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• The Bullish Narrative
• Is It All Priced In?
• Sector & Market Analysis
• 401k Plan Manager

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The Bullish Narrative

This past week was built for the “bulls” as just about every item on their “wish list.” was fulfilled. From a “trade deal” to more “QE,” what more could you want?

Trade Deal Near?

Concerning the ongoing “trade war,” our prediction that Trump would begin to back peddle on negotiations to get a “deal done” before the election came to pass.

Trump has once again delayed tariffs to allow the Chinese more time to position. China, smartly, is using the opportunity to buy soy and pork products (which they desperately need due to a virus which wiped out 30% of their pig population) to restock before the next meeting.

This is a not so insignificant point.

China is out for “China’s” best interest and will not acquiesce to any deal which derails their long-term plans. In the short-term, they may “play the game” to get what they need as a country, but in the long-run, they will protect their own interests. As we noted previously:

“If China does indeed increase U.S. imports, the stronger dollar will increase the costs of imports into China from the U.S., which negatively impacts their economy. The relationship between the currency exchange rate and U.S. Treasuries is shown below.”

“China uses U.S. Treasury bonds to “sanitize” trading operations. When the currency exchange rate is not favorable, China can adjust treasuries holdings to restore balance.”

However, don’t mistake China’s move as “caving” into Trump. Such is hardly the case.

While Beijing will allow Chinese businesses to purchase a “certain amount of farm products such as soybeans and pork” from the US, China has also cut a deal for soy meal from Argentina.

“China will allow the import of soymeal livestock feed from Argentina for the first time under a deal announced by Buenos Aires on Tuesday, an agreement that will link the world’s top exporter of the feed with the top global consumer.”

Hmmm…that sounds very familiar:

“Trade is a zero-sum game. There is only a finite amount of supply of products and services in the world. If the cost of U.S. products and services is too high, China sources demand out to other countries which drain the supply available for U.S. consumers. As imbalances shift, prices rise, increasing costs to U.S. consumers.” – Game Of Thrones 05-10-19

As Hua Changchun, an economist at Guotai Junan Securities, a brokerage in the PRC, said:

“Beijing’s latest ‘gesture’ has increased the prospects for a narrow trade deal with the US. But it’s a small deal. It means that there would be no escalation of tariffs as China has agreed to make more purchases. It could provide a certain level of comfort to US farmers and give Trump something to brag about.”

China knows how to play this game very well, and they know that Trump needs a way “out” of the mess he has gotten himself into.

Not surprisingly, as Trump said on Thursday, while he prefers a broad deal, he left open the possibility of a more limited deal to start, which is also code for:

“Let’s get a deal on the easy stuff, call it a win, and go home.”

Hmm, this is what we wrote earlier this year:

 

“Importantly, we have noted that Trump would eventually ‘cave’ into the pressure from the impact of the ‘trade war’ he started.”

For Trump, he can spin a limited deal as a “win” saying “China is caving to his tariffs” and that he “will continue working to get the rest of the deal done.” He will then quietly move on to another fight, which is the upcoming election, and never mention China again. His base will quickly forget the “trade war” ever existed.

Kind of like that “Denuclearization deal” with North Korea.

ECB Goes All In

If the potential for a “trade deal” wasn’t enough to spur equities, then surely the ECB throwing in the monetary policy stimulus towel would do the trick. Last week, the ECB went “all in” by:

• Cutting already negative deposit rates for the first time since 2016 to stimulate the sagging European economy, by 10bps to -0.50%.

• Restarted QE by €20 billion per month and it will be open-ended

• The ECB dropped calendar-based forward guidance and replaced it with inflation-linked guidance, noting that key ECB interest rates will “remain at their present or lower levels until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon.”

• The ECB eased TLTRO terms with banks whose eligible net lending exceeds a benchmark.

• Additionally, the maturity of the operations will be extended from two to three years.

• Finally, the ECB will introduce a two-tier system for reserve remuneration in which part of banks’ holdings of excess liquidity will be exempt from the negative deposit facility rate, in an attempt to mitigate the adverse impact to banks. 

(h/t Zerohedge)

We had previously stated the Central Banks are going to act to bail out systemically important banks which are on the brink of failure – namely, Deutsche Bank ($DB)

Not surprisingly, this was the same conclusion Bloomberg finally arrived at:

“Deutsche Bank AG will benefit the most by far from the European Central Bank’s new tiered deposit rate. Germany’s largest lender stands to save roughly 200 million euros ($222 million) in annual interest payments thanks to a new rule that exempts a big chunk of the money it holds at the ECB from the negative rate the central bank charges on deposits. That’s equivalent to 10% of the pretax profit the analysts expect the bank to report in 2020, compared with an average of just 2.5% for the EU banks included in the analysis.”

Duetsche Bank was heard singing:

“Thank you for the bailout,

On your way out,

Mr. Draghi.” 

But it isn’t just the ECB easy monetary policy to support global markets and economies. According to Charlie Bilello, everyone is doing it:

Fed: easing
ECB: easing
BOE: easing
BOJ: easing
Australia: easing
New Zealand: easing
Brazil: easing
Russia: easing
India: easing
China: easing
Hong Kong: easing
Korea: easing
Indonesia: easing
SouthAfrica: easing
Turkey: easing
Mexico: easing
Philippines: easing
Thailand: easing pic.twitter.com/1jzS8HYDPo

— Charlie Bilello (@charliebilello) September 12, 2019

Importantly, QE and negative rates are destroying the banking system globally. These programs DO NOT stimulate economic growth or an incentive for productive investment. Rather, these programs only succeed in inflating asset prices, increasing demand for risky debt, and acting as a “wealth transfer” system from the middle-class to the wealthy.

The reality is that these interventions have been “required” just to hold the current construct up. As we will discuss in a moment, the Federal Reserve tried to normalize rates, but was only able to make minimal progress before the “wheels came off the cart.”  

The question is, what’s going to happen when a recession finally occurs?

That is a question for later.

The Economy Shows Signs Of Life

Adding fuel to the “bullish” case, the economy did show signs of improvement. 

Before you get all excited, all this indicator denotes is that economic data is “less bad” than it was previously. The chart below is our RIA Economic Output Composite Index which is a comprehensive measure of the U.S. economy from both the manufacturing and service side of the ledger. 

While the data may have surprised recently, the overall economy is not accelerating; it just isn’t declining as quickly. With the Citi index already much improved, the temporary run of “less bad” data will likely reverse in the next couple of months.

Then, there is the last “hold out.” 

The Fed Is On Deck

All the bulls need now is the Fed to “cut” rates at the meeting next week. 

It is expected the Fed will cut rates by 0.25% at the next meeting. However, what will be important is how they couch their views going forward. 

The problem for the Fed is two fold.  

1. If they come out too “dovish,” they will appear to be “caving” to Trump’s demands which would threaten their “independence.” 
2. If they come out too “hawkish,” they run the risk of disappointing the markets, and already weaker consumer confidence. 

The Fed is in really a tough spot. Given they have already cut rates once this year, they have already depleted what little bit of “ammunition” they have to combat the next recessionary downturn in the economy. 

Furthermore, core CPI jumped over the past month, which will lead the Fed’s preferred measure of inflation which is the Personal Consumption Expenditure (PCE) index.

With PCE forecasted to rise over the next several months, this potentially puts the Fed in a box. Interestingly,  when Fed began “hiking rates” in 2015, over concerns of rising inflationary pressures, PCE is now higher than back then. This is going to make it difficult to support the case for “zero interest rates.” 

With markets hovering at all-time highs, the unemployment rate near record lows, and inflationary pressures near their target levels, there is little reason to be cutting rates now. 

For the bulls, the good news is, they will cut rates anyway. 

Is It All Priced In?

With all the bullish news this past week, it is certainly not surprising that market rallied sharply.  

Oh, wait….it was only a 0.6% gain?

“But, it’s a lot higher for the month. “

Yes, the market has rallied 3.4% for the month so far, but since the May highs, the market has risen by only 1.9%. Given the volatility and angst of the summer months, bonds have provided a better return.

However, with all the “bullish” news one could hope for, it certainly seems like the markets would/should have responded better. 

Or, maybe its the fact that the markets have been front running this news ever since the December lows.  From December 24th to today, the market has already risen markedly. 

• The Dow Jones Industrial Average has risen 5427 points
• The S&P 500 has risen 656 points.
• The Nasdaq Composite has surged 1983.79 points.

At the same time as markets were surging on hopes of a trade deal, Fed rate cuts, and more ECB QE, corporate profits have declined. (Note: Profits have fallen on a pre-tax basis and are barely stable at 2012 levels despite a full 5% decline in effective tax rate)

Earnings expectations have fallen.

Valuations have increased.

There is a decent argument to be made that whatever positive benefit may come from all these actions have already been priced into equities currently. 

As we noted last week, the “bulls” regained the narrative when the S&P 500 broke above 2945. Unfortunately, they just haven’t been able to do much with it so far. 

Currently, the risk/reward is not in the bulls favor short term. With the market back to very overbought conditions, the upside to the top of the bullish trend channel is about 1.9%. The downside risk is about 5.5%.

What about that bloodbath in bond yields?

Yes, we finally got the much-needed sell off in bonds. This is something we have been expecting now for several weeks as discussed with our RIAPRO subscribers:

• Like GLD, Bond prices have surged on Trump ramping up the trade war.
• The overbought condition is rather extreme, so be patient and wait for a correction back to the breakout level to add holdings.
• Prices could pullback to the $135-137 range which would be a better entry point.
• Long-Term Positioning: Bullish

That correction came last week with bonds taking it on the chin as shown in the chart below. 

However, let’s keep it in perspective for a moment. That little red square, if you can see it, is the rate jump this past week. 

I will note that previous overbought conditions (bonds are inverse from stocks) have led to decent reversals in rates, which have repeatedly been outstanding buying opportunities for bond investors. 

This is because higher rates negatively impact economic growth. It is also worth noting that collapsing bond prices tends to lead the S&P 500 as it suggests that something “just broke” in the market. 

While there are certainly many arguments supporting the “bullish case” for equities at the moment, the reality is that much of “news” has already been priced in. 

More importantly, if that is indeed the case, then where will the next leg of support for the bull market going to come from?

It is hard to suggest there will be a aggressive reversal of economic growth, profit margins, and confidence considering the current length of the economic cycle. 

I will reiterate from last week:

“This is why, despite the bullish overtone, we continue to hold an overweight position in cash (see 8-Reasons), have taken steps to improve the credit-quality in our bond portfolios, and shifted our equity portfolios to more defensive positioning. 

We did modestly add to our equity holdings with the breakout on Thursday from a trading perspective. However, we still maintain an overall defensive bias which continues to allow us to navigate market uncertainty until a better risk/reward opportunity presents itself. “

That remains the case this week as well. 

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

See you next week.

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Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

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S&P 500 Tear Sheet  

 

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Performance Analysis

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Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 has continued to fade and is close to turning negative. However, the sector is holding support and turned higher this past week. After taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

Outperforming – Staples (XLP), Utilities (XLU), Real Estate (XLRE), Communications (XLC)

Our more defensive positioning continues to outperform relative to the broader market. Volatility has risen markedly, which makes markets tough to navigate for now. However, after taking some profits and re-positioning the portfolio, we will remain patient and wait for the market to tell us what it wants to do next. Real Estate, Staples and Utilities all continue to make new highs but are GROSSLY extended. We added to our position in XLC bringing it to full weight previously.

Current Positions: Target weight XLP, XLU, XLRE, and XLC

Weakening – Technology (XLK), Discretionary (XLY), 

While Technology, and Discretionary did turn higher and are looking to set new highs. Relative performance is beginning to improve as well. We previously added to our position in Discretionary and continue to hold Technology. 

Current Position: Target weight XLY, XLK

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF), Materials (XLB)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. Energy has rallied over the last week and may give us an opportunity to add the position back to the portfolio. A one week advance doesn’t make up for the previous damage so we will be patient and look for the right opportunity. 

Current Position: 1/2 weight XLI, XLB

Market By Market

 

We know you get busy and don’t check on our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything that you might have missed.

The Week In Blogs

The Costs & Consequences Of $15/Hour – The Update

An Investor’s Desktop Guide To Trading – Part II

Black Monday – Can It Happen Again?

The August Jobs Report Confirms The Economy Is Slowing

The Best Of “The Lance Roberts Show”

Video Of The Week

Lance Roberts & Michael Lebowitz Discuss QE & The Impacts To Growth

Our Best Tweets Of The Week

This is a different way of saying "investors buy the most at the tops and the least at the bottoms" https://t.co/xd9hGF9QTM

— Lance Roberts (@LanceRoberts) September 13, 2019

China's exemption of tariffs on pork and soybeans is not "goodwill" as claimed. It is simply spin. Food prices are soaring in China

— Michael Lebowitz, CFA (@michaellebowitz) September 13, 2019

MMT is here. https://t.co/boAacRv33x

— Lance Roberts (@LanceRoberts) September 9, 2019

Shouldn't the media and the public be all over the ECB asking why this next dose of QE is the magic dose. QE and negative rates have thus far been detrimental to growth and the banking system. Will this time be different?

— Michael Lebowitz, CFA (@michaellebowitz) September 12, 2019

BLACK MONDAY! Can it happen again? For most people in the market today, the crash of 1987 isn't even a memory. But for those of us who lived through it, (I was 3-days into my first gig) it's something you don't forget. $SPY $TLT https://t.co/g1kR6ONmL0 pic.twitter.com/8HITtJH05U

— Lance Roberts (@LanceRoberts) September 11, 2019

Our Latest Newsletter

What You Missed At RIA Pro

RIA Pro is our premium investment analysis, research, and data service. (Click here to try it now and get 30-days free)

UPDATE: Profiting From A Steepening Yield Curve

See you next week!

People respond to incentives. So do national governments. This is foundational to both economics and geopolitics.

Carefully examining each side’s incentives can illuminate how a conflict will end. No one has infinite choices. They choose from limited options.

That applies to the US-China trade war, which is right now one of our top economic issues. So let’s think through what the players really want, and what each can actually do.

Outrageous or Flexible?

To begin, let’s note that the US and China really have two disputes.

One is about trade, the other is a struggle for military and technological dominance. These overlap. So knowing which drives any particular decision is hard. But for now, I’ll talk mostly about trade.

The first problem is that Donald Trump leads the US side. Understanding what he really wants from China is, well, difficult.

Often, he makes outrageous demands China could never accept. Possibly this is a negotiating tactic. Asking for the moon lets the other side think itself lucky to give anything less than the moon. And if that’s all you need, then you win.

But other times, US demands seem more flexible. We just want China to play fair, respect the rules, and open the Chinese market to US companies, just as the US is open to Chinese imports.

Underlying this is the fact Trump is a politician who wants to get re-elected. To do that, he needs to keep his base support. The base wants him to look tough against China. This limits his negotiating options.

Yet he also needs to keep the economy stable or growing. An extended trade standoff doesn’t help.

The one thing Trump can’t do is let China win. He needs Beijing to give him at least the appearance of significant concessions.

Excess Capacity

Xi Jinping doesn’t have to run for re-election, but he has a billion+ mouths to feed. He needs a growing domestic economy.

To date, much of that growth has come from building infrastructure and industrial production capacity. Someone has to buy what China produces with all that capacity—if not Westerners, then people in China.

Opening China to foreign competitors, as Trump demands, is inconsistent with Xi’s requirements. George Friedman of Geopolitical Futures explained in a recent analysis:

The Trump administration has used tariffs to try to force the Chinese to open their markets to U.S. competition. The problem is that the Chinese economy is in no position to accept such competition. The financial crisis severely affected China’s export industry as the global recession reduced the appetite for Chinese goods. This hurt the Chinese economy greatly, throwing it off balance in a crisis that still reverberates in China today.

China’s main solution to this problem has been to increase domestic consumption – a task that has proved difficult because of the distribution of wealth in China, the inability of financial markets to massively increase consumer credit, and the positioning of Chinese industry to target foreign, rather than domestic, consumers. Selling iPads to Chinese peasants isn’t easy.

Allowing the U.S. to access the Chinese market would have been painful if not disastrous. The Chinese domestic market was the only landing pad China had, and U.S. demands for greater access to it were impossible to meet.

If George is right, then we have the proverbial irresistible force meeting an immoveable object. Trump can’t reduce his demands. Xi can’t accept them.

Also, China’s government is communist. It allows some competition and other capitalist activities, but the kind of open markets that exist in the US are incompatible with China’s objectives.

That makes stalemate the likeliest near-term result… which is what we’ve seen.

This may explain why the US-China trade “negotiations” keep breaking down. They aren’t real negotiations. Agreement is impossible, but it serves both sides to look like they’re making progress.

Presenting that appearance is critical because the US and Chinese governments aren’t the only players here. Others are in the game, too.

Rational Choices

Business leaders are also part of this. What are their incentives?

They want to generate profits. That means making wise investments in new products and markets.

If, for instance, you lead a US manufacturer, the amount you invest in developing a new product depends on the number of potential buyers. That number is bigger if you can include China.

Likewise, your production costs depend on the availability and price of Chinese components.

When both those conditions are in doubt—as they are right now—then you have less incentive to invest in that new product.

You might use the cash that would have gone toward hiring workers and building new facilities to, say, repurchase your own stock. At least you’ll make shareholders happy.

That’s a perfectly rational choice, given the circumstances. But it has consequences.

The longer this drags on, the less confident businesses become, and the more reluctant they are to make growth investments. Eventually, it adds up to recession.

That is the outcome even if everyone involved—CEOs, Trump, and Xi—keeps doing what is reasonable to them, given their incentives and limitations.

Conclusion: This trade war has no off-ramp, so it will likely get worse, not better.

In June we wrote an RIA Pro article entitled Profiting From A Steepening Yield Curve, in which we discussed the opportunity to profit from a steepening yield curve with specific investments in mortgage REITs. We backed up our words by purchasing AGNC, NLY, and REM for RIA Advisor clients. The same trades were shared with RIA Pro subscribers and can be viewed in the RIA Pro Portfolios under the Portfolio tab.

We knew when we published the article and placed the trades that the short term risk to our investment thesis was, and still is, a further flattening and even an inversion of the yield curve. That is precisely what happened. In mid to late August the curve inverted by four basis points but has since widened back out.

The graph below compares the 2s/10s yield curve (blue) with AGNC (orange) and NLY (green). Beneath the graph is two smaller graphs showing the rolling 20-day correlation between AGNC and NLY versus the yield curve.

Since writing the article and purchasing the shares, the securities have fallen by about 5%, although much of the price loss is offset by double digit dividends (AGNC 13.20%, NLY 10.73%, and REM 9.06%). While we are not happy with even a small loss, we are emboldened by the strong correlation between the share prices and the yield curve. The trade is largely a yield curve bet, so it is comforting to see the securities tracking the yield curve so closely.

We still think the yield curve will steepen significantly. In our opinion, this will likely occur as slowing growth will prompt the Fed to be more aggressive than their current posture. We also think that there is a high probability that when the Fed decides to become more aggressive they will reduce rates at a faster clip than the market thinks. As we discussed in Investors Are Grossly Underestimating the Fed, when the Fed is actively raising or reducing rates, the market underestimates that path.

To wit:  If the Fed initiates rate cuts and if the data in the graphs prove prescient, then current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see. Taking it a step further, it is not farfetched to think that that Fed Funds rate could be back at the zero-bound, or even negative, at some point sooner than anyone can fathom today.

Heading into the financial crisis, it took the Fed 15 months to go from a 5.25% Fed funds rate to zero. Given their sensitivities today, how much faster might they respond to an economic slowdown or financial market dislocation from the current level of 2.25%?”

Bolstering our view for a steeper yield curve is that the Fed, first and foremost, is concerned with the financial health of its member banks. The Fed will fight an inverted yield curve because it hurts banks profit margins and therefore reduces their ability to lend money. Because of this and regardless of the economic climate, the Fed will use words and monetary policy actions to promote a steeper yield curve.

We are very comfortable with the premise behind our trades, and in fact in mid-August we doubled our position in AGNC. We will also likely add to NLY soon.

For more on this investment thesis, please watch the following Real Vision interview Steepening Yield Curve Could Yield Generational Opportunities.

I’ve been on Twitter (TWTR) quite a few times railing against the Dow Jones Industrial Average and its price-weighted calculation. And, of course, I am not alone. This index presents a distorted view of any given day’s events although most of the time its foibles are hidden in the performance of the rest of the market.

Let’s look at today, September 11, 2019. I am writing at about 2:30 in the afternoon and the Dow itself is up roughly 137 points on the day. All of that gain, and I mean all of it (within my writer’s margin of error) is attributable to three stocks and number three in that group is good for only 10 points.

That means for all practical purposes, only two stocks are responsible for the Dow’s gain. All the others more or less cancel each other out.

Right now, Boeing (BA) is up 3.4%. That’s a pretty substantial gain but since the stock carries such a high dollar price (381), that percentage yields a 12 point (rounded) gain. And that 12 points translate, through the magic of the Dow’s divisor, into 83 points for the DJIA, itself.

Boeing alone is responsible for the 83 of the Dow’s 127-point gain at this hour.

Apple (AAPL), fresh on the heels of its big tech reveal (no thanks, I do not need a phone with three camera lenses) is up 2.5% or 6 points. That’s 38 Dow points.

And for those of you keeping score, the third stock was Caterpillar (CAT), up 1.2% for 10 Dow points.

Why is this? Because the Dow is calculated by adding up all the changes on the day for the 30 stocks within and then dividing by some engineered number that is less than one. That means a one-point move in any stock, regardless of the stock’s actual price, results in a greater than one point move in the Dow itself.

Now, on days when the high-priced stocks such as Boeing, Apple, and Caterpillar have very small changes, the Dow Industrials will be in step with the other major market indices. But there are times, lots of times when the Dow will be higher on the day and every other major is lower.

Of course, the media will report that the market was up because they focus on the Dow. It does not matter (most of the time) that everything else was lower. Sure, you might hear a more advanced talking head say the market was mixed but that is an easy cop-out.

Here’s a recent tweet of mine – $BA responsible for 102 of the Dow’s 98-point gain.

Why? Because most everything else was lower or flat.

Lunacy!

A one-point change in UnitedHealth (UNH) is treated the same as a one-point move in Pfizer (PFE). At a price of 233, United’s one-point is good for 0.4%.  That’s just noise. Meanwhile, a one-point move in Pfizer at 37 is 2.7%.

Which stock had a more important day?

You know.

Fun with Fractions

And then comes the real fun. Every time they change the Dow, they have to change the divisor to keep the continuity of the historical price record. And every time a Dow stock splits, they have to do it again.

With each change, the divisor seems to get smaller and smaller and anyone who knows math just a little knows that the smaller the divisor (the bottom of the fraction) gets, the larger the value of the result gets.

By all means, track the Dow. It’s not always misleading and I personally more quickly absorb the level of the overall market and change on the day when I look at it, warts and all. However, if you want to really know what happened in the market, you need to look at a bunch of diverse indices, such as the Nasdaq, Russell and S&P 500. Toss in a few sector indices or ETFs, too.

The cheese may stand alone* but the Dow really cannot.

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* Hi-ho, the derry-o, the cheese stands alone.

Each week we produce a chart book of 10 of the current positions we have in our equity portfolio. Specifically, we are looking at the positions which warrant attention, or are providing an opportunity, or need to be sold.

While the portfolios are designed to have longer-term holding periods, we understand that things do not always go the way we plan. This monitoring process keeps us focused on capital preservation and long-term returns.

HOW TO READ THE CHARTS

There are four primary components to each chart:

• The price chart is contained within the shaded area which represents 2-standard deviations above and below the short-term moving average.  
• The Over Bought/Over Sold indicator is in orange at the top.
• The Support/Resistance line (green) is the longer-term moving average which also acts as a trailing stop in many cases.
• The Buy / Sell is triggered when the green line is above the red line (Buy) or vice-versa (Sell).

When the price of a position is at the top of the deviation range, overbought and on a buy signal it is generally a good time to take profits. When that positioning is reversed it is often a good time to look to add to a winning position or looking for an opportunity to exit a losing position.

With this basic tutorial, we will now review some of positions in our Equity Portfolio which are either a concern, an opportunity, or are doing something interesting.

AAPL – Apple, Inc.

• Last week we stated: “AAPL continues to wrestle with its previous breakout of its downtrend. After selling 20% of position previously there is no reason to rush into adding back to the position until the stock makes a decision. Currently, on a buy signal, but overbought, we will likely have some resolution to AAPL over the next month as the “trade issues” become more apparent.”
• Well, that didn’t actually turn out as planned and the move over the last couple of days on a less the stellar roll out of new products, sent investors scurrying into the stock.
• With AAPL testing all-time highs we will just have to hold our position for now and wait for a better entry point.
• Stop loss for the whole position is moved up to $200.

BA – Boeing Corp.

• We bought 1/2 position in BA when the 737MAX crash occurred. Since then BA has continued to consolidate that decline building a strong base of support.
• We have been patiently waiting to add to our position which will likely happen in the next day or two. Ideally, we are looking for the “buy signal” to turn up.
• Stop is moved up to $330.

IAU – Ishares Gold Trust

• We have been talking for weeks now about the need for a pullback to add to our Gold and Fixed Income holdings. We are finally getting that correction.
• IAU is still overbought, but the correction is beginning to enter our range of $14-14.25 to add to our holdings.
• We still think there is more corrective action which could occur which we will use to add to our holdings as well.
• Stop loss is moved up to $13

DOV – Dover Corp.

• After almost getting stopped out, DOV has turned up from support.
• DOV is currently on a sell signal, but we are now looking for an entry point to add to our existing holdings after taking profits previously.
• Stop loss is moved up to support at $87.50

NSC – Norfolk Southern Corp.

• NSC has been a great performer and after taking profits, we have been looking for an entry opportunity. We are now getting there.
• NSC is oversold and the “sell signal” is deeply oversold with NSC holding support following the recent sell-off.
• This is an ideal setup to add to our holdings and we would like to see the “sell signal” begin to close the gap to confirm our entry point. A little more patience here.
• Stop-loss moved up to $170

JNJ – Johnson and Johnson

• JNJ has been under pressure as of late due to legal woes which will pass sooner than later. We previously added to our position at these lower levels and last week the stock has begun to turn up.
• The stock is on a deeply oversold sell signal, so it will likely take little to get the stock moving higher soon. Fundamentals remain very solid and the position held the longer-term uptrend line.
• We are going to add additional weight to this holding opportunistically.
• Stop loss is moved up to $122.50

NLY – Annaly Capital Management

• As noted previously, we added to “yield curve steepener” positions to our portfolios. NLY and AGNC are constructed in a manner that benefit from a steeper yield curve.
• The recent flattening in the yield curve and inversion, pulled the positions lower but held our stop-loss levels and are now deeply oversold.
• We are looking for the right setup to continue building out these positions which also carry a hefty yield of 10%+.
• Stop-loss is set at $7.40

AGNC – AGNC Investment Corp.

• Same as above, AGNC is the second position in our “steepener” duo.
• We are looking to add to these positions opportunistically as the yield curve steepens.
• Due to the rather large yields we are using wider stop-losses on both positions.
• Stop-loss is set at $13.00

V – Visa Inc.

• Last week we stated: “Despite concerns over economic woes, spenders keep on swiping their credit cards. V is currently close to triggering a sell signal, and is extremely overbought. After having taken profits we will look for a correction to add to our holdings.
• Well, that didn’t take long as V had a large correction last week. This is not unusual for the stock so we are now looking for V to hold support to add back into our position.
• Stop loss remains at $160.00

XOM – Exxon Mobil

• As Maxwell Smart used to say: “Missed it by that much.”
• I had noted a couple of weeks ago that XOM was deeply oversold and we were looking to add to the position. I didn’t get it done.
• Since then the stock has bounced and I am reluctant to add to the trade just yet as we have seen the bounces fail numerous times previously.
• We are looking for our “buy signal” to turn higher and some further price action which gives us more confidence in adding back to our holding after selling 1/2 the position earlier this year.
• Stop loss remains at $67

After the monthly jobs report was released last week, I saw numerous people jumping on the unemployment rate as a measure of success, and in this particular case, Trump’s success as President.

• Unemployment November 2016: 4.7%
• Unemployment August 2019: 3.7%

Argument solved.

President Trump has been “Yuugely” successful at putting people to work as represented by a 1% decline in the unemployment rate since his election.

But what about President Obama?

• Unemployment November 2008: 12.6%
• Unemployment November 2016: 4.7%

Surely, a 7.9% drop in unemployment should be considered at least as successful as Trump’s 1%.

Right?

Here’s a secret, neither one is important.

First, Presidents don’t put people to work. Corporations do. The reality is that President Obama and Trump had very little to do with the actual economic recovery.

Secondly, as shown below, the recovery in employment began before either President took office as the economic recovery would have happened regardless of monetary interventions. Importantly, note the drop in employment has occurred with the lowest level of annual economic growth on record. (I wouldn’t necessarily be touting this as #winning.)

Lastly, both measures of “employment success” are erroneous due to the multitude of problems with how the entire series is “guessed at.” As noted previously by Morningside Hill:

• The Bureau of Labor Statistics (BLS) has been systemically overstating the number of jobs created, especially in the current economic cycle.
• The BLS has failed to account for the rise in part-time and contractual work arrangements, while all evidence points to a significant and rapid increase in the so-called contingent workforce.
• Full-time jobs are being replaced by part-time positions, resulting in double and triple counting of jobs via the Establishment Survey.  (Examples: Uber, Lyft, GrubHub, FedEx, Amazon)
• A full 93% of the new jobs reported since 2008 were added through the business birth and death model – a highly controversial model which is not supported by the data. On the contrary, all data on establishment births and deaths point to an ongoing decrease in entrepreneurship.
• Jobless claims have recently reached their lowest level on record which purportedly signals job market strength. Since hiring patterns have changed significantly and increasingly more people are joining the contingent workforce, jobless claims are no longer a good leading economic indicator. Part-time and contract-based workers are most often ineligible for unemployment insurance. In the next downturn, corporations will be able to cut through their contingent workforce before jobless claims show any meaningful uptick.

Nonetheless, despite a very weak payroll number, the general “view” by the mainstream media, and the Federal Reserve, is the economy is still going strong.

In reality, one-month of employment numbers tell us very little about what is happening in the actual economy. While most economists obsess over the data from one month to the next, it is the “trend” of the data which is far more important to understand.

The chart below shows the peak annual rate of change for employment prior to the onset of a recession. The current annual rate of employment growth is 1.4% which is lower than any previous employment level in history prior to the onset of a recession.

But while this is a long-term view of the trend of employment in the U.S., what about right now? The chart below shows the civilian employment level from 1999 to present.

While the recent employment report was slightly below expectations, the annual rate of growth is slowing at a faster pace. Moreover, there are many who do not like the household survey due to the monthly volatility in the data. Therefore, by applying a 3-month average of the seasonally-adjusted employment report, we see the slowdown more clearly.

But here is something else to consider.

While the BLS continually fiddles with the data to mathematically adjust for seasonal variations, the purpose of the entire process is to smooth volatile monthly data into a more normalized trend. The problem, of course, with manipulating data through mathematical adjustments, revisions, and tweaks, is the risk of contamination of bias. A simpler method to use for smoothing volatile monthly data is using a 12-month moving average of the raw data as shown below.

Near peaks of employment cycles, the employment data deviates from the 12-month average, but then reconnects as reality emerges.

Sometimes, “simpler” gives us a better understanding of the data.

Importantly, there is one aspect to all the charts above which remains constant. No matter how you choose to look at the data, peaks in employment growth occur prior to economic contractions, rather than an acceleration of growth. 

But there is more to this story.

A Function Of Population

One thing which is not discussed when reporting on employment is the “growth” of the working-age population. Each month, new entrants into the population create “demand” through their additional consumption. Employment should increase to accommodate for the increased demand from more participants in the economy. Either that or companies resort to automation, off-shoring, etc. to increase rates of production without increases in labor costs. The chart below shows the total increase in employment versus the growth of the working-age population.

The missing “millions” shown in the chart above is one of the “great mysteries” about the longest economic booms in U.S. history. This is particularly a conundrum when the Federal Reserve talks about the economy nearing “full employment.” The disparity shows up in both the Labor Force Participation Rate and those “Not In Labor Force.”

Note that since 2009, the number of those “no longer counted” has dominated the employment trends of the economy. In other words, those “not in labor force” as a percent of the working-age population has skyrocketed.

Of course, as we are all very aware, there are many who work part-time, are going to school, etc. But even when we consider just those working “full-time” jobs, particularly when compared to jobless claims, the percentage of full-time employees is still well below levels of the last 35 years.

It’s All The Baby Boomers Retiring

One of the arguments often given for the low labor force participation rate is that millions of “baby boomers” are leaving the workforce for retirement.

This argument doesn’t carry much weight given that the “Millennial” generation, which is significantly larger, is simultaneously entering the workforce. The other problem is shown below, there are more individuals over the age of 55, as a percentage of that age group, in the workforce today than in the last 50-years.

Of course, the reason they aren’t retiring is that they can’t. After two massive bear markets, weak economic growth, questionable spending habits,and poor financial planning, more individuals over the age of 55 are still working because they simply can’t “afford” to retire.

However, for argument sake, let’s assume that every worker over the age of 55 retires. If the “retiring” argument is valid, then employment participation rates should soar once that group is removed. The chart below is full-time employment relative to the working-age population of 16-54.

Nope.

The other argument is that Millennials are going to school longer than before so they aren’t working either. (We have an excuse for everything these days.)

The chart below strips out those of college-age (16-24) and those over the age of 55.

With the prime working-age group of labor force participants still at levels seen previously in 1988, it does raise the question o2f just how robust the labor market actually is?

Michael Lebowitz touched on this issue previously:

“Why are so many people struggling to find a job and terminating their search if, as we are repeatedly told, the labor market is so healthy? To explain the juxtaposition of the low jobless claims number and unemployment rate with the low participation rate and weak wage growth, a calculation of the participation rate adjusted unemployment rate is revealing.”

‘When people stop looking for a job, they are still unemployed, but they are not included in the U-3 unemployment calculation. If we include those who quit looking for work in the data, the employment situation is quite different. The graph below compares the U-3 unemployment rate to one that assumes a constant participation rate from 2008 to today. Contrary to the U-3 unemployment rate of 3.90%, this metric implies an adjusted unemployment rate of 8.69%.

Importantly, this number is much more consistent with the data we have laid out above, supports the reasoning behind lower wage growth, and is further confirmed by the Hornstein-Kudlyak-Lange Employment Index.”

(The Hornstein-Kudlyak-Lange Non-Employment Index including People Working Part-Time for Economic Reasons (NEI+PTER) is a weighted average of all non-employed people and people working part-time for economic reasons expressed as the share of the civilian non-institutionalized population 16 years and older. The weights take into account persistent differences in each group’s likelihood of transitioning back into employment. Because the NEI is more comprehensive and includes tailored weights of non-employed individuals, it arguably provides a more accurate reading of labor market conditions than the standard unemployment rate.)

One of the main factors which was driving the Federal Reserve to raise interest rates, and reduce its balance sheet, was the perceived low level of unemployment. However, now, they are trying to lower rates despite an even lower level of unemployment than previous.

The problem for the Federal Reserve is they are caught between a “stagflationary economy” and a “recession.” 

“With record low jobless claims, there is no recession on the horizon.” -says mainstream media.

Be careful with that assumption.

In November of 1969 jobless claims stood at 211,000, having risen slightly from the lows recorded earlier that year. Despite the low number of claims, a recession started a month later, and jobless claims would nearly double within six months.

This episode serves as a reminder that every recession followed interim lows in jobless claims and the unemployment rate. We are confident that the dynamics leading to the next recession will not be any different.

But then again, maybe the yield-curve is already giving us the answer.

The 1987 stock market crash, better known as Black Monday, was a statistical anomaly, often referred to as a Black Swan event. Unlike other market declines, investors seem to be under the false premise that the stock market in 1987 provided no warning of the impending crash. The unique characteristics of Black Monday, the magnitude and instantaneous nature of the drop, has relegated the event to the “could never happen again” compartment of investors’ memories.

On Black Monday, October 19, 1987, the Dow Jones Industrial Average (DJIA) fell 22.6% in the greatest one-day loss ever recorded on Wall Street. Despite varying perceptions, there were clear fundamental and technical warnings preceding the crash that were detected by a few investors. For the rest, the market euphoria raging at the time blinded them to what in hindsight seemed obvious.

Stock markets, like in 1987, are in a state of complacency, donning a ‘what could go wrong’ brashness and extrapolating good times as far as the eye can see. Even those that detect economic headwinds and excessive valuations appear emboldened by the thought that the Fed will not allow anything bad to happen. 

While we respect the bullish price action, we also appreciate that investors are not properly assessing fundamental factors that overwhelmingly argue the market is overvalued. There is no doubt that prices and valuations will revert to more normal levels. Will it occur via a long period of market malaise, a single large drawdown like 1987, or something more akin to the crashes of 2001 and 2008? When will it occur? We do not have the answers, nor does anyone else; however, we know that those who study prior market drawdowns are better prepared and better equipped to limit their risk and avoid a devastating loss.

History provides us with the gift of insight, and though history will not repeat itself, it may rhyme. While we do not think a 1987-like crash is likely, we would be remiss if we did not at least consider it and assign a probability. 

Fundamental Causes

Below is a summary of some of the fundamental dynamics that played a role in the market rally and the ultimate crash of 1987.

Takeover Tax Bill- During the market rally preceding the crash, corporate takeover fever was running hot. Leveraged Buyouts (LBOs), in which high yield debt was used to purchase companies, were stoking the large majority of stocks higher. Investors were betting on rumors of companies being taken over and were participating in strategies such as takeover risk arbitrage. A big determinant driving LBOs was a surge in junk bond issuance and the resulting acquirer’s ability to raise the necessary capital. The enthusiasm for more LBO’s, similar to buybacks today, fueled speculation and enthusiasm across the stock market. On October 13, 1987, Congress introduced a bill that sought to rescind the tax deduction for interest on debt used in corporate takeovers. This bill raised concerns that the LBO machine would be impaired. From the date the bill was announced until the Friday before Black Monday, the market dropped over 10%.

Inflation/Interest Rates- In April 1980, annual inflation peaked at nearly 15%. By December of 1986, it had sharply reversed to a mere 1.18%.  This reading would be the lowest level of inflation from that point until the financial crisis of 2008. Throughout 1987, inflation bucked the trend of the prior six years and hit 4.23% in September of 1987. Not surprisingly, interest rates rose in a similar pattern as inflation during that period. In 1982, the yield on the ten-year U.S. Treasury note peaked at 15%, but it would close out 1986 at 7%. Like inflation, interest rates reversed the trend in 1987, and by October, the ten-year U.S. Treasury note yield was 3% higher at 10.23%. Higher interest rates made LBOs more costly, takeovers less likely, put pressure on economic growth and, most importantly, presented a rewarding alternative to owning stocks. 

Deficit/Dollar- A frequently cited contributor to the market crash was the mounting trade deficit. From 1982 to 1987, the annual trade deficit was four times the average of the preceding five years. As a result, on October 14^th Treasury Secretary James Baker suggested the need for a weaker dollar. Undoubtedly, concerns for dollar weakness led foreigners to exit dollar-denominated assets, adding momentum to rising interest rates. Not surprisingly, the S&P 500 fell 3% that day, in part due to Baker’s comments.

Valuations- From the trough in August 1982 to the peak in August 1987, the S&P 500 produced a total return (dividends included) of over 300% or nearly 32% annualized. However, earnings over the same period rose a mere 8.1%. The valuation ratio, price to trailing twelve months earnings, expanded from 7.50 to 18.25. On the eve of the crash, this metric stood at a 33% premium to its average since 1924. 

Technical Factors

This section examines technical warning signs in the days, weeks, and months before Black Monday. Before proceeding, the chart below shows the longer-term rally from the early 1980s through the crash.

Portfolio Insurance- As mentioned, from the 1982 trough to the 1987 peak, the S&P 500 produced outsized gains for investors. Further, the pace of gains accelerated sharply in the last two years of the rally.

As the 1980s progressed, some investors were increasingly concerned that the massive gains were outpacing the fundamental drivers of stock prices. Such anxiety led to the creation and popularity of portfolio insurance. This new hedging technique, used primarily by institutional investors, involved conditional contracts that sold short the S&P 500 futures contract if the market fell by a certain amount. This simple strategy was essentially a stop loss on a portfolio that avoided selling the actual portfolio assets. Importantly, the contracts ensured that more short sales would occur as the market sell-off continued. When the market began selling off, these insurance hedges began to kick in, swamping bidders and making a bad situation much worse. Because the strategy required incremental short sales as the market fell, selling begat selling, and a correction turned into an avalanche of panic.

Price Activity- The rally from 1982 peaked on August 25, 1987, nearly two months before Black Monday. Over the next month, the S&P 500 fell about 8% before rebounding to 2.65% below the August highs. This condition, a “lower high,” was a warning that went unnoticed. From that point forward, the market headed decidedly lower. Following the rebound high, eight of the nine subsequent days just before Black Monday saw stocks in the red. For those that say the market did not give clues, it is quite likely that the 15% decline before Black Monday was the result of the so-called smart money heeding the clues and selling, hedging, or buying portfolio insurance.

Annotated Technical Indicators

The following chart presents technical warnings signs labeled and described below.

• A:  7/30/1987- Just before peaking in early August, the S&P 500 extended itself to three standard deviations from its 50-day moving average (3-standard deviation Bollinger band). This signaled the market was greatly overbought. (description of Bollinger Bands)
• B: 10/5/1987- After peaking and then declining to a more balanced market condition, the S&P 500 recovered but failed to reach the prior high.
• C: 10/14/1987- The S&P 500 price of 310 was a point of both support and resistance for the market over the prior two months. When the index price broke that line to the downside, it proved to be a critical technical breach.
• D: 10/16/1987- On the eve of Black Monday, the S&P 500 fell below the 200-day moving average. Since 1985, that moving average provided dependable support to the market on five different occasions.
• E: August 1987- The relative strength indicator (RSI – above the S&P price graph) reached extremely overbought conditions in late July and early August (labeled green). When the market rebounded in early October to within 2.6% of the prior record high, the RSI was still well below its peak. This was a strong sign that the underlying strength of the market was waning.  (description of RSI)

Volatility- From the beginning of the rally until the crash, the average weekly gain or loss on the S&P 500 was 1.54%. In the week leading up to Black Monday, volatility, as measured by five-day price changes, started spiking higher. By the Friday before Black Monday, the five-day price change was 8.63%, a level over six standard deviations from the norm and almost twice that of any other five-day period since the rally began.   

A longer average true range graph is shown above the longer term S&P 500 graph at the start of the technical section.

Similarities and differences

While comparing 1987 to today is helpful, the economic, political, and market backdrops are vastly different. There are, however some similarities worth mentioning.

Similarities:

• While LBO’s are not nearly as frequent, companies are essentially replicating similar behavior by using excessive debt and leverage to buy their own shares. Corporate debt stands at all-time highs measured in both absolute terms and as a ratio of GDP. Since 2015, stock buybacks and dividends have accounted for 112% of earnings
• Federal deficits and the trade deficit are at record levels and increasing rapidly
• The trade-weighted dollar index is now at the highest level in at least 25 years. We are likely approaching the point where President Trump and Treasury Secretary Steve Mnuchin will push for a weak dollar policy
• Equity valuations are extremely high by almost every metric and historical comparison of the last 100+ years
• Sentiment and expectations are declining from near record levels
• The use of margin is at record high levels
• Trading strategies such as short volatility, passive/index investing, and algorithms can have a snowball effect, like portfolio insurance, if they are unwound hastily

There are also vast differences. The economic backdrop of 1987 and today are nearly opposite.

• In 1987 baby boomers were on the verge of becoming an economic support engine, today they are retiring at an increasing pace and becoming an economic headwind
• Personal, corporate, and public Debt to GDP have grown enormously since 1987
• The amount of monetary stimulus in the system today is extreme and delivering diminishing returns, leaving one to question how much more the Fed can provide 
• Productivity growth was robust in 1987, and today it has nearly ground to a halt

While some of the fundamental drivers of 1987 may appear similar to today, the current economic situation leaves a lot to be desired when compared to 1987. After the 1987 market crash, the market rebounded quickly, hitting new highs by the spring of 1989.

We fear that, given the economic backdrop and limited ability to enact monetary and fiscal policy, recovery from an episodic event like that experienced in October 1987 may look vastly different today.

Summary

Market tops are said to be processes. Currently, there are an abundance of fundamental warnings and some technical signals that the market is peaking.

Those looking back at 1987 may blame tax legislation, portfolio insurance, and warnings of a weaker dollar as the catalysts for the severe declines. In reality, those were just the sparks that started the fire. The tinder was a market that had become overly optimistic and had forgotten the discipline of prudent risk management.

When the current market reverses course, as always, there will be narratives. Investors are likely to blame a multitude of catalysts both real and imagined. Also, like 1987, the true fundamental catalysts are already apparent; they are just waiting for a spark. We must be prepared and willing to act when combustion becomes evident.

The last few weeks marked a turning point in the global economy.

It’s more than the trade war. A sense of vulnerability is replacing the previous confidence—and with good reason.

We are vulnerable, and we’ll be lucky to get through the 2020s without major damage.

Let’s talk about the risks facing us in the next year or so and the economic environment in which we will face those risks.

Supply Shocks Ahead

In a recent Project Syndicate piece, NYU professor and economist Nouriel Roubini outlined three potential shocks, any one of which could trigger a recession:

• The US-China trade and currency war

• A slower-brewing US-China technology cold war (which could have much larger long-term implications)

• Tension with Iran that could threaten Middle East oil exports

The first of those seems to be getting worse. The second is getting no better. I consider the third one unlikely.

In any case, unlike 2008, which was primarily a demand shock, these threaten the supply of various goods. They would reduce output and thus raise prices for raw materials, intermediate goods, and/or finished consumer products.

Roubini thinks the effect would be stagflationary, similar to the 1970s.

Because these are supply and not demand shocks, if Nouriel is right, the kind of fiscal and monetary policies employed in 2008 will be less effective this time, and possibly harmful.

Interest rate cuts could aggravate price inflation instead of stimulating growth. That, in turn, would probably reduce consumer spending, which for now is the only thing standing between us and recession.

Subnormal Growth

Most of our problems come down to debt.

Debt isn’t bad and may even be good if it is used productively. Much of it isn’t.

In theory, an economy overloaded with unproductive debt should see rising interest rates due to the excess risk it is taking. Yet we are in a low and falling-rate world. Why?

Lacy Hunt of Hoisington Management proved that government debt accelerations depress business conditions. This reduces economic growth, so rates fall. The data shows the amount of GDP each dollar of new debt generates has been steadily declining.

This is a problem because, among other reasons, central banks still think lower rates are the solution to our problems. So does President Trump.

They are all sadly mistaken, but remain intent on pushing rates closer to zero and then below. This is not going to have the desired effect.

If Lacy is right, as I believe he is, the Federal Reserve is on track to do exactly the wrong thing by dropping rates further as the economy weakens.

The Fed also did the wrong thing by hiking rates in 2018. They should have been slowly raising rates in 2013 and after. They waited too long. This long string of mistakes leaves policymakers with no good choices now.

The best thing they can do is nothing, but that’s apparently not on the menu.

Paralyzed Business

All this bears down on us as other things are changing, too.

Many relate to shrinking world trade. Trump’s trade war hasn’t helped, but globalization was already reversing before he took office.

Industrial automation and other technologies are killing the “wage arbitrage” that moved Western manufacturing to low-wage countries like China. Higher wages in those places are also reducing the advantage. This will continue.

Ideally, this process would have happened gradually and given everyone time to adapt. Trump and his Svengali-like trade advisor, Peter Navarro, want it now. I think the president’s recent demand that US companies leave China wasn’t a bluff. He wants that outcome, and he has the tools to attempt to force it. The only question is whether he will.

I agree that we have to deal with China but the fact that we must do something doesn’t make everything feasible or advisable.

Tariffs are a counterproductive bad idea. Severing supply chains built over decades in less than a few years is, if possible, an even worse idea. It will kill millions of US jobs as factories shut down for lack of components.

Some say this is just more Trump negotiating bluster. Maybe so, but the mere threat paralyzes business activity.

CEOs and boards don’t make major capital commitments without some kind of certainty on their costs and returns. The president is making that impossible for many.

Europe in Shambles

Europe is rapidly turning into a major problem, too. Negative interest rates there are symptoms of an underlying disease. Italy is already in recession. Germany suffered its first negative quarter and may enter “official” recession soon.

Germany is highly export-dependent. The entire euro currency project was arguably a plot to boost German exports, and it worked pretty well.

But it boosted them too much, bankrupting countries like Greece which bought those exports. China, another big customer, is buying less as well.

A German recession will have a global effect. Automobile sales are down and Brexit could mean further declines. That would most assuredly deliver a German and thus a Europe-wide recession. And it will affect US exports and jobs.

Then there’s Brexit. At this point we still don’t know if the UK and EU will reach terms, but there is some risk of a hard end to this drama. News focuses on the damage within the UK, but it will also affect the EU countries, mainly Germany, who trade with the UK.

These supply chains are no less intricate and established than the US-China ones. Tearing them down and rebuilding them will take time and money. The transition costs will be significant.

Bumpy Ride

Remember when experts said to keep politics out of your investment strategy?

We no longer have that choice. Political decisions and election results around the globe now have direct, immediate market consequences. Brexit is just one example.

A far bigger one is the looming 2020 US campaign. None of the possible outcomes are particularly good. I think the best we can hope for is continued gridlock.

But between now and November 2020, none of us will know the outcome. Instead, a never-ending stream of poll results will show one side or the other has the upper hand.

That will generate high market volatility, inspiring politicians and central bankers to “do something” that will probably be the wrong thing.

As noted above, if Roubini is right then rate cuts aren’t going to help. Nor will QE. Both are simply ways of encouraging more debt which Lacy Hunt’s work shows is no longer effective at stimulating growth.

They are, however, effective at blowing up bubbles.

I expect 2020 to be one of the most volatile market years of my lifetime.

---

The Great Reset: The Collapse of the Biggest Bubble in History

New York Times best seller and renowned financial expert John Mauldin predicts an unprecedented financial crisis that could be triggered in the next five years. Most investors seem completely unaware of the relentless pressure that’s building right now. Learn more here.

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

With this basic tutorial let’s get to the sector analysis.

Basic Materials

• XLB remains confined to a very broad topping pattern currently BUT it continues to hold onto support at the 200-dma as rumors of a “trade deal” seem to always come just in the “nick of time.”
• With the buy signal fading the risk remains to the downside for now particularly as trade wars continue to linger on and tariffs were hiked over the weekend.
• XLB rallied last over the last three sessions on hopes of upcoming trade talks and is reversing the oversold condition.
• There are multiple tops just overhead which will provide significant resistance.
• We are remaining underweight the sector for now.
• Short-Term Positioning: Neutral
  • Last Week: Hold current positions with a tighter stop-loss.
  • This Week: Hold current positions with tighter stop-loss
  • Stop-loss adjusted to $55
• Long-Term Positioning: Bearish

Communications

• As noted last week, XLC held support and bounced back towards highs.
• With XLC not overbought yet, a further rally is possible if the market trades higher.
• Support is held at $48.
• XLC has a touch of defensive positioning from “trade wars” and given the recent pullback to oversold, a trading position was placed in portfolios.
• Short-Term Positioning: Neutral
  • Last Week: Hold trading positions
  • This Week: Hold trading positions.
  • Stop adjusted to $46
• Long-Term Positioning: Bearish

Energy

• XLE continues to struggle with supply builds and a weakening economy.
• As noted last week, with the sector oversold and the “sell signal” is getting extended, there is a decent probability for a retracement.
• That rally occurred over the last couple of sessions. However, as noted, any rallies should be used as clearing rallies for now to reduce weightings to the sector until the technical backdrop improves.
• We were stopped out of our position previously.
• Short-Term Positioning: Bearish
  • Last week: Stopped out.
  • This week: Stopped out.
  • No position currently
• Long-Term Positioning: Bearish

Financials

• XLF has been in a long consolidation rage since the beginning of 2018.
• XLF has triggered a “sell” signal and has gotten oversold. That oversold condition led to the reflexive bounce over the past few sessions on hopes of more Central Bank stimulus.
• We closed out of positioning previously as inverted yield curves and Fed rate cuts are not good for bank profitability. Use this rally to reduce holdings accordingly.
• Short-Term Positioning: Neutral
  • Last week: Closed Out/No Position.
  • This week: Closed Out/No Position.
  • Stop-loss adjusted to $26.00
• Long-Term Positioning: Bearish

Industrials

• XLI bounced back last week on hopes of a trade war “cease fire” but is about to run into major overhead resistance.
• XLI is almost back to overbought and the sell signal remains intact.
• We reduced our risk to the sector after reaching our investment target. We are now adjusting our stop-loss for the remaining position.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position.
  • Stop-loss adjusted to $72
• Long-Term Positioning: Neutral

Technology

• XLK remains one of the “safety” trades against the “trade war.”
• XLK has moved back to short-term overbought, and remains a fairly extended and crowded trade.
• XLK held support at $75 and is breaking its short-term consolidation. Next target are old highs and the top of the uptrend line.
• The buy signal is close to reversing to a “sell.”
• Short-Term Positioning: Bullish
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss adjusted to $75.00
• Long-Term Positioning: Neutral

Staples

• As noted previously, defensive positioning is now a VERY crowded trade.
• The “buy” signal (lower panel) is still in place and is very extended. We continue to recommend taking some profits if you have not done so.
• Short-Term Positioning: Bullish
  • Last week: Hold positions, take profits if needed.
  • This week: Hold positions, take profits if needed.
  • Stop-loss adjusted to $57
• Long-Term Positioning: Bullish

Real Estate

• As with XLP above, XLRE was consolidating its advance and has now pushed to new highs and is extremely extended.
• XLRE is also a VERY CROWDED defensive trade.
• XLRE is back to very overbought so be careful adding new positions and keep a tight stop for now.
• We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That occurred.
• Buy signal has been reduced and has turned positive which is bullish for now.
• Short-Term Positioning: Bullish
  • Last week: Hold position.
  • This week: Hold position.
  • Stop-loss adjusted to $36.00 for profits.
• Long-Term Positioning: Bullish

Utilities

• XLRE and XLU are virtually the same commentary.
• After taking profits, we have time to be patient and wait for the right setup.
• Long-term trend line remains intact and the recent test of that trend line with a break to new highs confirms the continuation of the bullish trend.
• Buy signal reversed and held and has now turned higher.
• Short-Term Positioning: Bullish
  • Last week: Hold position.
  • This week: Hold position
  • Stop-loss adjusted to support at $58.00
• Long-Term Positioning: Bullish

Health Care

• XLV has triggered a sell signal and will likely threaten our stop-loss.
• However, in the meantime, XLV continues to flirt with support levels. The current correction was expected, A breakout of the current downtrend will be bullish.
• We continue to maintain a fairly tight stop for now.
• Short-Term Positioning: Neutral
  • Last week: Hold position.
  • This week: Hold position
  • Stop-loss adjusted to $88
• Long-Term Positioning: Neutral

Discretionary

• Despite the fact the latest round of tariffs directly target discretionary items, XLY rallied anyway on hopes to a resolution of the “trade war” before the holiday shopping season.
• We added to our holdings last week to participate with the current rally, but are carrying a tight stop on the whole position.
• XLY has now triggered a “sell signal.”
  
• Short-Term Positioning: Neutral
  • Last week: Added 1/2 position.
  • This week: Hold position
  • Stop-loss adjusted to $115.
• Long-Term Positioning: Neutral

Transportation

• XTN spiked higher over the last couple of trading sessions on an “oversold” bounce.
• XTN remains is a very broad trading range, and this rally is most likely going to fail at the previous highs for the range.
• XTN has triggered a “sell” signal but remains confined to a consolidation which has lasted all year. The continued topping process continues to apply downward pressure on the sector.
• There is still no compelling reason at this juncture to add XTN to portfolios. We will watch and see what happens.
• Short-Term Positioning: Neutral
  • Last week: No position
  • This week: No position
• Long-Term Positioning: Bearish

Read Part-1 Here

Currently, it seems that nothing can derail the bull market. Trade wars, weakening economic growth, deteriorating earnings, and inverted yield curves have all been dismissed on “hopes” that a “trade deal” will come, and the Federal Reserve will cut rates. While the last two items may indeed extend the current cycle by a few months, they won’t change the dynamics of the former.

Eventually, this cycle ends. Of that, there is little argument. It is the “when,” that is tirelessly debated.

As I have often stated, 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 the “broken clock” syndrome owns both “bulls” and “bears” 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 by not being “wrong” during the second half.

The second half of the cycle IS coming.

This is why, in times like these that we have to follow our investment rules. Those rules allow us to grow capital but reduces the risk of massive drawdowns when the cycle turns. While there are many promoting “buy and hold” strategies, it is interesting that not one of the great investors throughout history have ever practiced such an investment discipline. In fact, they have all had very specific rules they followed which helped them not only to make investments, but also when to sell them.

So, in following up with part one of this series, here are some more rules from great investors which we can all learn from.

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William O’Neil’s 23 Trading Rules

William J. O’Neil is one of the greatest stock traders of our time, achieving a return of 5000% over a 25-year period. He uses a trading strategy called CANSLIM, which combines fundamental analysis, technical analysis, risk management and timing. CANSLIM is an acronym and stands for:

C: Current quarterly earnings per share (up at least 25% vs. year-ago quarter).

A: Annual earnings increases at a compound rate of no less than 25%.

N: New products, new management and new highs.

S: Supply and demand. Stocks with small floats experience greater price rises, plus big volume demand.

L: Leaders and laggards. Keep stocks that outperform and get rid of the laggards.

I: Institutional ownership. Follow the leaders.

M: Market direction. Three out of four stocks follow the trend of the market. When the intermediate trend is bearish, don’t invest.

Here are the rules:

1. Don’t buy cheap stocks. Avoid the junk pile.
2. Buy growth stocks that show each of the last three years annual earnings per share up at least 25% and the next year’s consensus earnings estimate up 25% or more. Most growth stocks should also have annual cash flow of 20% or more above EPS.
3. Make sure the last two or three-quarters earnings per share are up by a minimum of 25% to 30%. In bull markets, look for EPS up 40% to 500%.
4. See that each of the last three-quarter’s sales is accelerating in their percentage increases, or the last quarter’s sales are up at least 25%.
5. Buy stocks with a return on equity of 17% or more. The best companies will show a return on equity of 25% to 50%.
6. Make sure the recent quarterly after-tax profit margins are improving and near the stock’s peak after-tax margins.
7. Most stocks should be in the top five or six broad industry sectors..
8. Don’t buy a stock because of its dividend or P/E ratio. Buy it because it’s the number one company in its particular field in terms of earnings and sales growth, ROE, profit margins, and product superiority.
9. Buy stocks with a relative strength of 85 or higher.
10. Any size capitalization will do, but the majority of your stocks should trade an average daily volume of several hundred thousand shares or more.
11. Learn to read charts and recognize proper bases and exact buy points. Use daily and weekly charts to materially improve your stock selection and timing.
12. Carefully average up, not down, and cut every single loss when it is 7% or 8% below your purchase price with absolutely no exception.
13. Write out your sell rules that show when you will sell and nail down a profit in your stock.
14. Make sure your stock has at least one or two better-performing mutual funds who have bought it in the last reporting period. You want your stocks to have increasing institutional sponsorship over the last several quarters.
15. The company should have an excellent new product or service that is selling well. It should also have a big market for its product and the opportunity for repeat sales.
16. The general market should be in an uptrend and either favor small or big cap companies.
17. The stock should have ownership by top management.
18. Look for a “new America” entrepreneurial company rather than laggard, “old America” companies.
19. Forget your pride and ego; the market doesn’t know or care what you think.
20. Watch for companies that have recently announced they are buying back 5% to 10% or more of their common stock. Find out if there is new management in the company and where it came from.
21. Don’t try to buy a stock at the bottom or on the way down in price, and don’t average down
22. If the news appears to be bad, but the market yawns, you can feel more positive. The tape is telling you the underlying market may be stronger than many believe. The opposite is also true.
23. 37% of a stock’s price movement is directly tied to the performance of the industry group the stock is in. Another 12% is due to strength in its overall sector. Therefore, half of a stock’s move is due to the strength of its respective group.

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Richard Rhodes 16 Investing Rules

1. The first and most important rule is – in bull markets, one is supposed to be long. In a bull market, one can only be long or on the sidelines. Remember, not having a position is a position.
2. Buy that which is showing strength – sell that which is showing weakness. The public continues to buy when prices have fallen. The professional buys because prices have rallied. The rule of survival is not to “buy low, sell high”, but to “buy higher and sell higher.”
3. When putting on a trade, enter it as if it has the potential to be the biggest trade of the year. Don’t enter a trade until it has been well thought out, a campaign has been devised for adding to the trade, and contingency plans set for exiting the trade.
4. In bull markets, add to the trade on minor corrections back into support levels. In bear markets, add on corrections into resistance. Use the 33-50% corrections level of the previous movement or the proper moving average as a first point in which to add. 
5. Be patient. If a trade is missed, wait for a correction to occur before putting the trade on.
6. Be patient. Once a trade is put on, allow it time to develop and give it time to create the profits you expected.
7. Be patient. The real money in trading is made from the one, two or three large trades that develop each year. You must develop the ability to patiently stay with winning trades to allow them to develop into that sort of trade.
8. Be patient. Once a trade is put on, give it time to work; give it time to insulate itself from random noise; give it time for others to see the merit of what you saw earlier than they.
9. Be impatient. As always, small loses and quick losses are the best losses. It is not the loss of money that is important. Rather, it is the mental capital that is used up when you sit with a losing trade that is important.
10. Never, ever under any condition, add to a losing trade, or “average” into a position. If you are buying, then each new buy price must be higher than the previous buy price. If you are selling, then each new selling price must be lower. This rule is to be adhered to without question.
11. Do more of what is working for you, and less of what’s not. Each day, look at the various positions you are holding, and try to add to the trade that has the most profit while subtracting from that trade that is either unprofitable or is showing the smallest profit. 
12. When sharp losses in equity are experienced, take time off. Close all trades and stop trading for several days. The mind can play games with itself following sharp, quick losses. The urge “to get the money back” is extreme, and should not be given in to.
13. When adding to a trade, add only 1/4 to 1/2 as much as currently held. That moves the average price of your holdings less than half of the distance moved, thus allowing you to sit through 50% corrections without touching your average price.
14. Think like a guerrilla warrior. We wish to fight on the side of the market that is winning. Our duty is to earn profits by fighting alongside the winning forces. If neither side is winning, then we don’t need to fight at all.
15. Markets form their tops in violence; markets form their lows in quiet conditions.
16. The final 10% of the time of a bull run will usually encompass 50% or more of the price movement. Thus, the first 50% of the price movement will take 90% of the time and will require the most backing and filling and will be far more difficult to trade than the last 50%.

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Ed Seykota’s 21-Investment Guidelines

1. In order of importance to me are: (1) the long-term trend, (2) the current chart pattern, and (3) picking a good spot to buy or sell. Those are the three primary components of my trading.
2. If I am bullish, I neither buy on a reaction, nor wait for strength; I am already in. I turn bullish at the instant my buy stop is hit, and stay bullish until my sell stop is hit. Being bullish and not being long is illogical.
3. If I were buying, my point would be above the market. I try to identify a point at which I expect the market momentum to be strong in the direction of the trade, so as to reduce my probable risk
4. I set protective stops at the same time I enter a trade. I normally move these stops in to lock in a profit as the trend continues. Sometimes, I take profits when a market gets wild. This usually doesn’t get me out any better than waiting for my stops to close in, but it does cut down on the volatility of the portfolio, which helps calm my nerves. Losing a position is aggravating, whereas losing your nerve is devastating.
5. Before I enter a trade, I set stops at a point at which the chart sours.
6. The markets are the same now as they were five to ten years ago because they keep changing – just like they did then.
7. Risk is the uncertain possibility of loss. If you could quantify risk exactly, it would no longer be risk.
8. Speculate with less than 10% of your liquid net worth. Risk less than 1% of your speculative account on a trade. This tends to keep the fluctuations in the trading account small, relative to net worth.
9. I usually ignore advice from other traders, especially the ones who believe they are on to a “sure thing”. The old timers, who talk about “maybe there is a chance of so and so,” are often right and early.
10. Pyramiding instructions appear on dollar bills. Add smaller and smaller amounts on the way up. Keep your eye open at the top
11. Trend systems do not intend to pick tops or bottoms. They ride sides.
12. The key to long-term survival and prosperity has a lot to do with the money management techniques incorporated into the technical system. There are old traders and there are bold traders, but there are very few old, bold traders.
13. The manager has to decide how much risk to accept, which markets to play, and how aggressively to increase and decrease the trading base as a function of equity change. These decisions are quite important—often more important than trade timing.
14. The profitability of trading systems seems to move in cycles. Periods during which trend-following systems are highly successful will lead to their increased popularity. As the number of system users increases, and the markets shift from trending to directionless price action, these systems become unprofitable, and under-capitalized, and inexperienced traders will get shaken out. Longevity is the key to success.
15. Systems don’t need to be changed. The trick is for a trader to develop a system with which he is compatible.
16. I don’t think traders can follow rules for very long unless they reflect their own trading style. Eventually, a breaking point is reached and the trader has to quit or change, or find a new set of rules he can follow. This seems to be part of the process of evolution and growth of a trader.
17. Trading Systems don’t eliminate whipsaws. They just include them as part of the process.
18. The trading rules I live by are:
    1. Cut losses.
    2. Ride winners.
    3. Keep bets small.
    4. Follow the rules without question.
    5. Know when to break the rules.
19. The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.
20. If you can’t take a small loss, sooner or later you will take the mother of all losses.
21. One alternative is to keep bets small and then to systematically keep reducing risk during equity draw downs. That way you have a gentle financial and emotional touchdown.

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But, did you spot what was missing?

Every day the media continues to push the narrative of passive investing, indexing and “buy and hold.” Yet while these methods are good for Wall Street, as it keeps your money invested at all times for a fee, it is not necessarily good for your future investment outcomes.

You will notice that not one of the investing greats in history ever had “buy and hold” as a rule.

So, the next time that someone tells you the “only way to invest” is to buy and index and just hold on for the long-term, you just might want to ask yourself what would a “great investor” actually do. More importantly, you should ask yourself, or the person telling you, “WHY?”

The ones listed here are not alone. There numerous investors and portfolio managers that are revered for the knowledge and success. While we idolize these individuals for their respective “genius,” we can also save ourselves time and money by learning from their wisdom and their experiences. Their wisdom was NOT inherited, but was birthed out of years of mistakes, miscalculations, and trial-and-error. Most importantly, what separates these individuals from all others was their ability to learn from those mistakes, adapt, and capitalize on that knowledge in the future.

Experience is an expensive commodity to acquire, which is why it is always cheaper to learn from the mistakes of others.

Importantly, you will notice that many of the same lessons are repeated throughout. This is because there are only a few basic “truths” of investing that all of the great investors have learned over time. I hope you will find the lessons as beneficial as I have over the years and incorporate them into your own practices.

Each week we produce a chart book of the major financial markets to review whether the markets, as a whole, warrant higher levels of equity risk in portfolios or not. Stocks, as a whole, tend to rise and fall with the overall market. Therefore, if we get the short-term trend of the market right, our portfolios should perform respectively.

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

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

S&P 500 Index

• As noted in our daily portfolio commentary we added a 2x long with the breakout last week.
• We are still maintaining our core S&P 500 position as the market has not technically violated any support levels as of yet.
• However, with the market now on a registered “Sell” signal, it is unlikely the current advance is going to go far unless that signal can be reversed.
• The upside for this rally is the July highs but remains a rally to sell into.
• Short-Term Positioning: Bullish
  • Last Week: Hold position
  • This Week: Hold position.
  • Stop-loss moved up to $285
  • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

• Like the SPY, DIA is broke above resistance and the next target is the previous highs.
• DIA has registered a “Sell” signal which will put pressure on DIA to the downside. This rally needs to last long enough to reverse that signal.
• Look for this rally to fail likely next week.
• Short-Term Positioning: Neutral
  • Last Week: Hold current positions
  • This Week: Hold current positions.
  • Stop-loss moved up to $255.00
• Long-Term Positioning: Neutral

Nasdaq Composite

• We noted that QQQ had rallied modestly, but was uninspiring. On Friday, QQQ rallied into resistance.
• Like DIA and SPY, a “Sell signal” has been registered. It will be important for the market to rally enough next week to get above resistance and reverse the signal.
• Short-Term Positioning: Bullish
  • Last Week: Hold position
  • This Week: Hold position
  • Stop-loss moved up to $175
• Long-Term Positioning: Neutral

S&P 600 Index (Small-Cap)

• The buy signal has reversed to a sell, and performance continues to deteriorate.
• The rally last week was uninspiring and failed to get above important resistance. With a sell signal in place there is nothing suggesting taking on exposure currently.
• As we have repeatedly stated, there are a lot of things going wrong with small-caps currently so the risk outweighs the reward of a trade at this juncture.
• Short-Term Positioning: Bearish
  • Last Week: No position
  • This Week: No position.
  • Stop loss violated.
• Long-Term Positioning: Bearish

S&P 400 Index (Mid-Cap)

• MDY, like SLY, is technically not in great shape, but did manage to hold the 200-dma support for now.
• MDY has now registered a “sell” signal which must be reversed before considering adding exposure.
• Short-Term Positioning: Neutral
  • Last Week: No holding
  • This Week: No holding
• Long-Term Positioning: Bearish

Emerging Markets

• EEM continues to underperform. The sector did rally last week on hopes of a trade resolution, but that is an outcome that will not come soon. Look for this rally to fail.
• A sell signal has been triggered as well.
• EEM is running into heavy overhead resistance so next week will be important.
• As noted previously we closed out of out trading position to the long-short portfolio due to lack of performance.
• Short-Term Positioning: Bearish
  • Last Week: No position
  • This Week: No position
  • Stop-loss violated at $41
• Long-Term Positioning: Neutral

International Markets

• Like EEM, EFA continues to drag.
• EFA broke its downtrend line while maintaining a “buy signal” but did hold support at the 200-dma.
• EFA has also triggered a sell signal
• As with EEM, we did add a trading position to our long-short portfolio model but it, like EEM, was not performing so we closed it.
• Short-Term Positioning: Neutral
  • Last Week: No position
  • This Week: No position.
  • Stop-loss was violated at $64
• Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

• Oil continues to languish and remains on a sell signal currently. This doesn’t really bode well for either economic growth, or energy stocks near-term.
• More importantly, oil is confined to its downtrend and continues to fail at the 200-dma which is trending lower. A break of support at $54 and oil will test $50/bbl fairly quickly.
• Oil is not oversold and is in a downtrend. There is no reason to be long oil currently.
• Short-Term Positioning: Neutral
  • Last Week: No position
  • This Week: No position
  • Stop-loss for any existing positions is $54.
• Long-Term Positioning: Bearish

Gold

• Gold remains extremely overbought including its longer-term “buy signal.”
• As noted a month ago, we said that if support holds we will be able to move our stop-loss levels higher. That was indeed the case and we moved stops higher.
• Gold is too extended to add to positions here and we have been looking for a pullback which now seems to be in the works. We are looking to add further to our holding between $136-138 or whenever an oversold condition is achieved.
• Short-Term Positioning: Neutral
  • Last week: Hold positions.
  • This week: Hold positions
  • Stop-loss for whole position move up to $134
  • Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

• Like GLD, Bond prices have surged on Trump ramping up the trade war.
• The overbought condition is rather extreme, so be patient and wait for a correction back to the breakout level to add holdings.
• Prices could pullback to the $135-137 range which would be a better entry point.
• Short-Term Positioning: Bullish
  • Last Week: Hold positions after taking profits.
  • This Week: Hold positions
  • Stop-loss is moved up to $130
  • Long-Term Positioning: Bullish

U.S. Dollar

• The dollar had rallied above, and is holding support, at its 200-dma. This is bullish and suggests a stronger dollar as foreign dollars flow into U.S. Treasuries for yield and safety.
• We noted previously the dollar broke above key overhead resistance and suggests a move back towards $98-99 is likely. We have hit our target for now so take profits if you are long a dollar trade.
• USD is holding support at the previous resistance line. The rally has now triggered a “buy” signal.

In 2016, I first touched on the impacts of hiking the minimum wage.

“What’s the big ‘hub-bub’ over raising the minimum wage to $15/hr? After all, the last time the minimum wage was raised was in 2009.

According to the April 2015, BLS report the numbers were quite underwhelming:

‘In 2014, 77.2 million workers age 16 and older in the United States were paid at hourly rates, representing 58.7 percent of all wage and salary workers. Among those paid by the hour, 1.3 million earned exactly the prevailing federal minimum wage of $7.25 per hour. About 1.7 million had wages below the federal minimum.

Together, these 3.0 million workers with wages at or below the federal minimum made up 3.9 percent of all hourly-paid workers. Of those 3 million workers, who were at or below the Federal minimum wage, 48.2% of that group were aged 16-24. Most importantly, the percentage of hourly paid workers earning the prevailing federal minimum wage or less declined from 4.3% in 2013 to 3.9% in 2014 and remains well below the 13.4% in 1979.'”

Hmm…3 million workers at minimum wage with roughly half aged 16-24. Where would that group of individuals most likely be found?

Not surprisingly, they primarily are found in the fast-food industry.

“So what? People working at restaurants need to make more money.”

Okay, let’s hike the minimum wage to $15/hr. That doesn’t sound like that big of a deal, right?

My daughter turned 16 in April and got her first summer job. She has no experience, no idea what “working” actually means, and is about to be the brunt of the cruel joke of “taxation” when she sees her first paycheck.

Let’s assume she worked full-time this summer earning $15/hour.

• $15/hr X 40 hours per week = $600/week
• $600/week x 4.3 weeks in a month = $2,580/month
• $2580/month x 12 months = $30,960/year.

Let that soak in for a minute.

We are talking paying $30,000 per year to a 16-year old to flip burgers.

Now, what do you think is going to happen to the price of hamburgers when companies must pay $30,000 per year for “hamburger flippers?”

Not A Magic Bullet

After Seattle began increased their minimum wage, the NBER published a study with this conclusion:

“Using a variety of methods to analyze employment in all sectors paying below a specified real hourly rate, we conclude that the second wage increase to $13 reduced hours worked in low-wage jobs by around 9 percent, while hourly wages in such jobs increased by around 3 percent. Consequently, total payroll fell for such jobs, implying that the minimum wage ordinance lowered low-wage employees’ earnings by an average of $125 per month in 2016.”

This should not be surprising as labor costs are the highest expense to any business. It’s not just the actual wages, but  also payroll taxes, benefits, paid vacation, healthcare, etc. Employees are not cheap, and that cost must be covered by the goods or service sold. Therefore, if the consumer refuses to pay more, the costs have to be offset elsewhere.

For example, after Walmart and Target announced higher minimum wages, layoffs occurred (sorry, your “door greeter” retirement plan is “kaput”) and cashiers were replaced with self-checkout counters. Restaurants added surcharges to help cover the costs of higher wages, a “tax” on consumers, and chains like McDonald’s, and Panera Bread, replaced cashiers with apps and ordering kiosks.

A separate NBER study revealed some other issues:

“The workers who worked less in the months before the minimum-wage increase saw almost no improvement in overall pay — $4 a month on average over the same period, although the result was not statistically significant. While their hourly wage increased, their hours fell substantially. 

The potential new entrants who were not employed at the time of the first minimum-wage increase fared the worst. They noted that, at the time of the first increase, the growth rate in new workers in Seattle making less than $15 an hour flattened out and was lagging behind the growth rate in new workers making less than $15 outside Seattle’s county. This suggests that the minimum wage had priced some workers out of the labor market, according to the authors.”

Again, this should not be surprising. If a business can “try out” a new employee at a lower cost elsewhere, such is what they will do. If the employee becomes an “asset” to the business, they will be moved to higher-cost areas. If not, they are replaced.

Here is the point that is often overlooked.

Your Minimum Wage Is Zero

Individuals are worth what they “bring to the table” in terms of skills, work ethic, and value. Minimum wage jobs are starter positions to allow businesses to train, evaluate, and grow valuable employees.

• If the employee performs as expected, wages increase as additional duties are increased.
• If not, they either remain where they are, or they are replaced.

Minimum wage jobs were never meant to be a permanent position, nor were they meant to be a “living wage.”

Individuals who are capable, but do not aspire, to move beyond “entry-level” jobs have a different set of personal issues that providing higher levels of wages will not cure.

Lastly, despite these knock-off effects of businesses adjusting for higher costs, the real issue is that the economy will quickly absorb, and remove, the benefit of higher minimum wages. In other words, as the cost of production rises, the cost of living will rise commensurately, which will negate the intended benefit.

The reality is that while increasing the minimum wage may allow workers to bring home higher pay in the short term; ultimately they will be sent to the unemployment lines as companies either consolidate or eliminate positions, or replace them with machines.

There is also other inevitable unintended consequences of boosting the minimum wage.

The Trickle Up Effect:

According to Payscale, the median hourly wage for a fast-food manager is $11.00 an hour.

Therefore, what do you think happens when my daughter, who just got her first job with no experience, is making more than the manager of the restaurant? The owner will have to increase the manager’s salary. But wait. Now the manager is making more than the district manager which requires another pay hike. So forth, and so on.

Of course, none of this is a problem as long as you can pass on higher payroll, benefit and rising healthcare costs to the consumer. But with an economy stumbling along at 2%, this may be a problem.

A report from the Manhattan Institute concluded:

“By eliminating jobs and/or reducing employment growth, economists have long understood that adoption of a higher minimum wage can harm the very poor who are intended to be helped. Nonetheless, a political drumbeat of proposals—including from the White House—now calls for an increase in the $7.25 minimum wage to levels as high as $15 per hour.

But this groundbreaking paper by Douglas Holtz-Eakin, president of the American Action Forum and former director of the Congressional Budget Office, and Ben Gitis, director of labormarket policy at the American Action Forum, comes to a strikingly different conclusion: not only would overall employment growth be lower as a result of a higher minimum wage, but much of the increase in income that would result for those fortunate enough to have jobs would go to relatively higher-income households—not to those households in poverty in whose name the campaign for a higher minimum wage is being waged.”

This is really just common sense logic but it is also what the CBO recently discovered as well.

The CBO Study Findings

Overall

• “Raising the minimum wage has a variety of effects on both employment and family income. By increasing the cost of employing low-wage workers, a higher minimum wage generally leads employers to reduce the size of their workforce.
• The effects on employment would also cause changes in prices and in the use of different types of labor and capital.
• By boosting the income of low-wage workers who keep their jobs, a higher minimum wage raises their families’ real income, lifting some of those families out of poverty. However, real income falls for some families because other workers lose their jobs, business owners lose income, and prices increase for consumers. For those reasons, the net effect of a minimum-wage increase is to reduce average real family income.”

Employment

• First, higher wages increase the cost to employers of producing goods and services. The employers pass some of those increased costs on to consumers in the form of higher prices, and those higher prices, in turn, lead consumers to purchase fewer goods and services.
• The employers consequently produce fewer goods and services, so they reduce their employment of both low-wage workers and higher-wage workers.
• Second, when the cost of employing low-wage workers goes up, the relative cost of employing higher-wage workers or investing in machines and technology goes down.
• An increase in the minimum wage affects those two components in offsetting ways.
  • It increases the cost of employing new hires for firms
  • It also makes firms with raise wages for all current employees whose wages are below the new minimum, regardless of whether new workers are hired.

Effects Across Employers.

• Employers vary in how they respond to a minimum-wage increase.
• Employment tends to fall more, for example, at firms whose sales decline when they raise prices and at firms that can readily substitute machines or technology for low-wage workers.
• They might  reduce workers’ fringe benefits (such as health insurance or pensions) and job perks (such as employee discounts), which would lessen the effect of the higher minimum wage on total compensation. That, in turn, would weaken employers’ incentives to reduce their employment of low-wage workers.
• Employers could also partly offset their higher costs by cutting back on training or by assigning work to independent contractors who are not covered by the FLSA.

Macroeconomic Effects.

• Reductions in employment would initially be concentrated at firms where higher prices quickly reduce sales. Over a longer period, however, more firms would replace low-wage workers with higher-wage workers, machines, and other substitutes.
• A higher minimum wage shifts income from higher-wage consumers and business owners to low-wage workers. Because low-wage workers tend to spend a larger fraction of their earnings, some firms see increased demand for their goods and services, which boosts the employment of low-wage workers and higher-wage workers alike.
• A decrease in the number of low-wage workers reduces the productivity of machines, buildings, and other capital goods. Although some businesses use more capital goods if labor is more expensive, that reduced productivity discourages other businesses from constructing new buildings and buying new machines. That reduction in capital reduces low-wage workers’ productivity, which leads to further reductions in their employment.

Don’t misunderstand me.

Hiking the minimum wage doesn’t affect my business at all as no one we employee makes minimum wage. This is true for MOST businesses.

The important point here is that the unintended consequences of a minimum wage hike in a weak economic environment are not inconsequential.

Furthermore, given that businesses are already fighting for profitability, hiking the minimum wage, given the subsequent “trickle up” effect, will lead to further increases in automation and the “off-shoring” of jobs to reduce rising employment costs. 

In other words, so much for bringing back those manufacturing jobs.

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• Market Review & Update
• The Last Hoorah?
• They Want To Believe
• Sector & Market Analysis
• 401k Plan Manager

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

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Market Review & Update

Last week, we laid out 6-points about the market as the risk to the downside outweighed the potential reward. 

1. Historically, September is one of the weakest months of the year, particularly when it follows a weak August.
2. The market remains range bound and failed at both the 50-dma and downtrend line on Friday
3. The oversold condition has now reversed. (Top panel)
4. Volatility is continuing to remain elevated.
5. Important downside support moves up to 2875
6. The bulls regain control of the narrative on a breakout above 2945. 

The chart above is updated through Friday’s close. As noted, the bulls did regain control of the narrative for now as the breakout above consolidation sets the market up to rally towards 3000 and the July highs. However, with the markets already pushing back into overbought conditions, in conjunction with an extended buy signal, there is not a lot of “upside” in the markets currently. 

As we have reiterated over the last several weeks, this continues to be an opportunity to reduce portfolio risk and raise cash levels.

I say this because it took a bevy of positive overtones to reverse the selloff early in the week. After a sloppy Monday and Tuesday, the rally started on Wednesday with numerous Fed speakers all suggesting the Fed was likely to move forward with cutting rates and increasing monetary accommodation. (H/T Zerohedge)

Williams (Dovish): “Ready to act as appropriate”, July cut was right move, economy mixed (admitted consumer spending not a leading indicator), international news matters, low inflation biggest problem.

Kaplan (Dovish): “Monetary policy a potent force”, worried about yield curve inversion, economy mixed (factories weak due to trade, consumer strong), watching for “psychological effects” on consumers, “if you wait for consumer weakness, it might be too late.”

Kashkari (Dovish): Tariffs, “trade war are really concerning business”, job market not overheating, slower global growth will impact US, most concerned about inverted yield curve. Fed’s policy is “moderately contractionary.”

Bullard/Bowman (Looked Dovish): Took part in “Fed Listens” conference but made no comment on policy but then again when has Jim Bullard ever not been dovish.

Beige Book (Mixed): Moderate expansion but trade fears are mounting, but optimism remains, despite what Kashkari says: “although concerns regarding tariffs and trade policy uncertainty continued, the majority of businesses remained optimistic about the near-term outlook”

Evans (Dovish): Trade policy increases uncertainty and immigration restrictions lower trend growth to 1.5%, Auto industry especially challenged

Furthermore, on Tuesday, we suggested it wouldn’t be long before the Trump Administration dropped an announcement for “trade deal negotiation.” 

Meh! Just need a tweet that "trade talks" are back on and the Fed is cutting rates.

"Tis but a flesh wound." https://t.co/nDPLBeXInw

— Lance Roberts (@LanceRoberts) September 3, 2019

Of course, on Thursday, our wish was granted as the Administration announced that “trade talks” were back on for October. 

“China’s Ministry of Commerce said Thursday that the leaders of the U.S. and Chinese trade talks held a phone call in the morning and agreed to meet in early October for another round of negotiations. 

In a statement to CNBC, a U.S. Trade Representative spokesperson confirmed the phone call, but not the October meeting.

Beijing said the two sides agreed to hold another round of trade negotiations in Washington, D.C. — at the beginning of next month, and consultations will be made in mid-September in preparation for the meeting.”

While the markets once again rallied on the news, this is the same news we have repeatedly seen for the last 18-months. As @stockcats aptly noted:

I hope someone is keeping track of how many times this cycle has repeated pic.twitter.com/5kft4b8lGY

— StockCats (@StockCats) September 5, 2019

The last few months has been this gyration of exuberance and disappointment as the market has lived from one “trade headline” to the next.

Then, of course, on Friday, Jerome Powell spoke suggesting there was “no recession” in sight but gave confidence to the markets the Fed would cut rates at the next meeting. To wit:

“As we move forward, we’re going to continue to watch all of these factors, and all the geopolitical things that are happening, and we’re going to continue to act as appropriate to sustain this expansion.”

This was all enough to spark investor’s “animal spirits” and force a rotation from “defense” back to “offense.” This is an outcome we discussed with our RIAPRO subscribers last week specifically as it related to adding to our Gold positions. To wit: (Chart updated through Friday)

• Both GDX and IAU look identical.
• A near-vertical spike has taken these holdings to extreme overbought and extended conditions.
• We need a decent pullback, or consolidation, to add to holdings at this juncture. A rally in the market should give us that opportunity as it will pull Gold and Rates back to support.
• Looking for an entry point between $14-14.25 to add to holdings.

On Thursday, rates and gold both pulled back as the equity rally accelerated above the breakout level. This pulled the algo’s out of defensive holdings and back into equities confirming the breakout short-term. 

The next major hurdle is going to be the 3000-level initially, but our bullish target for 2019 could be challenged which resides at the top of the trend channel.

That is assuming that nothing disrupts the current bullish narrative. 

But, there are many issues from failed trade talks, to earnings, to economic disappointment which could do just that. 

This is why, despite the bullish overtone, we continue to hold an overweight position in cash (see 8-Reasons), have taken steps to improve the credit-quality in our bond portfolios, and shifted our equity portfolios to more defensive positioning. 

We did modestly add to our equity holdings with the breakout on Thursday from a trading perspective. However, we still maintain an overall defensive bias which continues to allow us to navigate market uncertainty until a better risk/reward opportunity presents itself. 

The Last Hoorah?

September 11, 2018, I wrote “3000 or Bust” and almost precisely one-year later we are finally, for the second time, approaching that level. 

Here is the problem.

The rally has been driven almost entirely by multiple expansion rather than improving fundamentals. This was a point made in last Tuesday’s missive:

“Investing is ultimately about buying assets at a discounted price and selling them for a premium. However, so far in 2019, while asset prices have soared higher on ‘optimism,’ earnings and profits have deteriorated markedly. This is shown in the attribution chart below for the S&P 500.

In 2019, the bulk of the increase in asset prices is directly attributable to investors ‘paying more’ for earnings, even though they are ‘getting less’ in return.”

The discrepancy is even larger in small-capitalization stocks which don’t benefit from things like “share repurchases” and “repatriation.” 

Just remember, at the end of the day, valuations do matter. 

Here is another way to look at the data. Since the beginning of 2018, to support the bullish meme that companies are “beating expectations,” those expectations have been, and continue to be, dramatically lowered. 

This is particularly important given that “operating earnings” (which are fantasy earnings before any of the “bad sh**,”) are extremely elevated above reported profits. 

S&P EPS BUBBLE: When equity earnings rise stupidly relative to (NIPA) profits, subsequent 2-year S&P500 returns are negative. Since mid-90, two episodes stand out – late 1990s and NOW! pic.twitter.com/htgHTzilt5

— Gaurav Saroliya (@GauravSaroliya) July 31, 2019

Of course, this all shows up in how much investors are currently “over-paying” for equity ownership.

As is always the case, investors forget during their momentary bout of exuberance, that valuations are all that matter over the long-term. The greater that over-valuation, the great the reversion to mean will ultimately be. 

But Lance, the markets just keep going up because Central Banks have it all under control.” 

I know it certainly seems that way currently. However, this is a market driven by “financial engineering” rather than fundamental measures. As noted previously, stock buybacks have continued to be a major support for asset prices since the financial crisis accounting for the bulk of the advance in the S&P 500. 

Not surprisingly, as rates of buybacks have slowed, so has the advance of the market. However, they have remained strong enough to offset the effects of negative economic news and trade wars. 

At least, so far. 

Importantly, as the benefit of “repatriation” from the tax reform legislation fades, it has been the rush to the corporate debt market to leverage up balance sheets to facilitate those repurchases. 

“On Wednesday new investment-grade issuance accelerated even more, rising to $28.8bn across 15 deals today, bringing the total for the two days of the week to a whopping $54.3 billion, as refinancing trades continued to dominate with $21.1bn of today’s issuance partially towards commercial paper, credit revolver, term loan, short and long-term debt repayments, according to BofA’s Hans Mikkelsen.” – Via Zerohedge

So, what was the reason for the rush to gobble up more debt at lower costs?

To refinance existing debt at lower rates for longer maturities, and, as Apple noted with their $5 Billion offering, to repurchase shares and issue dividends. 

At the same time, due to excessive confidence and complacency in the financial markets, investors are willing to take substantial credit risk without getting paid for it. Such previous periods of exuberance have also always ended badly.

With corporate debt to GDP levels now at record levels, it is only a function of time until something breaks.

All this brings to mind a note from my friend Doug Kass this past week that summed up well what investors are currently doing.

They Want To Believe

“Price has a way of changing sentiment.” – The Divine Ms M

“It is remarkable to me that the many that hated stocks a large percentage ago (when some of us were buying in the face of a more favorable reward vs. risk) are now bullish and buying.

Investors and traders seem to want to believe.

• They want to believe that the trade talks between the U.S. and China will be real this time.
• They want to believe that there is no “earnings recession” even though S&P profits through the first half of 2019 are slightly negative (year over year) and that S&P EPS estimates have been regularly reduced as the year has progressed. (see above)
• They want to believe that stocks are cheap relative to bonds even though there is little natural price discovery as central banks are artificially impacting global credit markets and passive investing is artificially buoying equities.
• They want to believe that technicals and price are truth – even though the markets materially influenced by risk parity and other products and strategies that exaggerates daily and weekly price moves.
• They want to believe that today’s economic data is an “all clear” – forgetting the weak ISM of a few days ago, the lackluster auto and housing markets, the U.S. manufacturing recession and the continued overseas economic weakness.
• They want to believe that, given no U.S. corporate profit growth, that valuations can continue to expand (after rising by more than three PEs year to date).
• They want to believe though that the EU broadly has negative interest rates and Germany is approaching recession (while the peripheral countries are in recession) – that the Fed will be able to catalyze domestic economic growth through more rate cuts.
• They want to believe that the U.S. can be an oasis of growth even though the economic world is increasingly flat and interconnected and the S&P is nearly 50% dependent on non U.S. economies.

I don’t know with certainty where the markets will be three or six months from today.

But I do know that, given the recent rise in the stock market, the reward vs. risk is vastly diminished and less favorable compared to other opportunities that existed since December, 2018.”

When it comes to investing, believing in “fairy tales” and “We Work” uhm, I mean, “unicorns” has repeatedly led to terrible outcomes. 

The data continues to deteriorate as the late-stage economic cycle advances.

This is as it should be as we move into a late-stage economy.

It is not a bad thing; it is just part of a healthy cycle. It is when entities take action to “extend” the cycle beyond norms, and into extremes, which leads to extremely poor outcomes. 

While none of this means the markets will crash tomorrow, next month, or even next year, it also doesn’t mean that it can’t, or won’t. 

Complacency is an investor’s worst enemy.

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

See you next week, and have a great Labor Day.

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Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

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S&P 500 Tear Sheet  

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Performance Analysis

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Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 continued to fade and is close to turning negative. However, the sector is holding support and remaining above stop-loss levels. The pickup in volatility in the market has hit all sectors, so after taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

Outperforming – Staples (XLP), Utilities (XLU), Real Estate (XLRE), Communications (XLC)

Our more defensive positioning continues to outperform relative to the broader market. Volatility has risen markedly, which makes markets tough to navigate for now. However, after taking some profits and re-positioning the portfolio we will remain patient and wait for the market to tell us what it wants to do next. Real Estate, Staples and Utilities all continue to make new highs but are GROSSLY extended. We added to our position in XLC bringing it up to full weight.

Current Positions: Target weight XLP, XLU, XLRE, and XLC

Weakening – Technology (XLK), Discretionary (XLY), Materials (XLB)

While Technology, and Discretionary did turn higher, the performance is dragging slightly on a relative basis. However, the sectors are very close to beginning to outperform once again, so we added to our position in Discretionary and continue to hold Technology. We remain underweight Materials as the “trade war” rages on. 

Current Position: Target weight XLY, XLK, 1/2 weight XLB

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. We were close to getting stopped out on that position as well but it rallied nicely this past week on hopes of a trade resolution. There is tremendous overhead resistance for the sector so we will remain patient for now.  

Current Position: 1/2 weight XLI

Market By Market

 

We know you get busy and don’t check on our website as often as you might like. Plus, with so much content being pushed out every week from the RIA Team, we thought we would send you a weekly synopsis of everything that you might have missed.

The Week In Blogs

Technically Speaking: Just How Long Will Markets Keep “Buying” It?

5-Things Your Broker Will Ignore – Part 3

What is Bill Dudley Thinking?

No, Bonds Still Aren’t Overvalued!

Having Your Cake & Eating It Too

The Best Of “The Lance Roberts Show”

Video Of The Week

Interview W/ Grant Williams: Negative Rates, Yield Curves & Gold Bugs

Our Best Tweets Of The Week

And why every economic report on income, debt and wealth are vastly skewed. https://t.co/KEJ5Ng4cwW

— Lance Roberts (@LanceRoberts) September 5, 2019

The Fed has spoken… 25bps is all but a done deal for September. https://t.co/1jwC2Bst7B

— Michael Lebowitz, CFA (@michaellebowitz) September 5, 2019

It's called a "late-cycle economy." https://t.co/uYHgxOmczM

— Lance Roberts (@LanceRoberts) September 6, 2019

For the last 8-Yeats we have been talking about the fallacy of QE…why is this NOW just a thing. https://t.co/Vt0Fz4AqUB

— Lance Roberts (@LanceRoberts) September 6, 2019

Our Latest Newsletter

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Cartography Corner – September 2019

See you next week!

The jobs report dramatically missed expectations today, especially with private jobs.

​Initial Reaction – Huge Misses

• The Econoday consensus was for a payroll expansion of 163,000 jobs, 150,000 of them private. The ADP forecast was 195,000 jobs.
• ADP missed consensus by 65,000 jobs.
• Econoday missed consensus by 33,000 jobs.
• Econonday missed the private consensus by 54,000 jobs.
• The Econoday lowest estimate missed the private consensus by 40,000 jobs.

A 34,000 surge in government jobs was primarily due to temporary census hiring of 25,000. So this report is far weaker than the headline number indicates.

By the way, revisions were negative for the third time.

The one positive in the report was a household survey surge in employment coupled with a household surge in the labor force thereby keeping the unemployment rate unchanged.

Even then, things are weaker than they look. The surge in involuntary part-time work was +397,000 and voluntary part-time work rose by +260,000. Don’t add those numbers together as it does not work that way.

U-6 Unemployment jumped 0.2% to 7.2%.

Job Revisions

The change in total nonfarm payroll employment for June was revised down by 15,000 from +193,000 to +178,000, and the change for July was revised down by 5,000 from +164,000 to +159,000. With these revisions, employment gains in June and July combined were 20,000 less than previously reported.

Also recall my August 21 report: BLS Revises Payrolls 501,000 Lower Through March.

BLS Jobs Statistics at a Glance

• Nonfarm Payroll: +130,000 – Establishment Survey
• Private Nonfarm Payroll: +96,000 – Establishment Survey
• Employment: +590,000 – Household Survey
• Unemployment: -19,000 – Household Survey
• Involuntary Part-Time Work: +397,000 – Household Survey
• Voluntary Part-Time Work:+260,000 – Household Survey
• Baseline Unemployment Rate: 3.7% – Household Survey
• U-6 unemployment: up 0.2 to 7.2% – Household Survey
• Civilian Non-institutional Population: +207,000
• Civilian Labor Force: +370,000 – Household Survey
• Not in Labor Force: -364,000 – Household Survey
• Participation Rate: +0.2 to 63.2% – Household Survey

Employment Report Statement

Total nonfarm payroll employment rose by 130,000 in August, and the unemployment rate was unchanged at 3.7 percent, the U.S. Bureau of Labor Statistics reported today. Employment in federal government rose, largely reflecting the hiring of temporary workers for the 2020 Census. Notable job gains also occurred in health care and financial activities, while mining lost jobs.

Unemployment Rate – Seasonally Adjusted

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

Nonfarm Employment Change from Previous Month

Hours and Wages

Average weekly hours of all private employees rose 0.1 hours to 34.4 hours. Average weekly hours of all private service-providing employees rose 0.1 hours to 34.3 hours. Average weekly hours of manufacturers rose 0.2 hours to 40.6 hours.

Average Hourly Earnings of All Nonfarm Workers rose $0.11 to $28.11. That a 0.39% gain.

Average hourly earnings of Production and Supervisory Workers rose $0.11 to $23.59. That’s a 0.47% gain.

Year-Over-Year Wage Growth

• All Private Nonfarm from $27.23 to $28.11, a gain of 3.2%
• All production and supervisory from $22.80 to $23.46, a gain of 3.5%.

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

Birth Death Model

Starting January 2014, I dropped the Birth/Death Model charts from this report. For those who follow the numbers, I retain this caution: Do not subtract the reported Birth-Death number from the reported headline number. That approach is statistically invalid. Should anything interesting arise in the Birth/Death numbers, I will comment further.

Table 15 BLS Alternative Measures of Unemployment

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

Notice I said “better” approximation not to be confused with “good” approximation.

The official unemployment rate is 3.7%. However, if you start counting all the people who want a job but gave up, all the people with part-time jobs that want a full-time job, all the people who dropped off the unemployment rolls because their unemployment benefits ran out, etc., you get a closer picture of what the unemployment rate is. That number is in the last row labeled U-6.

U-6 is much higher at 7.2%. Both numbers would be way higher still, were it not for millions dropping out of the labor force over the past few years.

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

Strength is Relative

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

In the household survey, if you work as little as 1 hour a week, even selling trinkets on eBay, you are considered employed.

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

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

Household Survey vs. Payroll Survey

The payroll survey (sometimes called the establishment survey) is the headline jobs number, generally released the first Friday of every month. It is based on employer reporting.

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

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

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

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

Final Thoughts

This was a huge miss vs expectations, especially on the private side. The addition of temporary census workers is not a positive.

Job volatility remains high. Revisions continue to be negative. Excluding January, job growth is clearly slowing.

This report is way weaker than the headline numbers.

In early July, Michael Lebowitz appeared on Real Vision’s, “Investment Ideas” (LINK), with Edward Harrison. In the interview, Michael stated that the window for a recession was open but that a recession was not necessarily imminent. He based this opinion on the premise that the benefits of increased government spending and recent tax reform are waning and economic headwinds such as China-U.S. trade discussions, slowing European growth, Iran, and a disorderly BREXIT are all serving to slow the growth of the economy. Importantly, he warned that historically the catalyst for recession is often something that is not easy to forecast or predict.

Over the last month, we have noted the “R” word increasingly bandied about by the media. This potential recession catalyst is in everyone’s face, literally, but few recognize it.

Consumers Drive the Bus

Almost 70% of U.S. GDP results from personal consumption. Since 1993, retail sales and GDP have a correlation of 78%, meaning that over three-quarters of the quarterly change in GDP is attributable to the change in retail sales.  

The table below shows the dominant role consumption plays in the GDP calculation. In this hypothetical example, 2.5% consumption growth more than offsets a 4% decline in every other GDP category (an increase in net exports negatively affects GDP). If in the same example consumption was 1% weaker at +1.5%, GDP would go from positive .12% to negative .58%.

Spending decisions, whether for low dollar items such as coffee or dinner or bigger ticket items like a new TV, vacation, or housing, are influenced by our economic outlooks. If we are confident in our job, financial situation, and the economy, we are likely to maintain the pace of consumption or even spend more. If we fear an economic slowdown with financial repercussions, we are likely to tighten our purse strings. Whether we skimp on a cup of Starbucks once a week or postpone the purchase of a car or house, these one-off decisions, when replicated by the masses, sway the economic barometer.

Our economic outlooks and spending habits are primarily based on gut analysis, essentially what we see and hear. Accordingly, print, television, and social media play a large role in molding our economic view.

Recession Fear Mongering

Increasingly, the media has been playing up the possibility of a recession. For example, on August 15, 2019, the day after the yield curve inverted for the first time in over a decade, the lead article on the Washington Post’s front page was entitled Markets Sink on Recession Signal. The signal, per the Washington Post, is the inverted curve. The New York Times followed a few days later with an article entitled How the Recession of 2020 Could Happen. Since mid-August, the number of articles mentioning recession has skyrocketed, as shown below. Furthermore, the number of Google searches for the “R” word has risen to levels not seen since the last recession.

Data Courtesy Google Trends

We have little doubt that the media airing recession warnings are partially politically motivated, but regardless of their motivation, these articles present a growing threat to the consumer psyche and economic growth. 

The more the media mentions “recession,” the higher the likelihood that consumers will retrench in response. Small decisions like not going out to dinner once a week may seem inconsequential, but when similar actions occur throughout a population of hundreds of millions of people, the result can be impactful.  To wit, in The Dog Whistle Heard Around the World, we personalized how our decisions play an important role in measuring economic activity:

Picture your favorite restaurant, one that is always packed and with a long waiting list. One Saturday night you arrive expecting to wait for a table, but to your delight, the hostess says you can sit immediately. The restaurant is crowded, but uncharacteristically there are a couple of empty tables. Those empty tables, while seemingly insignificant, may mean the restaurant’s sales that night will be down a few percent from the norm.

A few percent may not seem like a lot, but consider that the average annual recessionary GDP trough was only -1.88% for the last five recessions.

If economic growth is starting from a relatively weak point, as it is today, then it requires even smaller reductions in consumption habits than in the past to take the economy from expansion to contraction. GDP growth before the last three recessions peaked at 4.47%, 5.29%, and 4.32% respectively. The recent peak in GDP growth was 3.13%, leaving at least 25% less of a cushion than prior peaks.

Summary

Recessions are difficult to predict because they are usually borne out of slight changes in consumer behavior. Needless to say, changes in short term behavioral patterns are difficult to predict at best for a large population and likely impossible.  

Whether or not a recession is imminent is an open question, but the window for a recession is open, allowing a strong negative catalyst to push the economy into contraction. What if that catalyst is as simple as the media repeatedly using the dreaded “R” word?

Over the coming months, we will pay close attention to consumer confidence and expectations surveys for signs that consumer spending is slowing. We leave you with the most recent consumer sentiment and expectations surveys from the University of Michigan and the Conference Board. At this point, neither set of surveys are overly concerning, but we caution they can change quickly.

Data Courtesy Bloomberg

Until about 50 years ago, people paid attention to the area where they lived. They read local papers, shopped at local merchants, and socialized at local events.

Technology ended all that. Now we get our news from the internet. We buy imported goods. We converse on social media with friends thousands of miles away.

This “globalization” process changed the world, sometimes for the better but with significant side effects. Hence, today’s dissatisfaction.

Now, technology is swinging the pendulum back. Globalization is going in reverse. And again, the process will hurt some people.

We can’t stop it, but we can minimize this pain by letting it occur gradually. Give everyone time to adapt.

President Trump doesn’t see it that way. He wants to de-globalize now, no matter the cost.

Wrecking Ball

We all think Trump changed everything. He certainly changed some things, but it’s striking how many of today’s megatrends were already in motion before he took office.

I wrote this in August 2016, when I thought Trump would surely lose the election.

Humanity spent the last 50 years globalizing. Now, thanks to certain technologies, that whole process is going in reverse. I think historians will mark the 2008 financial crisis as the turning point: Peak Globalization.

I don’t say this because I want a de-globalized world. What any of us want or don’t want is irrelevant. I believe the transition will happen whether any of us want it or not.

It will not happen in a linear fashion, though. The process that brought us to this point had starts, stops, and slowdowns. Reverse globalization will have ups and downs, too, but a new set of technologies will keep pushing it forward.

I didn’t anticipate that Trump would be in position to attack all things global—and particularly China—like a wrecking ball demolishes a building. As a result, this process I thought would unfold over decades is now occurring far faster.

The president’s trade war and attacks on various international institutions were big dents. But last week, he took it to another level, saying the US and Chinese economies should separate completely.

Sigh. Where to begin? I could fact-check these tweets and show how wrong he is. But let’s stick with the broader point.

As the rhetoric and tariffs escalate, it is growing clear that Trump doesn’t just want China to play fair. He wants to sever the economic relationship completely. We’re “better off without them,” he says.

In fact, he feels so strongly he orders American companies to look for alternatives to China.

Many analysts laughed off that threat. He can’t do that, they said. But what if he can?

He Has the Power

President Trump can impose tariffs (i.e., taxes) on Chinese and other imported goods because past Congresses allowed presidents to do so under certain conditions.

Trump has stretched that power far beyond what Congress intended, and he’s getting away with it. Yes, we’ve heard a few rumbles about legislation to reduce his trade authority. But it is nowhere near passing both houses.

And even if Congress passes a law ending Trump’s tariff power, Trump can veto it. Overriding his veto requires a two-thirds vote in both House and Senate—unlikely as long as a few Republicans stick with him.

So as a practical matter, nothing stops Trump from raising tariffs on Chinese goods as high as he wants. He doesn’t have to stop at 20% or 30%. He could make the tax 100%, 500%, 10,000%, whatever he likes. He has that power, right now, and Congress is too gridlocked to take it back.

Court challenges might stop him, but that would take time and courts might just say it’s up to Congress. Which, as noted, is hopelessly gridlocked.

Not Backing Down

When Trump tells US companies to abandon China, it’s not an empty threat. He has a way to force their compliance. He can make Chinese imports so expensive they have no choice.

This would, of course, quickly plunge the US economy into recession. Factories that depend on Chinese components would shut down and lay off their workers.

It would be bad… but I’m not sure it would make Trump back down. Nothing binds people together like shared adversity.

We see this already. Many farmers still support Trump even as his policies hurt them. Combine that with Trump’s ability to scapegoat others (hello, Jerome Powell), and I’m dubious even a deep recession would cost him much support.

Trump is president right now because he understands ordinal preference. He believes (correctly, I think) he doesn’t need to be everyone’s ideal. He just has to convince them the alternative is worse.

So, by the time Trump gets through demonizing whoever the Democrats nominate, even the Republican business owners whom his policies are devastating will hold their noses and support him, with both votes and donations.

He might still lose the election. But until then, he will keep doing whatever he thinks maximizes his side’s turnout. Attacking China seems to be high on the list.

I don’t see this getting better. I think it will get much worse.

But in the bigger picture, in the last few months globalization has gone from “unhealthy” to “critically ill.” The US-China trade relationship is its heart, and the pulse is slowing fast.

Major, epic economic change is happening before our eyes at an unnatural speed.

One of the more interesting aspects of our social and investment landscape is how little appetite many people have for bad news. Problems can be so messy and hard after all; who wants to deal with them? Boris Johnson catered to this reality in the UK when he said his policy on cake is “Pro having it, and pro eating it.” Why make difficult choices when they can be obviated with a rhetorical flourish?

Not only do people not want to hear bad news, though, but often they work actively to ignore or reframe it. This makes a difficult investment environment even more so by inviting opportunists to exploit such tendencies by misrepresenting things. While following proclamations that are too good to be true will inevitably produce pain for many investors, it will also create opportunities for others.

One thing that can be objectively said about the investment landscape is that interest rates are low on an absolute and historical basis. As a result, it is fair to say that “easy” investment options like buying Treasury bonds that yield well more than the inflation rate are just not available to today’s investors. If you want anything like the returns of past years, you are going to have to take on more risk.

This is the mild account of the investment landscape. The harsher version was provided by a “luminary of one of America’s largest family offices” in the Financial Times:

“It is the hardest investing climate I have ever seen in my career in public markets now.”

There simply are not abundant opportunities in publicly traded financial assets like stocks and bonds. As a result, the vast majority of investors are “exposed to the vagaries of low interest rates.”

Low rates force ordinary investors into a difficult trade-off: They must either accept the vagaries of low interest rates or forego the potentially higher returns of risky assets altogether. Temptation often tips the scales. As the FT describes, “eagerness to outperform benchmarks is likely to push investors into the riskiest and least liquid areas.” 

It is easy to get a sense of deja vu.

It was just over ten years ago when low rates were driving persistent demand for yield which compelled efforts to manufacture yield and disguise risk. As Zwirn, Kyung-Soo Liew, and Ahmad explain in their paper, “This Time is Different but it will End the Same Way“, the same basic risks exist today. The only difference is that some of the specifics are different:             

1. “Lack of market-making and other regulatory changes that will impede price discovery in the next downturn
2. Masking of the deterioration of underlying collateral and ‘rearview mirror’ analysis
3. New versions of the old games played by the rating agencies
4. Explosion in Asset-Liability mismatched structures
5. Regulatory changes in compliance of financial institutions.”

The outcome, however, is unlikely to be very different:

“Wrapping fixed-income securities into ETFs does not solve the problem of the lack of exchange-traded markets for fixed-income securities. It only hides the lack of liquidity of the underlying constituents.”

John Dizard addressed the issue in the FT: 

“Because we no longer have the banks doing market-making, we have created the conditions for liquidity mismatching. We need to do better analysis of both sides of the balance sheet and not confuse listed assets with liquid assets, since in a crisis, liquidity and even pricing is uncertain.” 

Stephanie Pomboy of MacroMavens summarized the situation as well as anyone:

“In 2007, the lie was that you could take a cornucopia of crap, package it together, and somehow make it AAA. This time the lie is that you can take a bunch of bonds that trade by appointment, lump them together in an ETF, and magically make them liquid.“

In important respects, it is odd that after investors got beaten down so badly in the GFC that they would expose themselves to the same kind of beating again. Why are they behaving so foolishly?

Why are they repeating the same mistakes?

Rana Foroohar throws out one idea in the FT:

“My answer to the question of why we haven’t yet seen a deeper and more lasting correction is that, until last week, the market had been willfully blind …”

According to Foroohar, investors have been blind to “the fact that there will be no trade deal between the US and China” and blind to the reality “the Fed’s decade-long Plan A — blanket the economy with money, and hope for normalisation — has failed.”

Ben Hunt and Rusty Guinn from Epsilon Theory have also picked up on this oddity in investor behavior. They believe that many important issues don’t garner more attention because they never hit the radar of mainstream media. In “Does it make a sound“, Rusty Guinn describes serious topics like the Jeffrey Epstein case and the protests in Hong Kong are unlikely to fade “because they don’t exist.”  He explains,

“There is no narrative, no common knowledge in the US about these [Hong Kong] protests. American media have largely stopped covering them.”

Mainstream media does not consider them newsworthy – so they don’t cover them – so they don’t exist in any meaningful sense for most people.

For curious people and concerned investors, the pervasiveness of willful blindness is as cringe-worthy as it is astonishing. Why don’t people push back? Why don’t people demand better coverage, better information? Guinn has a hypothesis for that too. In “The Country HOA and Other Control Stories“, Guinn describes: 

“Even when we know something is a story written for us, that we are being told how to think or feel about something to serve someone else’s purposes, there is a visceral, emotional part of us that wants to believe it. Needs to believe it. We yearn to see it as an echo of some truth rather than a construction, and when some paltry data emerges to confirm it, it becomes almost irresistible.“

Indeed, it is nice to believe stories. The Fed has our back. The economy just needs some time to get back to normal. High debt levels don’t have serious long-term consequences. Modern companies have such abundant growth prospects that they don’t need to focus on profitability. 

However, these are all just stories. As Mohamed El-Erian recently warned in the FT, the believability of some stories is now being seriously tested: “Long spoiled by the comforting support of central banks, investors are getting a feel for what it would be like when economic concerns rather than central bank monetary policies take a bigger role in determining asset prices.”

More specifically, El-Erian highlights two different narratives that deserve fresh consideration:

“With recent developments, however, investors need to seriously reconsider two other widely held hypotheses: that trade tension is temporary and reversible; and that a more indebted global economy would navigate them without serious setbacks.”

Additionally, cracks are now beginning to appear to the narrative that “Everything is OK” in ways that echo the problems with Bear Stearns hedge funds in early 2008. John Mauldin describes one such early warning indicator:

“Some bond issues have been bought in their entirety by a small handful of high-yield bond funds. The problem is that the company that issued these bonds has defaulted on them. Not just missed a payment or two, but full default. Their true value, if the funds tried to sell them, might be 25–30% of face if they actually traded, according to the people who told me this. But the funds still value them at the purchase price of $0.95 on the dollar.”

This can happen because the funds have not tried to sell the bonds and therefore there is no “mark-to-market” price. The important lesson for investors is that the loss has already been incurred; it just hasn’t been recognized yet. This creates what will be very disappointing news for unwary investors. Their returns are already down; they just don’t know it yet. 

Higher yielding sovereign bonds are also suffering severe losses. Argentina’s markets got hammered on a single day in August on the basis of a single primary election. As the FT reported, “the biggest loser was the $11.3 billion Templeton Emerging Markets Bond Fund, which fell by 3.5%, a drop that has continued on Tuesday as the selling was nowhere near done. That was its largest daily drop since the October 2008 global financial crisis.” 

Nor was this a one-off blip that could easily be recovered. In the last month conditions in Argentina eroded to the point where it defaulted on a number of short-term bonds and implemented capital controls to buy time to restructure. In short, a lot of pain will be felt by investors.

Other cracks are appearing as well. Asset managers such as Woodford Investment Management and H2O Asset Management have had difficulty meeting surging redemption requests due to a proliferation of illiquid investments in their funds. This highlights another interesting nuance of the current environment. During the GFC, banks suffered the greatest liquidity crises; this time it may be money managers that have the biggest liquidity problems.

Regardless, the overarching point for investors to understand is that you don’t get to have your cake and eat it to. John Mauldin describes the investment consequences of those who try:

“More money is going to be lost by more people reaching for yield in this next high-yield debacle than all the theft and fraud combined in the last 50 years.”

Unfortunately, investors are unlikely to get much help from mainstream commentators and advisers. For example, Schwab sent out a note trying to calm investors after a big down day in early August by encouraging them to “Maintain a long-term view on investing”. The note advised:

“It’s important to remember that timing the market is virtually impossible and that it’s generally better to maintain a long-term perspective on investing. Market fluctuations, such as those we’re experiencing, should not alter your overall investment strategy, unless your financial plan has changed.”

The problem is, there is a lot of truth to the statement, so it sounds plausible enough to not be challenged very seriously. What the statement does not do, however, is consider the possibility that recent volatility might be providing useful new information. Nor does it acknowledge the inherently flawed financial system that undermines what constitutes long-term financial planning. The ultimate message is that most investors don’t want to hear those things, so you won’t hear them from major channels.

Despite such obstacles, it is still distinctly possible to navigate the investment landscape successfully. In doing so, it is useful to keep in mind that we’ve seen this movie before. There is no need to overthink things; it will end the same way. A day will come when liquidity freezes and prices start dropping in chunks rather than small increments. Many investors will be shocked, and many will be in denial. 

In such an event, however, there will also be opportunity. Mauldin describes: 

“My own goal is to be a buyer, not a seller, whenever it [a liquidity crisis] occurs. For now, that means holding cash and exercising a lot of patience. If I’m right, the payoff will be a once-in-a-generation chance to buy quality assets at pennies or dimes or quarters on the dollar. I think the next selloff in high-yield bonds is going to offer one of the great opportunities of my lifetime. In a distressed debt market, when the tide is going out, everything goes down. Some very creditworthy bonds will sell at a fraction of the eventual return.”

This highlights an underappreciated aspect of investing: One person’s gain is another’s loss. On one hand, it is hard to tolerate low returns and harder yet to do so when commentators and advisers encourage complacency. As a result, it is easy to fall prey to lies and misrepresentations – like being able to get decent yields with the same amount of risk. Most people want to have their cake and eat it too, but that is usually a formula for losing money.

On the other hand, because it is so hard to resist such temptations, few succeed. As a result, enormous opportunities get created for the few who are diligent and disciplined enough to do so. They only come along a few times in your life, though, so you need to be prepared. That preparation involves incorporating the deep structural flaws of the financial system as a risk factor, actively seeking out information outside the channels of mainstream media, and “holding cash and exercising a lot of patience”.

 

HOW TO READ THE CHARTS

There are four primary components to each chart:

• The price chart is contained within the shaded area which represents 2-standard deviations above and below the short-term moving average. 
• The Over Bought/Over Sold indicator is in orange at the top.
• The Support/Resistance line (green) is the longer-term moving average which also acts as a trailing stop in many cases.
• The Buy / Sell is triggered when the green line is above the red line (Buy) or vice-versa (Sell).

LONG CANDIDATES

PGR – Progressive Corp.

• While PGR is on a short-term sell signal, it is sitting on important long-term uptrend support. The last violation of that trend support was fully reversed within just a few weeks.
• Given the bullish bias to the stock, and considering there are very tight parameters for a trade, a long position can be added.
• Buy at current levels.
• Stop is $72.50

MMM – 3M Corp.

• MMM has been under a lot of pressure from trade war concerns and a slowing economy. However, much of the downside appears to have been rung out for now.
• Buy a position with a stop at $155.
• Initial target for the trade is $175-180
• The set up for the trade is pretty clear with limited risk and decent reward.

ROK – Rockwell Automation

• ROK is on a very deep oversold “sell signal” and sitting on important support from previous bottoms.
• Previous oversold conditions have lead to decent rallies.
• Buy a position at current levels.
• Stop-loss is very tight at $145
• Target is $165

AMGN – Amgen, Inc.

• AMGN recently broke out to new highs and has triggered a buy signal from fairly low levels. A bit of a pullback is needed to add to holdings.
• Buy a position on a pullback to anywhere between $190 and $200.
• Stop-loss after purchase is set at $185.

ITW – Illinois Tool Works

• ITW is sitting on support and is current working a sell signal. However, the risk./reward parameters suggest a trade made be in the offing.
• Buy a position in ITW at current levels.
• Target for trade is $155-160
• Stop loss is set at $145.

SHORT CANDIDATES

AMP – Ameriprise Financial

• AMP has broken several important supports and triggered a sell signal. With financial vulnerable to rate cuts, look for further declines.
• Sell short the position on break of $125.
• Target for trade is $100
• Stop-loss is at $130

BLK – Blackrock, Inc.

• BLK was recently selected as a short position near the previous highs. The sell-off has been enough to warrant taking profits.
• Close out the short-position if you haven’t already.

NTRS – Northern Trust Cop.

• As noted above, the Fed cutting rates aren’t great for banks.
• Sell short NTRS on a break below $85
• Target for trade is $77.50
• Stop-loss is set to $90

CMI – Cummins, Inc.

• CMI makes diesel engines for long-haul trucks where we are seeing substantially less demand currently.
• CMI is on a sell signal and is not deeply oversold.
• Sell short CMI on any failed rally to $155
• Stop loss following trade setup is $160
• Target for trade is $125

CSCO – CSCO Systems Inc.

• CSCO is running into a good bit of trouble and is sitting on very dangerous support level.
• Short CSCO on a break below $46
• Target for trade is $38
• Stop-loss is set to $48

Interest rates have plunged lately as concerns about a recession in the U.S. economy have risen. This has led many media commentators to suggest the bonds are now wildly overvalued. To wit:

“When evaluating the desirability of government bonds as a long-term investment, it’s imperative to compare the prevailing yields of bonds with the earnings yields for stocks.” 

While this is a common comparison, it is also wrong. Let’s compare the two:

Earnings Yield:

• “Earnings yield” is the inverse of P/E ratios and only tells you what the yield is currently, not what the future will be.
• Investors do not “receive” an “earnings yield” from owning stocks. There is no “yield payment” paid out to shareholders, it is simply a mathematical calculation.
• There is no protection of principal.

Treasury Yield:

• Investors receive a specific, and calculable to the penny, “yield” which is paid to the holder.
• A Government guaranteed return of principal at maturity.

As we noted previously, it is essential to align expectations and investing requirements. Stocks have liquidity, and potential return (or loss), but no safety of principal. Treasuries have a stated return, and a high degree of safety. However, in order to guarantee the stated return, Treasuries must be held to maturity and may not be liquid if that is your goal.

For most investors, completely discounting the advantage of owning bonds over the last 20-years has been a mistake. By reducing volatility and drawdowns, investors were better able to withstand the eventual storms which wiped out large chunks of capital. Some may look at the graph below and say ‘hey, but in the end bonds and stocks are now at the same point’. True, but the heart burn and risk taken with stocks was needless. It is also worth pointing out that stocks are once again grossly overvalued and a large drawdown is probable in the coming years.

All risk, all the time, has repeatedly led to bad outcomes for investors unwilling to evaluate the benefits of owning fixed income because they are comparing a “phantom yield” to a “real yield.”

Valuations

However, this does not answer the question of “valuation” as it relates to bonds. For that analysis, we need to look at three factors:

1. Economic growth and inflation
2. Current trader positioning
3. Relative yields

(We are specifically focusing on the U.S. Treasury market since this is the market which is specifically affected by monetary policies.)

In April 2017, I wrote an article discussing “Why Bonds Aren’t Overvalued.”  As I stated then:

“I agree that stocks are indeed overvalued. Since investors pay a price for what they believe will be the future value of cash flows from the company, it is possible that investors can misjudge that value and pay too much. Currently, with valuations trading at the second highest level in history, it is not difficult to imagine that investors have once again overestimated the future earnings and cash flows they might receive from their invested capital.”

“However, bonds are a different story.”

Unlike stocks, bonds have a finite value. At maturity, the principal is returned to the holder along with the final interest payment. Therefore, bond buyers are very coherent of the price they pay today, for the return they will get tomorrow.

Since the future return of any bond, on the date of purchase, is calculable to the 1/100th of a cent, a bond buyer is not going to pay a price that yields a negative yield to maturity. (This is assuming a holding period until maturity. A negative yield might be purchased on a trading basis if benchmark rates are expected to decline further and/or in a deflationary environment.) “

In other words, it is very difficult for a bond to be tremendously “overvalued” as rates are ultimately set by the supply and demand for credit. As I have discussed many times in the past, interest rates are a function of three primary factors: economic growth, wage growth, and inflation. The relationship can be seen in the chart below. (I have included debt, which I will discuss momentarily.)

We can clean up the chart by combining inflation, wages, and economic growth into a single composite for comparison purposes.

As you can see, the level of interest rates is directly tied to the strength of economic growth and inflation. Since wage growth is what allows individuals to consume, which makes up roughly 70% of economic growth, the level of demand for borrowing is directly tied to the demand from consumption. As demand increases, businesses then demand credit for increases in capital expenditures or production. The interest rates of loans are driven by demand from borrowers. Currently, as shown below, the level of demand is consistent with the interest rates currently being charged. (Also: note the sharp drop in activity over the last several months which has been previously consistent with recessionary onsets)

The debt is also an important determinant of the “fair value” of interest rates. In an economy that is dependent on debt for consumption (70% of GDP), if interest rates rise, consumption immediately falls given the inability to afford higher payments. As I noted last week:

“This is why the “gap” between the “standard of living” and real disposable incomes is more clearly shown below. Beginning in 1990, incomes alone were no longer able to meet the standard of living so consumers turned to debt to fill the “gap.” However, following the “financial crisis,” even the combined levels of income and debt no longer fill the gap. Currently, there is almost a $3200 annual deficit that cannot be filled.”

Since “borrowing costs” are directly tied to the underlying economic factors that drive the NEED for credit; interest rates, and therefore bond values can not be overvalued.

Furthermore, since bonds have a finite value at maturity, there is little ability for overvaluation in the “price paid” for a bond as compared to its future “finite value” at maturity.

Still Way To Many Bond Bulls

Another signal that bonds are potentially still “undervalued” can be seen by looking at the Commitment of Traders report to see the net positioning on U.S. Treasuries.

I discussed this previously:

“[June 2019] 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.

However, as shown in the chart below, despite the sharp drop in rates, traders are still betting on a surge in rates and the net-short positioning on the 10-Year Treasury is at the second-highest level on record. Combined with the recent spike in Eurodollar positioning, as noted above, it suggests that there is a high probability that rates will fall further in the months ahead; most likely in concert with the risks of a recession.”

“The chart below looks at net-short positioning ONLY when net-short contracts exceed 100,000. Since peaks in net-short contracts generally coincide with peaks in interest rates, it suggests there is more room for rates to fall currently.”

Despite rates falling to multi-year lows, traders are still at some of the most extreme net-short positioning on rates in history. This net short positioning provides “fuel” for further price increases in bonds, and declines in rates, as traders are ultimately forced to cover their positioning.

Since “over-valuation” is mostly a function of sentiment, given the extreme short-positioning in bonds suggests that bonds are still “under-valued” from an investment perspective. When the short-positioning is reversed, rates are going to quickly approach zero at which point it will be fair to say bonds are “fully valued.” 

All Rates Are Relative

Lastly, rates are ultimately directly impacted by the strength of economic growth and the demand for credit. While short-term dynamics may move rates, ultimately the fundamentals, combined with the demand for safety and liquidity, will be the ultimate arbiter. 

When you have $17 Trillion in negatively yielding sovereign debt, money will flow to the bonds with the highest, and safest, yield. Today, the sovereign debt with the highest yield, and most safety, is the U.S. Treasury.

As money flows into the U.S. Treasuries for safety, security, and return, from both domestic and foreign purchasers, yields are driven lower. (This will be exacerbated by the short-squeeze in bonds as noted above.)

Take Japan, for example. Rates can’t rise in one country, while a majority of global economies are pushing low to negative rates. This is simply a function of monetary flows which will find the highest, safest, and most liquid yield. Therefore, given the global status of the U.S.. Treasury as a “safe haven,” the Treasury is “undervalued” relative to the other relatively stable sovereign bonds which currently all sport substantially lower yields.

Not unlike Japan, the U.S. faces many of the same demographic and economic challenges which suggest that yields are not only “undervalued,” but will approach full valuation during the next recession.

Unfortunately, for the current Administration, the reality is that cutting taxes, tariffs, and sharp increases in debt, is unlikely to change the outcome in the U.S. The reason is simply that monetary interventions, and government spending, don’t create organic, 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.

Conclusion

The problem with the statement that “bonds are in a bubble,” is the assumption 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 are an entirely different matter.

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

Given the current demographic, debt, pension and valuation headwinds, the future rates of growth are going to be low over the next couple of decades. Even the Fed’s own “long run” economic growth rates currently run below 2%.

Bonds are at a minimum “fairly valued,” but most likely “under-valued” based on the factors set out above.

While there is little room left for interest rates to fall in the current environment, there is also not a tremendous amount of room for increases. Therefore, bond investors are going to have to adopt a “trading” strategy in portfolios as rates continue to trade in a flat line over the next decade.

Of course, that line will be closer to zero than not.

Don’t believe me? You don’t have to look much further than Japan for your answer.

Each week we produce a chart book of 10 of the current positions we have in our equity portfolio. Specifically, we are looking at the positions which warrant attention, or are providing an opportunity, or need to be sold.

While the portfolios are designed to have longer-term holding periods, we understand that things do not always go the way we plan. This monitoring process keeps us focused on capital preservation and long-term returns.

HOW TO READ THE CHARTS

There are four primary components to each chart:

• The price chart is contained within the shaded area which represents 2-standard deviations above and below the short-term moving average.  
• The Over Bought/Over Sold indicator is in orange at the top.
• The Support/Resistance line (green) is the longer-term moving average which also acts as a trailing stop in many cases.
• The Buy / Sell is triggered when the green line is above the red line (Buy) or vice-versa (Sell).

When the price of a position is at the top of the deviation range, overbought and on a buy signal it is generally a good time to take profits. When that positioning is reversed it is often a good time to look to add to a winning position or looking for an opportunity to exit a losing position.

With this basic tutorial let’s get to the sector analysis.

The general theme of this week’s portfolio position review is to look at our positions which have been underperforming as of late, and are at risk of violating stop-loss levels. We have taken profits in many of our positions and are now looking to raise a bit more cash to hedge against market volatility and a re-accelerating “trade war.”

AAPL – Apple, Inc.

• AAPL continues to wrestle with its previous breakout of its downtrend. After selling 20% of position previously there is no reason to rush into adding back to the position until the stock makes a decision.
• Currently, on a buy signal, but overbought, we will likely have some resolution to AAPL over the next month as the “trade issues” become more apparent.
• Stop loss for the whole position is set at $195.

ABT – Abbott Laboratories

• ABT has finally take a breather and is consolidating its recent advance.
• On a short-term sell signal we are watching support closely and have moved stops up.
• We have taken profits previously, so we can be patient in adding to our position.
• Stop is moved up to $180.

CHCT – Community HealthCare

• CHCT has been a big winner since we added it to the portfolio to take advantage of falling yields.
• CHCT is very overbought and on a “buy signal” which is beginning to weaken a bit.
• A correction that holds support would finally give us an opportunity to add to our holdings.
• Stop loss is moved up to $37

COST – Costco Wholesale Corp.

• After almost getting stopped out, COST has turned into one of our best performers. The new location in China has to close early due to demand, so we are optimistic about further gains.
• However, we need a pullback to support to work off the extreme overbought condition.
• After taking profits we can give COST a little more room, so a pullback to the $250-260 range would provide a better entry point.
• Stop loss is set at $340

GDX – VanEck Vectors Gold Miners

• Both GDX and IAU look identical.
• A near vertical spike has taken these holdings to extreme overbought and extended conditions.
• We need a decent pullback, or consolidation, to add to holdings at this juncture. A rally in the market should give us that opportunity as it will pull Gold and Rates back to support.
• Looking for an entry point between $26-28 to add to holdings.
• Stop-loss set at $25

JNJ – Johnson and Johnson

• JNJ has been under pressure as of late due to legal woes which will pass sooner than later.
• The stock is on a deeply oversold sell signal, so it will likely take little to get the stock moving higher soon. Fundamentals remain very solid.
• The position continues to hold important support and we will look to add to the position once things become more clear.
• Stop loss is moved up to $122.50

MDLZ – Mondelez International

• MDLZ recently pulled back and consolidated to its very sharp uptrend line.
• However, the stock remains extremely overbought and has triggered a short-term sell signal at a high level.
• After having taken profits, there is little for us to do but wait for this correction to complete and give us an opportunity to add back to our position accordingly.
• Stop-loss is set at $51

PEP – Pepsico, Inc.

• Staples stocks continue to shine in this rally due to the dividend yields and the perceived safety against economic recession. All of these holdings are exceedingly overbought.
• Currently on a sell signal, PEP has broken out to all-time highs which will reverse that signal very shortly. PEP remains extremely overbought.
• We previously took profits in the position, so we are holding our remaining position for now but moving our stop up slightly.
• Stop-loss is set at $122.50

V – Visa Inc.

• Despite concerns over economic woes, spenders keep on swiping their credit cards.
• V is currently close to triggering a sell signal, and is extremely overbought. After having taken profits we will look for a correction to add to our holdings.
• Stop loss is moved up to $160.00

WELL – WellTower, Inc.

• As with CHCT, WELL has performed well since we added it to the portfolio.
• Currently very overbought and on an elevated “Buy” signal we need some corrective action to add to our holdings. Patience will be required at this juncture.
• Stop loss is moved up to $80

On August 27, 2019, Bill Dudley, former Chief Economist for Goldman Sachs and President of the Federal Reserve Bank of New York from 2009-2018, published a stunning editorial in Bloomberg (LINK). After reading the article numerous times, there are a few noteworthy observations worth discussing.

Dudley’s Myopic View

Before we dissect Bill Dudley’s opinions and try to understand his motivations, consider the article’s subtitle- “The central bank should refuse to play along with an economic disaster in the making.”

There is little doubt that Trump’s hard stance on trade and the seemingly impetuous use of tariffs and harsh Twitter commentary presents new challenges for economic growth. Global trade has slowed and manufacturers are retrenching to limit their risks.

Whether the trade war is or will be an “economic disaster” as Dudley says, is up for debate. What is remarkable about this comment is the lack of understanding of the economic instability prior to the trade war and how it got to that point.   

As we have discussed on numerous occasions, the Fed has used excessive monetary policy over the last decade to promote economic growth. Dudley and the Fed fail to recognize that their actions have led to rampant speculation in the financial markets, encouraged significant uses of debt for nonproductive purposes, and have fueled the wealth and income divergences. More concerning, their actions have reduced the natural economic growth rate of the country for years and possibly decades to come. Dudley and colleagues arranged the tinder for what will inevitably be an economic disaster. Trump may or may not be the spark.

Dudley sets up his article with a leading question-“This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?”

He answers, in part, by saying that, based on the Fed’s obligations and “conventional wisdom”, the Fed should respond to economic weakness due to the trade war by “adjusting monetary policy accordingly.” Historically, the Fed has changed policy to counter outside, non-economic factors.

Dudley, however, takes a different tack and asks if easier Fed policy would encourage “the President to escalate the trade war further.” This is where the editorial gets political. He goes on to state his case for the Fed taking a hard line and not adjust monetary policy if the trade war negatively affects economic activity. Dudley believes that by doing nothing, the Fed would:

• Discourage further trade war escalation
• Reinforce the Fed’s independence
• Preserve much needed “ammunition”, as there is little room to cut rates

In the next paragraph, he stresses Trump’s attacks on Chairman Powell and provides more reasoning for the Fed to leave policy alone. Dudley believes the Fed, by not adjusting monetary policy to offset the effects of the trade war in progress, would send a clear signal to the President that he bears the risks of a recession and losing an election. The Fed, thereby, would not be complicit.  

Before going on, we think it’s appropriate to re-emphasize that the next recession will be amplified due to Fed actions over the last ten years. Bernanke should never have extended extraordinary measures beyond the first round of quantitative easing, and Janet Yellen had ample opportunities to raise interest rates and reduce the Fed’s balance sheet during her tenure. Trying to place all of the blame on the current President, or anyone else for that matter, may work in the media and even the populace but it does not line up with the facts.

Dudley’s Summary

Dudley concludes with a stunning and politically motivated statement- “There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”   

Dudley is essentially imploring Powell to base monetary policy on the coming election. If Fed independence is what Dudley cherishes, he certainly did not do the Fed any favors. This implicates elites like Dudley, one of the “Davos Men,” who think they know better than the collective decisions of people engaged in free-market exchanges. It also makes him guilty of an effort to manipulate an election.

Summary

Here is an important question. Is this editorial solely Dudley’s thoughts, or was Jerome Powell and the Fed involved in any way?  The Fed has already come out against the article, but in Washington, nothing is ever that clear cut.

If the editorial was in some way subsidized or suggested by Powell, the implications of the Fed going after the President will call into question their independence in the future. No matter how deeply improper that is, it certainly leaves open the question of whether or not people are justified in those efforts. In the same way that no Fed official should ever be viewed as complicit, no President should impose his will from the bully pulpit of the Presidency to influence monetary policy.

From an investment perspective, this is not good. The markets have benefited from a Fed that has promoted asset price inflation and sought to convince us that the economic cycle is dead. Despite sky-high valuations, investors tend to believe that these valuations are fair and that the Fed will always be there as a reliable safety net.

We do not know how this saga will end, but we do know that if confidence in the Fed is compromised, investors will likely vote with their feet.

Caroline’s Summary

We leave you with some thoughts on the subject from Caroline Baum of MarketWatch:

“It is hard to fathom what Dudley was thinking in advocating such an off-the-wall idea of factoring political outcomes into policy decisions. The Fed has a dual mandate from Congress to promote maximum employment and price stability. There is nothing in that mandate, or in the Federal Reserve Act, about influencing election outcomes. Nothing in there either about being part of “the Resistance” to this president.

That would be a dangerous expansion of Federal Reserve’s operating framework.”

I’m going to start with a story.

There is a drug produced in China that works well on strokes and numerous other less devastating medical issues.

It is derived from pig pancreases or human urine. It isn’t approved in the US due to justifiable regulatory issues, but it is used in Europe as well as China.

A small biotechnological firm in the US has the technology to synthesize this drug without using pancreases or urine. This would be safer and cheaper.

The Chinese company agreed to pay the US company $4.5 million upon the meeting of certain guidelines and then to purchase the drug from the company at a fraction of its Chinese production cost.

The US company spent a great deal of money and met its guidelines, providing the Chinese company with everything required under the contract. The Chinese company then said, basically, “We need to see the actual process and cell lines in order to verify the process.”

That means, in essence, “Give us your intellectual property.” With that knowledge, the Chinese company would no longer have needed the US company.

When the US company had to tell shareholders that the deal fell through because it (correctly) told the Chinese company to go pound sand, its stock value plummeted.

The Chinese company knew that would happen and had bet the Americans would fold. In this case, they didn’t.

This is just a small part of the cost of Chinese intellectual property theft..

China’s Dirty Playbook

Countries that trade with each other need fair and reasonable rules governing it, and both sides must enforce the rules. Trade works only if all sides are committed to making it work

Problems occur when a country flouts the rules or enforces them selectively, as China does. I’ve often talked about China’s rapid entry into the advanced world’s economy.

In less than a few generations, it went from subsistence farming to modern industry. This happened because the US and others agreed to let their domestic businesses trade with China on favorable terms.

China was supposed to reciprocate with similar terms of its own. It pretended to, but hasn’t been thorough or consistent. This is most evident in intellectual property.

The Chinese government often steals trade secrets from foreign businesses that wish to operate in China. Software code, drug formulas, consumer goods… all find their way to Chinese companies that shamelessly copy it.

Sadly, talks to resolve these and other problems have been fruitless.

Trade Deficit… That We Need

Give Trump credit for at least recognizing the problem and trying to do something about it. Unfortunately, he has some odd ideas about what “winning” looks like.

Trump seems to believe trade deficit is some kind of scorecard. If the US buys more from China than China buys from the US, the US is losing.

That is not what it means at all.

Both sides get what they want. China (or other exporters) gets cash, we get useful goods at fair prices (or we would stop buying them).

Better yet, since we own the reserve currency, we get to pay for these goods in dollars, which then return here as the Chinese or foreign recipients invest in US assets, namely our Treasury debt.

That’s good for Americans. In fact, it’s critical.

If not for the trade deficit, US savers would have to cover our entire government debt. And we don’t save nearly enough to do that.

Our interest rates would also be much higher, and our currency much lower.

If you have the reserve currency, it is your obligation to run deficits so that the world has enough currency to conduct trade. No country south of the Rio Grande has that privilege.

The Europeans kind of, sort of do. And the Japanese. The Chinese are working diligently to make the yuan a reserve currency, though they are not there yet.

If the US fails to run a real trade deficit, we will cease to have the reserve currency. It is that simple.

The Wrong Weapon

The US is using the wrong weapon to solve the wrong problem and harming our own economy in the process.

What would work better?

I believe that Trump’s choice to leave the Trans-Pacific Partnership was a mistake.

That agreement would have set up a giant free-trade zone as a counter to China. At a minimum, it would have forced Beijing to negotiate more sincerely.

TPP had more than a few problems, but they could have been fixed. But best case, it would’ve made it much easier for companies in the US to skip over China for their supply chains.

Meanwhile, the other TPP nations went forward without the US and are now trading with each other on more favorable terms.

Thanks to Trump, Japan increasingly imports food products from Canada instead of the US.

Tariffs also don’t do any good in solving the problem. China is not paying those tariffs, we are, and any economist worth their salt (other than Navarro) knows it.

Get tough with China? Damn Skippy. But don’t make Americans pay for it. If you’re going to fight a trade war, then don’t point the gun at yourself.

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The Great Reset: The Collapse of the Biggest Bubble in History

New York Times best seller and renowned financial expert John Mauldin predicts an unprecedented financial crisis that could be triggered in the next five years. Most investors seem completely unaware of the relentless pressure that’s building right now. Learn more here.

At our extensive Retirement Right Lane Classes which fill seats all over Houston, our planning group spend hours with a wide demographic of attendees who give up their Saturdays to tackle head on, the challenging topics that are crucial to financial survival in retirement.

An important goal of the class is to rewire the years of bad advice consumers have been given from an industry which thrives on outdated theories. From “pre-tax investment vehicles are the greatest invention since electricity,” to “you need to take Social Security at 62 because it’s going away,” our planners are proud to address myths and help hundreds of people avoid permanent mistakes, maximize retirement, Medicare benefits and reduce taxes in the creation of lifetime retirement income. I only touch on a few of the topics we address; the class is extensive and lasts over two hours. If attendees gain enough insight to avoid just one mistake, our RIA team has accomplished their mission.

During and after classes, most of the feedback and questions involve Social Security and Medicare. Inaccurate information is pervasive; the sources are varied – Financial professionals, insurance brokers, HR departments, friends and family. Thankfully, we are able to help before actions are taken.

Many brokers would rather avoid a discussion about Medicare. We find that when advice is provided, it’s generally incorrect or based on anecdotal information, not facts.

Here is some of the bad Medicare advice we hear from class participants who spend their Saturday mornings with us:

Don’t worry about signing up for Medicare, you’re covered by an employer’s plan. 

The multiple (initial, general, special) Medicare enrollment periods are confusing enough. Understanding when to sign up for Part B (medically necessary services, preventive services) when covered by an employer plan, adds another element of confusion. So, when a 67 year-old woman explained to me that her insurance agent was adamant that she did not need to enroll for Part B even though she was employed by an organization with less than 20 workers, I knew she was not going to like what I was about to tell her. 

The BENES Act which is designed to simplify the  enrollment process has stalled in Congress. Unfortunately, the responsibility of Medicare enrollment awareness will continue to fall on senior Americans and the professionals they turn to for guidance.  The Medicare Payment Advisory Committee (MedPAC), estimates that 800,000 Medicare recipients were paying Part B permanent late-enrollment penalties as of 2016. I’m certain as of this writing, the number has increased.

Retirement at 65 is an outdated concept. It’s not unusual for older Americans to work longer or return to the workforce at 70 or older. Frankly, I find it delightfully odd when someone looks to retire sooner unless there is a pension available (rare). Perhaps you have a working spouse with employer-covered health insurance who is eligible to cover you as well – or fortunate enough to have healthcare benefits as part of a corporate retirement package. Otherwise, the purchase of healthcare insurance in the open marketplace or ‘bridge coverage’ before Medicare is cost prohibitive. To enroll or not enroll in Medicare at 65 when more older Americans are working means the decision isn’t as easy as it used to be back in the 1960s and 70s.

Per the Bureau of Labor Statistics:

“Since 1996, participation rates have steadily increased among the 65-years-and-older age groups. The participation rate for workers age 65 to 74 is projected to be 30.2 percent in 2026, compared with 17.5 percent in 1996. For workers age 75 and older, the participation rate in 2026 is projected to be 10.8 percent, compared with 4.7 percent in 1996.”

Unless you have access to qualified (under Medicare) healthcare and prescription drug plans, you will need to enroll in Medicare Parts A, B and a Part D prescription drug plan. Envision Medicare as Swiss cheese. Original Medicare coverage has plenty of holes. Additional insurance is required to fill them. At RIA, we suggest Medigap supplemental policies. These plans are offered by private insurance companies and standardized by letter. All plans cover Part A coinsurance.

You also want a plan that covers at least 75% of Part B co-pay which is 20% of the Medicare-approved cost for most doctor-approved expenditures. Coverage for Part B excess charges or those above Medicare-approved charges, should also be mandatory. The most comprehensive plans available this year are F and G. Next year,  per the Medicare Access and CHIP Reauthorization Act of 2015 (MACRA), Medicare supplemental plans that cover the Part B deductible will no longer be offered in 2020.  Plans C and F will no longer be available to Medicare-eligible recipients next year.

If you’ve decided to postpone Social Security benefits to take advantage of the annual 8% delayed retirement credit that accrues after full retirement age up until age 70, you’ll need to proactively sign up for Part A and B coverage during the initial enrollment period which begins the first day of the third month before your 65^th birthday and extends for seven months. Part A or hospital coverage has been paid through payroll taxes. Part B requires ongoing monthly premiums. The standard Part B premium is $135.50 per recipient this year and may be higher depending on income.  Ostensibly, if your modified adjusted gross income is above specific thresholds, you’ll pay the standard premium plus an “Income Related Monthly Adjustment Amount.”

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

At our classes, we hear from attendees who are employed by companies with less than 20 employees and advised by human resources and financial professionals to wait to sign up for Medicare Part B, which is incorrect. We speak with clients and attendees who suffer 10% permanent penalties on Part B premiums due to this bad advice. It’s important to remember; don’t be dissuaded: If your employer does not have 20 or more workers, you will need to sign up for Medicare Part B. In most cases, a non-qualified (for Medicare purposes), employer health plan will serve as secondary coverage to Medicare’s Part A & B primary coverage. If you fail to enroll into Medicare and incur health expenses, your employer healthcare plan won’t cover the bills. They’ll default to Medicare as your primary option. If you don’t sign up for Medicare, expenses won’t be paid which means the costs are ultimately going to come out of your pocket. You don’t want this situation to occur!

It’s fine to continue an employer’s healthcare insurance option if it’s not qualified under Medicare. However, it may not be worth the risk.

For example, let’s say an employee of  a company with less than 20 workers enrolls in Part B. The clock then starts for six-month enrollment into a Medigap policy which you’ll recall, is designed to ‘fill the holes in the Swiss cheese’. Importantly, during that period,  insurers cannot deny coverage due to pre-existing conditions. The employee decides to stick with his employer’s coverage instead of obtaining a Medigap policy. The six-month window passes. Medicare becomes the primary healthcare coverage; the employer’s plan, secondary.  In month eight, our employee decides to retire. The former employee is indeed covered by Medicare Parts A & B. However, he no longer has supplemental or secondary insurance for services Medicare doesn’t cover. Unfortunately, during the same month, our new retiree is diagnosed with a life-threatening illness. He attempts to sign up for Medigap during the next enrollment period;  unfortunately he’s denied due to illness, a pre-existing condition. Our retiree is now responsible for out-of-pocket additional costs that Medicare Parts A & B do not cover.

The retiree can certainly look to switch from Original Medicare into an all-inclusive Medicare Advantage Plan during Fall Open Enrollment which runs from October 7th – December 15. Medicare Advantage Plans do not come with pre-existing restrictions. However, the sad stories about these plans and what they won’t cover appear regularly through reliable sources such as medicarerights.org. The retiree will likely suffer gaps in medical coverage depending on the time between when treatment started and the selected Medicare Advantage Plan becomes officially active.  Also, since many Medicare Advantage providers operate as HMOs, it’s highly common for current doctors or treatment options to change or not be accepted by the new plan,  thus creating undue stress at the worst possible time.

Don’t worry about signing up for Medicare, you’re covered by COBRA.

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

It’s of utmost importance to partner with a knowledgeable professional before you navigate the coordination of employer healthcare coverage with proper Medicare enrollment. Employees of small companies and former employees who plan to utilize COBRA can suffer additional confusion.

What you don’t know or fail to anticipate can cost you, dearly.

Have Medicare-related questions? Reach out to our team at RIA.

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Next up in the blog series:

4). The common Social Security mishaps we encounter at our Right Lane Retirement Classes.

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

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

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

GTA Users Guide

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In addition to the normal format in which we review last month’s commentary and present new analysis for the month ahead, we provide you with interesting research on long-term market cycles.

A Review of August

Silver Futures

We begin with a review of Silver Futures (SIU9/SIZ9) during August 2019. In our August 2019 edition of The Cartography Corner, we wrote the following:

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

• M4         18.805
• M1         17.745
• M3           17.469
• PMH       16.685
• Close        16.405
• M2           15.265
• MTrend   15.263             
• PML          14.915                        
• M5            14.205

Active traders can use 16.685 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 1 below displays the daily price action for August 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first five trading sessions were spent with silver ascending to and settling above, our isolated pivot level at PMH: 16.685.  Silver’s rally, which began in June, extended significantly in August. 

The following twelve trading sessions were spent with silver consolidating with an upward bias, testing our clustered resistance levels at M3: 17.469 and M1: 17.745.  On August 26^th, silver settled above M1: 17.745 and proceeded over the following three trading sessions to test our Monthly Upside Exhaustion level at M4: 18.805.   The high price for August 2019 was achieved on August 29th at 18.760, a difference from M4 of 0.24%.

 Active traders following our analysis had the opportunity to capture a 12.4% profit.

 

Figure 1:

E-Mini S&P 500 Futures

We continue with a review of E-Mini S&P 500 Futures during August 2019.  In our August 2019 edition of The Cartography Corner, we wrote the following:

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

• M4                3330.25
• M2                3182.25
• M1                3089.75
• PMH              3029.50
• M3               3020.25      
• Close             2982.25
• PML               2955.50     
• M5                 2941.75    
• MTrend         2897.03

Active traders can use 3029.50 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Figure 2 below displays the daily price action for August 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first four trading sessions of August saw the market price collapse 206.50 points from July’s settlement price.  The descent accelerated once our isolated support levels at PML: 2955.50 and M5: 2941.75 were breached.  When August Monthly Trend at MTrend: 2897.03 was breached, the descent accelerated again.      

The remaining trading sessions of August 2019 were spent with the market price oscillating between 2817.00 (roughly) and our isolated support level at M5: 2941.75, now acting as resistance.  As can be seen in Figure 2, there were essentially five swing trades during the remainder of August, three up and two down.  Each swing covered approximately 125 points.

The war between bulls and bears continues with the battles becoming fiercer.

Figure 2:

September 2019 Analysis

We begin by providing a monthly time-period analysis of E-Mini S&P 500 Futures (ESU9).  The same analysis can be completed for any time-period or in aggregate.

Trends:

• Monthly Trend        2924.92       
• Current Settle         2924.75
• Daily Trend             2905.47       
• Weekly Trend         2884.92       
• Quarterly Trend      2727.50

In the quarterly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”.  Stepping down one time-period, the monthly chart shows that E-Mini S&P 500 Futures have been “Trend Up” for three months.  Stepping down to the weekly time-period, the chart shows that E-Mini S&P 500 Futures are in “Consolidation”.

We commented in August:

“We would like to point out the slope of the Weekly Trend has been forming a rounded top over the previous three weeks.  Weekly Trend is currently developing at 2996.58 for the week of August 5, 2019.  If that developing level holds (or develops lower), the topping process will be complete (in the weekly time-period) as 2996.58 is lower than this week’s Weekly Trend level of 2999.83.  Also, a weekly settlement this week below 2999.83 will end the current eight-week uptrend.”

The formation of the rounded top in the Weekly Trend was an excellent indicator of the directional turn in the short time period. 

Support/Resistance:

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

• M4                 3073.00
• PMH              3014.25
• M1                 2999.00
• MTrend        2924.92
• Close            2924.75      
• M3                 2867.25
• PML               2775.75     
• M2                 2596.00    
• M5                2522.00

Active traders can use 2924.92 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

U.S. Treasury Bond Futures

For the month of September, we focus on U.S. Treasury Bond Futures (“bonds”).  We provide a monthly time-period analysis of USZ9.  The same analysis can be completed for any time-period or in aggregate.

Trends:

• Daily Trend            165-20          
• Current Settle        165-08
• Weekly Trend        164-22          
• Monthly Trend       157-17          
• Quarterly Trend     147-27

As can be seen in the quarterly chart below, bonds have been “Trend Up” for three quarters.  Stepping down one time-period, the monthly chart also shows that bonds have been “Trend Up” for nine months.  Stepping down to the weekly time-period, the chart shows that bonds have been “Trend Up” for five weeks.

The condition was met in August 2019 that makes us anticipate a two-month low within the next four to six months.  That would be fulfilled with a trade below 152-28 in September 2019.  This is the second “signal” that has been given since this nine-month uptrend began.  The first was given in December 2018 and the two-month low was realized three months later.  In the week of July 29^th, the condition was met that made us anticipate a two-week low within the next four to six weeks from that week.  The market is entering the fifth week of that time window and a two-week low can be realized this week with a trade below 162-06.

Like the rounded top highlighted in E-Mini S&P 500 futures in the August 2019 edition of The Cartography Corner, the Weekly Trend in bonds is beginning to take on the same curvature.  Short-time-period-focused market participants. . . Caveat Emptor.

 

Support/Resistance:

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

• M4         181-00
• M1         176-26
• M3         174-29
• PMH       166-30
• Close        165-08
• MTrend    157-17
• M2         157-02             
• PML        154-31                          
• M5            152-28

Active traders can use 166-30 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

 

Equity Cycle, 1799 – 2061

What if the basis of causation in human affairs, economics, and markets is embedded in the law of vibration of nature?  Sound, light, and heat are all forms of vibration.  Sound is energy vibrating at a frequency that the ear can perceive.  Light is energy vibrating at a frequency that the eye can perceive.  Heat is energy that vibrates at a frequency that our internal thermometers can perceive.  Radiation that penetrates the Earth’s atmosphere causes proven psychological changes in people.

My dog barking at 2:30 each afternoon does not cause the mailman to deliver the mail to my house.  However, when my dog barks at 2:30 each afternoon, I can reliably trust that the mail is being delivered.  Similarly, it is not necessary for the market participant to answer in-depth questions of how or why, with regards to causation.  It is only necessary to answer the question of correlation and, if a correlation exists, what are the results?  Market participants of old, including W.D. Gann, Louise McWhirter, Donald Bradley, and others, not only recognized but successfully utilized the law of vibration across many individual markets.

We spent significant time collecting, organizing, and processing planetary data in the identification and construction of the composite equity cycle graphed on the following three pages.  The composite equity cycle is comprised of six individual cycles, each with a different phase, amplitude, and length.  The average cycle length is 13.5 years.

Our data series of the nominal equity index level spans 220 years, with a low value of 2.85 and high value of 26,864.27.  We faced the challenge of how to graphically present this data series in the most aesthetic manner.  We started by graphing lognormal values, but the result did not “tell the story” in a legible way.  We finally were enlightened (thank you, Jack) to present a rolling return.  The benefit of using a rolling return is that the range of values is relatively narrow and presents itself well graphically.  We set the length of the rolling return equal to the average cycle length.

The first graph displays the cycle over the entire time period, 1799 – 2061.

The second graph highlights the peaks in the cycle and how well they line up with peaks in the rolling 13.5Y annualized return in the Dow Jones Industrial Average.  The dashed lines represent anticipated future peaks.

The third graph highlights the troughs in the cycle and how well they line up with troughs in the rolling 13.5Y annualized return in the Dow Jones Industrial Average.  The dashed lines represent anticipated future troughs.

Compelling.

CLICK TO ENLARGE

Summary

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

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

HOW TO READ THE CHARTS

There are three primary components to each chart:

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

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

With this basic tutorial let’s get to the sector analysis.

Basic Materials

• XLB remains confined to a very broad topping pattern currently BUT it continues to hold onto support at the 200-dma as rumors of a “trade deal” seem to always come just in the “nick of time.”
• With the buy signal fading the risk remains to the downside for now particularly as trade wars continue to linger on and tariffs were hiked over the weekend.
• XLB is oversold short-term which could provide a bounce. That bounce should be used to sell/reduce holdings as needed.
• We are remaining underweight the sector for now, but are close to being stopped-out at current levels.
• Short-Term Positioning: Neutral
  • Last Week: Hold current positions with a tighter stop-loss.
  • This Week: Hold current positions with tighter stop-loss
  • Stop-loss adjusted to $55
• Long-Term Positioning: Bearish

Communications

• XLC held support last week and did bounce back. A further rally is possible if the market trades up this week but risk is currently to the downside.
• Support is holding so far at $48.
• XLC has a touch of defensive positioning from “trade wars” and given the recent pullback to oversold a trading position was placed in portfolios.
• Short-Term Positioning: Neutral
  • Last Week: Hold trading positions
  • This Week: Hold trading positions.
  • Stop adjusted to $46
• Long-Term Positioning: Bearish

Energy

• XLE continues to struggle with supply builds and a weakening economy.
• The sector is pretty oversold and the “sell signal” is getting extended. So there is a decent probability for a retracement.
• Any rallies should be used as clearing rallies for now to reduce weightings to the sector until the technical backdrop improves.
• We were stopped out of our position recently.
• Short-Term Positioning: Bearish
  • Last week: Hold current position
  • This week: Stopped out.
  • No position currently
• Long-Term Positioning: Bearish

Financials

• XLF has been in a long consolidation rage since the beginning of 2018.
• XLF has triggered a “sell” signal and has gotten oversold.
• We closed out of positioning previously as inverted yield curves and Fed rate cuts are not good for bank profitability. Use rallies to reduce holdings accordingly.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position
  • This week: Closed Out/No Position.
  • Stop-loss adjusted to $26.00
• Long-Term Positioning: Bearish

Industrials

• XLI bounced back last week on hopes of a trade war “cease fire” which failed to come to fruition over the weekend.
• XLI is back to oversold and the buy signal has reversed to a sell signal.
• We reduced our risk to the sector after reaching our investment target. We are now adjusting our stop-loss for the remaining position. We will look to sell on this rally.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position.
  • Stop-loss adjusted to $72
• Long-Term Positioning: Neutral

Technology

• XLK remains one of the “safety” trades against the “trade war.”
• While XLK is not overbought,it is still fairly extended and a crowded trade.
• XLK failed at the uptrend line so it must hold support at $75. It is currently in a very tight consolidation. A break to the downside will be bearish.
• The buy signal is close to reversing to a “sell.”
• Short-Term Positioning: Bullish
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss adjusted to $75.00
• Long-Term Positioning: Neutral

Staples

• Defensive positioning is now a VERY crowded trade. I don’t know when a rotation is going to occur, but there is little safety anywhere in the market currently.
• The “buy” signal (lower panel) is still in place and is very extended. We continue to recommend taking some profits if you have not done so.
• Short-Term Positioning: Bullish
  • Last week: Hold positions, take profits if needed.
  • This week: Hold positions, take profits if needed.
  • Stop-loss adjusted to $57
• Long-Term Positioning: Bullish

Real Estate

• As with XLP above, XLRE was consolidating its advance and has now pushed to new highs.
• XLRE is also a VERY CROWDED defensive trade.
• XLRE is back to very overbought so be careful adding new positions and keep a tight stop for now.
• We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected. That occurred.
• Buy signal is being reduced along, but is holding for now.
• Short-Term Positioning: Bullish
  • Last week: Hold position.
  • This week: Hold position.
  • Stop-loss adjusted to $36.00 for profits.
• Long-Term Positioning: Bullish

Utilities

• XLU is also a very overcrowded defensive trade.
• After taking profits, we have time to be patient and wait for the right setup.
• Long-term trend line remains intact and the recent test of that trend line with a break to new highs confirms the continuation of the bullish trend.
• Short-Term Positioning: Bullish
  • Last week: Take profits and rebalance holdings.
  • This week: Hold position
  • Stop-loss adjusted to support at $58.00
• Long-Term Positioning: Bullish

Health Care

• XLV has triggered a sell signal and will likely threaten our stop-loss.
• While the current correction was expected, support is looks to failing.
• We will honor of stop-loss.
• Short-Term Positioning: Neutral
  • Last week: Reduce to portfolio weight
  • This week: Hold position
  • Stop-loss adjusted to $88
• Long-Term Positioning: Neutral

Discretionary

• With the latest round of “tariffs” directly targeting consumer goods, XLY is under a threat. While it rallied last week on hopes of a “cease fire” that failed to occur. Look for pressure this week.
• We recommended taking profits previously. But XLY has now triggered a “sell signal.” If current support at $115 is violated we will consider selling out the rest of the position to avoid downside risk.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position.
  • This week: Hold 1/2 position
  • Stop-loss adjusted to $107.50 after sell of 1/2 position.
• Long-Term Positioning: Neutral

Transportation

• XTN has continued to lag the overall market and continues to suggest there is “something wrong” economically.
• XTN has triggered a “sell” signal but remains confined to a consolidation which has lasted all year. The continued topping process continues to apply downward pressure on the sector.
• There is still no compelling reason at this juncture to add XTN to portfolios. We will watch and see what happens.
• Short-Term Positioning: Neutral
  • Last week: No position
  • This week: No position
• Long-Term Positioning: Bearish

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

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Market Review & Update

Really! Another week of nowhere? 

This is the same chart from last week, updated, but here is the salient point.

“This has been an impossible market to effectively trade as rhetoric between the White House, the Fed, and China has reached a fevered pitch.”

Don’t fall into the trap.

On Thursday, the market rallied as China said they were not going to retaliate against the U.S. on trade immediately. They also stated they wanted to take a “calm” approach to the discussions. 

The media, and Wall Street, heard:  “Trade Deal.” 

That is NOT the case by any stretch of the imagination.

As we wrote previously:

China is playing a very long game. The pressure is on the Trump Administration to conclude a ‘deal,’ not on China. Trump needs a deal done before the 2020 election cycle, AND he needs the markets and economy to be strong. If the markets and economy weaken because of tariffs, which are a tax on domestic consumers and corporate profits, as they did in 2018, the risk-off electoral losses rise. China knows this and is willing to ‘wait it out’ to get a better deal. China is not going to jeopardize its 50 to 100-year economic growth plan on a current President who will be out of office within the next 5-years at most.”

What China has figured out is they can easily manipulate Trump into giving up strategic positioning by offering to “talk.” This continues to be an effective strategy since they know Trump’s re-election is contingent upon a strong U.S. economy, and stock market. By slow-rolling progress, and agreeing to “talk,” Trump has given up ground to support U.S. corporations. At the G-20 he agreed to allow companies to sell products to Huawei. Then, he delayed tariffs until December on major consumer goods, which would have negatively impacted U.S. corporations Christmas selling season. 

In exchange, China has done….nothing. 

This is the same trap I warned Trump would fall into with North Korea over nuclear weapons. To wit:

“As a dictator, he [Kim Jung Un] can not afford to show weakness. Therefore, he needs the U.S. to acquiesce to some degree to allow him to claim victory over the ‘evil empire’ of the west. By continuing to bring Trump to the table to ‘talk,’ he doesn’t give up anything. However, the ‘talks’ continue to buy time to continue his missile development.” 

Today, there is “no deal” with either North Korea or China. 

In the coming weeks, China will once again come to the table, they will make concessions, which will temporarily excite the markets, and then they will default on those agreements. Trump will get mad, he will slap more tariffs on China, and the entire cycle will begin again. 

The risk, however, with tariffs already engaged, is whether economic growth falters before the upcoming election. An economic downturn prior to the 2020 election is the greatest threat to Trump’s re-election. This is precisely what China is trying to achieve which would give them tremendous bargaining power over Trump.

One thing is certain, there will be much more volatility between now, and the end of the year. 

From a short-term market perspective, the risk is to the downside next week:

1. Historically, September is one of the weakest months of the year, particularly when it follows a weak August.
2. The market remains range bound and failed at both the 50-dma and downtrend line on Friday
3. The oversold condition has now reversed. (Top panel)
4. Volatility is continuing to remain elevated.
5. Important downside support moves up to 2875
6. The bulls regain control of the narrative on a breakout above 2945. 

It is from this perspective that we continue to hold an overweight position in cash (see 8-Reasons), have taken steps to improve the credit-quality in our bond portfolios, and shifted our equity portfolios to more defensive positioning. 

For now, the reduced volatility, and hedges, continue to allow us to navigate market uncertainty until a better risk/reward opportunity presents itself. 

The email is a great example of the “quandary” facing investors currently. On the one hand, there is troubling economic data and “trade wars,” which provide a logical concern for investors with capital at risk. But, on the other hand, the “algo’s” which make up roughly 80% of the trading in the markets are knee-jerking every “trade,” or “Fed,” related headline keeping asset prices elevated near all-time highs.

What do you do?

The answer is “nothing.” 

As we noted previously, sometimes, when the path forward is unclear, and volatility is high, the best thing to do is to “sit on your hands” and wait for the market to “tell” you what to do next. Over the last few weeks, being “long” equities has been frustrating. However, being “short” has been equally discouraging.

The email hits on a few of the “myths” which prevail in the markets currently. These are fairly important concepts to understand, so let’s break them down individually. 

1) Sentiment Is Hardly Bearish

Currently, individuals could not be more confident about the markets or the economy. As shown in the chart below both investor confidence about the economy, and expected returns from stocks over the next 12-months, are near record highs, not lows.

Moreover, as I noted just recently in “When A Bond Bull Becomes A Raving Stock Bull,” the retail investor is just about as long-biased as they can get. 

While it may “seem” like everyone is “bearish,” it isn’t the case. Part of this has to do with the “training,” investors have received over the last decade.

While some sentiment indicators clearly show a surge in bearish sentiment, which normally denotes a substantial level of fear by investors, there has been no substantial change to actual allocations.

While stock allocations have fallen modestly, cash and bond allocations have barely budged. This is a far different story than was seen during previous major and intermediate-term corrections in the market.

This suggests that while investors are worried about the markets and their investments, they are too afraid to actually make changes to their portfolio as long as Central Banks continue to support the markets.

“Are you afraid of a market crash? Yes.

Are you doing anything about it? No.” 

This “fear” to do something, leaves lots of room for “panic” when something eventually breaks.

2) Record Outflows?

There has been lot’s of discussions about the record outflows from equities. That really isn’t the case as shown by the most recent fund flows analysis. 

“Long-term fund flows enjoyed a solid second quarter and a robust first half of 2019. Long-term fund flows—open-end and exchange-traded funds—collected nearly $93 billion in the second quarter, a slight decrease from the first quarter’s $136 billion. In total, long-term fund flows collected $224 billion in the first half of the year, slightly ahead of 2018’s $219 billion.”

Of course, the crowding into ETF’s is a whole other “time bomb” waiting for unwitting investors.

To wit:

“With more ETF’s than individual stocks, and the number of outstanding shares traded being reduced by share buybacks, the risk of a sharp and disorderly reversal remains due to compressed credit and liquidity risk premia. As a result, market participants need to be mindful of the risks of diminished market liquidity, asset price discontinuities and contagion across asset markets.

Secondly, individual investors are NOT passive even though they are investing in “passive” vehicles. Today, more than ever, advisors are actively migrating portfolio management to the use of ETF’s for either some, if not all, of the asset allocation equation. However, they are NOT doing it ‘passively.’

Just because individuals are choosing to “buy baskets” of stocks, rather than individual securities, it is not a ‘passive’ choice but rather ‘active management’ in a different form.  

While the idea of passive indexing works while all prices are rising, the reverse is also true. The problem is that once prices begin to fall the previously ‘passive indexers’ will become ‘active panic sellers.’ The tables are once again set for a dramatic and damaging ending.”

Furthermore, it is hard to suggest there are record outflows when the market is extremely overbought. As Ned Davis noted: 

3) The Myth Of Cash On The Sidelines

Despite 8-years of a bull market advance, one of the prevailing myths that seeming will not die is that of “cash on the sidelines.” To wit:

“Underpinning gains in both stocks and bonds is $5 trillion of capital that is sitting on the sidelines and serving as a reservoir for buying on weakness. This excess cash acts as a backstop for financial assets, both bonds and equities, because any correction is quickly reversed by investors deploying their excess cash to buy the dip,” Nikolaos Panigirtzoglou, the managing director of global market strategy at JPMorgan, wrote in a client note.

Stop it.  

This is the age-old excuse why the current “bull market” rally is set to continue into the indefinite future. The ongoing belief is that at any moment investors are suddenly going to empty bank accounts and pour it into the markets. However, the reality is if they haven’t done it by now after 3-consecutive rounds of Q.E. in the U.S., a 300% advance in the markets, and ongoing global Q.E., exactly what will that catalyst be?

Clifford Asness previously touched on this issue as well.

“There are no sidelines. Those saying this seem to envision a seller of stocks moving her money to cash and awaiting a chance to return. But they always ignore that this seller sold to somebody, who presumably moved a precisely equal amount of cash off the sidelines.”

Every transaction in the market requires both a buyer and a seller with the only differentiating factor being at what PRICE the transaction occurs. Since this is required for there to be equilibrium in the markets, there can be no “sidelines.” 

Furthermore, despite this very salient point, a look at the stock-to-cash ratios also suggest there is very little available buying power for investors current.

The reality is that investors remain more invested in riskier assets than has historically been the case. And, as Ned Davis noted:

“Cash is low, meaning households are fairly fully invested.” 

Not A Bull In Sight

Lastly, our emailer suggests he can’t find a bull anywhere. It is only because he isn’t looking in the right places.

“Our full year GDP is on pace for 2.6%, which is stronger than the average annual GDP of this entire 10½ year expansion. Unemployment is near record lows. Consumer confidence is near record highs. And corporate earnings continue to impress.

None of that says recession.

But let me just play along for a moment and pretend that the inverted yield curve actually meant something this time around – the fact of the matter is that the economy often expands after an inversion, and the stock market goes up on average of double-digits afterwards.

If anything, the inverted yield curve is one of the best buy signals of all time.”– Kevin Matras, Zacks Research

Or, this:

“Despite recent recession fears and yield curve inversions, the bull market should live on until early 2021, analyst Tom McClellan said Thursday on CNBC’s ‘Closing Bell. ‘ Everyone needs to just keep their pants on for now and realize that the yield curve gives a really long early warning about trouble. It doesn’t say that trouble is upon us now. It takes several months to over a year before we get the final price high after a yield curve inversion. If you get an instance like 1995, there was a very momentary yield curve inversion and then it backed off and the bull market kept on going. So that is possible.” – CNBC

You can’t get much more bullish than that.

However, as I wrote previously in “The Yield Curve Is Sending A Message:” 

“While everybody is ‘freaking out’ over the ‘inversion,’ it is when the yield-curve ‘un-inverts’ that is the most important.

The chart below, shows that when the Fed is aggressively cutting rates, the yield curve un-inverts as the short-end of the curve falls faster than the long-end. (This is because money is leaving ‘risk’ to seek the absolute ‘safety’ of money markets, i.e. ‘market crash.’)”

“As noted above, the current economic data is only a ‘guess’ about the current economy. In the next 12-months, we will see the ‘revised’ data, but the yield curve is already telling you it will be weaker.

Just as in December 2007, there was ‘no recession.’ It wasn’t until December 2008, when the data was revised, that the National Bureau of Economic Research (NBER) announced the recession had begun a full year earlier. In December 2007.” 

Lastly, this isn’t 1995. 

The Fed did cut rates in 1995 to fend off risks from the Orange County Bankruptcy, but the yield curve was nowhere near inversion. When The Fed begin seriously cutting rates, in 1999, as the yield curve inverted, well, I don’t need to remind you what happened next.

The Fed is cutting rates with the “yield curve” inverted. 

I wouldn’t dismiss that too quickly.

Kevin Matras is correct. The stock market DOES indeed go up double digits following a yield curve inversion. The only issue is that it is the first step in recovering from the bear market that preceded it.

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

See you next week, and have a great Labor Day.

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Market & Sector Analysis

Data Analysis Of The Market & Sectors For Traders

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S&P 500 Tear Sheet  

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Performance Analysis

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Improving – Healthcare (XLV)

The relative performance improvement of HealthCare relative to the S&P 500 is now fading and is close to turning negative. However, the sector is holding support and remaining above stop-loss levels. The pickup in volatility in the market has hit all sectors, so after taking profits in the sector previously we will continue to hold our current positioning for now.

Current Positions: Target weight XLV

Outperforming – Staples (XLP), Utilities (XLU), Materials (XLB), Communications (XLC)

Our more defensive positioning continues to outperform relative to the broader market. Volatility has risen markedly which makes markets tough to navigate for now. However, after taking some profits and repositioning the portfolio we will remain patient and wait for the market to tell us what it wants to do next.

Current Positions: Overweight XLP, Target weight XLU, 1/2 XLB and XLC

Weakening – Technology (XLK), Discretionary (XLY), Real Estate (XLRE)

While Technology, and Discretionary did turn higher, the performance is dragging slightly on a relative basis. However, the sectors are very close to beginning to outperform once again, so we will maintain our positioning for now. 

Current Position: 1/2 weight XLY, Target weight XLK, XLRE

Lagging – Energy (XLE), Industrials (XLI), Financials (XLF)

We were stopped out of XLE previously, but are maintaining our “underweight” holdings in XLI for now. We are close to getting stopped out on this position as well. We also closed out our holdings in Financials last week as both the Fed lowering rates, and an inverted yield curve, are not beneficial their profits.

Current Position: 1/2 weight XLI

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