In Beware of the Walking Dead, we revealed an analysis illustrating those companies in the S&P 1500 that qualify as zombie corporations. As promised in the article, we are providing a full list of those companies here for RIA Pro members.

According to James Grant of Grant’s Interest Rate Observer, zombie companies fail to generate enough operating income to cover the interest on their outstanding debt. The screen we used evaluates companies based on their three-year average for that metric. Those companies highlighted in yellow in Table 1 are the worst offenders with three consecutive years of a negative zombie metric. The remaining zombie companies are in Table 2.

The list of stocks that qualify as zombies under this definition is based on Bloomberg data through Q1 2019, revealing a total of 128 companies or 9% of the S&P 1500. The listing below also includes the three-year annualized total rate of return on those stocks as well as S&P rating and rating outlook when available.

I recently had the privilege to visit with Raoul Pal, the founder of Real Vision, to discuss a variety of topics including:

• The risk of recession in the U.S.
• What Trump’s nomination of Judy Shelton to the Fed means.
• Can you have a gold standard AND zero interest rates.
• The future of the ECB and monetary policy in Europe
• The real value of gold.

After we stopped rolling tape on the interview Raoul and I kept going and discussed Facebook’s Libra, cypto currency, and how much you should own. The cameras kept rolling so we have a great bonus clip for you.

Check out the new FREE version of Real Vision at www.realvision.com/free

I hope you enjoy our interview with Raoul Pal.

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RECESSION: Can The U.S. Have A Recession Without GDP Showing It?

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The Future Of The Fed, Monetary Policy, Rates, Judy Shelton, IMF, and the ECB

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The True Value Of Gold

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BONUS TRACK: Crypto Currency, Facebook’s LIBRA, & How Much You Should Own.

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In a previous article, The Fed’s Body Count, we stated:

“Markets and economies, like nature itself, are beholden to a cycle, and part of the cycle involves a cleansing that allows for healthy growth in the future. Does it really make sense to prop up dead “trees” in the economy rather than allow them to fall and be used as a resource making way for new growth?”

We come back to that thought in this article inspired by the notion that investors find themselves in a forest increasingly littered with dead trees. In today’s market parlance, the dead trees (corporations) are called zombies.  This article details the corporate zombie concept in-depth and provides a few examples to illustrate the topic.

The Walking Dead

It is no small irony that one year after the end of the great recession, a television show about the zombie apocalypse quickly became one of the most successful shows on TV. The Walking Dead features a large cast of “survivor” characters under near-constant threat of attack from mindless zombies, or “walkers” as they are called.

In the investment world, the term zombie has a special connotation generally referring to a company that might otherwise not be around had the Federal Reserve not suppressed interest rates for so long. The zombie label is fitting as these companies do not die as they should and at the same time, they devour capital and resources that could otherwise be used by healthy companies. They are a drain on the economy.

Although not a matter of life and death, investing in zombie companies or failing to understand the implications of their existence poses a unique risk to one’s economic well-being.

Zombies Defined

The generic description used for zombified companies is too obtuse to use to precisely identify such companies. If the suppression of interest rates served a key role in maintaining these firms, what would be the circumstances fundamental to that condition?

Corporate zombies are generally described as companies that cannot function without bailouts and/or those firms that can only afford to service the interest on their debt while deferring repayment of principal indefinitely. In our view, those definitions do not go far enough.

In a recent interview, James Grant of Grant’s Interest Rate Observer offered what seems to be the most precise definition – zombie companies fail to generate enough operating income to cover the interest on their outstanding debt. Furthermore, that condition would have to persist for more than one year to eliminate any anomalous results.

In other words, a corporation that fails to cover its interest expense can, for a time, keep borrowing to make up the shortfall, especially if money is cheap. On the other hand, true zombie status is revealed, and the “headshot” of demise ultimately comes, when the company runs out of borrowing runway. That circumstance can unfold rather quickly in an economic downturn or a period of rising interest rates when the negative differential between operating income and interest expense widens further.

Operating Income is defined as gross revenue minus wages, cost of goods sold, and selling, general and administrative expenses (SG&A). Operating income does not include items such as investments in other companies, taxes, or interest expense. Isolating the difference between operating income and interest expense is a way of comparing the revenue that a company expects to become profit versus the cost incurred for borrowed funds. It is a variation of a leverage ratio.

Zombie Hunt

We analyzed the broad S&P 1500 to identify companies having zombie characteristics under Grant’s definition. Namely, does their interest expense exceed their operating income and has it done so when averaged over the last three years?

The list of stocks that qualify as zombies under this definition using Bloomberg data through Q1 2019 reveals 204 companies or 13.5% of the S&P 1500. Some of these companies do not show any interest expense but have operating income losses, so we removed those companies. That leaves 128 companies or 9% of the members of the index. Using a stricter methodology of requiring three consecutive years of interest expense exceeding operating income returns 43 companies that meet the criteria or roughly 3% of the index. These 43 companies are the worst in class of the zombie population.

While defining and identifying the zombies is a good start, what we care about is a divergence between fundamentals and valuations. In other words, we want to truly protect ourselves from the zombies who appear alive due solely to a well-performing share price. In doing this, we find that 34% of the 128 companies have positive 3-year annualized total returns. Of these firms, the average 3-year annualized return of that population through June 30, 2019, is 13.6%. There are also another 11 companies that have been relatively stable as defined by annualized total returns of zero to -5%.

Such returns do not reflect the underlying fundamentals of companies that cannot service their debt and are a recession away from going bankrupt. The graph below charts operating income less interest expense with the three-year total returns for the 128 zombie companies.

Data Courtesy Bloomberg

For the 128 companies represented in the graph, they either have weak revenue generation and/or onerous debt levels. That, however, raises another issue for consideration – just how bad is the situation if the company cannot cover the interest expense on their debt due to weak demand for their products and/or services? Equally concerning, what if there is so much debt that even solid demand for their products and accompanying revenues do not cover that expense?

Deeper Dive

Awareness of this issue and quantifying it is useful and important to help us understand the kinds of imbalances that exist in the economy. At the same time, while most zombie companies would not exist were it not for years of suppressed interest rates, those that do should be priced for the uncertainty of an economic downturn and the higher probability of their demise in that event. As mentioned, many are not. Out of the 128 companies whose operating income cannot cover interest expense, many are priced at valuations that imply they are a normal going concern.

To gain a better perspective of zombies, we selected three individual candidates to explore in-depth. As discussed, the market is crawling with these companies that bear very similar characteristics. A table of the relevant fundamental statistics for each company is shown below each summary.

RIA Pro subscribers are being provided a complete list of zombie companies beyond the three detailed below.

Rent-A-Center, Inc. (RCII)

RCII, a BB-rated company with a stable outlook, operates and franchises rent-to-own merchandise stores offering electronics, appliances, and furniture under “flexible rental purchase agreements” (lucrative financing plans). Based in Plano, Texas, they have 14,000 employees and a market capitalization of $1.3 billion. RCII stock has a three-year annualized return of 30.7% and three-year average EBITDA (earnings before interest taxes depreciation and amortization) through the end of 2018 of $51.2 million. Meanwhile, three-year average net income and free cash flow are negative $30.0 million and negative $106.2 million respectively.

Their zombie metric of operating income less interest expense was positive $18.3 million in 2018, but the three-year average is negative $69.9 million. Additionally, revenue for 2018 was the lowest since 2006 at $2.66 billion and total debt for the company increased by 52% (from $540 million to $825 million) in the first quarter of this year alone. It is hard to imagine the consumer showing enough strength to bail out the circumstances facing RCII. However, apart from us, most analysts are constructive in their outlook.

Scientific Games Corp. (SGMS)

Based in Las Vegas, Nevada, SGMS is a single-B-rated company with a stable outlook that provides gambling products and services under four operating divisions of gaming, lottery, digital, and social. The company has 9,700 employees and a market cap of $1.7 billion. Despite a significant correction since June 2018, SGMS stock has a stellar three-year annualized return of 29.2%. Given their negative earnings per share, the current price-to-earnings (PE) multiple cannot be calculated, but the expected PE for the end of the year based on earnings projections is 1,693. The company generated over $3.3 billion in revenue in 2018 but had net income of negative $352 million. The company sports a net debt obligation (net of cash) of $8.8 billion at the end of 2018.

Their zombie metric is -$332 million and has been negative every year since 2008. Despite their fundamentals, through June 30, 2018, SGMS produced a 47% 3-year annualized return showing the power and irrationality of momentum investing. The enthusiasm for SGMS revolves around the legalization and commercialization of nation-wide sports betting. Over the last ten years, insider selling dominated executive transaction flows. Our guess is they will wish they had sold even more.

The Williams Companies (WMB)

WMB, based in Tulsa, Oklahoma, is an energy infrastructure company focused on connecting North America’s hydrocarbon resources to markets for natural gas. The company owns and operates midstream gathering and processing assets, and interstate natural gas pipelines. It has 5,300 employees and a market cap of $33 billion. WMB is rated BBB by Standard & Poors with a negative outlook. Through the end of June 2019, WMB shares have a 3-year annualized total return of 14.0%. Net income for 2018 was -$155 million on revenue of $8.7 billion. Revenue grew at a three-year average of 5.7%, but net income was negative in three of the past four years. The company has net debt outstanding of over $22 billion, which is up 200% from $7.4 billion in 2011. Interest expense on that debt has exceeded operating income (zombie metric) in each of the past four years. Since 2017, insider selling of company shares was 4.4 times larger than insider purchases.

The following table compares our three zombies:

Data Courtesy Bloomberg

Summary

Loose monetary policy contributed to the financial crisis as the Fed held interest rates at 1.0% in 2003-2004 despite an economy that was rebounding and a housing bubble that was inflating well beyond its natural means. The Fed also imprudently used forward guidance to keep rates low for “a considerable period” which further prompted investors to speculate. In a troubling parallel, and proving lessons learned in finance are cyclical, not cumulative, the Fed has maintained and extended emergency policies following the crisis for nearly a decade. New bubbles have since replaced those that popped in 2008.

Upon receiving the Alexander Hamilton award in 2018, Stan Druckenmiller said, “If I were trying to create a deflationary bust, I would do exactly what the world’s central banks have been doing for the past six years.” The important point of his comment is that the deflationary episodes most feared by central bankers are caused by imploding asset bubbles. Those asset bubbles are invariably caused, in large part, by imprudent monetary policies that encourage market participants – households, corporations, and governments – to misallocate resources.

Corporate zombies are but one example. Their existence is evident, but the true extent to which they populate the market landscape cannot be known. Our analysis here reveals only the easiest to identify but rest assured, when economic twilight comes, many more zombies will be fully exposed.

Remember “No Child Left Behind,” George W. Bush’s education reform plan? Congress passed it in 2001.

Whether that law actually helped is subject to debate, but Bush picked a good name for it. Humans are social creatures. Our instincts tell us to make sure no one in our tribe gets “left behind,” economically or otherwise.

That instinct breaks down sometimes. Or we disagree about who belongs in our tribe. It’s a big problem in either case.

Hence, when people say even the poorest Americans live better than their grandparents did, or better than those in other countries, they miss the point.

Past generations and people overseas are the wrong comparison. We get angry when our own group leaves us behind.

Millions of Americans feel that way. And the data say they aren’t wrong.

Unhappy Quarter

In 2013, the Federal Reserve began conducting a yearly “Survey of Household Economics and Decisionmaking,” under the catchy acronym “SHED.” It measures the economic well-being of US families and identifies possible risks.

The latest SHED found 34% of adult Americans say they are “living comfortably.” Another 41% report they are “doing okay.” So 75% of us are generally satisfied, economically.

That sounds great, and in one sense it is. The 2013 SHED found only 62% were in those two groups. So to now have three-quarters satisfied is a significant improvement.

The problem is 75% ≠ 100%, and millions of people aren’t economically satisfied.

Specifically, 18% of us think we are “just getting by,” and 7% are “finding it difficult to get by.”

We lack historical data for comparison, but to me, this seems high.

Note, being satisfied doesn’t require any particular income or net worth. Lots of well-paid people think they are just getting by, and some low-income folks believe they’re doing okay.

But however you slice it, one-fourth of the adult population thinks it is being left behind. This is a problem.

No Cushion

This month the current expansion became the longest in postwar history. Unemployment is historically low. So why are so many people unsatisfied?

SHED has some other data that helps explain.

Just as seat cushions let you sit more comfortably, a financial cushion helps you feel more secure. Conversely, lack of a cushion makes you more anxious.

The SHED researchers asked respondents how they would cover a $400 unexpected expense. That’s really not much. A toothache, an emergency room visit (even if you’re insured), a minor car repair—all can easily run $400 or more.

Some 61% of Americans say they could cover such an emergency with cash, savings, or a credit card they paid off the next month.

But almost four out of ten Americans would have to borrow the money, sell something, turn to relatives, or just give up.

That’s not all. Even without emergencies, 17% of adults said they expected to miss some of their routine bill payments that month. And not always for luxuries; 7% expected to leave rent, mortgage, or utilities at least partially unpaid.

Adding it all together, the SHED data show about one-third of US adults either can’t pay all their bills or are one small problem away from it.

If you’re reading this, you probably aren’t in that group. But don’t rest easy.

Tight Spot

Some of these people who can’t pay their bills probably made unwise choices. But it is still the case that…

• Lenders and retailers entice people into buying things they shouldn’t, and

• Even life’s basic necessities often cost more than they should.

So before you condemn them, consider the possibility you may join them.

While the SHED data show some improvement since 2013, it coincided with a growing economy and falling unemployment. Neither will continue once the next recession strikes. Which could be soon.

If a third of the population can’t pay its bills today, how big will that group be when unemployment rises to 8% or more?

That’s not a crazy idea. It was reality as recently as 2013.

When (not if) that happens, the number of economically distressed Americans is going to rise considerably. Probably to more than half the population—enough to force major political change in an attempt to ease its pain.

Those who are perceived to have caused that pain will be in a tight spot. Their best move: Act now to help those millions of left-behind Americans.

As far as I can tell, most aren’t. They’re too busy enjoying their own good fortune.

This isn’t likely to end well.

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.

AEP – American Electric Power

• Despite what has been a bit of a “risk on” rally over the last couple of week, defensive positions continue to hold up as well.
• AEP is extremely overbought and on an elevated “buy” signal so we are keeping a close stop on the position currently.
• Hold current position for now with a “profit-stop” at $89
• Stop loss now moves up to $82.

BA – Boeing Co.

• We added BA several months ago after the initial plunge from the 737 MAX crash.
• Since then BA has continued to consolidate within a fairly tight range. With a bulk of the concerns now behind the company, we need to see earnings to see what the damage has actually been.
• A break above resistance at $365-370 should allow BA to move markedly higher given the deeply depressed “sell signal” in the lower panel.
• Stop is being moved up from $300 to $320.
• The recent rise has not yet triggered a “buy” signal so we can’t add to the position yet, however, the deep oversold condition currently suggests plenty of upside.

CMCSA – Comcast Corp.

• CMCSA has broken above resistance and sprinted to new highs.
• We continue to carry a full position currently and with the stock extremely overbought, with a very extended “buy signal,” we are going to be patient for a better opportunity to add to our holdings.
• CMCSA is back on our list for profit taking the next time we do a portfolio rebalance.
• Stop-loss is moved up to $41

XOM – Exxon Mobil Corp.

• Oil continues to struggle with resistance at the $60 level failing once again this week.
• We sold 1/2 of our position in XOM at the end of April. We currently remain underweight our holding for the time being.
• XOM is close to registering a “buy signal” which would give us the opportunity to add back to our holding. We would like to see the “buy signal” initiate with a break above $78 to add to our position.
• Our stop remains at $66 given we sold 1/2 of the position.

MSFT – Microsoft Corp.

• With MSFT continuing to drift higher, we continue to hold our position.
• The buy signal on MSFT is extremely extended and is very overbought to boot.
• We would like to add to our position on a reversal of those conditions which do not violate the long-term trends.
• MSFT is on our list to take-profits in when we run our rebalance process.
• Stop-loss remains at $120

JPM – J.P. Morgan Chase & Co.

• JPM announced better than expected earnings and is currently wrestling with a “triple top” resistance level.
• There is a risk to JPM when the Fed starts cutting rates as it will impact their Net Interest Income levels.
• However, for now we are holdings our position and will look to take profits when we rebalance.
• Stop loss is moved up to $107.50

PEP – Pepsi Inc.

• PEP, has been making us smile more than Coca-Cola as of late.
• Kidding aside, PEP has done well along with the consumer staple sector but, like many other stocks in our portfolio, is extremely extended and overbought.
• We will look to take profits on a portfolio rebalance as the extension above long-term moving averages is now at extremes.
• Stop-loss is moved up to $120.00

JNJ – Johnson & Johnson

• Along with our defensive themes, JNJ continues to hold up.
• JNJ sold off last week on news of a potential criminal probe into the recent “Talc” case, however, such an investigation has limited effects longer-term.
• The earnings release yesterday was very encouraging and we think there is an opportunity forming to add to our holding.
• We continue to hold our weighting in JNJ and may look to increase exposure if the “buy signal” turns up and current support levels hold.
• Stop-loss remains at $130

VZ – Verizon Communications

• VZ has been trapped in an extremely tight trading range over the last several weeks. This will be resolved sooner rather than later.
• Earnings will likely be the deciding factor and VZ is likely to beat current earnings estimates.
• A break above triple-top resistance at $59 will be an opportunity to add to our holdings.
• We will take profits in the position when we rebalance the portfolio.
• Stop loss remains at $53.00

PPL – PPL Corp.

• PPL simply hasn’t performed as expected since adding it to the portfolio. However, we continue to collect the 5% yield in the meantime.
• As noted last week, with the recent addition of WELL, we are carrying an extra position in the portfolio.
• During our next profit taking/rebalancing exercise, PPL will most likely be removed from the portfolio.
• We are moving our stop-loss up to $30

FaceApp is taking over social media.

It also may help procrastinators focus on long-term goals, like retirement.

The face recognition smartphone application is available for free download; a Pro version is available for a fee. The features available in the free version are enough to motivate you to immediately (possibly dramatically), increase your retirement account contribution percentages.

So, what is FaceApp?

FaceApp is artificial intelligence facial software which allows users to change up their face – add smiles, beards, impressions, change hair colors, hair styles, add glasses, tattoos, makeup. All in a manner that appears hauntingly realistic. Users can also hit the ‘age editor,’ to see how they look young and most important, old.

Whether it’s off the mark or not, staring at an eerily-realistic, much older, future, frailer-looking iteration of self in a mirror today may be compelling enough for financial procrastinators to face a future reality (literally), motivate one to ask – Am I saving enough for retirement? Am I taking care of my health?

To see yourself in a physically vulnerable state of being, to immediately pull a future into the present day, may jumpstart a brain to also clarify long-term nebulous inevitabilities like aging (in my case you’ll see, not so gracefully), and push a user to get serious about finances, complete a comprehensive financial plan, get that estate plan updated, increase contributions to retirement accounts.

You get the picture. It sure scared me straight to consider the viability of my long-term goals and examine the pitfalls in my financial strategy and I create financial plans for a living!

Listen, this isn’t a new concept. Years ago, Merrill Lynch launched an application which ages a picture of a user and shows how one may look even after 100 years old. Along with the aging photos, Merrill also showcased messages about the impact of inflation on everyday goods like milk and bread. Smart.

The idea of linking facial recognition software to financial viability was founded through experiments conducted at Stanford University and published in a November 2011 edition of the Journal of Marketing Research. Stanford’s studies discovered that people who viewed their aged selves, considered allocating more money to their retirement vehicles.

From the study:

“Many people fail to save what they will need for retirement. Research on excessive discounting of the future suggests that removing the lure of immediate rewards by precommitting to decisions or elaborating the value of future rewards both can make decisions more future oriented. The authors explore a third and complementary route, one that deals not with present and future rewards but with present and future selves. In line with research that shows that people may fail, because of a lack of belief or imagination, to identify with their future selves, the authors propose that allowing people to interact with age-progressed renderings of themselves will cause them to allocate more resources to the future. In four studies, participants interacted with realistic computer renderings of their future selves using immersive virtual reality hardware and interactive decision aids. In all cases, those who interacted with their virtual future selves exhibited an increased tendency to accept later monetary rewards over immediate ones.”

I don’t believe FaceApp is going to magically turn financial profligates into saints. However, I do believe that a long-term financial dilemma which weighs on one’s mind coupled with a photo of one’s aged self, may push a procrastinator to take a positive, financial action.

Try it and let me know if the application helped you get out of the fiscal foxhole and make a run at a financial goal that has been weighing on your mind.

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 is back to extreme overbought and failed at resistance last week.
• XLB is testing support which must hold.
• With the trade deal put on hold, temporarily, XLB got a boost on hopes one may be completed someday. However, it is likely more tariffs are coming so take profits and rebalance portfolio risk.
• 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 moved up to $57
• Long-Term Positioning: Bearish

Communications

• XLC has mustered a decent rally which has been less than inspiring relative to other sectors.
• While on a buy signal, XLC is back to extreme overbought. If you are still long positions, take profits and reduce exposure.
• Short-Term Positioning: Neutral
  • Last Week: Hold trading positions, but take profits.
  • This Week: Hold trading positions, but take profits.
  • Hard Stop set at $47.50
• Long-Term Positioning: Bearish

Energy

• Currently, XLE is wrestling with the 200-dma. While, as noted yesterday, $WTIC has broken above resistance, energy shares are still lagging behind a bit.
• With XLE back to overbought, take profits and rebalance risk accordingly.
• A convincing break above the 200-dma would clear the way for a move higher, but wait for the break first.
• The sell signal is being reversed to a “buy” which is a good sign.
• Short-Term Positioning: Neutral
  • Last week: Hold current position
  • This week: Hold current position, add to holding on a break above the 200-dma.
  • Stop-loss adjusted to $62
• Long-Term Positioning: Bearish

Financials

• XLF has rallied and is now testing, and trying to clear previous resistance.
• XLF remains on a “buy” signal currently but is back to extreme overbought.
• Short-Term Positioning: Neutral
  • Last week: Recommended “hold” 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss moved up to $25.00
• Long-Term Positioning: Bearish

Industrials

• XLI has rallied and is now testing a “quadruple top.” It is now, or never, for industrials to breakout and move higher.
• XLI is extremely overbought, but a break above $70 will set up a move higher.
• As stated previously, with the “trade war” on hold for now, there is upside to the “triple top.”
• Take profits for now and wait for the next setup.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position.
  • Stop-loss moved up to $76 to protect gains.
• Long-Term Positioning: Neutral

Technology

• XLK has reversed back to an overbought condition and has pushed out to new highs although the breadth of that breakout remains suspect.
• XLK has been driven by the largest cap-weighted companies so it may be prudent to remain cautious for now.
• The buy signal remains intact, which is bullish, but is back to extreme overbought. Risk vs reward is not optimal currently.
• Short-Term Positioning: Bullish
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss moved up to $75 to protect gains.
• Long-Term Positioning: Neutral

Staples

• Defensive positions cooled off a bit after an exceptionally strong rally. It didn’t last long as “defensive positioning” continues to lead the markets higher.
• XLP is grossly extended. and the buy signal is very elevated.
• We previously recommended taking profits but maintaining holdings.
• The “buy” signal (lower panel) is still in place and is back to 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.
  • Profit stop-loss moved up to $58
• Long-Term Positioning: Bullish

Real Estate

• XLRE also broke out to “new highs,” retested support and is now testing old highs once again.
• If XLRE can break out to new highs, that will confirm the previous breakout and keep allocations in place.
• We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected.
• That correction did not last long and real estate is back testing all-time highs, take profits and rebalance once again.
• Buy signal is being reduced along with the “buy signal” but more works needs to be done.
• Short-Term Positioning: Bullish
  • Last week: Holding position.
  • This week: Hold position.
  • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

• XLU, is back to extremely overbought so a correction is expected again.
• Like XLRE, XLU is testing highs once again.
• 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 worked off some of the excess. (bottom panel) and the overbought condition is also on the mend.
• Short-Term Positioning: Bullish
  • Last week: Hold overweight position
  • This week: Hold overweight position
  • Stop-loss moved up to $57.50.
• Long-Term Positioning: Bullish

Health Care

• Sell-signal (bottom panel), as anticipated, has reversed to a buy signal.
• XLV performance improved markedly but after a big run, the current correction was expected.
• XLV is back to overbought so $90 is important support.
• Short-Term Positioning: Neutral
  • Last week: Hold current position (overweight)
  • This week: Hold current position (overweight)
  • Stop-loss moved up to $90 to protect profits.
• Long-Term Positioning: Neutral

Discretionary

• With AMZN and AAPL now considered discretionary stocks, it is not surprising to see XLY rise and fall with XLK and XLC as those two major stocks rallied last week and on Monday.
• The “buy” signal has been reduced and is holding up and XLY is now breaking out to all-time highs although participation remains weak.
• XLY is back to extreme overbought, so take profits on this rally and wait to see what happens next.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 of 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 “buy” signal but remains confined to an overall downtrend.
• 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

In this past weekend’s newsletter, I laid out the bull and bear case for the S&P 500 rising to 3300. In summary, the basic driver of the “bull market thesis” essentially boils down to Central Bank policy, as noted by the WSJ yesterday:

“U.S. indices hit record highs last week on rate cut expectations. We’ve shifted from fiscal stimulus to monetary stimulus as the driver of the rally.”

In other words, it is all about “rate cuts.”

This reliance on the Fed has led to a marked rise in “complacency” by investors in recent weeks despite a burgeoning list of issues. As shown in the chart below, the ratio of the “volatility index” as compared to the S&P 500 index is near it’s lowest level on record going back to 1995.

(Of course, exceedingly low levels of volatility relative to the S&P 500 have historically denoted periods of price corrections or worse.)

The following considerations fly in the face of the high level of complacency ruling the financial markets:

• The global economy is slowing.
• Growth in European economies is slowing dramatically, including Germany where 10-year bond yields dropped below zero for the first time since 2016. (There is currently a record level of nearly $13 Trillion in negative yielding debt globally.)
• China, representing 30% of global GDP growth, is weakening rapidly.
• Domestic GDP is expected to rise by only 1.50% in the second quarter, which is a sharp reversal from last year.
• The trade war with China, and to a lesser degree Europe, has not been resolved and could accelerate on a Tweet.
• Despite being ten years into an expansion, markets at record highs, and unemployment near 50-year lows, the Fed is talking about cutting rates at the end of the month. What does the Fed know that we do not? 
• The potential for a hard BREXIT is still prevalent.
• Earnings expectations have fallen markedly along with actual earnings and revenues.

There is much more, but you get the idea.

As we previously wrote for our RIA PRO Subscribers:  (Get A 30-day FREE Trial)

“Based solely on today’s levels of implied volatility, the media, central bankers and uninformed cocktail chatter would have us conclude that there is little to worry about. We see things quite differently and believe current indicators offer far more reason for fear than when implied volatility is high and fear is more acute.

The graph below is constructed by normalizing VIX (equity volatility), MOVE (bond volatility) and CVIX (US dollar volatility) and then aggregating the results into an equal-weighted index. The y-axis denotes the percentage of time that the same or lower levels of aggregated volatility occurred since 2010. For instance, the current level is 1.91%, meaning that only 1.91% of readings registered at a lower level.”

What both charts above show is that when these complacency has previously reached such low levels, a surge occurred soon thereafter. This does not mean the index will bounce higher immediately, but it does suggest we should expect higher volatility over the next few months.

Furthermore, prices are ultimately constrained by longer-term moving averages. At the beginning of May, I wrote “A Warning About Chasing This Bull Market,” and in particular noted the deviations above long-term means which were at 8% at that time.  Of course, that preceded the May slide which knocked about 5% off of stock prices at the time.

Currently, prices are almost 10% above the long-term mean.

As I stated back in May, this doesn’t mean the market will begin a mean reversion process tomorrow; but, it is suggestive of a market that is certainly at risk of a reversal.

Millennial Soccer

There is one thing the Fed can’t fix by lowering rates – corporate earnings. Next week, the markets will begin to face the quarterly barrage of reports. Don’t worry, as always, we will see a high percentage of companies “beating estimates.”

As I discussed previously, such shouldn’t be a surprise given the massive reduction in expectations leading up to reporting season.

This is why I call it “Millennial Soccer.” 

“Earnings season is now a ‘game’ where scores aren’t kept, the media cheers, and everyone gets a ‘participation trophy’ just for showing up.”

Another warning sign for investors, and something they should be paying attention to, is the rather dramatic decline in net income from a year ago.

While it is currently expected the slowdown in earnings this quarter is a temporary anomaly, the reality is it may not be. The ongoing trade war with China, potential for additional tariffs, and slower economic growth suggest earnings weakness may be with us longer than many suspect.

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The same is true for hedge funds which are also piling into equity risk in order to generate returns. (It is worth noting previous peaks in equity increases which has been a good contrarian indicator in the past.)

This rush back into equities should not be surprising.

The one thing about bullish sentiment is that it begets more bullish sentiment. The more the market rises, the more ingrained the belief comes that it can only go higher. In a “Pavlovian” manner, as each “dip” is bought, the “fear” of loss is eliminated repeatedly teaching investors they should “only buy” and “never sell.”

This is why, as I noted over the weekend, we remain bullishly biased in portfolios for now.

“We are well aware of the present risk. Stop loss levels have been moved up to recent lows and we continue to monitor developments on a daily basis. With the trend of the market positive, we want to continue to participate to book in performance now for a ‘rainy day’ later.”

That “rainy day” is coming.

As noted above, while market participants are “giddy” about the prospects for the markets based on the Fed cutting rates, there is a laundry list of things issuing warning signals. We can add to the list above:

• Growing divergences between the U.S. and abroad
• Peak autos, peak housing, peak GDP.
• Political instability and a crucial Presidential election.
• The failure of fiscal policy to ‘trickle down.’
• An important pivot towards restraint in global monetary policy.
• An unprecedented lack of coordination between super-powers.
• Short-term note yields now eclipse the S&P dividend yield.
• A record levels of private and public debt.
•  Near $3 trillion of covenant light and/or sub-prime corporate debt. (eerily reminiscent of the size of the subprime mortgages outstanding in 2007)
• Narrowing leadership in the market.

But, for now, this “wall of worry” has yielded little concern.

The more the market rises, the more reinforced the belief “this time is different” becomes.

As I wrote previously:

“This is why we have been saying for the last two weeks – the market is rising and you need to be invested…FOR NOW. However, this is not the next great leg of a bull market so this will be a good rally to liquidate positions into and begin setting your portfolio up for more protectionary investments going into [next year].”

That was on December 7, 2007.

Are we complacent?

Absolutely not.

Just recently I ran a 3-part series on the variety of things individuals believe about saving and investment which is either erroneous or misunderstood. (Part 1, Part 2, Part 3)

The feedback I get when challenging some of the more commonly held beliefs is always interesting. In almost every single case, the arguments against “mathematical realities” comes down to either:

1. An inability, or unwillingness, to sacrifice today to save more for the future, or;
2. A “hope” that markets will continue to create returns which will offset the lack of savings.

Okay, it is just a reality that most people don’t want to sacrifice today, for the future tomorrow.

“Live like no one else today, so that you can live like no one else tomorrow.” – Dave Ramsey

Unfortunately, that is the same problem that plagues pension funds all across America today.

As I discussed in “Pension Crisis Is Worse Than You Think,”  it has been unrealistic return assumptions used by pension managers over the last 30-years, which has become problematic.

“Pension computations are performed by actuaries using assumptions regarding current and future demographics, life expectancy, investment returns, levels of contributions or taxation, and payouts to beneficiaries, among other variables. The biggest problem, following two major bear markets, and sub-par annualized returns since the turn of the century, is the expected investment return rate.

Using faulty assumptions is the linchpin to the inability to meet future obligations. By over-estimating returns, it has artificially inflated future pension values and reduced the required contribution amounts by individuals and governments paying into the pension system

Pensions STILL have annual investment return assumptions ranging between 7–8% even after years of underperformance.”

However, why do pension funds continue to have high investment return assumptions despite years of underperformance? It is only for one reason:

To reduce the contribution (savings) requirement by their members.

As I explained previously:

“However, the reason assumptions remain high is simple. If these rates were lowered 1–2 percentage points, the required pension contributions from salaries, or via taxation, would increase dramatically. For each point of reduction in the assumed rate of return, it would require roughly a 10% increase in contributions.

For example, if a pension program reduced its investment return rate assumption from 8% to 7%, a person contributing $100 per month to their pension would be required to contribute $110. Since, for many plan participants, particularly unionized workers, increases in contributions are a hard thing to obtain. Therefore, pension managers are pushed to sustain better-than-market return assumptions, which requires them to take on more risk.

The chart below is the S&P 500 TOTAL REAL return from 1995 to present. I have projected an average return of every period in history where the market peaked following P/E’s exceeding 20x earnings. This provides for variable rates of market returns with cycling bull and bear markets out to 2060. I have also projected “average” returns from 3% to 8% from 1995 to 2060. (The average real total return for the entire period is 6.56% which is likely higher than what current valuation and demographic trends suggest it should be.)”

This is also the same problem for the average American faces when planning for 6-8% annual returns on their investment strategy.

Clearly, there is no reason you should save money if the market can do the work for you? Right?

This is a common theme in much of the mainstream advice. To wit:

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

Ms. Orman’s statement, while very optimistic, requires the 25-year old to achieve an 11.25% annual rate of return (adjusting for inflation) every single year for the next 40-years.

That certainly isn’t very realistic.

More importantly, as I explained previously, $1 million today, and $1 million in 30-years, are two very different issues due to a rising cost of living over time (a.k.a. inflation.) 

Pick a current income level on the left chart, the number on the right is the current income inflated at 2.1% (average inflation rate) over 30-years. Then pick that level of income on the right chart to see how much is needed to fund that amount annually in retirement at 4% (projected withdrawal rate.) Click to enlarge

What pension funds have now discovered, and unfortunately it is far too late, is that using faulty assumptions, and not requiring higher contributions, has led to an inability to meet future obligations.

“Pensions across the U.S. are falling deeper into a crisis, as the gap between their assets and liabilities widens at the same time that investment returns are falling, according to Bloomberg. 

The average U.S. plan has only 72.5% of its future obligations in 2018, compared to more than 100% in 2001. The Center for Retirement Research at Boston College attributes the deficit to recessions, insufficient government contributions, and generous benefit guarantees. Importantly, the underfunded status is still based on 7% annual return assumptions. 

Unfortunately, the problem will only get worse between now and 2050, according to Visual Capitalist:

“According to an analysis by the World Economic Forum (WEF), there was a combined retirement savings gap in excess of $70 trillion in 2015, spread between eight major economies…The WEF says the deficit is growing by $28 billion every 24 hours – and if nothing is done to slow the growth rate, the deficit will reach $400 trillion by 2050, or about five times the size of the global economy today.”

It isn’t just Pension Funds

Importantly, this is the same trap that individual investors have fallen into as well. By over-estimating future returns, future retirement values are artificially inflated, which reduces the required savings rates. Such also explains why 8-out-of-10 American’s are woefully underfunded for retirement currently.

Using the long-term, total return, inflation-adjusted chart of the S&P 500 above, the chart below compares $1000 compounded at 7% annually to the variable-rate of return model above. The bottom part of the chart shows the difference between actual and compounded rates of return.

This is the “pension problem” the majority of individuals have gotten themselves into currently.

As I wrote previously:

“When imputing volatility into returns, the differential between what individuals are promised (and this is a huge flaw in financial planning) and what actually happens to their money is substantial over the accumulation phase of individuals. Furthermore, most of the average return calculations are based on more than 100-years of data. So, it is quite likely YOU DIED long before you realizing the long-term average rate of return.”

Excuses Will Leave You Short

I get it.

I am an average American too.

Here are the most common excuses I hear:

1. I “need” to be able to enjoy my life today. 
2. I have “plenty of time” to save up for retirement.
3. “Budget,” what ‘s that?
4. I have social security (or a a pension plan), so I don’t really need to save much.

Let’s talk about that last point.

If you have a public pension plan, congratulations, you are in the 15% of workers that do. Future generations won’t be as fortunate. Moreover, with the underfunded status of pensions funds running between $4-5 Trillion, this may not be a “safety net” to bet your entire retirement on.

Social security is also underfunded and payout cuts are expected by 2025 if actions are taken to resolve its issue. The same demographic trends which are plaguing pension funds also weigh heavily on the social security system.

As stated above, the biggest problem for Social Security is that it has already begun to pay out more in benefits than it receives in taxes. As the cash surplus is depleted, which is primarily government I.O.U.’s, Social Security will not be able to pay full benefits from its tax revenues alone. It will then need to consume ever-growing amounts of general revenue dollars to meet its obligations–money that now pays for everything from environmental programs to highway construction to defense. Eventually, either benefits will have to be slashed or the rest of the government will have to shrink to accommodate the “welfare state.” 

It is highly unlikely the latter will happen.

Demographic trends are fairly easy to forecast and predict. Each year from now until 2025, we will see successive rounds of boomers reach the 62-year-old threshold.

Excuses aside, continuing to under-save, and counting on social security and a pension fund to make up the difference, may have very different outcomes than many are currently planning on.

Simple Is Not Always Better

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

• Last week, the market cracked 3000 driven by hopes of a “Fed rate cut” at the end of the month.
• On a technical basis the breakout is constructive and suggests higher highs. However, in the near-term the market is extremely overbought so a bit of a correction is needed to add to our position.
• Short-Term Positioning: Bullish
  • Last Week: Hold position
  • This Week: Hold position.
  • Stop-loss adjust to $275
  • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

• Last week, we noted DIA did break out to new highs and triggered a short-term buy signal.
• DIA is very overbought short-term, so like SPY above, we will look for a better entry point to suggest adding weighting to portfolios.
• Short-Term Positioning: Neutral
  • Last Week: Hold current positions
  • This Week: Hold current positions.
  • Stop-loss moved up to $252.50
• Long-Term Positioning: Neutral

Nasdaq Composite

• QQQ rallied from the oversold condition and is now back to EXTREMELY overbought.
• While QQQ did breakout to new highs along with DIA and SPY it is lagging in terms of relative performance.
• With the “buy signal” getting elevated towards levels that have previously signaled short-term peaks, use corrections that do not violate support to add to positions.
• 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)

• SLY continues to be a technical disaster. Small-caps are also not confirming the exuberance of its large-cap brethren because small-caps do not engage in massive stock repurchase programs.
• Last week, SLY did break above the 200-dma but remains confined to a very negative downtrend.
• SLY has triggered a short-term buy signal so that could help small-caps gain ground if they can hold up.
• 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. Mid-caps, like small-caps, also do not participate in major share repurchase programs and are economically sensitive. Both suggest the overall market environment is weaker than headlines suggest.
• MDY did regain its 200-dma but the rally has been weak and has failed at resistance.
• Mid-caps are also very overbought so take profits if you are long and tighten up stops.
• Short-Term Positioning: Neutral
  • Last Week: Use any further rally this week to sell into.
  • This Week: Use any further rally this week to sell into.
• Long-Term Positioning: Bearish

Emerging Markets

• EEM rallied back to the top of its downtrend channel on news that the ECB will potentially cut rates and increase QE programs.
• EEM is back on a “buy signal” but is confined to a more major downtrend currently.
• We previously added a small trading position to the long-short portfolio which has minimal success so far.
• Short-Term Positioning: Bearish
  • Last Week: Hold current position
  • This Week: Hold current position
  • Stop-loss set at $41
• Long-Term Positioning: Neutral

International Markets

• Like EEM, EFA rallied on news the ECB will leap back into action to support markets.
• Last week, EFA broke above its downtrend line while maintaining a “buy signal.” That “buy signal” is now very extended.
• We did add a trading position to our long-short portfolio model, and will see if support at the previous downtrend can hold.
• Short-Term Positioning: Neutral
  • Last Week: Hold position
  • This Week: Hold position.
  • Stop-loss is set at $64
• Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

• Oil finally was able to push above the 50% retracement line on a bigger than expected crude draw and “Tropical Storm Barry” shutting down production in the Gulf.
• Oil is back into overbought conditions and a “buy signal” has been registered suggesting a push towards $64-65 is likely.
• Short-Term Positioning: Neutral
  • Last Week: No position
  • This Week: Add trading position on pullback that holds $58.
  • Stop-loss for new positions is $54.
• Long-Term Positioning: Bearish

Gold

• Gold has quickly reversed its oversold condition to extreme overbought including its longer-term “buy signal.”
• The rally could be done for the moment, so look for a pullback to add gold to portfolios if you haven’t done so already.
• Gold is too extended to add to positions here. Look for a pullback to $126-127 to add.
• Short-Term Positioning: Neutral
  • Last week: Hold positions.
  • This week: Hold positions
  • Stop-loss for whole set at $126
• Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

• As noted previously,
  • “Bond prices have gone parabolic and are now at extremes. Even the “buy” signal on the bottom panel has reached previous extremes which suggests a reversal in rates short-term is likely.”
• That correction started last week.
• Prices could pullback to the $126-127 range which would be an ideal entry point.
• Strong support at the 720-dma (2-years) (green dashed line) which is currently $119.
• Short-Term Positioning: Bullish
  • Last Week: Take profits and rebalance risks. A correction IS coming which will coincide with a bounce in the equity markets into the end of the month.
  • This Week: Hold positions after taking profits.
  • Stop-loss is moved up to $125
  • Long-Term Positioning: Bullish

U.S. Dollar

• Comments from the Fed about more accommodative policies tripped up the dollar previously, but as noted last week, the dollar has gotten extremely oversold.
• The dollar did rally and is currently trying to hold support at its 200-dma. There is likely more rally to go next week particularly if it looks like the Fed will not reduce rates in July.
• The dollar is starting to reverse its oversold condition, and the rally to $97 last week has put the dollar back on our radar as suggested last week.
• Short-Term Positioning: Bullish
  • Last Week: No Position
  • This Week: No Position

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• Review & Market Update
• The Case For 3300
• Sector & Market Analysis
• 401k Plan Manager

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Market Review & Update

We had suggested last week that:

“With a majority of short-term technical indicators extremely overbought, look for a correction next week. What will be important is that any correction does not fall below the early May highs.”

Monday and Tuesday were indeed a bit sloppy, as shown below, but “fireworks” started on Wednesday as Jerome Powell said everything possible to ensure Wall Street a “rate cut” in July without actually saying so.

As we will discuss in a moment, almost 18-months after I originally discussed it, the market finally cleared the psychological level of 3000.

That is the good news.

The “not-so-good” news is the market continues to rally into a more extreme overbought condition with a rather extreme deviation above the 200-dma. Also, the negative-divergences in indicators which suggest further upside to the current rally may be limited. In particular, the divergence between small-cap and large-cap performance is typical of periods leading to corrections.

Also, since the September peak in the market, every other major index is lagging the performance of the S&P 500 index which suggests a narrower rally.

With that said, the markets are on a “buy signal,” which suggests further upside is likely in the near-term. This is why we continue to maintain our long-equity bias for now.

However, once we get past the end of the month, and assuming the Fed does indeed cut rates and no “trade deal” with China, the markets will return their focus to economics and earnings. As we said last week, such continues to suggest the August/September time frame for a larger corrective cycle is still in play.

Bonds Retreat

My colleague Patrick Hill asked me to address the retreat in bond prices over the last week or so. While many are assigning a variety of reasons for the recent reversal in rates including a resurgence on inflationary pressures, Central Bank demands, to a lack of buying by foreigners, I think the reason is much more simplistic.

Ever since rates spiked up to 3.25% at the beginning of 2018, we have repeatedly been discussing why rates would fall, and economic weakness and deflation would be the driver. Such has indeed been the case, and our long-bets on bonds have paid off nicely.

However, bonds are also a “safety” trade in times of uncertainty. The rotation from “risk” to “safety” has been THE trade since September of last year and rates, as I have discussed over the last several weeks, had become “egregiously” overbought. A correction was inevitable as money began chasing equities on hopes of a Fed rate cut. 

However, as shown below, we need to keep the recent reversal in the context of the broader move. It is kind of hard to spot.

This sell-off in bonds WILL provide another terrific buying opportunity most likely by the end of July. Look for rates to retrace back to previous resistance between 2.4% to 2.6%. Also, it is advisable to increase the duration of bond holdings for the yield curve steepening, which will occur as the economy slips closer to the recession.

That is how we are playing it.

So, let’s talk about S&P 3300!

The Case For 3300

It only took eighteen-months longer than expected, but the markets finally reached 3000 on the S&P 500 index this past week.

“What do you mean ‘expected?’ You are always bearish.” 

I am just going to save our “reading impaired” individuals some time by reminding them of what I wrote in January of 2018:

“While the record-breaking pace is certainly breathtaking, it should not be surprising as we discussed in the June 9th, 2017 edition of the weekly newsletter.

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

Of course, that piece of legislative agenda was ‘tax reform.’

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

In March, we followed up that post stating:

“Since that time, tax cuts/reform have been passed, earnings estim+tes have exploded higher, and corporate stock buybacks have surged to record levels while wage growth has remained non-existent for the bottom 80% of workers.

Not surprisingly, with those tailwinds, the market has pushed sharply higher towards our original target of 3000.”

As we know now, the market wound up following our mid-2017 accelerated projection trend.

So, here we are 18-months later, and the market finally hit 3000.

What is interesting, however, is the advance to 3000 incorporated both the original bull and bear projections.

The 20% slide from the September highs came on concerns the Fed was tightening too aggressively as Trump’s “trade war” took a bite out of economic growth and profitability. The subsequent rally back, which brutally reminded investors what “volatility” is, was based on “hope” that Trump would find a resolution with China and the Fed would cut rates.

Neither has happened yet, but the markets remain hopeful.

“But you missed out on the whole rally because you have been all in cash.”

Again, for those that cannot read more than 280-characters at a time:

“Portfolios have remained allocated toward equities, although we did shift to more defensive holdings earlier this year. We had also been aggressive buyers of bonds at 3% and higher on the 10-year bond which has added to portfolio performance this year. “

The Bull & Bear Case

As we face down the last half of 2019, we can once again run some projections on the bull and bear case going into 2021, as shown in the chart below:

Let us break down both potential pathways into the “bull” and “bear” case.

The Bull Case For 3300

• Momentum
• Stock Buybacks
• Fed Rate Cuts
• Stoppage of QT
• Trade Deal

Price momentum has been in control of the markets over the last several months. Given that “an object in motion, tends to stay in motion,” momentum is a hard thing to stop without a bigger event triggering a reversal in investor attitudes.

While Fed rate cuts, and stopping QT, will be seen as “accommodative” to asset prices, the “efficacy” of monetary policy has likely reached its limits. We have a decent understanding this is likely the case given that nearly 100% of all “net new equity purchases” have come from share buybacks in recent years. As I wrote last week

“So, how is it that stocks remain near record highs? The primary culprit, as discussed previously, remains corporate buybacks which remain the primary source of market support in 2019. This is especially the case after US banks announced $129 bn in buybacks over the next 4-quarters.

Buybacks, according to BofA, are on pace for a record at $43B so far this year versus just $75B for the entirety of 2018. This suggests a record of over $1 trillion in S&P 500 buybacks for 2019.”

A “Trade Deal” will also be helpful as it will take the pressure off of bottom-line corporate earnings. As J.P. Morgan’s chief equity strategist Dubravko Lakos-Bujas recently told MarketWatch:

“If you have a trade deal, and if the trade deal coincides with one or two rate cuts from the Fed, we see an upside scenario of 3,200-3,300.”

Yep, the same number we came up with.

However, as investors, we must also analyze what could go wrong and derail our investment strategy. Unfortunately, the “bearish” case has “sharper teeth” to it. (Yes, pun intended.)

The Bear Case Against 3300

• Earnings Deterioration
• Recession
• No Trade Deal/Higher Tariffs
• Credit Related Event (Junk Bonds)
• Mean Reversion
• Volatility / Loss Of Confidence

Earnings have already deteriorated markedly since 2018, as I discussed previously.

“However, the red dashed line denotes an 11% reduction to those estimates due to a ‘trade war’ where an across-the-board tariff of 10% on all US imports and exports would lower 2018 EPS for S&P 500 companies and, thus, completely offset the positive fiscal stimulus from tax reform.

Surprise! As of the end of the Q4-2018 reporting period, guess where we are? Exactly 11% lower than where we started which, as stated then, has effectively wiped out all the benefit from the tax cuts.”

Since then, 2019 earnings have been downgraded substantially. As Ian Harnett, chief investment strategist at Absolute Strategy Research recently noted:

“We do not think insurance cuts will be enough, we think earnings growth is not going to be 7% this year, it is going to be -5%, and maybe even -10. We are looking at these recession risk models rising, credit impulse numbers in the states are weak, that tends to bring unemployment up and tends to bring equity markets down.”

Given there has been no “trade deal” as of yet, the increase in tariffs in June to 25% have yet to show up in reports just yet, and global growth slowing, there is an elevated risk of an “earnings recession” currently.

There is also just the simple issue that markets are very extended above their long-term trends, as shown in the chart below. A geopolitical event, a shift in expectations, or an acceleration in economic weakness in the U.S. could spark a mean-reverting event which would be quite the norm of what we have seen in recent years.

Then there are the tail-risks of a credit-related event caused by a dollar funding shortage, a banking crisis (Deutsche Bank), or a geopolitical event, or a surge in defaults on “leveraged loans” which are twice the size of the “sub-prime” bonds liked to the “financial crisis.”  (Read more here)

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

Most likely, this is the final run-up before the next bear market sets in. However, where the “top” is eventually found is the big unknown question. We can only make calculated guesses.

Currently, the “math” suggests there are just 200 points of upside to our next target, but there is roughly 800-points of downside.

Be careful how you bet; these are odds that Vegas would love to give you.

I know. I know.

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

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

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

Then they will ask “why YOU did not see it coming when it so obvious.” 

In the end, being right, or wrong, does not affect the media as they are not managing your money. Nor are they held responsible for consistently poor advice. However, being right, or wrong, has a very big effect on you.

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

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

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

In The General Theory of Employment, Interest and Money, John Maynard Keynes wrote:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.”

I think Lord Keynes himself would appreciate the irony that he has become the defunct economist under whose influence the academic and bureaucratic classes now toil, slaves to what has become as much a religious belief system as an economic theory.

Men and women who display appropriate skepticism on other topics indiscriminately funnel facts and data through a Keynesian filter without ever questioning the basic assumptions. Some go on to prescribe government policies that have profound effects upon the citizens of their nations.

And when those policies create the conditions that engender the income inequality they so righteously oppose, they often prescribe more of the same bad medicine. Like 18^th-century physicians applying leeches to their patients, they take comfort that all right-minded people will concur with their recommended treatments.

This is an ongoing series of a discussion between Ray Dalio and myself (read Part 1, Part 2, Part 3, and Part 4) . Today’s article addresses the philosophical problem he is trying to address: income and wealth inequality.

Last week I dealt with the equally significant problem of growing debt in the United States and the rest of the world. The Keynesian tools much of the economic establishment wants to use are exacerbating the problems. Ray would like to solve it with a blend of monetary and fiscal policy, what he calls Monetary Policy 3.

The Problem with Keynesianism

Let’s start with a classic definition of Keynesianism from Wikipedia, so that we can all be comfortable that I’m not coloring the definition with my own bias (and, yes, I admit I have a bias). (Emphasis mine.)

Keynesian economics (or Keynesianism) is the view that in the short run, especially during recessions, economic output is strongly influenced by aggregate demand (total spending in the economy). In the Keynesian view, aggregate demand does not necessarily equal the productive capacity of the economy; instead, it is influenced by a host of factors and sometimes behaves erratically, affecting production, employment, and inflation.

The theories forming the basis of Keynesian economics were first presented by the British economist John Maynard Keynes in his book The General Theory of Employment, Interest and Money, published in 1936 during the Great Depression. Keynes contrasted his approach to the aggregate supply-focused “classical” economics that preceded his book. The interpretations of Keynes that followed are contentious, and several schools of economic thought claim his legacy.

Keynesian economists often argue that private sector decisions sometimes lead to inefficient macroeconomic outcomes which require active policy responses by the public sector, in particular, monetary policy actions by the central bank and fiscal policy actions by the government, in order to stabilize output over the business cycle. Keynesian economics advocates a mixed economy—predominantly private sector, but with a role for government intervention during recessions.

Central banks around the world and much of academia have been totally captured by Keynesian thinking. In the current avant-garde world of neo-Keynesianism, consumer demand—consumption—is everything. Federal Reserve policy is clearly driven by the desire to stimulate demand through lower interest rates and easy money.

And Keynesian economists (of all stripes) want fiscal policy (essentially, government budgets) to increase consumer demand. If the consumer can’t do it, the reasoning goes, then the government should step into the breach. This of course requires deficit spending and borrowed money (including from your local central bank).

Essentially, when a central bank lowers interest rates, it is encouraging banks to lend money to businesses and telling consumers to borrow money to spend. Economists like to see fiscal stimulus at the same time, as well. They point to the numerous recessions that have ended after fiscal stimulus and lower rates were applied. They see the ending of recessions as proof that Keynesian doctrine works.

This thinking has several problems.

The Flaws of Keynesian Stimulus

First, using leverage (borrowed money) to stimulate spending today must by definition reduce consumption in the future. Debt is future consumption denied or future consumption brought forward. 

Keynesian economists argue that bringing just enough future consumption into the present to stimulate positive growth outweighs the future drag on consumption, as long as there is still positive growth.

Leverage just equalizes the ups and downs. This has a certain logic, of course, which is why it is such a widespread belief.

Keynes argued, however, that money borrowed to alleviate recession should be repaid when growth resumes. My reading of Keynes does not suggest he believed in the unending fiscal stimulus his disciples encourage today.

Secondly, as has been well documented by Ken Rogoff and Carmen Reinhart, there comes a point at which too much leverage becomes destructive. There is no exact way to know that point.

It arrives when lenders, typically in the private sector, decide that borrowers (whether private or government) might have some difficulty repaying and begin asking for more interest to compensate for their risks.

An overleveraged economy can’t afford the higher rates, and economic contraction ensues. Sometimes the contraction is severe, sometimes it can be absorbed. When accompanied by the popping of an economic bubble, it is particularly disastrous and can take a decade or longer to work itself out, as the developed world is finding out now.

Every major “economic miracle” since the end of World War II has been a result of leverage. Often this leverage has been accompanied by stimulative fiscal and monetary policies. Every single “miracle” has ended in tears, with the exception of the current recent runaway expansion in China, which is still in its early stages.

Insufficient Income Causes Recessions

I would argue (along, I think, with the “Austrian” economist Hayek and other economic schools) that recessions are not the result of insufficient consumption but rather insufficient income.

Fiscal and monetary policy should aim to grow incomes over the entire range of the economy. That is best accomplished by making it easier for entrepreneurs and businesspeople to provide goods and services. When businesses increase production, they hire more workers and incomes go up.

Without income, there are no tax revenues to redistribute. Without income and production, nothing of any economic significance happens. Keynes was correct when he observed that recessions are periods of reduced consumption, but that is a result and not a cause.

Entrepreneurs must be willing to create a product or offer a service in the hope there will be sufficient demand for their work. There are no guarantees, and they risk economic peril with their ventures, whether we’re talking about the local bakery or hairdressing shop or Elon Musk trying to compete with the world’s largest automakers. If government or central bank policies hamper their efforts, the economy stagnates.

The Reason Keynesianism Sticks

Many politicians and academics favor Keynesianism because it offers a theory by which government actions can become decisive in the economy. It lets governments and central banks meddle in the economy and feel justified.

It allows 12 people sitting in a board room in Washington DC to feel they are in charge of setting the most important price in the world, the price of money (interest rates) of the US dollar and that they know more than the entrepreneurs and businesspeople who are actually in the market risking their own capital every day.

This is essentially the Platonic philosopher king conceit: the hubristic notion that a small group of wise elites is capable of directing the economic actions of a country, no matter how educated or successful the populace has been on its own.

And never mind that the world has multiple clear examples of how central controls eventually slow growth and make things worse over time. It is only when free people are allowed to set their own prices of goods and services and, yes, even interest rates, that valid market-clearing prices can be determined. Trying to control them results in one group being favored over another.

In today’s world, savers and entrepreneurs are left to eat the crumbs that fall from the plates of the well-connected crony capitalists and live off the income from repressed interest rates. The irony of using “cheap money” to drive consumer demand is that retirees and savers get less money to spend, and that clearly drives their consumption down.

Why is the consumption produced by ballooning debt better than the consumption produced by hard work and savings? This is trickle-down monetary policy, which ironically favors the very large banks and institutions.

If you ask Keynesian central bankers if they want to be seen as helping the rich and connected, they will stand back and forcefully tell you “NO!” But that is what happens when you start down the road of financial repression. Someone benefits. So far it has not been Main Street.

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.

This article was originally published at Kiplinger and submitted by Michael Kahn

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The U.S. economy is putting up some impressive numbers in GDP, jobs and wages, but many pundits fear that a slowdown is pending. Trade-war fears with China and the European Union remain front and center in the news. And the yield curve is threatening to invert, meaning short-term interest rates may be moving higher than long-term rates. That’s often a sign of pending recession on its own.

By some measures, the current expansion is now 10 years old, making it one of the longest on record. That seems ancient, but there’s no rule that says it can’t continue. Australia is in its 28th consecutive year of economic growth.

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Even so, all good things do eventually come to an end. And for the U.S. (and for Australia, for that matter), economists are looking for slowdowns. Even the Federal Reserve has indicated it is ready to lower short-term interest rates to combat any problems that may arise.

Professional investment managers may look to sell a good deal of their holdings to step aside as the market falls. However, for most individuals, timing the market by selling when conditions seem dicey, and buying back when conditions firm up, is a big mistake. Even the pros don’t always get it right, and they have armies of analysts and rooms full of technology at their disposal.

Here are six ways to prepare for the next stock market decline. The key is to make smaller adjustments to your portfolio to reduce risk and still be ready to participate when the market resumes its upward march.

Sell Speculative Stocks

Investors often have stocks in their portfolios that come with a bit more risk than they might like. What might have seemed like a good idea – think General Electric (GE) in 2015 – may have been all smoke and mirrors. The market has a way of punishing these types of companies when times get shaky.

Uber-investor Warren Buffett famously said,

“You only find out who is swimming naked when the tide goes out.”

A bull market tends to hide the sins of weak companies; when the bear comes knocking, they are the first to get hit.

Even if they’re not a disaster-in-waiting like GE was, some companies just may not have the financial resources to withstand a prolonged period of hard times. They might have too much debt on their books. Or they might be in a cyclical business, such as steel or oil drilling, that will seriously contract should the economy stumble. Perhaps you have shares in a company where legal battles, instead of their increasing market share, dominate their headlines.

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If you are getting nervous about the health of the stock market, lighten up on some of these weaker positions.

Here’s a quick test: Any stock that hit a 52-week low in April or May as the Standard & Poor’s 500 hit a 52-week (and all-time) high probably will not fare well on a market swoon. The same goes for stocks at 52-week lows at today’s highs.

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.

Shelton, The Fed, & The Realization Of A Liquidity Trap

Technically Speaking: Monthly S&P 500 Chart Update & Review

What You Need To Know About Medicare & The “BENES” Act

The Fed May Give Trump His Rate Cut, But It Won’t Help

Recession Probability Charts: Current Odds Now About 33%

Investors Are Grossly Underestimating The Fed – RIA Pro UNLOCKED

Questions About The “Stellar” June Jobs Report (Which Also Confirm The Fed’s Concerns)

Will History Repeat Itself in the Gold Market?

The Best Of “The Lance Roberts Show”

Podcast Interview Of The Week

Our Best Tweets Of The Week

Wage growth and compensation is booming? Importantly, watch the deviation between national income (ex rent) versus #GDP. https://t.co/TpyxGdxFwB pic.twitter.com/xlhi7nJ9lj

— Lance Roberts (@LanceRoberts) July 11, 2019

*EVANS: WITH A COUPLE RATE CUTS PCE COULD BE 2.2% IN 2021

To that Mr. Evans, we say wishful thinking…. pic.twitter.com/U9f45dajsb

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

Damn…reminds me a lot of #Lehman in June/July of 2008 https://t.co/eoSnyCG0Un

— Lance Roberts (@LanceRoberts) July 7, 2019

The Real Fed Mandate: Avoid recession at all cost.

Clearly they are scared that a normal and healthy cyclical economic cleansing will be disastrous.

— Michael Lebowitz, CFA (@michaellebowitz) July 10, 2019

Bonds will outperforming stocks since 1999. https://t.co/4eoLdxeYeR pic.twitter.com/34KX0CFHrd

— Lance Roberts (@LanceRoberts) July 9, 2019

So core CPI is 2.1% and above the Fed target. Jobless claims and unemployment are at or near 50+ year lows and the Fed is going to ease because of BREXIT, Federal Debt Ceiling, and trade developments. Seems to me the main reason is political expediency.

— Michael Lebowitz, CFA (@michaellebowitz) July 11, 2019

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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)

Selected Portfolio Position Review: 07-10-19

See you next week!

On July 1st, Michael Lebowitz was interviewed by Real Vision TV. In the interview he discussed our thoughts on the yield curve, corporate bonds, recession odds, the Federal Reserve, and much more. In particular, Michael pitched our recent portfolio transactions NLY and AGNC, which were both discussed in the following RIA PRO article: Profiting From a Steepening Yield Curve.

Real Vision was kind enough to allow us to share their exclusive video with RIA Pro clients. We hope you enjoy it.

To watch the Video please click HERE

Mark Twain once said, “history doesn’t repeat itself, but it often rhymes.”  Since President Nixon removed the gold standard in the early 1970s, gold has seen several significant rallies, all of which have similar wave characteristics.  Gold rallies seem to rhyme.

The first two price rallies began in 1971 and 1977, during and after the de-linking of the U.S. dollar from gold. The most recent price rally has its seeds in the dot-com bubble in the early 2000s.  The chart below shows two long-term monthly gold rallies, with the second rally appearing to be an amplified but similar version of the first.  I have overlaid Fibonacci sequence numbers to demonstrate how the price of gold has spiked upward in expanding, fractal waves during these prior surges. 

In the 1970s, gold traveled through four Fibonacci levels (by this measure) in less than a decade after the removal of the gold standard. From 2000 through 2012, amid the dot-com and housing bubbles, gold also traveled through four Fibonacci levels on the way to $1,900.  

If history rhymes again, and I believe it will, then the price of gold will again spike upward through three or four Fibonacci extensions to the upside, but then re-trace 50% to 70% of that upward move.   If so, then the next upward spike could peak in the range between $7,000 and $11,000 per ounce.

Investors tend to make rash decisions based on fear and greed. These emotions are typically amplified during times of financial stress. It is during such times that gold solicits fear and greed motivated buyers.  During a crisis, fear investors will rotate into gold to hold value, and greed investors see the upward momentum and jump on the train. The upward momentum of the next gold rally might feel like the Bitcoin surge in 2017.

“Striking Out” in the 1980s

In baseball, its “three strikes and you’re out.”  After the 1970’s surge and blow-off top in 1980, gold failed three key technical tests.  After these failures, the gold market floundered for another decade.  Let’s take a closer look at those three technical failures.

First, in early 1983, gold failed to retake and hold the psychologically important $500/oz price level.  This rejection resulted in sideways to lower movement for another year before gold failed again, breaking below its upward trend line near $360/oz.  After falling to a low in early 1985, gold moved higher over the next three years, only to fail a third key resistance test near $500/oz in late 1987.  After “striking out” in the 1980s, gold fell throughout the next decade back to $250/oz.

Current Technical Structure Is Bullish

Unlike the gold bear market of the 1980s, gold has been passing periodic tests of support and resistance since its sharp decline in 2013.  Gold’s price retracement from a high above $1,900 to a low near $1,040 kept the price above a 61.8% Fibonacci retracement level as well as the psychologically important $1,000 per ounce level. 

The monthly wave structure of gold is bullish, and the price is now trading above key resistance levels, with solid support at $1,379 and $1,250. Even if the price of gold falls back to support at $1,250 per ounce, the long term technical picture remains bullish.  I view the recent breakout over $1,380 to be significant and has likely opened the door towards the $1,580 resistance area.

To the downside, technical breakdowns below $1,250 could lead the way to $1,211 and $1,043.  If history does indeed rhyme, a breakdown below $1,043 could lead to another decade of futility.  This downside scenario does not appear likely, especially not with the uber-accommodative interest rate policies worldwide.  High U.S. dollar interest rates broke the back of the gold rally in the 1980s, and there does not appear to be any such risk of this happening again anytime soon. 

Short-term Indicator

In addition to my longer-term view on gold, I also track shorter-term price signals to locate areas of accumulation and/or hedging.  An indicator I developed shows a mean-reversion relationship between price and the point of Neutral Delta in the options market.  Essentially, the point of Neutral Delta shows where the options market participants have placed their bets and hedges.  At the moment, Neutral Delta is near $1,345 per ounce for the options which expire on July 25^th. 

When the price is over-bought in relation to Neutral Delta (as it is now), we tend to see headwinds for further price increases.  Interpreting the current data, I am led to believe that the price of gold will re-test the $1,380 price level before July 25^th, and this will give the options hedgers an opportunity to optimize their hedge book ahead of the next few option expirations.  A lower probability event would be a price spike again towards $1,450 which would like force a short-covering rally by the call option sellers who may already be out-of-the-money.

If we are in the opening innings of a new rally in gold, a retest of $1,380 or even $1,250 will represent great opportunities to buy or add to your gold positions.

You can learn more about my research by clicking this link: Introduction to Options Sentiment.

Final Thoughts

Gold can be best viewed as financial insurance.  If you believe that you should own insurance, then you should also own gold.  In terms of investment performance, gold will do best during times of international financial stress.  In the past, the price of gold has moved exponentially higher during these periods as demand for the ultimate safe haven goes viral. 

The world is slowly but steadily transitioning from a U.S. dollar-backed financial system to a multi-currency, multi-polar system.  One day, the leaders of our world will let the rest of us know the plan for a modified financial system, and we will have to admit that we were warned many times in advance.  I expect that the gold price spike will happen before, during, and after a new Bretton Woods-type conference.  While there are many signs that a new financial order is imminent, the transition to this new financial order could take more time than many have been led to believe.

From a short-term perspective, I use gold puts to protect my current precious metal allocations.  This is like purchasing insurance on the value of my current insurance policy. It also helps preserve my wealth allowing me to buy more gold if prices do in fact, drop to $1,380 or $1,250.

Disclaimer and Notes

This article was written for informational purposes and is not a recommendation to buy or sell any securities. All my articles are subject to the disclaimer found here.

On Wednesday, Jerome Powell testified before Congress the U.S. economy is “suffering” from a bout of uncertainty caused by trade tensions and slow global growth. To wit:

“Since [the Fed meeting in mid-June], based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook.”

That outlook, however, would seem to be askew of the recent employment report for June from the Bureau of Labor Statistics last week. That report showed an increase in employment of 224,000 jobs. It was also the 105th consecutive positive jobs report, which is one of the longest in U.S. history.

However, if employment is as “strong” as is currently believed, which should be a reflection of the underlying economy, then precisely what is the Fed seeing?

Well, I have a few questions for you to ponder concerning to the latest employment report which may actually support the Fed’s case for rate cuts. These questions are also important to your investment outlook as there is a high correlation between employment, economic growth, and not surprisingly, corporate profitability.

Let’s get started.

Prelude: 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 1.5%, which is lower than any previous employment level prior to a recession in history.

More importantly, as noted by Lakshman Achuthan and Anirvan Banerji via Bloomberg:

“A key part of the answer lies with jobs ‘growth,’ which has been slowing much more than most probably realize. Despite the better-than-forecast jobs report for June, the fact is the labor force has contracted by more than 600,000 workers this year. And we’re not just talking about the disappointing non-farm payroll jobs numbers for April and May.

Certainly, that caused year-over-year payroll growth, based on the Labor Department’s Establishment Survey – a broad survey of businesses and government agencies – to decline to a 13-month low. But year-over-year job growth, as measured by the separate Household Survey – based on a Labor Department survey of actual households – that is used to calculate the unemployment rate is only a hair’s breadth from a five-and-a-half-year low.”

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Question: Given the issues noted above, does it seem as if the entirety of the economy is as robust as stated by the mainstream media? More importantly, how does 1.5% annualized growth in employment create sustained rates of higher economic growth going forward?

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Prelude: One thing which is never 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 next chart shows the total increase in employment versus the growth of the working age population.

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Question: Just how “strong” is employment growth? Does it seem that 96%+ of the working-age population is gainfully employed?

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Prelude: The missing “millions” shown in the chart above is one of the “great mysteries” about one of 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 next several charts focus on the idea of “full employment” in the U.S. While Jobless Claims are reaching record lows, the percentage of full time versus part-time employees is still well below levels of the last 35 years. It is also possible that people with multiple part-time jobs are being double counted in the employment data.

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Question: With jobless claims at historic lows, and the unemployment rate below 4%, then why is full-time employment relative to the working-age population at just 50.10% (Only slightly above the 1980 peak)?

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Prelude: One of the arguments often given for the low labor force participation rates is that millions of “baby boomers” are leaving the workforce for retirement. This argument doesn’t carry much weight given the significantly larger “Millennial” generation that is simultaneously entering the workforce.

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.

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Question: At 50.38%, and the lowest rate since 1981, just how big of an impact are “retiring baby boomers” having on the employment numbers?

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Prelude: One of the reasons the retiring “baby boomer” theory is flawed is, well, they aren’t actually retiring. Following two massive bear markets, weak economic growth, questionable spending habits, and poor financial planning, more individuals over the age of 55 are still working than at any other time since 1960.

The other argument is that Millennials are going to school longer than before so they aren’t working either. The chart below strips out those of college age (16-24) and those over the age of 55. Those between the ages of 25-54 should be working.

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Question: With the prime working age group of labor force participants still at levels seen previously in 1988, just how robust is the labor market actually?

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Prelude: Of course, there are some serious considerations which need to be taken into account about the way the Bureau of Labor Statistics measures employment. The first is the calculation of those no longer counted as part of the labor force. Beginning in 2000, those no longer counted as part of the labor force detached from its longer-term trend. The immediate assumption is all these individuals retired, but as shown above, we know this is not exactly the case.

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Question: Where are the roughly 95-million Americans missing from the labor force? This is an important question as it relates to the labor force participation rate. Secondly, these people presumably are alive and participating in the economy so exactly how valid is the employment calculation when 1/3rd of the working-age population is simply not counted?

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Prelude: The second questionable calculation is the birth/death adjustment. I addressed this in more detail previously, but here is the general premise.

Following the financial crisis, the number of “Births & Deaths” of businesses unsurprisingly declined. Yet, each month, while the market is glued to the headline number, they additions from the “birth/death” adjustment go both overlooked and unquestioned.

Every month, the BLS adds numerous jobs to the non-seasonally adjusted payroll count to “adjust” for the number of “small businesses” being created each month, which in turns “creates a job.”  (The total number is then seasonally adjusted.)

Here is my problem with the adjustment.

The BLS counts ALL business formations as creating employment. However, in reality, only about 1/5th of businesses created each year actually have an employee. The rest are created for legal purposes like trusts, holding companies, etc. which have no employees whatsoever. This is shown in the chart below which compares the number of businesses started WITH employees from those reported by the BLS. (Notice that beginning in 2014, there is a perfect slope in the advance which is consistent with results from a mathematical projection rather than use of actual data.)

These rather “fictitious” additions to the employee ranks reported each year are not small, but the BLS tends even to overestimate the total number of businesses created each year (employer AND non-employer) by a large amount.

How big of a difference are we talking about?

Well, in the decade between 2006 and 2016 (the latest update from the Census Bureau) the BLS added roughly 7.6 million more employees than were created in new business formations.

This data goes a long way in explaining why, despite record low unemployment, there is a record number of workers outside the labor force, 25% of households are on some form of government benefit, wages remain suppressed, and the explosion of the “wealth gap.” 

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Question: If 1/3rd of the working-age population simply isn’t counted, and the birth-death adjustment inflates the employment roles, just how accurate is the employment data?

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Prelude: If the job market was as “tight” as is suggested by an extremely low unemployment rate, the wage growth should be sharply rising across all income spectrums. The chart below is the annual change in real national compensation (less rental income) as compared to the annual change in real GDP. Since the economy is 70% driven by personal consumption, it should be of no surprise the two measures are highly correlated.

Side Question: Has “renter nation” gone too far?

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Question: Again, if employment was as strong as stated by the mainstream media, would not compensation, and subsequently economic growth, be running at substantially stronger levels rather than at rates which have been more normally associated with past recessions?

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I have my own assumptions and ideas relating to each of these questions. However, the point of this missive is simply to provide you the data for your own analysis. The conclusion you come to has wide-ranging considerations for investment portfolios and allocation models.

Does the data above support the notion of a strongly growing economy that still has “years left to run?”  

Or, does the fact the Fed is considering cutting interest rates to stimulate economic growth suggests the economy may already be weaker than headlines suggest?

One important note to all of this is the conclusion from Achuthan and Banerji:

“But there’s even more cause for concern. Months from now, the Establishment Survey will undergo its annual retrospective benchmark revision, based almost entirely on the Quarterly Census of Employment and Wages conducted by the Labor Department. That’s because the QCEW is not just a sample-based survey, but a census that counts jobs at every establishment, meaning that the data are definitive but take time to collect. 

The Establishment Survey’s nonfarm jobs figures will clearly be revised down as the QCEW data show job growth averaging only 177,000 a month in 2018. That means the Establishment Survey may be overstating the real numbers by more than 25%.”

These facts are in sharp contrast to strong job growth narrative.

But then again, maybe the yield-curve is already telling the answer to these questions.

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

BRK.B – Berkshire Hathaway

• If the market is going to continue its rally on the expectation of “Fed rate cuts” then BRK.B is a way to play the broader market in a stock position.
• Just turning up onto a buy signal from fairly low levels is attractive.
• Buy at current levels.
• Stop level is $205

GOOG – Alphabet, Inc.

• We previously recommended going long GOOG, then shorting GOOG, and now we are suggesting going back long again.
• GOOG has gotten oversold and is lagging the rest of the tech market currently. With earnings season approaching there is upside potential for a trade.
• Buy at current levels as stop loss levels are very close.
• Stop-loss is currently $1100

CRM – Salesforce.com

• CRM has been holding support and consolidating for the last few months.
• With earnings season approaching, an upside surprise could give the position a lift and stop-loss levels are very close.
• Add a position at current levels.
• Stop loss is set at $150.

FAST – Fastenal Co.

• After a big run earlier this year, FAST has pulled back and is sitting on support.
• While on a sell signal currently, we want to remain cautious with positioning.
• Buy 1/2 position at current levels.
• Stop loss is tight at $30.50
• Add to position if FAST moves above #33
• Currently the position is not overbought and is close to registering a buy signal.
• Add a position to portfolios with a tight stop at $87

CVS – CVS Health Corp.

• We recently added a position in CVS to our portfolio as the buy signal is approaching.
• CVS is extremely beaten up and oversold after a brutal few months of selling.
• We are looking for a tradeable bounce in CVS back to the mid-70’s.
• Buy at current levels.
• Stop is set at $50 – honor thy stop.

SHORT CANDIDATES

AMTD – TD Ameritrade

• We had previously recommended a short-sell on AMTD and the recent break below consolidation suggests more downside to come.
• Short at current levels.
• Target for trade is $40
• Stop-loss is set at $52

CAT – Caterpillar

• CAT has been in a long-term downtrend but with earnings approaching a disappointing announcement due to China weakness and “Trade” will not be surprising.
• Short on a break below $130
• Target for trade is $110
• Stop loss is $140

AVGO – Broadcom, Inc.

• AVGO recently made an acquisition of a weak company with old technology. I think this will ultimately prove to be a mistake.
• With AVGO on a sell signal and close to breaking important support and decent short setup seems to be forming.
• Short on a break below $270
• Target is $210
• Stop loss is $290

AMC – AMC Entertainment

• We previously recommended a short on AMC.
• It is time to close that position out.
• Buy back and close the short position tomorrow.
• Short at current levels.
• Stop is set at $15.50
• Target for the trade is $13

HBI – HanesBrands

• HBI has been “taking it in the shorts” for a while. (I know, bad joke, but I couldn’t help it.)
• HBI is very close to registering a “sell signal” and remains overbought from the recent rally.
• Sell short on a break of support at $16
• Target is $12
• Stop is set at $17.50

 If you think the Fed may only lower rates by .50 or even .75, you may be grossly underestimating them.  The following article was posted for RIA Pro subscribers two weeks ago.

For more research like this as well as daily commentary, investment ideas, portfolios, scanning and analysis tools, and our new 401K manager sign up today at RIA Pro and test drive our site for 30 days before being charged.

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Currently, the December 2019 Fed Funds futures contract implies that the Fed will reduce the Fed Funds rate by nearly 75 basis points (0.75%) by the end of the year. While 75 basis points may seem aggressive, if the Fed does embark on a rate-cutting policy and history proves reliable, we should prepare ourselves for much more.

The prospect of three 25 basis point rate cuts is hard to grasp given that the unemployment rate is at 50-year lows, economic growth has begun to slow only after a period of above-average growth, and inflation remains near the Fed’s 2% goal.  Interest rate markets are looking ahead and collectively expressing deep concerns based on slowing global growth, trade wars, and diminishing fiscal stimulus that propelled the economy over the past two years. Meanwhile, credit spreads and stock market prices imply a recession is not in the cards.

To make sense of the implications stemming from the Fed Funds futures market, it is helpful to assess how well the Fed Funds futures market has predicted Fed Funds rates historically. With this analysis, we can hopefully avoid getting caught flat-footed if the Fed not only lowers rates but lowers them more aggressively than the market implies.

Fed Funds vs. Fed Funds Futures

Before moving ahead, let’s define Fed Funds futures. The futures contracts traded on the Chicago Mercantile Exchange (CME), reflect the daily average Fed Funds interest rate that traders, speculator, and hedgers think will occur for specific one calendar month periods in the future. For instance, the August 2019 contract, trades at 2.03%, implying the market’s belief that the Fed Funds rate will be .37% lower than the current 2.40 % Fed Funds rate. For pricing on all Fed Funds futures contracts, click here.

To analyze the predictive power of Fed Funds futures, we compared the Fed Funds rate in certain months to what was implied by the futures contract for that month six months earlier. The following example helps clarify this concept. The Fed Funds rate averaged 2.39% in May. Six months ago, the May 2019 Fed Funds future contract traded at 2.50%. Therefore, six months ago, the market overestimated the Fed Funds rate for May 2019 by .11%. As an aside, the difference is likely due to the recent change in the Fed’s IOER rate.

It is important to mention that we were surprised by the conclusions drawn from our long term analysis of Fed Funds futures against the prevailing Fed Funds rate in the future.

The graph below tracks the comparative differentials (Fed Funds vs. Fed Fund futures) using the methodology outlined above. The gray rectangular areas represent periods where the Fed was systematically raising or lowering the Fed funds rate (blue line). The difference between Fed Funds and the futures contracts, colored green or red, calculates how much the market over (green) or under (red) estimated what the Fed Funds rate would ultimately be. In this analysis, the term overestimate means Fed Funds futures thought Fed Funds would be higher than it ultimately was. The term underestimate, means the market expectations were lower than what actually transpired.

To further help you understand the analysis we provide two additional graphs below, covering the most recent periods when the Fed was increasing and decreasing the Fed Funds rate.

Data Courtesy Bloomberg

Data Courtesy Bloomberg

Looking at the 2004-2006 rate hike cycle above, we see that the market consistently underestimated (red bars) the pace of Fed Funds rate increases.

Data Courtesy Bloomberg

During the 2007-2009 rate cut cycle, the market consistently thought Fed Funds rates would be higher (green bars) than what truly prevailed.

As shown in the graphs above, the market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully. The dotted lines highlight that the market has underestimated rate cuts by 1% on average, but at times during the last three rate-cutting cycles, market expectations were short by over 2%. The market has underestimated rate increases by about 35 basis points on average.

Summary

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%?

We remind you that equity valuations are at or near record highs, in many cases surpassing those of the roaring 1920s and butting up against those of the late 1990s. If the Fed needs to cut rates aggressively, it will likely be the result of an economy that is heading into an imminent recession if not already in recession. With the double-digit earnings growth trajectory currently implied by equity valuations, a recession would prove extremely damaging to stock prices.

Treasury yields have fallen sharply recently across the entire curve. If the Fed lowers rates and is more aggressive than anyone believes, the likelihood of much lower rates and generous price appreciation for high-quality bondholders should not be underestimated.

The market has a long history of grossly underestimating, in both directions, what the Fed will do. The implications to stocks and bonds can be meaningful. To the extent one is inclined and so moved to exercise prudence, now seems to be a unique opportunity to have a plan and take action when necessary.

The New York Fed has the odds of a recession within the next year at 33%. Some of the other models are humorous.

New York Fed Treasury Spread Model

The New York Fed Recession Model is based on yield curve inversions between the 10-year Treasury Note and the 3-Month Treasury Bill.

I added the highlights in yellow and the dashed red line.

The model uses monthly averages.

Smoothed Recession Odds

I do not know the makeup of the smoothed recession chart but it is clearly useless. The implied odds hover around zero, and are frequently under 20% even in the middle of recession.

GDP Recession Model

The GDP-based recession model is hugely lagging. The current estimate is 2.4%. This model will not spike until there is at least one quarter of negative or near-zero GDP.

Estimated Recession Probabilities

Predicting Recessions

The above chart is from the Yield Curve as a Predictor of U.S. Recessions by Arturo Estrella and Frederic S. Mishkin. It is from 1996 so the table may have been revised.

Practical Issues

One might also wish to consider the 2006 discussion the Yield Curve as a Leading Indicator: Some Practical Issues.

With regard to the short-term rate, earlier research suggests that the three-month Treasury rate, when used in conjunction with the ten-year Treasury rate, provides a reasonable combination of accuracy and robustness in predicting U.S. recessions over long periods.

Maximum accuracy and predictive power are obtained with the secondary market three-month rate expressed on a bond-equivalent basis, rather than the constant maturity rate, which is interpolated from the daily yield curve for Treasury securities.

Spreads based on any of the rates mentioned are highly correlated with one another and may be used to predict recessions. Note, however, that the spreads may turn negative—that is, the yield curve may invert—at different points and with different frequencies.

Our preferred combination of Treasury rates proves very successful in predicting the recessions of recent decades. The monthly average spread between the ten-year constant maturity rate and the three-month secondary market rate on a bond equivalent basis has turned negative before each recession in the period from January 1968 to July 2006 (Chart1). If we convert this spread into a probability of recession twelve months ahead using the probit model described earlier (estimated with Treasury data from January 1959 to December 2005), we can match the probabilities with the recessions (Chart 2). The chart shows that the estimated probability of recession exceeded 30 percent in the case of each recession and ranged as high as 98 percent in the 1981-82 recession.

Other Spreads

The article mentions “The ten-year minus two-year spread tends to turn negative earlier and more frequently than the ten-year minus three-month spread, which is usually larger.“

That is certainly not the case today.

The 2-year yield is 1.882 whereas the 10-year yield is 2.041.

Chalk this up to QE, Fed manipulation, taper tantrums, and hedge funds front-running expected rate cut moves.

Investors are in a buying mood despite many economic warning signs. Why?

For some, it’s because they expect the Federal Reserve to cut interest rates and otherwise “stimulate” the economy. They believe (correctly) it would drive stock and real estate prices higher.

At the risk of stating the obvious… higher asset prices mainly benefit those who own the assets. Which, in the stock market’s case, is not most Americans.

The ordinary worker’s main asset is the income stream from their job. Lower interest rates don’t necessarily help them.

Nonetheless, that seems to be what the Fed will give us, if President Trump gets his way.

Convenient Timing

The Federal Funds rate, the Fed’s overnight benchmark, is historically low right now. But with zero rates now a more recent memory than 5% rates, it seems high to many folks. President Trump is one of them.

The weird part is that Trump appointed most of the Fed governors whom he now calls incompetent. If he wanted doves, many were available. He didn’t pick them and now blames everyone but himself for the results.

But set that aside. Fed chair Jerome Powell says they respond to data, not presidential jawboning.

I used to think that was true. Now, I’m not so sure.

Amid the drip-drip-drip, it’s easy to lose sight of the timeline. Bloomberg has a handy digest of Trump’s Federal Reserve comments. His first hit was almost a year ago: July 19, 2018.

“I’m not thrilled” the central bank is raising borrowing costs and potentially slowing the economy, [Trump said] in an interview with CNBC. “I don’t like all of this work that we’re putting into the economy and then I see rates going up.”

It got worse from there, but the Fed seemed unperturbed. Powell and the FOMC kept raising rates and markets dropped last fall. After the December rate hike and some especially hawkish Powell comments, Trump reportedly discussed firing Powell.

(I reported months earlier that Trump appeared to have that power, though I didn’t predict he would use it.)

Anyway, six weeks after the December rate hike, the Fed made a remarkably convenient reversal. The committee was suddenly sure rates were high enough.

Was it coincidence the Fed changed course right after Trump raised the pressure? Maybe. But other things were happening behind the scenes.

Private Dinner

Here’s a little-known fact for you. The Fed chair’s daily calendar is public record. You can see it on the Federal Reserve website after a two-month delay.

Powell’s schedule is pretty boring: mostly meetings and phone calls with Fed officials and other central bankers.

Last January—between those two FOMC meetings in which the Fed changed its mind—Powell had several contacts with Treasury Secretary Steven Mnuchin.

He also met White House economic advisor Larry Kudlow, as well as Goldman Sachs (GS) CEO David Solomon and several members of Congress.

Those aren’t necessarily unusual. Look at other months and you’ll see Powell and Mnuchin talk frequently. About what? We don’t know.

Still, high officials have busy schedules. These probably weren’t social calls. Maybe somebody delivered Powell a, ahem, “message.”

On February 4, Powell had a private dinner with Secretary Mnuchin and President Trump. Then the next day a meeting with Senate Majority Leader Mitch McConnell.

Possibly this was all normal business… but given that period’s pivotal events, it’s fair to wonder.

And it’s a fact that since then, the Fed has avoided raising rates, just as Trump wanted. It hasn’t cut rates (yet) and may not. And Trump is still making threats.

So one interpretation is that Powell tried to mollify Trump by meeting him halfway, but Trump isn’t satisfied. He clearly wants lower rates, not just stability.

What if he gets them?

Path to Japan

This used to be pretty simple. When the economy slowed, the Fed would cut rates. This encouraged borrowing and investment. People bought houses. Businesses expanded and hired people. The economy would recover.

Now, it doesn’t seem to work that way. My friend Peter Boockvar succinctly explained why in one of his recent letters. The problem is that “easy money” stops working when it becomes normal, as it now is.

“[When easy money is] a permanent state of being, it doesn’t incentivize any new economic behavior to happen today instead of tomorrow.”

Bingo. Lower rates don’t encourage borrowing unless potential borrowers think it’s a limited-time opportunity. Which they don’t anymore, and shouldn’t, since the Fed shows no sign of ever going back to what was once normal.

That’s not just me. The FOMC’s own projections show they think 2.5% is now the “longer run” normal. Even the most hawkish foresee only 3.3%.

When this is also the president’s stated desire, it is very hard to foresee the Fed raising rates significantly higher than they are now. Hence, rate cuts probably won’t do much to stimulate the economy.

Nonetheless, lower rates from here would have effects. They would…

• Inflate stock and real estate prices even more,

• Cut returns for retirees and small savers, and

• Reduce the federal government’s borrowing costs.

That last point may be significant. As John Mauldin showed last weekend, there is simply no way to balance the budget with interest rates where they are now. Maybe that is Trump’s concern.

Or maybe not. Lower rates would also help, say, highly leveraged real estate developers.

What rate cuts won’t do, in my opinion, is prevent or even mitigate the next recession. More likely, they will push the US further down the same path Japan is now on: decades of slow growth, enormous debt, and social stress.

That’s the best case. The worst one?

You don’t want to think about it.

The Medicare Rights Center a national non-profit consumer advocacy organization, fields thousands of questions as it assists older adults to make sense of the complexity of Medicare.

The Center publishes its Medicare Trends and Recommendations report each year; the work is a highlights compilation of the roughly 15,000 helpline questions and 3 million online queries fielded by staff and volunteers. Their Medicare interactive web pages garner millions of views per year. So, if you have questions about Medicare believe me, you’re not alone!

Three main areas of concern provide crucial insight for those who are new to Medicare enrollment or face ongoing healthcare cost challenges.

1. Complex enrollment periods are a mess to navigate.

There’s no rhyme or reason to Medicare enrollment – the structure of initial enrollment, special enrollment, general enrollment periods date back to the creation of Medicare in 1965. Perhaps it made sense in the beginning. Today, many recipients experience gaps in healthcare coverage or are subject to permanent penalties for late enrollment due to confusion and lack of a formal notification process.

When dramatic U.S. workplace and healthcare changes are considered, 1965 standards may as well be 1865. The Labor Force Participation Rate for those 65 & older has increased dramatically since 2000 which also means more workers are covered longer by employer-based healthcare plans. It’s also apparent two devastating bear markets coupled with prolonged wage stagnation have fueled the trend to retire later or return to work.

Better education about Social Security is helping a growing number of future recipients defer benefits. In addition, full retirement age for Social Security purposes is 66 for those born between 1943 and 1954. In other words, these changes mean prospective recipients must juggle multiple complex Medicare enrollment timelines to actively enroll. Those already receiving Social Security benefits before 65 are automatically enrolled in Medicare Part A and B.

The public’s understanding of how and when to enroll in the Medicare alphabet soup of benefits including Prescription Part D is amiss.

The bipartisan Beneficiary Enrollment Notification and Eligibility Simplification (BENES) Act is designed to bring the Medicare enrollment process into this century (finally).

Through the BENES Act, the Federal Government would initiate two notices to individuals who are near to eligibility for Medicare. First notice would arrive six months before an individual’s initial enrollment period; another one month before the IEP.

Most important, the Act looks to fix the fragmented Part B enrollment periods by eliminating coverage gaps between initial and general enrollment periods. For example, initial enrollment period begins the first day of the third month before your 65^th birthday and extends for 7 months. Coverage begins the first day of your birthday month; if you sign up after your birthday month yet still within the initial enrollment period, then coverage begins on the first of the month following enrollment.

If you miss open enrollment, your next window of opportunity opens during general enrollment which starts January 1 through March 31^st of every year, with coverage beginning July 1.

Let’s use my birth day and month for illustration purposes. Also, assume I don’t have qualified healthcare coverage with an employer. Let’s say I turned 65 last March and in August I realize I missed my initial enrollment window. Tough luck for me. I’m expeditious to get on track. During general enrollment in January 2020, I get it done. On July 1, 2020, my Medicare coverage begins. In September, I decide to retire, or most likely, Lance gets tired of my jokes and has the locks changed on my office door.

Unless I purchase coverage in the open marketplace, I am financially exposed to a catastrophic healthcare event until July 1, 2020. Thankfully, I dodged the Part B penalty bullet because fewer than 12 months had elapsed. Reminder: The penalty increases permanently the Part B premium by 10% for each twelve-month period missed. In 2017, it’s estimated that 701,000 people were paying late enrollment penalties for failing to sign up for Medicare Part B during the appropriate enrollment period. The average penalty was an onerous 30% increase to monthly premiums.

The BENES Act looks to eliminate gaps in healthcare coverage such as my example above.

In addition, BENES seeks to align general enrollment with existing enrollment periods for Medicare Advantage and Part D prescription drug plans. So, when you’re bombarded by media ads and mailers from October 15 through December 7 every year, you’ll also know that’s time to enroll in original Medicare Part A & B if you missed initial enrollment.

Currently, the government is unforgiving when it comes to waiving permanent Part B penalties. BENES creates a path for consumer-friendly relief.

According to Govtrack, this bill is in the first stage of the legislative process. It was introduced into Congress on May 2, 2019. I passionately hope during such a dysfunctional time for Congress, both sides can see the overwhelmingly positive impact this bill would have on our nation’s older adults.

1. Yes, you can appeal Medicare Advantage denials of care. Don’t give up.

Medicare Advantage or all-inclusive HMO-type plans are growing en masse which also means more confusion over selecting a plan, changing a plan, how coverage is approved per procedure, pre-procedure; how coverage may differ or not apply depending on a doctor or hospital and the astounding confusion over why certain life-saving operations and treatments are denied even though MA-approved doctors require them. Per Medicare Rights based on a report from the Office of Inspector General, only 1% of Medicare Advantage enrollees appeal denied claims. Yet for those who do appeal, the report found that plans reverse 75% of their own decisions.

Our advisors prefer Original Medicare coupled with Medigap PPO and Part D supplemental plans as they resemble plans most of us are used to at our employers; procedures covered are comprehensive.

2. The costs of prescription drugs remain a major concern.

The cost of drugs in some cases, is a decision between life or death.

Keep in mind, half of all Medicare recipients live on incomes below $26,200. Those with adequate Prescription D coverage contact Medicare Rights seeking assistance with drug costs Part D won’t cover or cover in full. Obviously, there must be greater transparency in pricing and the ability for Medicare to negotiate.

The Medicare Rights Center is a much-needed protection and advocacy program with many commonsense ideas on how to improve the program. They are also a frontline, in the trenches partner for Medicare enrollees and caregivers who are desperate for help to navigate a complicated system.

Check out their content at www.medicarerights.org.

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.

WELL – Welltower, Inc.

• Last week, we added a full position weight of WELL to our portfolio. This fits within our dual theme of an aging demographic and a shift to “safety” over “risk” within allocations.
• With a 4% yield, the total return continues to be attractive.
• The position is overbought and on an elevated “buy” signal so we are keeping a close stop on the position currently.
• Added the position at $83.59
• Stop loss now moves up to $80.

AGNC – AGNC Investment Corp.

• We recently added 1/2 positions in two “agency” REIT’s to potentially hedge against a steepening yield curve.
• With a 12% dividend yield we like the total return aspect while we wait for the our thesis to work.
• The recent rise has not yet triggered a “buy” signal so we can’t add to the position yet, however, the deep oversold condition currently suggests plenty of upside.
• We are moving up stops up to $16.25

NLY – Annaly Capital Mgmt.

• NLY is the second position in our “agency” play.
• Like AGNC, the position has rallied carries a 11% yield for a nice total return play.
• Stop-loss is moved up to $8.50

CHCT – Community Healthcare Trust

• In our “healthcare” REIT exposure theme, we have been long CHCT for a while.
• We continue to hold our position for now and will likely take some profits very soon and rebalance the position as the overbought condition is getting rather extreme.
• Our stop is moved up to $38

AAPL – Apple, Inc.

• AAPL was recently downgraded on outlook for iPhone sales. Expectations for earnings have already been reduced markedly so we are expecting a positive surprise from earnings.
• We have already clipped 20% of the position back in May for a nice profit and will look to buy any significant weakness that doesn’t break support or the longer-term bullish trend.
• Stop-loss remains at $180

COST – Costco Wholesale

• Defensive positioning continues to perform well in this current market advance and COST continues to rise.
• We will likely take profits again soon and rebalance for a second this year as the extension above the long-term moving average is reaching extremes.
• Stop loss is moved up to $240

HCA – HCA Healthcare

• HCA struggled for a while, but has turned up recently.
• The previously “sell signal” is close to reversing which keeps us long our position for now.
• We may look to increase our weighting.
• Stop-loss is moved up to $120

JNJ – Johnson & Johnson

• Along with our defensive themes, JNJ continues to perform well.
• We continue to hold our weighting in JNJ and may look to increase exposure if the “buy signal” turns up and confirms the recent break above consolidation.
• Stop-loss is moved up to $132.50

NSC – Norfolk Southern

• NSC has been consolidating over the last several weeks and the previous “buy signal” is close to reversing.
• We have already taken profits and would like a correction to work off some of the overbought condition so we can add to our holding.
• Stop loss is moved up to $182.50

PPL – PPL Corp.

• PPL simply hasn’t performed all that well since adding it to the portfolio but we like the defensive positioning and the 5% yield.
• However, with the recent addition of WELL, we are carrying an extra position in the portfolio.
• During our next profit taking/rebalancing exercise PPL will be removed from the portfolio.
• We are moving our stop-loss up to $30

With June now officially in the books, we can take a look at our long-term monthly indicators to see what they are telling us now.

Does the recent breakout to “all-time highs” mean the bull market is finally back?

Or, is this breakout doomed to failure as the previous breakouts have been?

That’s the answer we all want to know.

Each week on RIA PRO we provide an update on all of the major markets for trading purposes.

(See an unlocked version here. We also do the same analysis for each S&P 500 sector, selected portfolio holdings, and long-short ideas. You can try RIA PRO free for 30-days.)

However, as longer-term investors and portfolio managers, we are more interested in the overall trend of the market. While it is fundamental analysis derives “what” we buy, it is the long-term “price” analysis which determines the “when” we buy and sell in our portfolio management process.

For us, the best way to measure the TREND of the market is through longer-term weekly and monthly data. Importantly, when using longer-term data, the signals are only valid at the end of the period. It is not uncommon for signals to be triggered and reversed during the middle of the period which creates “false” signals and poor outcomes. Since we are more interested in discerning changes to the overall “trend” of the market, we find monthly indicators, which are slow-moving, tend to reveal this more clearly.

In April of 2018, I penned an article entitled “10-Reasons The Bull Market Ended” in which we discussed the yield curve, slowing economic growth, valuations, volatility, and sentiment. While volatility and sentiment have gone back into complacency, the fundamental and economic backdrop has deteriorated further. Had you heeded our warning then, you could have saved yourself some pain.

But, if you did hold on, and ride it out, your portfolio is now 4% higher than it was at the peak of the market in January 2018. That is an average return, so far, of 2.67% which is only slightly higher than the yield from a 10-year treasury.

However, bond holders earned a total return of nearly 7% during the same period with much lower volatility.

As I noted in this past weekend’s missive, while the mainstream media and Wall Street prognosticates “stock ownership” as the way to build wealth, you might want to ask bond holders exactly what they missed out on.

Perspective is important.

For example, in June, the market rallied 6.89% which was touted as one of the “best June months on record.” While the statement was true, it lost perspective when compared to the May decline of -6.58%, which was also one of the “largest monthly losses” on record. More importantly, the June rally failed to recoup the May losses.

(Fun with numbers: it took a 6.9% advance to repair a 6.58% decline. This is why measuring performance in percentage terms is deceiving.)

As noted, monthly data, while very slow moving, reveals longer-term signals which can uncover changes to the overall market trend which short-term market rallies can obfuscate.

The chart shows the monthly buy/sell signals stretched back to 1999. As you will see, these monthly “buy” and “sell” indications are fairly rare. During the entirety of that period, only the 2015-2016 signal didn’t evolve into a deeper correction as Central Bank interventions flooded the markets with liquidity to stem the risk of a disorderly “Brexit” and slower economic growth.

Currently, we are once again facing slower global economic growth, the potential of a disorderly “Brexit,” “trade wars,” an “earnings recession,” “negative yields globally,” a potential bank problem with “Deutsche bank,” and geopolitical upheaval.

Yet markets remain near highs currently hoping “Central Banks” will once again come to the rescue. They may try, but there is a more than significant chance further accommodative measures may have little or no effect. As I noted recently, the Fed is likely “pushing on a string.”  

Or, more simplistically, as Doug Kass noted in his daily missive on Monday:

“The markets are underpricing risk.” 

With the summer months upon us, when have a tendency to display both weakness and higher levels of volatility, it tends to pay to “err to the side of caution.”

“But this time is different because of ‘_(fill in the blank__’”

We can take those same monthly indicators and review them going back to 1950. I have added two confirming monthly indicators as well, so the vertical “red dashed lines” are when all three indicators have aligned which reduces false signals.

I can’t believe I actually have to write the next sentence, but if I don’t I invariably get an email saying “but if you sold out, you missed the whole rally.”

What should be obvious is that while the monthly “sell” signals have gotten you out to avoid more substantial destructions of capital, the reversal of those signals were signs to “get back in.”

Investing, long-term is about both deployment of capital and the preservation of it.

Currently, the monthly indicators have all aligned to “confirm” a “sell signal” which since 1950 has been somewhat of a rarity. Yes, the recent signal could turn out to be a “1987” scenario where the market rallied immediately back and reversed the signals back to a “buy” a few months later. Or this could be the beginning of a more substantial corrective process over the course of many months.

Unfortunately, we won’t know for sure until we get there.

This why we pay attention to these indicators to give us “clues” about potential risks so we can hedge portfolios accordingly. If you “wait” to be “sure,” well, it is generally too late by that point to do anything meaningful about it.

One of the biggest reasons not to equate the current monthly “sell” signal to a “1987” type period is valuations. In 1987, valuations were low and rising at a time where interest rates and inflation were high and falling. Today, that economic and valuation backdrop are entirely reversed. Currently, a correction from current price levels of the market to PE20 (20x current earnings) would be another 10.10% decline. However, a drop back to the long-term average of PE15 would entail a 32% decline and a reversion to PE10, which would be required to “reset” the market, would be a fall of 55.3%.

Still not convinced?

I get it.

Emotionally, the hardest thing for investors to do is to sit on their hands and avoid “risk” when the markets are rising. But this is the psychological issue which plagues all investors over time, which is to “buy high”and “sell low.”

It happens to everyone.

This is why we use technical signals to help reduce the “emotional” triggers that lead to poor investment decisions over the long-term. As I have noted before, the following chart is one of my favorites because it combines a litany of confirming signals all into one monthly chart.

Despite the recent rally, which has pushed prices back above their longer-term moving average, the longer-term trends of the signals remain “non-confirming” of the recent rally.

While the technical signals do indeed lag short-term turns in the market, they currently do not support the “bullish narrative” of the market. Rather, and as shown in the chart above, the negative divergence of the indicators from the market should actually raise some concerns about longer-term capital preservation.

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 is back to extreme overbought and challenging resistance.
• With the trade deal put on hold, temporarily, XLB got a boost on hopes one may be completed someday. However, it is likely more tariffs are coming so take profits and rebalance portfolio risk.
• 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 moved up to $57
• Long-Term Positioning: Bearish

Communications

• XLC has mustered a moderate rally which has been less than inspiring.
• While on a buy signal, XLC is back to very overbought. If you are still long positions, take profits and reduce exposure.
• Short-Term Positioning: Neutral
  • Last Week: Hold trading positions, but take profits.
  • This Week: Hold trading positions, but take profits.
  • Hard Stop set at $47.50
• Long-Term Positioning: Bearish

Energy

• Currently, XLE is running into the 200-dma, take profits and rebalance risk accordingly. If this level proves to be resistance, a retest of recent lows is probable.
• The “sell-signal” remains intact for now but is trying to reverse. A break above the 200-dma would clear the way for a move higher, but wait for the break first.
• Short-Term Positioning: Neutral
  • Last week: Hold current position
  • This week: Hold current position, add to holding on a break above the 200-dma.
  • Stop-loss adjusted to $62
• Long-Term Positioning: Bearish

Financials

• XLF has rallied and is now testing, and trying to clear previous resistance.
• XLF remains on a “buy” signal currently but is back to extreme overbought.
• Short-Term Positioning: Neutral
  • Last week: Recommended “hold” 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss moved up to $25.00
• Long-Term Positioning: Bearish

Industrials

• XLI has failed to rally to a new high, and the previous triple top remains formidable resistance.
• Our stop level has held for now and XLI is rallying back to overhead resistance.
• With the “trade war” on hold for now, there is upside to the “triple top.” Take profits.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position.
  • Stop-loss moved up to $76 to protect gains.
• Long-Term Positioning: Neutral

Technology

• XLK has reversed back to an overbought condition and has pushed out to new highs although the breadth of that breakout remains suspect.
• XLK has been driven by the largest cap-weighted companies so it may be prudent to remain cautious for now.
• The buy signal remains intact, which is bullish, but is back to extreme overbought. Risk vs reward is not optimal currently.
• Short-Term Positioning: Bullish
  • Last week: Hold 1/2 position
  • This week: Hold 1/2 position
  • Stop-loss moved up to $75 to protect gains.
• Long-Term Positioning: Neutral

Staples

• Defensive positions cooled off a bit after an exceptionally strong rally. It didn’t last long as “defensive positioning” continues to lead the markets higher.
• XLP is grossly extended. and the buy signal is very elevated.
• We previously recommended taking profits but maintaining holdings.
• The “buy” signal (lower panel) is still in place and is back to very extended. We continue to recommend taking some profits if you have not done so.
• XLP was oversold and we stated additional gains were likely. $56.50 was initial resistance which was taken out with new all-time highs.
• Short-Term Positioning: Bullish
  • Last week: Hold positions, take profits if needed.
  • This week: Hold positions, take profits if needed.
  • Profit stop-loss moved up to $57.50
• Long-Term Positioning: Bullish

Real Estate

• XLRE, like XLP, had broken out to all-time highs as “defense” was attracting flows.
• We previously recommended taking profits and rebalancing risk as the overbought condition needed to be corrected.
• That correction did not last long and real estate is back testing all-time highs.
• Buy signal is being reduced along with the “buy signal” but more works needs to be done.
• Short-Term Positioning: Bullish
  • Last week: Holding position.
  • This week: Hold position.
  • Stop-loss adjusted to $36.00 for profits.
  • Long-Term Positioning: Bullish

Utilities

• XLU, is back to extremely overbought so a correction is expected again.
• 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 worked off some of the excess. (bottom panel) and the overbought condition is also on the mend.
• Short-Term Positioning: Bullish
  • Last week: Hold overweight position
  • This week: Hold overweight position
  • Stop-loss moved up to $57.50.
• Long-Term Positioning: Bullish

Health Care

• Sell-signal (bottom panel), as anticipated, has reversed to a buy signal.
• XLV performance improved markedly but after a big run, the current correction was expected.
• XLV is back to overbought so $90 is important support.
• Short-Term Positioning: Neutral
  • Last week: Hold current position (overweight)
  • This week: Hold current position (overweight)
  • Stop-loss moved up to $90 to protect profits.
• Long-Term Positioning: Neutral

Discretionary

• With AMZN and AAPL now considered discretionary stocks, it is not surprising to see XLY rise and fall with XLK and XLC as those two major stocks rallied last week and on Monday.
• The “buy” signal has been reduced and is holding up and XLY is now breaking out to all-time highs although participation remains weak.
• XLY is back to extreme overbought, so take profits on this rally and wait to see what happens next.
• Short-Term Positioning: Neutral
  • Last week: Hold 1/2 of 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 reversed its buy signal (bottom panel) and while the sector is bouncing off of an oversold condition, there is a lot going wrong.
• We noted two weeks ago to “look for a failed rally to $60 to sell into if you are still long positioning.”
• As we have been saying for several weeks, our “sell stop” was triggered previously. No real need to rush back into adding a new position. We will watch and see what happens.
• Short-Term Positioning: Neutral
  • Last week: No position
  • This week: No position
• Long-Term Positioning: Bearish

As central banks have become collectively more dovish throughout 2019, monetary stimulus appears to be back in control of the economic cycle. The Federal Reserve ratcheted up their easing posture at the June Federal Open Market Committee (FOMC) meeting as one voting member dissented from the group in favor of a rate cut. There were other non-voting members even arguing for a 50 basis point rate cut on concerns about the economic outlook and still muted inflation pressures. Keep in mind this abrupt flip in policy is coming despite unemployment at near half-century lows and inflation hovering around 2.0%, the supposed Fed target.

With that backdrop in play, it is no surprise that June was a good month for all risk assets. Within the Fixed income arena, the riskiest of bonds outperformed against the spectrum of safer fixed-income products. As the table below highlights, every major category performed well with emerging markets (EM) leading the way and investment grade (IG) and high yield (HY) corporate returns close behind.

Fixed income has now completed a “round trip” from June 2018 as yields and spreads in almost every category are back below the levels observed at the same time last year. The tables below illustrate those moves in both yields and spreads.

The anticipation of what is being called “insurance rate cuts” from the Fed as well as easing measures expected from the European Central Bank (ECB), offered investors comfort that these potential actions will keep downside risk and volatility at bay. The hope is that the central bankers are sufficiently ahead of the curve in combating weaker global growth.

Despite investor optimism about the outlook as evidenced in the first half performance, risks remain. Most notably, ongoing deceleration in trade and industrial activity could worsen and bring an end to the current record-long economic U.S. expansion. The United States is surrounded by economies that are faltering, including Canada, Australia, Europe, Japan, much of southeast Asia and, most importantly, China. The Trump trade policy agenda only adds to these risks, especially for those countries dependent on exports for economic growth.

If risks do not abate, then we should expect forceful actions from central bankers. The common response of Treasury yields and the yield curve is for the short end (out to two- or three-year maturities) to drop significantly and the long end to either hold steady or fall but much less so than short rates resulting in what is called a bullish curve steepener. As we discussed in Yesterday’s Perfect Recession Warning May Be Failing You, past episodes of rate cuts illustrate this effect.

With investors complacent, yields and spreads on risky assets back to extremely rich levels, and global trouble brewing, the pleasant by-product of recent Fed rhetoric might quickly be disrupted. If so, the gains of the first half of 2019 would become a vague memory.

Apart from slowing global trade and industrial activity, keep in mind there are plenty of other potentially disruptive issues at hand including China leverage, Brexit, the contentious circumstances between the U.S. and Iran, the Italian government fighting with the European Commission on fiscal issues, Turkish currency depreciation, on-going problems in Argentina and more.

At the moment, the Fed and the ECB appear to have the upper hand on the markets, and higher yielding asset alternatives that reward an investor for taking risk are benefiting. Still, a critical assessment of the current landscape demands that investors engage and think critically about the risk-reward trade-off under current circumstances. The Fed and the ECB are not hyper-cautious and dovish for no reason at all. There is more to the current economic dynamic than meets the passive observer’s eye.

All Data Courtesy Barclays

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

• Last week, we suggested the current setup, “suggests a bit more rally could occur next week given comments from both the Fed and the G-20 summit are on deck. That remains the case this week.”
• We may be at the limits of that rally for now but given that last week was an extremely light trading week due to the holiday, we will hold until Monday to see what happens next.
• The market is back to very overbought short-term so a bit of a correction is needed to add to our position.
• Short-Term Positioning: Bullish
  • Last Week: Hold position
  • This Week: Hold position.
  • Stop-loss adjust to $275
  • Long-Term Positioning: Neutral due to valuations

Dow Jones Industrial Average

• Last week, we noted DIA did break out to new highs and triggered a short-term buy signal.
• DIA is very overbought short-term, so like SPY above, we will look for a better entry point to suggest adding weighting to portfolios.
• Short-Term Positioning: Neutral
  • Last Week: Hold current positions
  • This Week: Hold current positions.
  • Stop-loss moved up to $252.50
• Long-Term Positioning: Neutral

Nasdaq Composite

• QQQ rallied from the oversold condition and is now back to very overbought.
• We noted previously the market could rally further into previous resistance from the August/September highs of 2018. The rally has been fairly weak, but it did get above last years resistance levels. New highs are being challenged so we will see if they can hold into next week.
• 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)

• As noted several weeks ago, SLY has fallen apart as market participation has weakened. SLY, and MDY are particularly susceptible to “trade wars” and slowing economic growth.
• Last week, SLY did break above the 200-dma but remains confined to a very negative downtrend.
• SLY is close to triggering a short-term buy signal so that could help small-caps gain ground if they can hold up.
• 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.
• MDY did regain its 200-dma but the rally has been weak.
• Mid-caps did rally this past week and are now very overbought. Take profits if you are long and tighten up stops.
• Short-Term Positioning: Neutral
  • Last Week: Use any further rally this week to sell into.
  • This Week: Use any further rally this week to sell into.
• Long-Term Positioning: Bearish

Emerging Markets

• EEM rallied back to the top of its downtrend channel on news that the ECB will potentially cut rates and increase QE programs.
• We previously added a small trading position to the long-short portfolio which has minimal success so far.
• Short-Term Positioning: Bearish
  • Last Week: Hold current position
  • This Week: Hold current position
  • Stop-loss set at $41
• Long-Term Positioning: Neutral

International Markets

• Like EEM, EFA rallied on news the ECB will leap back into action to support markets.
• Last week, EFA broke above its downtrend line while maintaining a “buy signal.”
• We did add a trading position to our long-short portfolio model.
• EFA is maintaining its 200-dma which is positive but the overall trend is concerning.
• Short-Term Positioning: Neutral
  • Last Week: Hold position
  • This Week: Hold position.
  • Stop-loss is set at $64
• Long-Term Positioning: Neutral

West Texas Intermediate Crude (Oil)

• Oil rallied into resistance at the 50% retracement and the 200-dma and failed.
• As noted last week:
  • “The market remains in a major downtrend and the current bounce in oil prices is likely just that with $59 providing the most likely top.”
• That did turn out to be the case and now support is at the $55 level.
• Oil is not overbought yet, and is close to registering a buy signal.
• Short-Term Positioning: Neutral
  • Last Week: No position
  • This Week: No position, but look for pullback to $54 to add a trading position.
  • Stop-loss for new positions is $50.
• Long-Term Positioning: Bearish

Gold

• Gold has quickly reversed its oversold condition to extreme overbought and has also broken above important overhead resistance.
• The “buy” signal has quickly surged to historically high levels which suggests the rally could be done for the moment, so look for a pullback to add gold to portfolios if you haven’t done so already.
• Gold is too extended to add to positions here. Look for a pullback to $127-128 to add.
• Short-Term Positioning: Neutral
  • Last week: Hold positions.
  • This week: Hold positions
  • Stop-loss for whole set at $126
• Long-Term Positioning: Neutral

Bonds (Inverse Of Interest Rates)

• Bonds prices have gone parabolic and are now at extremes. Even the “buy” signal on the bottom panel has reached previous extremes which suggests a reversal in rates short-term is likely.
• Currently on a buy-signal (bottom panel), bonds are now back to extremely overbought and need to pullback, which should be coincident with a further rally in equities in the next couple of weeks.
• Strong support at the 720-dma (2-years) (green dashed line) which is currently $119.
• Short-Term Positioning: Bullish
  • Last Week: Take profits and rebalance risks. A correction IS coming which will coincide with a bounce in the equity markets into the end of the month.
  • This Week: Same as last week.
  • Stop-loss is moved up to $126
  • Long-Term Positioning: Bullish

U.S. Dollar

• Comments from the Fed about more accommodative policies tripped up the dollar previously, but as noted last week, the dollar has gotten extremely oversold.
• The dollar did rally and is currently trying to hold support at its 200-dma. There is likely more rally to go next week particularly if it looks like the Fed will not reduce rates in July.
• The dollar is back to very oversold, so a rally above $96 will put the dollar back on our radar.
• Short-Term Positioning: Bullish
  • Last Week: No Position
  • This Week: No Position
  • Stop-loss at $96 was violated.

Last week, President Trump nominated Judy Shelton to a board seat on the Federal Reserve. Shelton has been garnering a lot of “buzz” because of her outspoken and alternative stances, including “zero interest rates” and a “gold standard” for the U.S. dollar.

But, Shelton is full of inconsistent and incongruous views on monetary policy. For instance, in 2017 she stated:

“When governments manipulate exchange rates (by changing interest rates) to affect currency markets, they undermine the honest efforts of countries that wish to compete fairly in the global marketplace. Supply and demand are distorted by artificial prices conveyed through contrived exchange rates. Businesses fail as legitimately earned profits become currency losses,”

In short, when the Fed, or any central bank/government, lowers or raises interest rates it directly affects the currency exchange rates between countries and, ultimately, trade.

However, when recently asked on her views about whether the Fed should cut rates to boost economic growth, she said:

“The answer is yes.”

So, the U.S. should lower rates as long as it is beneficial for the U.S., but no one else should be allowed to do so because it is “unfair” to U.S. businesses.

Hypocritical?

This is also the same woman who supports a return to the “gold standard” for the U.S. dollar. With a limited supply of gold and a massive level of global trade based on the U.S. dollar reserve system, the value of the dollar would skyrocket effectively collapsing the entire global trade system. Zero interest rates and “gold back dollar” can not co-exist.

Shelton’s nomination by Trump is not surprising as he has been lobbying the Fed to cut rates in the misguided belief it will support economic growth. Shelton, who has been supportive of Trump’s views, recently stated her support to the WSJ which again shows her ignorance as to the actual workings of the economy.

“Today we are seeing impressive gains in productivity, which more than justify the meaningful wage gains we are likewise seeing—a testimonial to the pro-growth agenda. The Fed’s practice of paying banks to keep money parked at the Fed in deposit accounts instead of going into the economy is unhealthy and distorting; the rate should come down quickly as the practice is phased out.”

Well, this is the point, as we say in Texas, “We call Bulls**t.” 

As shown, the U.S. is currently running at lower levels of GDP, productivity, and wage growth than before the last recession. While this certainly doesn’t confirm Shelton’s analysis, it also doesn’t confirm the conventional wisdom that $33 Trillion in bailouts and liquidity, zero interest rates, and surging stock markets, are conducive to stronger economic growth for all.

However, what the data does confirm is the Fed is caught in a “liquidity trap.” 

The Liquidity Trap

Here is the definition:

“A liquidity trap is a situation described in Keynesian economics in which injections of cash into the private banking system by a central bank fail to lower interest rates and hence fail to stimulate economic growth. A liquidity trap is caused when people hoard cash because they expect an adverse event such as deflation, insufficient aggregate demand, or war. Signature characteristics of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.”

Let’s take a moment to analyze that definition by breaking it down into its overriding assumptions.

There is little argument that Central Banks globally are injecting liquidity into the financial system.

However, has the increase in liquidity into the private banking system lowered interest rates?  That answer is also “yes.”  The chart below shows the increase in the Federal Reserve’s balance sheet, since they are the “buyer” of bonds, which in turn increases the excess reserve accounts of the major banks, as compared to the 10-year Treasury rate.

Of course, that money didn’t flow into the U.S. economy, it went into financial assets. With the markets having absorbed the current levels of accommodation, it is not surprising to see the markets demanding more, (The chart below compares the deviation between the S&P 500 and the Fed’s balance sheet. That deviation is the highest on record.)

While, in the Fed’s defense, it may be clear the Fed’s monetary interventions have suppressed interest rates, I would argue their liquidity-driven inducements have done much to support durable economic growth. Interest rates have not been falling just since the monetary interventions began – it began four decades ago as the economy began a shift to consumer credit leveraged service society.  The chart below shows the correlation between the decline of GDP, Interest Rates, Savings, and Inflation.

In reality, the ongoing decline in economic activity has been the result of declining productivity, stagnant wage growth, demographic trends, and massive surges in consumer, corporate and, government debt.

For these reasons, it is difficult to attribute much of the decline in interest rates and inflation to monetary policies when the long term trend was clearly intact long before these programs began.

There is also no real evidence excess liquidity and artificially low interest rates have spurred economic activity judging by some of the most common measures – Real GDP, Industrial Production, Employment, and Consumption.

While an argument can be made that the early initial rounds of QE contributed to the bounce in economic activity it is important to also remember several other supports during the latest economic cycle.

1. Economic growth ALWAYS surges after recessionary weakness. This is due to the pent up demand that was built up during the recession and is unleashed back into the economy when confidence improves.
2. There were multiple bailouts in 2009 from “cash for houses”, “cash for clunkers”, to direct bailouts of the banking system and the economy, etc., which greatly supported the post-recessionary boost.
3. Several natural disasters from the “Japanese Trifecta” which shut down manufacturing temporarily, to massive hurricanes and wildfires, provided a series of one-time boosts to economic growth just as weakness was appearing.
4. A massive surge in government spending which directly feeds the economy

The Fed’s interventions from 2010 forward, as the Fed became “the only game in town,” seems to have had little effect other than a massive inflation in asset prices. The evidence suggests the Federal Reserve has been experiencing a diminishing rate of return from their monetary policies.

Lack Of Velocity

Once again, we find Judy Shelton completely clueless as to how monetary policy actually translates into the economy. She recently stated:

“When you have an economy primed to grow because of reduced taxes, less regulation, dynamic energy, and trade reforms, you want to ensure maximum access to capital. The Fed’s practice of paying banks to keep money parked at the Fed in deposit accounts instead of going into the economy is unhealthy and distorting; the rate should come down quickly as the practice is phased out.”

Poor Judy.

There is absolutely no evidence that the Fed’s “zero interest rate policy” spurred a dramatic increased in lending over the last decade. Monetary velocity has been clear on this point.

The definition of a “liquidity trap” states that people begin hoarding cash in expectation of deflation, lack of aggregate demand or war. As the “tech bubble” eroded confidence in the financial system, followed by a bust in the credit/housing market, and wages have failed to keep up with the pace of living standards, monetary velocity has collapsed to the lowest levels on record.

The issue of monetary velocity is the key to the definition of a “liquidity trap.”  As stated above:

“The signature characteristic of a liquidity trap are short-term interest rates that are near zero and fluctuations in the monetary base that fail to translate into fluctuations in general price levels.” 

The chart below shows that, in fact, the Fed has actually been trapped for a very long time. The “economic composite” indicator is comprised of 10-year rates, inflation (CPI), wages, and the dollar index. While the BEA measure of GDP ticked up (due to consistent adjustments to calculation) the economic composite has not. More importantly, downturns in the composite lead the BEA measure.

The problem for the Fed has been that for the last three decades every time they have tightened monetary policy it has led to an economic slowdown or worse. More importantly, each rate hike cycle has continued to start at a lower rate level than the previous low, and has stopped at a level lower than the previous low as economic weakness set in.

While, in the short term, it appeared such accommodative policies aided in economic stabilization, it was actually lower interest rates increasing the use of leverage. However, the dark side of the increase in leverage was the erosion of economic growth, and increased deflationary pressures, as dollars were diverted from productive investment into debt service.

No Escape From The Trap

The Federal Reserve is now caught in the same “liquidity trap” that has been the history of Japan for the last three decades. With an aging demographic, which will continue to strain the financial system, increasing levels of indebtedness, and unproductive fiscal policy to combat the issues restraining economic growth, it is unlikely continued monetary interventions will do anything other than simply continuing the boom/bust cycles in financial assets.

The chart below shows the 10-year Japanese Government Bond yield as compared to their quarterly economic growth rates and the BOJ’s balance sheet. Low interest rates, and massive QE programs, have failed to spur sustainable economic activity over the last 20 years. Currently, 2, 5, and 10 year Japanese Government Bonds all have negative real yields.

The reason you know the Fed is caught in a “liquidity trap” is because they are being forced to lower rates due to economic weakness.

It is the only “trick” they know.

Unfortunately, such action will likely have little, or no effect, this time due to the current stage of the economic cycle.

While Judy Shelton may certainly have the President’s ear, her recent statements clearly show inconsistencies and a lack of understanding about how the economy and monetary policies function in the real world.

Of course, as we learned from Jerome Powell, what officials say before they are appointed, and do afterward, tend to be two very different things particularly when they have become “political animals.”

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Quick Takes

Market

While the market rallied last week and continues to flirt with all-time highs, not surprisingly, volume was exceedingly light because of the July 4th holiday on Thursday. As Carl Swenlin noted:

” SPY has formed a bearish rising wedge, and the VIX penetrated the upper Bollinger Band, which is short-term bearish. The wedge looks particularly weak because price rose off the bottom of the wedge this week, but it failed to reach the top of the wedge before touching the bottom of the wedge again today.”

With a majority of short-term technical indicators extremely overbought, look for a correction next week. What will be important is that any correction does not fall below the early May highs.

Furthermore, with participation continuing to narrow, it continues to look like the August/September time frame for a larger corrective cycle is still in play.

Such corrective actions would coincide with emergence of risk factors from trade, to disappointment from the Fed, to a disappointing earnings cycle and rising recessionary indications.

This doesn’t mean sell everything and go to cash. It goes suggest carrying some hedges, a higher than normal level of cash, and a rotation into “defensive” positioning will likely remain prudent.

Employment

The employment number on Friday was strong as we anticipated. This puts the Federal Reserve in a more difficult position with respect to cutting rates in July. The markets initially sold off on the news but did manage to stage a bit of recovery by late afternoon as “hope” remains high the Fed will cut rates regardless.

However, let’s take a look at a couple of “off the run” indicators about employment.

First, the Fed looks at the 3-month average of employment, still a lagging indication, to smooth out month to month variability. The chart is below:

Clearly, not only has the trend turned lower as of late, but has been weakening since 2015. This is commensurate with a late-stage economic expansion. However, the current weakness has been consistent with previous ebbs and flows of the business cycle and is not currently “weak” enough to suggest cutting rates in July is warranted.

Second, the “quality of jobs” continues to deteriorate as shown by the surge in “multiple part-time job holders.” Per ZeroHedge on Friday:

“While the headline payrolls number was stellar, coming in higher than even the most optimistic Wall Street forecast, one aspect of today’s jobs report that will likely become a major talking point for Democrats and other critics of the Trump economy, is that the number of multiple-jobholders soared from 7.855 million to 8.156 million, a monthly surge of 301,000 – the biggest since July 2018, and an indication that the jobs number was far weaker than the headline represents if one excludes all those workers who represented two jobs to the BLS’ various surveys.”

Lastly, the “birth-death adjustment” is, as we say in Texas, a “load of S***!”

Every month, the BLS adds numerous jobs to the non-seasonally adjusted payroll count to “adjust” for the number of “small businesses” being created each month, which in turns “creates a job.”  (The total number is then seasonally adjusted.)

Here is my problem with the adjustment.

The BLS counts ALL business formations as creating employment. However, in reality, only about 1/5th of businesses created each year actually have an employee. The rest are created for legal purposes like trusts, holding companies, etc. which have no employees whatsoever. This is shown in the chart below which compares the number of businesses started WITH employees from those reported by the BLS. (Notice that beginning in 2014, there is a perfect slope in the advance which is consistent with results from a mathematical projection rather than use of actual data.)

These rather “fictitious” additions to the employee ranks reported each year are not small, but the BLS tends even to overestimate the total number of businesses created each year (employer AND non-employer) by a large amount.

How big of a difference are we talking about?

Well, in the decade between 2006 and 2016 (the latest update from the Census Bureau) the BLS added roughly 7.6 million more employees than were created in new business formations.

This data goes a long way in explaining why, despite record low unemployment, there is a record number of workers outside the labor force, 25% of households are on some form of government benefit, wages remain suppressed, and the explosion of the “wealth gap.” 

However, while this data should concern you about the real strength of the economy, it is NOT data the Fed considers with respect to monetary policy decisions.

Volatility Warning

In the past we have spoken of the high-levels of complacency by investors in the market. As my friend Doug Kass recently pointed out, there are a litany of things investors should be concerned about:

• The U.S./China trade negotiations last weekend didn’t “move the ball forward.” The outcome was just as expected with no promise of a substantive deal in the near future. (The two sides remain quite far apart with regard to the core issues of intellectual property and technology transfer, among other debated items).
• The future U.S./China trade negotiations will not produce tangible results over the next 12 months.
• Global cooperation and coordination is at an all-time low
• Uncertainty of trade policy and the destruction of the post World War II political and economic order (in an increasingly flat and interconnected world) is consequential to future worldwide economic growth.
• The precipitous drop in global bond yields is a sign of an imminent contraction (relative to consensus expectations) in global economic and U.S. corporate profit growth.
• There is a lack of “natural share price discovery” in the face of monumental shifts in market structure (from active to passing investing.)
• The dominance of products and strategies that worship at the altar of price momentum raise the risk of a major “Flash Crash.”
• We are currently in an “earnings recession.”
• Unbridled fiscal spending has adverse consequences.
• There is over $12 trillion of sovereign debt having negative yields.
• Large levels of debt in the system raised the risk of a credit-related event if something “breaks.”
• The Federal Reserve (and other central bankers) can not catalyze economic activity (by lowering rates) from current low levels (“pushing on a string.”) 
• The current low level of interest rates are an important factor in holding down business fixed investment.
• Current consensus economic and profit growth expectations will not be met in 2019-20.
• GDP growth cannot exceed the rate of labor growth and productivity.
• The recent downturn in high frequency economic data will be market impactful at some point. 

Yet, despite all of this, implied volatility is flirting with record low levels.

As the old saying goes: “What could possibly go wrong?”

One thing you might want to ask yourself, if you indeed believe the former, is why “rich people,” own more bonds than stocks generally speaking?

If buybacks are indeed supporting market performance, it is worth noting that such support can be turned off like a water spigot. 

Which means someone is going to be left “holding the bag.”

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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A Review of June

U.S. Dollar Index Futures  

We begin with a review of U.S. Dollar Index Futures during June 2019. In our June 2019 edition of The Cartography Corner, we wrote the following:

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

• M4         100.155
• M1         98.435
• PMH        98.260
• M3           98.131
• Close        97.666
• M2            97.255           
• MTrend  97.119
• PML          96.810                        
• M5            95.535

Active traders can use 98.260 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 97.119 as the downside pivot, whereby they maintain a flat or short position below it.

Figure 1 below displays the daily price action for June 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first four trading sessions were spent with U.S. Dollar Index Futures breaching our isolated downside pivot levels at M2: 97.255 and the downside pivot (MTrend): 97.119.  On the fifth trading session, the market price closed below May’s low price at PML: 96.810 and sustained below that level for the following four trading sessions.

On June 14^th the market price rotated back above May’s low price and, over the next two trading sessions, tested our isolated support levels at MTrend: 97.119 and M2: 97.255, now acting as resistance.  That test failed.

Over the following four trading sessions, U.S. Dollar Index Futures achieved our downside exhaustion level at M5: 95.535.  The final four trading sessions in June were spent with the market price trading slightly above our downside exhaustion level.

The realized error between our isolated downside exhaustion level at M5: 95.535 and June’s low price equaled 0.18%.    

Figure 1:

E-Mini S&P 500 Futures

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

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

• M4                3078.00
• M1                2966.00
• PMH             2961.25
• MTrend        2849.28
• Close             2752.50     
• PML               2750.00
• M2                2655.50     
• M3                 2556.50    
• M5                 2543.50

Active traders can use 2750.00 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 June 2019 in a candlestick chart, with support and resistance levels isolated by our methodology represented as dashed lines.  The first trading session of June saw the market price test our isolated pivot level at PML: 2750.00 intrasession, with the low price for June being realized at 2728.75.  Early weakness was overcome by strength and E-Mini S&P 500 Futures closed higher for the session.  The price action for that day is a good reminder of why market participants should judgmentally emphasize closing levels, relative to upside and downside pivots when initiating positions.  The market price closed within 0.50 points of our isolated pivot, with mechanical shorts suffering a fifty-point loss the following day while those respecting daily closing levels were spared.  

The following four trading sessions were spent with the market price ascending to, and closing above, our first isolated resistance level at MTrend: 2849.28.  The following ten trading sessions saw the market price continue its ascent, with our clustered resistance levels at PMH: 2961.25 and M1: 2966.00 being achieved and slightly exceeded intrasession on June 21^st.  However, the market price did not close above those levels.

The final five trading sessions saw the market price pull back from (three sessions) and re-approach (two sessions) our clustered resistance levels.

Figure 2:

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July 2019 Analysis

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

Trends:

• Current Settle         2944.25       
• Daily Trend             2931.61
• Weekly Trend         2923.12       
• Monthly Trend        2872.83       
• Quarterly Trend      2727.50

In our June 2019 edition of The Cartography Corner, we wrote the following:

We would like to bring your attention to two important points with respect to the Trend Levels.  First, the relative positioning of the trend levels is beginning to align in a very bearish manner.  Daily is below Weekly.  Weekly is below Monthly.  The final alignment that would increase our concern further is to have Quarterly at the top of the order.  The second point is that June Monthly Trend rose relative to May Monthly Trend.  The significance of this is that it informs us that there remain many “trapped” longs at prices 3.5% higher than the current settlement price.  May’s weakness introduced significant pressure on them.

What a difference a month’s price action can make.  The relative positioning of the Trend Levels, as shown above, is aligned in the most bullish posture possible.

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

Within the context of the market price relative to the trend levels and the relative positioning of the trend levels to one another, technical analysis of E-Mini S&P 500 Futures is bullish.  The need for a two-month high that we highlighted in last month’s commentary was realized in June.

Facts are facts… and the fact is that the market is not sustaining weakness.  It is a trader’s market, prone to swift and violent price swings.  We are not abandoning our idea of being in the time window for a sustained reversal to occur.  However, we are increasing our respect for the possibility of continued strength.

There are two facets of this market that we are certain of:

1. Energy is building and a large and sustained move is imminent.
2. Our analysis will accurately identify the landmarks along the way.

Support/Resistance:

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

• M4                3188.50
• M3                3136.00
• M1                2977.25
• PMH              2969.25
• Close             2944.25     
• MTrend        2872.83
• PML               2728.75     
• M2                 2707.50    
• M5                 2496.25

Active traders can use 2977.25 as the pivot, whereby they maintain a long position above that level and a flat or short position below it.

Investment Grade Corporate Bond ETF

For the month of July, we focus on the Investment Corporate Bond ETF.  We provide a monthly time-period analysis of LQD.  The same analysis can be completed for any time-period or in aggregate.

Trends:

• Current Settle        124.37          
• Daily Trend            123.90
• Weekly Trend        122.90          
• Monthly Trend       120.69          
• Quarterly Trend     117.42

As can be seen in the quarterly chart below, LQD is in “Consolidation”.  Stepping down one time-period, the monthly chart shows that LQD has been “Trend Up” for six months.  Stepping down to the weekly time-period, the chart shows that LQD has been “Trend Up” for seven weeks.

Support/Resistance:

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

• M4         130.59
• M1         128.04
• M3           127.91
• PMH       124.44
• Close        124.37
• M2           122.54
• MTrend   120.69             
• PML          120.41                        
• M5            119.99

Active traders can use 124.44 as the upside pivot, whereby they maintain a long position above that level.  Active traders can use 122.54 as the downside pivot, whereby they maintain a flat or short position below it.

Technical analysis of LQD is bullish.  Having said that, there are bearish technical factors to be cognizant of.  The condition was met on a quarterly basis in 1Q2019 that makes us anticipate a two-quarter low within the next three to five quarters.  That can be achieved this quarter with a trade below 112.78.  The condition was also met on a monthly basis in January 2019 that makes us anticipate a two-month low in July.  That can be achieved this month with a trade below 118.29.  Lastly, the condition was met on a weekly basis, the week of May 27^th that makes us anticipate a two-week low within the next two weeks.  That can be achieved this week with a trade below 121.62.

Figure 3:

Figure 3 above displays an LQD monthly candlestick chart for the period of January 2005 through June 2019.  Inversely overlaid is the spread between Moody’s Seasoned Baa Corporate Bond Yields and the Bank Prime Rate, measured in basis points.  As Charles Gave explains:

“Artificially depressed prime rates below the natural rate of corporate credit have allowed banks to generate ‘artificial’ money, kept zombie companies alive, but most of all permitted most viable corporations to engage in ‘financial engineering’ such as issuing debt to repurchase stocks, all of which are predicated on cheap borrowing costs continuing indefinitely, the risk, of course, is that the credit-funded party ends once the curve inverts… When the private sector curve inverts, the zombie companies will fail, capital spending will be cut, workers will be laid off, and the economy will move into recession.”

In 2006, the spread reached a trough of -205 basis points.  We believe that the spread today, currently at -103 basis points will not be able to reach the 2006 level.  We also believe the pending market repricing in LQD could be much more exaggerated than the thirty-three-point decline experienced during the Great Financial Crisis.  We ask that you reflect upon the following:

• In 2006, the Bank Prime Rate equaled 8.25% and Moody’s Seasoned Baa Corporate Bonds yielded 6.20%. Today those levels are 5.50% and 4.47%, respectively.  (Our next step is to normalize the spread relative to rate levels.)
• The size of the corporate bond market in 2006 totaled $4.9 trillion. As of the end of 2018, it totaled $9.2 trillion.
• As detailed by Michael Lebowitz in The Corporate Maginot Line, “50% of BBB companies, based solely on leverage, are at levels typically associated with lower rated companies. If 50% of BBB-rated bonds were to get downgraded, it would entail a shift of $1.30 trillion bonds to junk status. To put that into perspective, the entire junk market today is less than $1.25 trillion, and the subprime mortgage market that caused so many problems in 2008 peaked at $1.30 trillion.”

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.