redundant to me.

What is more important to me, and the basis from which I write, is what potentially could take a large chunk of capital away from our clients. For us, capital preservation is the key to winning the long-term investment game.

Take a look at the chart above.

The markets have ONLY been this extended, overbought and exuberant a few times throughout history. The subsequent outcomes for investors have never been good and, in some instances, have been downright disastrous.

Could this time be different?


It is only a function of timing as to when something triggers a mean-reverting event. However, it could be 6-months or 2-years before such an event occurs.

It will, but, as the saying goes, “timing is everything.” 

So, I apologize if I seem to be a “Schleprock,” but as I have written many times in the past:

I am not bullish or bearish. My job as a portfolio manager is simple; invest money in a manner that creates returns on a short-term basis but reduces the possibility of catastrophic losses which wipe out years of growth.

In the end, it does not matter IF you are ‘bullish’ or ‘bearish.’ The reality is that both ‘bulls’ and ‘bears’ are owned by the ‘broken clock’ syndrome during the full-market cycle. However, what is grossly important in achieving long-term investment success is not necessarily being ‘right’ during the first half of the cycle, but not being ‘wrong’ during the second half.”

No Excuses

My hope, through my writings, is that you have been sufficiently warned.

It may not be today, next month, or even next year.

“Bull markets are built on optimism and die on exuberance.”

But they all die. Simply ignoring history won’t make the damage any less catastrophic.

Of course, given that investors are just “mere mortals” and do not have an infinite amount of time to reach their financial goals, the ends of bull market cycles matter, and they matter a great deal.

While “perma-bulls” may enjoy taking stabs at portfolio managers who take their risk management and capital preservation responsibilities very seriously, it should be done without taking those comments out of context.

Have I warned of risks in the markets?


Does that mean I have somehow been sitting in “cash” this whole time and “missing out?” 

Absolutely Not.

We are all trying to predict the future. No one will ever be right all the time.

I have more than once in my career written a “mea culpa,” and I am sure that I will write many more before I am finished with this business.

But here is my point.

The chart below brings this idea of reversion into a bit clearer focus. I have overlaid the real, inflation-adjusted, S&P 500 index over the cyclically-adjusted P/E ratio. 

Historically, we find that when both valuations and prices have extended well beyond their intrinsic long-term trendlines, subsequent reversions BEYOND those trend lines have ensued.

Every Single Time.

Importantly, these reversions have wiped out a decade, or more, in investor gains. As noted, if the next correction begins in 2018 and ONLY reverts back to the long-term trendline, which historically has never been the case, investors would reset portfolios back to levels not seen since 1997.

Two decades of gains lost…again.

A Prescription For Portfolio Health

With valuations elevated, the economic cycle very long in the tooth, and the 3-Ds applying downward pressure to future economic growth rates, there is a valid reason to consider the following:

  • Expectations for future returns and withdrawal rates should be downwardly adjusted.
  • The potential for front-loaded returns going forward is unlikely.
  • The impact of taxation must be considered in the planned withdrawal rate.
  • Future inflation expectations must be carefully considered.
  • Drawdowns from portfolios during declining market environments accelerate the principal bleed. Plans should be made during rising market years to harbor capital for reduced portfolio withdrawals during adverse market conditions.
  • The yield chase over the last 8-years and the low interest rate environment have created an extremely risky situation for retirement income planning. Caution is advised.
  • Expectations for compounded annual rates of returns should be dismissed in lieu of plans for variable rates of future returns.

Investing for retirement, no matter what age you are, should be done conservatively and cautiously with the goal of outpacing inflation over time. This doesn’t mean that you should never invest in the stock market, it just means that your portfolio should be constructed to deliver a rate of return sufficient to meet your long-term goals with as little risk as possible.

Chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk than you most likely want, or can afford. Two massive bear markets over the last decade have left many individuals further away from retirement goals than they ever imagined. Furthermore, all investors lost something far more valuable than money – the TIME that was needed to reach their retirement goals.

Oh, and while you’re at it, it’s probably time to call the doctor for that annual physical.

I can already hear the latex gloves popping.

Just remember, you have been sufficiently warned.

Thanks to Funeral Man, I am an avid reader.

Funeral man would lament. In the heat of summer, in the shade of a blood-red plush entrance to one of the fanciest funeral parlors in Brooklyn. A human frazzle of homeless dust. Inside the storm, a stack of books ranging from legit classics like “Moby Dick” to hip then now-classics like “The Joy of Sex”, he’d read.

He’d sit there for hours and shift focus from book to book like a tenured blackjack dealer armed with a familiar deck. Share thoughts mid-shift. All the time I wondered how someone who smelled like a dead body was optimistic enough to read about the joy of sex.

He was never without a book.

From a white-granite ornate bench. A rest stop for the grieving (now reading).

Funeral man in his Rolling Stones ’77 concert tee, fascinated me for several summers. Inspired my love of books and printed words. He’d show up in June, gone in September. For years I sat with him, listened as he read. Didn’t sit too close though. The musky odor of moldy page and human mixed with New York urban heat was occasionally too much.

“Have two books. One read. One save. One book perfect. One book messy.”

It made my parents, (especially dad) insane when I asked him for money for the school book fair.

“Why in hell does he need so much money for books? And then he buys two of the same %)@))@#_@ damn book, too? What a  f***ing retard!”

Funeral Man was correct. I learned to hate cracking the binder of a new book, bending a page, messing up the cover of a new paperback. I was obsessed/distressed. Even with “one book messy.” It didn’t sit kindly with me to be “one book messy.” I did it. I read the book. But it stressed me out, regardless.

Today, I’m no longer obsessed with “one book perfect.” The messier, the better. Notes, highlights. I’ve come a long way from the days when the permanent crease in the paperback cover of my favorite book, “The Poseidon Adventure,” put me out of commission for a couple of days. I still own that book. It’s funny, if you live long enough, the creases of a life pale in comparison to those of a drugstore paperback.

For a few 1970’s summers I stayed. Near the dead. As Funeral Man espoused the benefits of reading, I listened closely.

And learned.

I read 18 books a year and excited to share my top-ten selections with readers of Real Investment Advice.

Diversification among reading material is a method I use to gain knowledge and remain engaged in the material.

So, here goes:

Skin in the Game: Hidden Asymmetries in Daily Life – A provocative and foremost thinker, Nassim Nicholas Taleb shatters outdated beliefs about risk, probabilities and randomness. Taleb, one of my favorite writers and thinkers, is as close we have to a modern-day stoic. He’s never hesitant to question conventional thought and back his insights with wisdom possessed only by brilliant minds such as Marcus Aurelius.

Upon reading his books, it’s clearly understandable why mainstream economists, financial pundits and media personalities, dislike him so much. In turn, he considers their ridicule a badge of courage and calls these so-called experts out (by name) on their flawed theories in his publications and through social media.

In 2007, I sent copies of his seminal work “The Black Swan,” to several Deep-State Wall Street types for feedback. They were kind enough to inform me that Taleb’s analysis was paranoia and ridiculous. There’s motivation to purchase this new release, coming in February.

Dollars & Sense: How We Misthink Money and How to Spend Smarter  – Duke Professor and behavioral economist Dan Ariely along with Jeff Kreisler, continue to dive into the quirky motivations behind our simplest spending decisions. This isn’t boring stuff, either. The authors explore why we spend like we do and explore methods to improve our saving and spending behavior. Dan Ariely is the master of odd psychological experiments that get to the heart of what makes us tick, financially.

When: The Scientific Secrets of Perfect Timing – Daniel Pink studies people across all cultures and geographies to scientifically unlock the secrets that lead to the synchronization of maximum productivity to times of peak daily energy. The author’s methods are designed to help readers manage their hours wisely so that the most important tasks are tackled at the “right” time every day.

Adaptive Markets: Financial Evolution at the Speed of Thought  – M.I.T. behavioral economics professor Andrew Lo is far from the quixotic believer in the “random walk,” or daily randomness of stock prices, which is unusual. After all, academia lives and dies by the Efficient Market Hypothesis and the randomness of stock prices; so, I’m betting professor Lo doesn’t get to sit with the cool kids much.

He outlines in this book how the market as a collective soup of human emotions, really operates. It’s not the way your broker believes it does. Markets aren’t always rational and efficient even though as investors, we are force-fed this dogma as a convenient excuse to keep us fully invested at all times.

Lo’s unique adaptive theory is a realistic approach that blends elements of the Efficient Market Hypothesis with a necessary addition of humanity, a behavioral flow that makes emotions or animal spirits an integral part of the equation. The financial community at large hasn’t appeared to embrace this work which makes it a must read for me.

We the Corporations: How American Businesses Won Their Civil Rights – Law professor Adam Winkler documents how a 2010 Supreme Court decision to constitutionally protect big business, has turned the Constitution into a weapon corporations use to violate the rights of ordinary people like you and me.

The history which lead up to the 2010 rulings is explored. Sadly, corporations use the 2010 ruling to protect themselves against further regulatory actions that protect American citizens.

The Kings of Big Spring: God, Oil, and One Family’s Search for the American Dream – Author Bryan Mealer weaves a master tale of a Texas family that spans four generations overwhelmed with flaunted financial opulence, personal drama, heartache and failure. A big-state tale of fortune and ruin, the author outlines a story of his great-grandfather that not only spans wealth and adventure, tragedy and prosperity; it’s one of those books that simultaneously takes the reader along for the birth of a Texas nation. I’m a sucker for sweeping epics like this. They’re healthy for the imagination and a welcomed break from finance and economics.

Tribe of Mentors: Short Life Advice from the Best in the World -Entrepreneur and motivational guru Timothy Ferriss interviews his business and entertainment idols about their daily rituals, failures and successes. There are over one hundred interviews in the book. Some you’ll relate to, others you’ll ignore. This is my ‘lightest’ reading choice of the year and I’m especially interested in positive morning rituals that get the day started on productive footing.

Revolution Song: A Story of American Freedom  – I’m envious of Russell Shorto. He’s one of the most gifted wordsmiths I’ve ever read. Every sentence he pens is poetic and breathtaking. The struggle for freedom (which continues today), during the American Revolution is chronicled through the eyes of six people whose lives were forever changed. His style reminds me of historical fiction written by John Jakes.

Shorto uses words the way an artist employs a brush; the Revolution’s freedom song is brought down to the notes of the collective individuals who form it with a relentless, turbulent forming nation as a brilliant yet unmerciful backdrop.

Thinking in Bets: Making Smarter Decisions When You Don’t Know All the Facts – Poker champion Annie Duke advises readers how to embrace uncertainty and make clear decisions in the face of it.  The author now business consultant, teaches readers how to graduate from a need for certainty to a perspective of probabilities when it comes to making decisions – an analysis of what you know, what you don’t, and the outcomes that may occur (good and bad), can help decision makers remain calm and increase the odds of success, or at the least, deal successfully with adversity in the face of bad decisions.

The Truth Machine: The Blockchain and The Future of Everything– Michael Casey and Paul Vigna seek to demystify the blockchain, an open digital ledger of economic transactions, and explore how this cutting-edge technology will permanently alter the landscape of several industries from finance to shipping.

Blockchain technology per the authors, will level the playing field for billions of people who currently have limited access to the global economy, shift the balance of power away from self-interested middlemen and allow consumers to bypass those financial, banking institutions which have been rapidly losing credibility since the financial crisis. Hey, you may not believe in cryptocurrencies like Bitcoin, but the technology behind them will probably affect how you transact business in less than a decade.

Early in the new year, I’ll again pull one of my forever favorites from my business and investing library and re-read. If you haven’t checked out my “go-to” library selections, check out: Ignore Business Insider’s Reading List: This is What You Should Read.

In the summer of ’77, I threw Funeral Man a psychological curve ball. While reading near the foot of the master, a self-improvement book he recommended, I looked to him and said:

“You know, you read some great stuff. Why can’t you live the words?”

He was clearly hurt. I mean with all this knowledge, why hadn’t he done more with his life?

What words will you read today and really take to heart?

Will sentences change your perspective, motivate you?

Words change and improve who I am every day.

So do the lessons learned.

Funeral Man died in 1979.

I attended the service. Room B. Inside plush further inside plush of his favorite death parlor.

I didn’t recognize him at first: I thought it was a mix up. All cleaned up. Hair neat. His name was Sam. He wore a military uniform. With multiple medals hanging from his chest.

I truly felt bad for what I said.

Funeral Man was indeed a man of lessons.

He did live words. His truth. Obviously, it was just enough to drive him insane.

I ran four blocks home for my copy of “The Sun Also Rises.”

It was buried with Funeral Man a long time ago.

Not a cover was bent.

One book perfect.

One book saved.

Like a life not lived.

But not you, Sam.

You live on.

I hope RIA readers enjoy these selections for the new year.

The New England Patriots are the winningest professional football team of the new millennia. While we could post a long list of reasons for their success, there is one that stands above the rest. In a recent interview, Patriots quarterback Tom Brady stated that they start each year with one goal; win the Super Bowl. Unlike many other teams, the Patriots do not settle for a better record than last year or improved statistics. Their single-minded goal is absolute and crystal clear to everyone on the team. It provides a framework and benchmark to help them coach, manage and play for success.

Interestingly, when most individuals, and many institutions for that matter, think about their investment goals, they have hopes of achieving Super Bowl like returns. Despite their well-intentioned ambitions, they manage their portfolios based on benchmarks that are not relevant to their goals. In this paper, we introduce a simple investment benchmark that simplifies the tracking process toward goals which if achieved, provide certitude that one’s long-term objectives will be met.

The S&P 500

Almost all investors benchmark their returns, manage their assets and ultimately measure their success based on the value of a stock, bond or blended index(s). The most common investor benchmark is the S&P 500, a measure of the return of 500 large-cap domestic stocks.

Our belief is that the performance of the S&P 500 and your retirement goals are unrelated. The typical counter-argument claims that the S&P 500 tends to be well correlated with economic growth and is a valid benchmark for individual portfolio performance and wealth. While that theory can be easily challenged over the past decade the question remains: Is economic growth a more valid benchmark than achieving a desired retirement goal?  Additionally, there are long periods like today where the divergence between stock prices and underlying economic fundamentals are grossly askew. These variances result in long periods when stock market performance can vary greatly from economic activity.

Even if we have a very long investment time frame and are willing to ignore the large variances between price and valuation, there is a much bigger problem to examine. Consider the following question: If you are promised a consistent annualized return of 10% from today until your retirement, will that allow you to meet your retirement goals?

Inflation and Purchasing Power

Regardless of your answer, we are willing to bet that most people perform a similar analysis. Compound current wealth by 10% annually to arrive at a future portfolio value and then determine if that is enough for the retirement need in mind. Simple enough, but this calculus fails to consider an issue of vital importance. What if inflation were to run at an 11% annual rate from today until your retirement date?  Your portfolio value will have increased nicely by retirement, but your wealth in real terms, measured by your purchasing power, will be less than it is today. Now, suppose you were offered annual returns equal to the annual rate of inflation (the consumer price index or CPI) plus 3%.

Based on 2017 CPI of approximately 2% for a total return of approximately 5% compared to almost 20% for the S&P 500, we venture to say that many readers would be reluctant to accept such an “unsexy” proposition. Whether a premium of 3% is the right number for you is up for debate, but what is not debatable is that a return based on inflation, regardless of the performance of popular indexes, is a much more effective determinant of future wealth and purchasing power.

To show why this concept is so important, consider the situation of an investor with plans to retire in 25 years. Our investor has $600,000 to invest and believes that he will need $1,500,000 based on today’s purchasing power, to allow him to live comfortably for the remainder of his life. To achieve this goal, he must seek an annualized return of at least 4.50%. As a point of reference, the total return of the S&P 500 is 6.60% over the past 100 years. At first blush our investor, given his relatively long time frame until retirement, might think the odds are good that the S&P 500 will allow him to achieve his retirement goal. However, his failure to factor in inflation causes his calculations to be incorrect. Since 1917, inflation has averaged 3.09%. The S&P 500 total return since 1917 including the effect of inflation is only 3.51%. The odds are not in his favor, and his oversight may ultimately leave him in a difficult situation.

The graph below shows the resulting 25 year total returns based on each monthly starting point since 1917. The red line shows our investor’s goal of 4.50%. Keep in mind that since the graph requires 25 years of data, the last data point on the graph is December 1992.

Over the time frame illustrated, the investor was subjected to anxiety-inducing random high and lows relative to his target return. His portfolio performance is a flag in the wind at the mercy of the volatility of the equity markets.

Instead of rolling the dice like an investor managing and benchmarking towards the S&P 500, why not manage your portfolio based on an index that will properly target a dollar amount of purchasing power in the future? In our prior example, achieving a benchmark of the annual rate of CPI plus 4.50% would allow our investor to retire with at least $1,500,000 in today’s purchasing power.

Inflation based indexing

Unlike benchmarking to a popularly traded equity or bond index using ETFs and mutual funds, managing to an inflation-linked benchmark is more difficult. It requires an outcome-oriented approach that considers fundamentals and technical analysis across a wide range of asset classes. At times, alternative strategies might be necessary or prudent. Further, and maybe most importantly, one must check one’s ego at the door, as returns can vary widely from those of one’s neighbors. The challenge of this approach explains why most individuals and investment professionals do not subscribe to it. It is far easier to succeed or fail with the crowd than to take an unconventional path that demands rigor.

The reward for using the proper index and successfully matching or exceeding it is certitude. The CPI-plus benchmark approach described here is far more honest and durable in its ability to compound wealth and show definitive progress. It is deliberate and does not hand over control of the outcome to the whim of the market. It also requires an investor to avoid the hype and distractions that continually surround the day-to-day movements of the stock market.


We understand the difficulty in achieving one’s financial goals, especially in today’s unique environment of low-interest rates and high stock market valuations. Why compound the difficulty by managing your wealth to the random volatility of an index or benchmark that is different from your goals? Matching the performance of the S&P 500 is cheap and easy for a reason. It is also irrelevant to compounding wealth as it ignores important aspects of the wealth management process such as avoiding large and wealth-debilitating drawdowns.

Meeting your goals requires a logical and deliberate strategy guided by a set of rules that few investors understand. There is a reason many investors and retirees are failing to meet their goals. Using a reliable but different approach will help ensure that you don’t end up as one of them.

“For many, it will be increasingly difficult to navigate a market dominated by the overly popular ETFs and quant (volatility-trending and risk-parity) strategies that worship at the altar of price momentum. It is also because the ‘buy the dip’ mentality remains indelibly etched on the forehead of most investors and traders that the Pavlovian reaction won’t die easily.

Favoring the bulls is the diminished number of publicly held companies outstanding (from more than 7,600 in 2000 to 3,800 in 2017), a 17% reduction in the float of the remaining companies via corporate buybacks, and still-abundant liquidity. And on top of this, as previously mentioned, is the market’s participants confidence in buying the dips.” – Kass Diary, The Bull Wont Die Easily (November, 2017)

In trying to understand the relentless “Bull Market” advance since the Trump Election fourteen months ago I am reminded of what I wrote above in November, 2017.

These words were underscored in Jim “El Capitan” Cramer’s “Four Reasons Stocks Keep Going Up,” written at the end of yesterday’s trading session, in which he discusses the important structural changes that have led to the popularity of passive investing (ETFs) and in the share count drop caused by a near decade of aggressive corporate buybacks.

Of course there are numerous other reasons (some Jim details further) like the employment of large liquidity infusions from central bankers around the world, optimism about the cut in corporate taxes, the reductions of business regulations (around the fringe), sustained lower interest rates, etc.

As I have also written, investment vision is always 20/20 when viewed in the rear view mirror.

These past observations don’t really help us project the future — though I did touch on some of my concerns in yesterday’s opening missive, “Blinded By a Sense of History” (with some updates in parentheses):

“It is a mania shared by philosophers of all ages to deny what exists and to explain what does not exist.” – Jean-Jacques Rousseau

I have no clue how long it will continue:

* What I am certain about is that liquidity, which has buoyed our markets for years, is starting to be reduced. (Central Bankers are reversing course and beginning to contract their balance sheets)

* What I am fairly certain about is that we are at sentiment and valuation extremes — at least based on history. (And every day these measures grow more stretched)

* Interest rates are likely headed higher, posing — at some point — a potential risk and alternative to stocks. (The ten year US note yield rose above 2.50% this morning)

* I expect no further major legislative initiatives coming out of Washington, D.C. — specifically on the infrastructure front — and a further deterioration in the relationship between the Republicans and Democrats as we move toward key midterm elections. (My expectation is that the House goes Democrat while the Senate stays Republican.)

* As to the Administration, their belief appears to be that the benefit of world leadership is not worth the costs — which runs the risk of a policy mistake in the year ahead.

* As well, though markets have not been yet unnerved even with the White House having gotten bitten by a Wolff this past week, there exists the possibility that the Special Counsel’s
activities could be market unfriendly.

* And I am of the view that the earnings and economic growth expectations will, once again, be disappointing in 2018-19. (Earnings revisions higher have been material (in large measure from tax cuts) but I see mid year as a pivot point of slowing, not accelerating growth)

The markets seem to be moving back to being one with more concentrated leadership — as technology and the FAANGs (a large percent of the S&P Index) have regained their strength. Small caps, supposed tax cut beneficiaries, are lagging. Again, historically these are not positive signposts but it can continue, I have learned, far longer than I anticipated.

The speculation in cryptocurrencies and blockchain and penny stocks is yet another thin reed indicator of a mature Bull. And so is the self confidence and hubris seen in the business media.

Risk assets, like stocks, are called risk assets because they have risk — though you wouldn’t know it from the recent action in which fear and doubt has left the Exchanges.

But, wrong is wrong — and I continue to see ghosts that few market participants are viewing, blinded by a sense of history.

My strategy, given that the markets have clearly moved so much higher than my baseline expectations — is to become more trading oriented and to maintain high cash levels.

As described in my Diary, I see few longs that meet my standards of purchase.

As the market moves almost parabolically, I have recently begun to more aggressively short strength while keeping my stops fairly tight. (Day or days trades.)

Recently, with the exception of the last day of the year in which I profited, this has been a losing proposition.

Wash, rinse, repeat.

My view through the windshield (and the future) has been dramatically worse than my view through the rear view mirror (and the past) as stocks have marched ever higher without the sign of any meaningful pause.

While Grandma Koufax used to say, “Dougie, matzah doesn’t grow to the sky,” the investment trees are like redwoods these days.

This past weekend, I discussed the surge in market exuberance in terms of both individual and professional investors. Of course, such surges in exuberance are generally indicative of the “capitulation phase” as the last of the “holdouts” finally jump back into a market which “can seemingly never go down.”

But therein lies the danger. It worth noting that despite the “hope” of more fiscal support for the markets, longer-term conditions currently persist which have led to rather sharp market reversions in the past. 

“There are many factors from economic, monetary, geopolitical, and financial which have ignited each bubble, and bust, period throughout history. However, each bubble had in common the same extreme levels of confidence, exuberance, valuation and price extension that we see today. And they all ended the same, as well.”

Regardless, the market is currently ignoring such realities as the belief “this time is different” has become overwhelming pervasive. Importantly, such levels of exuberance have NEVER been resolved by a market that moved sideways.

Positioning Review

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

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

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

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

Therefore, as shown in the series of charts below, we can take a look at their current net positioning (long contracts minus short contracts) to gauge excessive bullishness or bearishness. With the exception of the 10-Year Treasury which I have compared to interest rates, the others have been compared to the S&P 500.

Volatility Extreme

The extreme net-short positioning on the volatility index suggests there will be a rapid unwinding of positions given the right catalyst. As you will note, reversals of net-short VIX positioning have previously resulted in short to intermediate-term declines.

Currently, the record level of short-volatility positions has started to decline. Such events have tended to precede market corrections in the past as seen in early 2016 as the then-record net-short positioning turned net-long.

With the ratio of the short-to-long term VIX index at near record levels, with the market also pushing the upper-end of the current trading range, the reduction in the net-short positioning suggests a correction in the next couple of months is likely. Currently, such a correction should remain confined within the bullish trend channel. However, a violation of that channel will certainly get our attention.

Crude Oil Extreme

The recent attempt by crude oil to get back to $60/bbl coincided with a “mad rush” by traders to be long the commodity. For investors, it is also worth noting that crude oil positioning is also highly correlated to overall movements of the S&P 500 index. With crude traders currently extremely “long,” a reversal will likely coincide with both a reversal in the S&P 500 and oil prices being pushed back towards $40/bbl. 

While oil prices could certainly fall below $40/bbl for a variety of reasons, the recent bottoming of oil prices around  $45/bbl should provide some reasonable support (barring an economic recession.)

Given the extreme long positioning on oil, a reversion of that trade will likely coincide with a “risk off” move in the energy sector specifically. As you know, we added a trading position in XLE back in December, we will continue to maintain that position for now, but with the sector now very overbought and extended we will look to rebalance our positions in portfolios. 

US Dollar Extreme

Recent weakness in the dollar has been used as a rallying call for the bulls. However, a reversal of US Dollar positioning has been extremely sharp and has led to a net-short position.

As shown above, and below, such negative net-short positions have generally marked both a short to intermediate-term low for the dollar as well as struggles for the S&P 500 as a stronger dollar begins to weigh on exports and earnings estimates. Just recently, that net-short positioning has turned positive which suggests a rally in the dollar is likely.

Historically, strong dollar rallies have not been kind to asset prices. With tax cuts now passed, a near-term bump to economic strength will lead to an influx into dollar-denominated assets. Strong dollar surges negatively impact exports which comprises roughly 40% of corporate earnings. With the dollar VERY oversold currently, look for a strong-dollar rally this year. 

It is also worth watching the net-short positioning the Euro-dollar as well which has also begun to reverse in recent weeks. Historically, the reversal of the net-short to net-long positioning on the Eurodollar has often been reflected in struggling financial markets. The reversal is still early, but worth watching closely.

Interest Rate Extreme

One of the biggest conundrums for the financial market “experts” is why interest rates fail to rise. Apparently, traders in the bond market failed to get the “memo.” The reversal of the net-long positioning in Treasury bonds will likely push bond yields lower over the next few months. This will accelerate if there is a “risk-off” rotation in the financial markets in the weeks ahead.

More importantly, yields are now approaching levels which have historically been significant buying opportunities to add exposure to portfolios particularly if yields begin to approach 3% as last seen in 2014.

Smart Vs. Dumb Money Extreme

As I noted this past weekend, investors are currently “all in” on a variety of “sentiment” based measures.

“Even our composite fear/greed index which is a combination of AAII, INVI, MarketVane and the VIX is now also registering extreme greed on a rolling 4-week basis.”

However, we can also look at the overall net exposure of retail investors (considered the “dumb money”) versus that of the major institutional players (“smart money”)

The first chart below shows the 3-month moving average of both smart and dumb-money players as compared to the S&P 500 index. With dumb-money running close to the highest levels on record, it has generally led to outcomes that have not been favorable in the short-term.

We can simplify the index above by taking the net-difference between the two measures. Not surprisingly, the message remains the same. With the confidence of retail investors running near historic peaks, outcomes have been less favorable.

Amazingly, investors seem to be residing in a world without any perceived risks and a strong belief that the financial markets are NOT in a bubble. The arguments supporting those beliefs are based on comparisons to previous peak market cycles.

The inherent problem with much of the mainstream analysis is that it assumes everything remains status quo. But data, markets, economies, and liquidity are never the same. The question is simply what can go wrong for the market?

In a word, “much.”

It is likely that in a world where there is “no fear” of a market correction, an overwhelming sense of “urgency” to be invested, and a continual drone of “bullish chatter;” markets are poised for the unexpected, unanticipated and inevitable reversion.

But that doesn’t mean today, tomorrow or next week? No.

With the markets up more than 2% during the “first 5-trading days of January,” the bulls remain clearly in charge of this market. Historically, when the first 5-days have been positive, so has the year. More importantly, when the first 5-days have been up 2% or more as is currently the case, the market has posted double-digit gains for the year. 

We remain fully allocated to markets currently, although we have added some “risk hedges” to portfolios recently.

With investor exuberance pushing peaks, it is not surprising to see net positioning extremely one-sided. Just understand, that positioning will NOT always be that way. When this current cycle ends, and it will, it will just as disastrous to long-term investment objectives as every other reversion throughout history.

Pay attention, have a plan and act accordingly.

In Q3 of last year, Michael Lebowitz and I decided that each quarter we would produce a “chartbook” of the “most important charts” from the last quarter for you to review.

In addition to the graphs, we provided a short excerpt from the article as well as the links to the original articles for further clarification and context if needed. We hope you find them useful, insightful, and importantly we hope they give you a taste of our unique brand of analysis. In most cases, the graphs, data, and commentary we provide are different from that of the business media and Wall Street.  Simply put, our analysis provides investors an edge that few are privy to.

The Federal Reserve Reveals The Ugly Truth

The 2016 survey confirms statements I have made previously regarding the Fed’s monetary interventions leaving the majority of Americans behind:

However, setting aside that point for the moment, how valid is the argument the rise of asset prices is related to economic strength. Since companies ultimately derive their revenue from consumers buying their goods, products, and services, it is logical that throughout history stock price appreciation, over the long-term, has roughly equated to economic growth. However, unlike economic growth, asset prices are psychologically driven which leads to “boom and busts” over time. Looking at the current economic backdrop as compared to asset prices we find a very large disconnect.

Since Jan 1st of 2009, through the end of June, the stock market has risen by an astounding 130.51%. However, if we measure from the March 9, 2009 lows, the percentage gain explodes to more than 200%. With such a large gain in the financial markets we should see a commensurate indication of economic growth – right?”

“The reality is that after 3-massive and unprecedented Federal Reserve driven “Quantitative Easing” programs, a maturity extension program, bailouts of TARP, TGLP, TGLF, etc., HAMP, HARP, direct bailouts of Bear Stearns, AIG, GM, bank supports, etc., all of which total more than $33 Trillion, the economy grew by just $2.64 Trillion, or a whopping 16.7% since the beginning of 2009. The ROI equates to $12.50 of interventions for every $1 of economic growth.

Read: Fed Study: The Bottom 90% And The Failure Of Prosperity

Risk vs. Reward

There are two divergent facts that make investing in today’s market extremely difficult.

  1. The market trend by every measure is clearly bullish. Any novice technician with a ruler projected at 45 degrees can see the trend and extrapolate ad infinitum.
  2. Markets are extremely overvalued. Intellectually honest market analysts know that returns produced in valuation circumstances like those observed today have always been short-lived when the inevitable correction finally arrives.

In The Deck is Stacked we presented a graph that showed expected five-year average returns and the maximum drawdowns corresponding with varying levels of Cyclically-Adjusted Price-to-Earnings (CAPE) ratios since 1958. We alter the aforementioned graph, as shown below, to incorporate the odds of a 20% drawdown occurring within the next five years.

Over the next five years we should expect the following:

  1. Annualized returns of -.34% (green line)
  2. A drawdown of 27.10% from current levels (red line)
  3. 76% odds of a 20% or greater correction (yellow bars)

Read: Protecting Your Blind Side

Tax Cut Impact

So, with 80% of Americans living paycheck-to-paycheck, the need to supplant debt to maintain the standard of living has led to interest payments consuming a bulk of actual disposable income. The chart below shows that debt has exceeded personal consumption expenditures. Therefore, any tax relief will most likely evaporate into the maintaining the current cost of living and debt service which will have an extremely limited, if any, impact on fostering a higher level of consumption in the economy.

Read: Bull Trap – The False Promise Of Tax Cuts

One Chart

Our chart of the day is a long-term view of price measures of the market. The S&P 500 is derived from Dr. Robert Shiller’s inflation adjusted price data and is plotted on a QUARTERLY basis. From that quarterly data I have calculated:

  • The 12-period (3-year) Relative Strength Index (RSI),
  • Bollinger Bands (2 and 3 standard deviations of the 3-year average),
  • CAPE Ratio, and;
  • The percentage deviation above and below the 3-year moving average. 
  • The vertical RED lines denote points where all measures have aligned

Read: One Chart Show Why Investors Are Dealt A Losing Hand

Borrowing From The Future

The stock market has returned more than 60% since 2007 peak, which is more than three times the growth in corporate sales growth and 30% more than GDP. The all-time highs in the stock market have been driven by the $4.5 trillion increase in the Fed’s balance sheet, hundreds of billions in stock buybacks, PE expansion, and ZIRP.

It is critical to remember the stock market is NOT the economy. The stock market should be reflective of underlying economic growth which drives actual revenue growth. Furthermore, GDP growth and stock returns are not highly correlated. In fact, some analysis suggests that they are negatively correlated and perhaps fairly strongly so (-0.40).

However, in the meantime, the promise of a continued bull market is very enticing as the “fear of missing out” overrides the “fear of loss.”

Read: Bogle, Buffett, Shiller, Tobin – Valuations Are Expensive

Markets Don’t Compound

Morgan Stanley states that in 30-years if the Dow grows at just 5% annually, it will hit 500,000. However, if the Dow actually compounded returns at 5%, in the future, as Morgan suggests, it would have done so in the past and would ALREADY be at 500,000. 

But it’s not. We are just stuck here at a crappy ole’ 23,000.

There is a huge difference between compound returns and average returns. The historical return of the markets since 1900, including dividends, has averaged a much higher rate of return than just 5% annually. Therefore, the Dow should actually be much closer to 1,000,000 than just 500,000.

Read: Dow 500,000? We Are Already There

Not In A New Secular Bull Market

However, as noted above, and as shown below, “secular bull markets,” which are long-term growth trends, have never started from 15x valuations and immediately surged to the second highest level on record. Historically, as shown below, secular bull markets are born of excessive pessimism and low valuations that stay in place for years as earnings and profitability grow faster than prices (keeping valuations lower.) Despite Mr. Saut’s hopes, that is simply not the case today as valuations exploded as earnings, economic and profit growth lagged the liquidity induced surge in asset prices.

Read: Fundamentally Speaking – Markets Being Driven By Fundamentals?

The Myths Of Tax Cuts

Myth #1: Tax Cuts Will Create An Economic Revival

As the Committee for a Responsible Federal Budget stated last week:

“Tax cuts do not pay for themselves; they can create growth, but in the amount of tenths of percentage points, not whole percentage points. And they certainly cannot fill in trillions in lost revenue. Relying on growth projections that no independent forecaster says will happen isn’t the way to do tax reform.”

That is absolutely correct and as I pointed out on Friday:

“As the chart below shows there is ZERO evidence that tax cuts lead to stronger sustained rates of economic growth. The chart compares the highest tax rate levels to 5-year average GDP growth. Since Reagan passed tax reform, average economic growth rates have only gone in one direction.”

Read: The 3-Myths Of Tax Cuts

What does 2028 hold in store?

The following graph and table explore the range of outcomes that are possible given the scenarios outlined above. To help put context around the wide range of expected returns, we calculated an equity-equivalent price of the 10-year U.S. Treasury Note and added it to the graph as a black dotted line. Investors can use the line to weigh the risk and rewards of the S&P 500 versus the option to purchase a relatively risk-free U.S. Treasury Note. The table below the graph serves as a legend and reveals more information about the forecasts. The color shading on the table affords a sense of whether the respective scenario will produce a positive or negative return as compared to the U.S. Treasury Note. The far right column on the table indicates the percentage of observations since 1881 that CAPE has been higher than the respective scenarios.

Data Courtesy: Robert Shiller and 720Global/Real Investment Advice

Read: Three Easy Pieces

Why Rates Can’t Rise

The chart below shows only the composite index and the 10-year Treasury rate. Not surprisingly, the recent decline in the composite index also coincides with a decline in interest rates.

In the current economic environment, the need for capital remains low, outside of what is needed to absorb incremental demand increases caused by population growth, as demand remains weak. While employment has increased since the recessionary lows, much of that increase has been the absorption of increased population levels.

Read: Bond Bears & Why Rates Won’t Rise

On Punditry

So sorry, Suze. This bit of knowledge? Strikeout. Not everything compounds.

“Orman explained that if a 25-year-old puts $100 into a Roth IRA each month, they could have $1 million by retirement.” 

This statement perplexes me. While I wholeheartedly agree with a monthly investing or saving discipline spouted here, especially into a Roth IRA where earnings grow tax-deferred and withdrawn tax-free at retirement, I had a dilemma making her retirement numbers work.

As outlined in the chart above, on an inflation-adjusted basis, achieving a million-buck balance in 40 years by dollar-cost averaging $100 a month, requires a surreal 11.25% annual return. In the real world (not the superstar pundit realm), a blind follower of Suze’s advice would experience a whopping retirement funding gap of $695,254.68.

I don’t know about you, to me, this is a Grand Canyon expectation vs. reality-sized unwelcomed surprise.

Read: Fabrications Of Financial Media Superstars

The Myth Of Buy & Hold

Once you set aside the daily media chatter, sales pitches, poor investment advice and investing methods that have a complete lack of evidence to support them, you find out one simple truth:

“Managing the risk of drawdowns is what separates having enough money to live out your retirement dreams, or not.”

With this in mind, the reality of saving for your retirement should be clear as 2 of the 3 methods discussed above leave you well short of your financial goals.

Read: 2-Of-3 Investing Methods Will Leave You Short

Global QE

Global central banks’ post-financial crisis monetary policies have collectively been more aggressive than anything witnessed in modern financial history. Over the last ten years, the six largest central banks have printed unprecedented amounts of money to purchase approximately $14 trillion of financial assets as shown below. Before the financial crisis of 2008, the only central bank printing money of any consequence was the Peoples Bank of China (PBoC).

The central banks’ goals, in general, are threefold:

  • Expand the money supply allowing for the further proliferation of debt, which has sadly become the lifeline of most developed economies.
  • Drive financial asset prices higher to create a wealth effect. This myth is premised on the belief that higher financial asset prices result in greater economic growth as wealth is spread to the masses.
    • “And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.”– Ben Bernanke Editorial Washington Post 11/4/2010.
  • Lastly, generate inflation, to help lessen the burden of debt.

Read: A Question For Every Investor

Turning Japanese

More importantly, while there are many calling for an end of the “Great Bond Bull Market,” this is unlikely the case. As shown in the chart below, interest rates are relative globally. Rates can’t rise in one country while a majority of economies are pushing negative rates. As has been the case over the last 30-years, so goes Japan, so goes the U.S.

Unfortunately, for the Administration, the reality is that cutting taxes, and MORE debt, is unlikely to change the outcome in the U.S. The reason is that monetary interventions and government spending don’t create organic, and sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever-growing void in the future that must be filled. Eventually, the void will be too great to fill.

Read: Tax Reform And The Japanification Of America

The Long End Of The Curve

Each time, when liquidity was extracted from the financial markets, the rotations from “risk” to “safety” pushed yields lower. Not higher. The chart below is the 8-rolling average of the Fed’s balance sheet which more clearly shows the correlation.

The correlation makes complete sense when you think about it. When the Fed is expanding their balance sheet, money flows into the equity markets driving “risk” assets higher. With the reduced need for “safety,” money rotates from bonds into stocks on an asset allocation basis. The opposite occurs when the Fed extracts liquidity from the markets.

Read: Can The Fed Really Boost Bond Yields

These are some of our favorite charts and we hope you find them useful and insightful. Please send us any comments, suggestions, or your favorite charts to us for consideration.

Real Investment Advice is pleased to introduce J. Brett Freeze, CFA, founder of Global Technical Analysis. Going forward on a monthly basis we will be providing 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.


We believe that the chief determinant of future total returns is the relative valuation of the index at the time of purchase. We measure valuation using the Price/Peak Earnings multiple as advocated by Dr. John Hussman. We believe the main benefit of using peak earnings is the inherent conservatism it affords: not subject to analyst estimates, not subject to the short-term ebbs and flows of business, and not subject to short-term accounting distortions. Annualized total returns can be calculated over a horizon period for given scenarios of multiple expansion or contraction.

Our analysis highlights expansion/contraction to the minimum, mean, average, and maximum multiples (our data-set begins in January 1900) . The baseline assumptions for nominal growth and horizon period are 6% and 10 years, respectively. We also provide graphical analysis of how predicted returns compare to actual returns historically.

We provide sensitivity analysis to our baseline assumptions. The first sensitivity table, ceterus paribus, shows how future returns are impacted by changing the horizon period. The second sensitivity table, ceterus paribus, shows how future returns are impacted by changing the growth assumption.

We also include the following information: duration, over(under)-valuation, inflation adjusted price/10-year real earnings, dividend yield, option-implied volatility, skew, realized volatility, historical relationships between inflation and p/e multiples, and historical relationship between p/e multiples and realized returns.

Our analysis is not intended to forecast the short-term direction of the SP500 Index.  The purpose of our analysis is to identify the relative valuation and inherent risk offered by the index currently.


Yesterday, as I was researching the data on the Fed’s balance sheet as it relates to the future direction of interest rates, I stumbled across an interesting piece of analysis.

The chart below shows the deviation of the market from the underlying liquidity provided by the Fed’s balance sheet.

Not surprisingly, in 2006-2007 as the deviation reached extremes, market liquidity became problematic. While we only recognized this in hindsight, the correlation is important to consider.

Currently, this “Brawny Market” has become the “quicker picker-upper” of market liquidity. The issue becomes, as discussed yesterday, with the Federal Reserve beginning to extract liquidity from the markets, along with the ECB tapering their QE program simultaneously, at what point does liquidity once again become a problem? 

For now, however, market exuberance has completely overtaken investor mentalities. Such is not surprising as we head into the 9th-year of the current bull market advance. As shown in the chart below, the current market conditions, while bullish and positive which keeps portfolios allocated toward risk, are at levels seen only three-times previously.

Such does not mean a “crash” is coming tomorrow, but it does suggest that this “Brawny Market” has much more limited upside than what most investors currently believe.

Remain long equities for now. But don’t forget that what goes up, will eventually come down. So it is worth paying attention to the risk and having a plan of action in place to do with the eventual reversion when it comes.

Just something to think about as you catch up on your weekend reading list.

Economy & Fed



Technically Speaking: Revisiting Bob Farrell’s 10-Rules

Cryptocurrency Mania

Research / Interesting Reads

“The trick of successful investors is to sell when they want to, not when they have to.” – Seth Klarman

Questions, comments, suggestions – please email me.

Originally Posted At Forbes

Two months ago, I asked the question “Is A Santa Claus Rally Ahead?” knowing that we were heading into a historically bullish time of year. I showed several consolidation patterns that I believed could have led to another leg of the rally. In November, the U.S. stock indices broke out of their consolidation patterns and rallied right into the end of the year due to excitement over president Trump’s tax reform plan. In this piece, I will look at the latest charts to help determine if the uptrend is still intact or if another consolidation or pullback is ahead.

For the past week or so, the Dow has struggled underneath its 25,000 resistance level, which is a key psychological level. On Friday, the Dow experienced a low-volume sell-off after struggling to clear 25,000. A convincing break above 25,000 on high-volume is necessary to confirm the next leg of the uptrend. If Friday’s sell-off continues, however, the next price target to watch is the uptrend line that started in September.

The weekly Dow chart shows that the index is in a clear uptrend with steepening uptrend lines over the past two years. If there is a pullback, the steeper, closer uptrend line is the price target to watch.

Similar to the Dow, the SP500 has struggled underneath its 2,700 resistance level for the past week or so. A solid breakout above 2,700 with strong volume would signal the next leg up, while a continuation of Friday’s pullback would put the 2,600 support and uptrend line into play.

The weekly SP500 chart is in a clear uptrend with steepening uptrend lines that started in early-2016. In the event of a pullback, the nearest uptrend line is the next major support level to watch.

The tech-heavy Nasdaq 100 has been acting the weakest of all the major U.S. stock indices in the past two weeks. If the pullback continues, it would put the 6,200 support and uptrend line into play as the next price target to watch.

The weekly Nasdaq 100 price chart shows no technical damage whatsoever as long as it remains above its two uptrend lines that started in early-2016.

The small cap Russell 2000 has been struggling to break above its 1,550 resistance level. A high-volume breakout over this level is necessary to confirm the next phase of the rally. If Friday’s pullback continues, the next support to watch is the uptrend line that began in August 2017.

The weekly Russell 2000 chart shows that the index is trading in a rising channel pattern. The longer-term uptrend is still intact as long as the index stays within this channel.

Despite Friday’s pullback, there is very little chart damage in the U.S. stock indices – at least for now. I want to see how the markets act this week, when traders come back from their vacations. Though I believe we’re in a dangerous, longer-term stock market bubble, I respect the trend as a trader and investor.

(Disclaimer: All information is provided for educational purposes only and should not be relied on for making any investment decisions. These chart analysis blog posts are simply market “play by plays” and color commentaries, not hard predictions, as the author is an agnostic on short-term market movements.)