The financial terrain is strewn with robust fables cleverly disguised as facts.

The setbacks to financial security due to stock market returns never realized, the precious time and human capital necessary to make up for market losses, the ingenious data-mining undertaken by populist gurus that want you to believe that stocks are a panacea; talking heads at big-box brokerage firms disguised as fiduciaries who make fortunes convincing investors to feel silly for being cautious.

The deck is stacked against the retail investor.

Now more than ever.

As the majority, this marketing force cranks out stories and grinds down the painful past of market events into the mist of averages. They so want investors to forget the past.

And like the destruction of so many pebbles on this road, your retirement and other financial life benchmarks are left as rubble.

The tenacious nature of outdated financial tenets is never questioned.

These rules of thumb, words that should weigh a thousand pounds each, roll off the tongues of financial pros and layman alike as lightly today as they did generations ago.

Rancid bits of wisdom preached as gospel.

Thank goodness this isn’t medicine.

Sickness would still be drained by leeches.

Let’s bust open the stories and myths that place your efforts to build wealth in danger.

Myth #1 – Compound interest will make you rich. 

Compound interest is the coolest story ever, but that’s about it

You so want to believe it.

And there was a time you could.

But not so much today.

Albert Einstein is credited with saying “compound interest is the eighth wonder of the world.”  Well, that’s not the entire quote.

Here’s the rest: “He who understands it, earns it; he who doesn’t pays it.”

I’m not going to argue the brilliance of Einstein although I think when it comes down to today’s interest-rate environment he would be quite skeptical (and he was known for his skepticism) of the real-world application of this “wonder.”

First, Mr. Einstein must have been considering an interest rate with enough “fire power” to make a dent in your account balance.

Over the last eight years, short-term interest rates have remained at close to zero, long term rates are deep below historical averages and are expected to remain that way for some time.

Indeed, compounding can occur as long as the rate of reinvestment is greater than zero, but there’s nothing magical about the “snowballing” effect of compounding in today’s rate environment.

Most important: Compounding only works when there is NO CHANCE of principal loss. It’s a linear wealth-building perspective that no longer has the same effectiveness considering two devastating stock market collapses which have inflicted long-term damage on household wealth.

What good is compounding when the foundation of what I invested in is crumbling?

Perhaps you should focus on the “he who understands it, earns it; he who doesn’t pays it.”

What does that adage mean to you?

Empowerment comes from living simply, avoiding credit card debt, and searching out deals on big ticket items like automobiles and appliances.

Don’t give compound interest another precious thought.

If it comes along, consider it a great gift.  A bounty.

Fine tune what you can control and that primarily has to do with outflow or household expenses.

I believe the eighth wonder of the world is human resolve in the face of economic reality post-Great Recession.

Not compound interest.

Myth #2 – Ditch that latte and energize your wealth. 

This advice is as bitter as the gas station brew that languishes in stained pots poised hot burners way too long.

Mega-money celebs like Suze Orman and Dave Ramsey fall all over themselves with wisdom that attempts to make you feel guilty for waiting in the coffee line at Starbucks. Listeners and readers of these two customarily are served swill like this on a regular basis.

A sweet topping on the sentiment is the tempting promise of consistent, annual investment returns of 10 to 11% in the market which is as far from reality as a broker without a sales quota.

Re-directing $2.50 from simple, daily enjoyment into risk assets is not going to move your wealth needle but you may wind up with a heck of a headache from caffeine withdrawals.


In the book, “Pound Foolish” author and financial blogger Helaine Olen investigates and busts open the myths of personal finance in an entertaining yet thorough tell-all.  Helaine discovered the latte factor surfaced as far back as 1994 in a Money Magazine article.

Touted by Suze Orman in her 1999 bestseller The Courage To Be Rich” the perky, blonde-top advocate for savvy personal financial choices was downright polemic about the subject (perhaps from overloading on caffeinated beverages whilst writing).

There’s no doubt your uptown caffeine addiction is under siege by pundits who take themselves so seriously they believe they can peddle trivial watered-down financial Pablum and you’ll take it in, bask in epiphany, see a white light.  Frankly, the only thing high-octane about this wisdom is the egos it took to deliver it.

With close to three decades of financial services industry experience under my belt, I have yet to witness anyone pump an arm in victory over the wealth they’ve accumulated by reducing coffee intake.

To place it in perspective, $2.50 a day, invested for 30 years at 4% will provide a whopping $1,691 “windfall” not adjusted for inflation, investment fees and charges.

What’s your return on satisfaction for $2.50 a day? I think it’s a bargain if a small purchase provides a big breather, peace of mind, and a recharge to carry on with important tasks.

Purchase the coffee. Buy a cup for me while you’re at it.

Deprivation of simple pleasures is not a path to financial fulfillment. While you’re partaking, place the time aside with pen and paper (put the smartphone away), and in a sentence, describe your ongoing relationship with money.

In simple sentence number two, identify a single financial action that achieves three-digit success each month. In other words, if you’re going to make a change, do it with gusto. Consider how can you cut $100 a month in expenses and direct the funds into an emergency savings account first, investments after you’ve accumulated three to six months of living expenses in financial cushion.

Last, create a rule for the big stuff. This could be tough (and ostensibly may require that brain boost from that make-or-break-your-finances latte).

A tenet I created is featured in a new book titled “WORTH IT,” by Amanda Steinberg a friend and fintech thought leader with a passion to help girls and women begin, improve and prosper in their relationships with money and debt:

“Never take on a mortgage that exceeds twice your gross income.” 


“House Mortgage = 2X Gross Salary.” 

It’s simple. To the point. If you earn $50,000 a year, the mortgage you obtain cannot exceed $100,000. This is not house price. It’s the mortgage. For most it’s going to mean a much greater down payment or smaller dwelling.

Obey and respect your personal formula. You’re going to hate the boundaries and that means they’ll be uncomfortable and successful if consistently followed.

Avoiding house-poor will super-charge your ability to build wealth. Now, that end result I have indeed witnessed from people I’ve been grateful to counsel over the last three decades.

Myth #3 – The Rule of 72 

Where do I begin with this rule after I’m done hemorrhaging from disappointment?

Recently, a well-known financial showman was lamenting, stretching the meaning (again) and hitting sound effect buzzers over this pearl.

As a reminder, the Rule of 72 is a method to determine how long an investment will take to double given a fixed annual rate of interest. Just divide 72 by an annual rate of return.

When working with low rates of return, interestingly, the rule is precise. As returns increase, the rule gets less precise per Investopedia.

Yet, this rule is bandied about when it comes to stock investing where rates of return are anything but fixed.

As of the morning of this writing I had met with two couples who still maintain carryforward losses from the tech bubble that popped in 2000.

Perhaps, the Rule of 72 should be reworked to consider how long it may take to recover from investment setbacks.

Could it be plausible that it may take 72 years to fully utilize losses incurred during the tech bubble and the financial crisis?

Hey, that’s nowhere near as farfetched as applying the Rule of 72 to volatile investments.

When you come across this rule again (and if you haven’t yet, you will), I need you to remember that it only holds water for fixed, low rates of return which clearly rules out stocks.

Myth #4 – I read somewhere that I should use the formula 100 minus my age to determine how much of my money needs to be invested in stocks. 

I abhor this creation.

What does age have to do with how much of a portfolio is allocated to riskier investments like stocks?

I’m not willing to believe those who are younger should be more exposed or increasingly vulnerable to market risk than anybody else, when the reward from stocks is less for every investor going forward.

This rule is a clear disadvantage for all including beginners.

An investment allocation must be customized for your life, needs, and your sheer will to withstand volatility. Most important, it should be based on the valuation conditions that exist at the time you’re looking to place dollars into the market.

I witness cookie-cutter dogma blindly followed and money invested immediately regardless of where stocks are valued. Ultimately, the forward returns are anemic or wealth destroyed altogether.

Financial consultants and brokers have needles deep stuck in thought grooves. It’s not just this rule per se. It’s the belief that younger people must, MUST be more aggressive because they have time to weather through disaster.

Risk couldn’t care less about how old you are. When the environment is favorable to take on greater risk for higher returns, then why be so focused on age?

How would you perceive my advice if I explained that you should fasten your seatbelt before driving however, your 18-year-old child doesn’t need to be concerned about doing the same?

I mean, after all, if there’s an accident and injuries suffered, common sense tells me you may require a longer convalescence period, correct?

Not to be flippant, but I can make a formidable case that based on savings accumulated, earning power, and driver (investment) experience, that the older, wiser navigator may forgo the seat belt but the novice cannot. Never.

Think about it.

Myth #5 – Stocks always outperform bonds. 

They do?

I heard this gem from an industry pro on CNBC the early morning of 3/17.

Hey if a financial guru proclaims it, and a powerhouse backs it up, it must be truth.

Over the long term, stocks do better. Since 1926, large stocks have returned an average of 10 % per year; long-term government bonds have returned between 5% and 6%, according to investment researcher Morningstar.

Don’t ask me why 1926 is so magical a launching pad for the formation of those colorful charts every broker whips out at every meeting. You’ve seen them.

Perhaps, it’s because there’s limited data set and deciding to preach from an arbitrary point in time just feels right?

Seems plausible.

The gatekeepers of finance who make rules for investors and professionals to follow like lemmings, create pretty pictures that we’re never to question.

Frankly, I don’t care why 1926 is so special. Neither should you.

It’s irrelevant to your situation and the cycle you’re either accumulating or distributing wealth through.

The coolest tidbits of 1926 involve increased gangster warfare and bloodshed employed to establish territory for illegal alcohol distribution.

Depending on how I slice and dice the data, I can show a magnificent run for bonds when compared to stocks.

The chart above outlines the performance of the PIMCO Total Return Bond fund, an intermediate duration bond fund offering (and one of the most popular), compared to S&P 500 beginning in 1999.

Why 1999?

Because I wanted to, that’s why.

Appears to me that stocks don’t always outperform bonds.

What do you see?

Silly myths, misused snippets of information, creative data mining.

They’re all not so silly when your wealth is on the line.

Are they?

Things get serious.

And so many myths and stories need to die away.

Never to return.

Real Investment Advice welcomes Ben Masters to our growing list of contributors. Benjamin Masters is the creator, designer, and writer for Third Wave Finance, With over ten years of experience working as a lead Portfolio Analyst, Ben brings additional insights into the discussion of economics, markets and portfolio management.

Part 1 Of The Series

Part 2 Of The Series

Currency Devaluation


After addressing the dire condition of economics and monetary policy in Part 1, and highlighting some of their more-damaging effects in Part 2, it’s now time to address one of the fundamental pillars of current policy — a hazard so deeply rooted yet one so easily accepted due to its illusory nature: namely, the process of currency devaluation and inflation targeting.

Yet another adjustment/manipulation scheme used to temporarily boost growth, currency devaluation (via currency creation) is not a new policy — it’s one that has been used throughout history by many countries and empires, including the Roman Empire.  And while the process of currency devaluation can evolve so slowly (potentially over a lifetime or more in a major economy/empire) that an unawareness develops and the instinct to question it subsides, its temporary benefits are often merely offset by a reduction in economic prosperity in the future; depending on the extent to which the policy is used, the economic strains may even lead to social disruption.

For an extreme example one need only look to the social disruptions and anger that developed in 1920s Weimar Germany; currency devaluations were so extreme that they yielded bizarre cases of zero stroke, and created an environment where it was cheaper to burn currency than use firewood. 

This example is not highlighted to imply that inflation or deflation should be the desired target, but merely to point out that economic policy can often be over-influenced by recent history — the economic and social strain of hyperinflation in the 1920s led to a German tendency to fear inflation, while the U.S. Great Depression of the 1930s has led to an American tendency to fear deflation.

The important point to make here is that deflationary and inflationary economic forces can often be occurring at the same time in different areas of the economy — they may simply be indicating a transition (cost and/or popularity of one time falls as the cost and/or popularity of another item rises).  The more-dangerous situation is when extremes in deflation or inflation develop throughout the economy indicating an imbalance, or when that imbalance is specifically targeted.

Inflation Targeting

As discussed, following the Great Depression, modern economic policies have reversed course so drastically that they have merely unbalanced the ship to the other side.  The fear of inflation has given rise to a tendency for central banks to “lean on inflation” (i.e. actively target inflation) via a process of currency-creation/currency-devaluation.

However, actively targeting positive inflation to avoid its counterpoint, deflation, may simply result in a storing of deflationary energy to be released later, as a misallocation of wealth builds.  Here again the wildfire suppression scenario highlighted in Part 2 is at play: just as fires are restricted (the kindling builds, the ecosystem changes storing potential energy for larger fires), so too does inflation-targeting work in the same way; it inhibits deflationary forces, allowing the potential energy of deflation to be stored and released later.  A further visualization of this concept — the storage-and-release of energy — can be seen in introductory physics…

A roller coaster that momentarily stops on the top of its very last large ramp has a high potential energy (energy that is not currently being used, as the coaster is motionless and high above the ground), but a low kinetic energy (energy of movement).  Then as the coaster begins to descend, the potential energy transitions to kinetic energy (motion).

“So inflation turns out to be merely one more example of our central lesson.  It may indeed bring benefits for a short time to favored groups, but only at the expense of others.  And in the long run it brings ruinous consequences to the whole community.  Even a relatively mild inflation distorts the structure of production.  It leads to the overexpansion of some industries at the expense of others.  This involves a misapplication and waste of capital.  When the inflation collapses, or is brought to a halt, the misdirected capital investment — whether in the form of machines, factories or office buildings — cannot yield an adequate return and loses the greater part of its value…

…Yet the ardor for inflation never dies.  It would almost seem as if no country is capable of profiting from the experience of another and no generation of learning from the sufferings of its forebears.  Each generation and country follows the same mirage.  Each grasps for the same Dead Sea fruit that turns to dust and ashes in its mouth.  For it is the nature of inflation to give birth to a thousand illusions.” 

– Henry Hazlitt (H.H.)

The difficulty in “leaning on inflation” (i.e. creating currency above the natural state) is that creating more currency to distribute does not increase real purchasing power — the country has more currency, but that currency buys less items than it could before (a currency is only a tool used to exchange real wealth items, it is not fundamental wealth).

Yet, regardless, inflation continues to be targeted — arguably due to ease, and its illusory nature — to “paper over” the restrictive reality of deflation; and in that respect, inflation can be considered a clandestine redistribution of wealth — one that is similar to an unpredictable, unbalanced, and spontaneous tax.  The redistribution of wealth occurs as the created currency disproportionately benefits those who receive it first; they have the first bid (vote) on assets, goods, and services.  As the newly created currency reaches other individuals, the more desirable assets, goods, and services will have already been bid up (higher prices) by those that received the currency first.  In effect, those that receive the currency last are punished at the expense of those that receive it first; and knowing who will be affected — and to what extent — will be difficult (What will the desirable assets be when the currency makes its way through the economy?).  By its very nature inflation indicates that some individuals benefited before others, yet it typically rests heavier on those least able to pay.

“…inflation does not and cannot affect everyone evenly.  Some suffer more than others.  The poor are usually more heavily taxed by inflation, in percentage terms, than the rich, for they do not have the same means of protecting themselves by speculative purchases of real equities.  Inflation is a kind of tax that is out of control of the tax authorities.  It strikes wantonly in all directions.” – H.H.

So although it’s possible that inflation targeting can be used to temporarily offset deflation, its risk is that it’s illusory and more easily abused.  In our current environment the tendency to question deflation is more commonplace than the inclination to challenge inflation (maybe merely due to a lack of education and awareness).  In deflation, the imbalance is visible; in inflation, the problems are for another day.

A more direct illustration, case 1:  If your income rises but inflation is greater than the change in your income, you’re actually poorer than you were before even though you have more money.  How can this be?  It’s because the total currency in circulation has increased, thus your currency — simply a medium of exchange — buys less real items; you’re poorer even though you have more dollars because each dollar now buys fewer real items.

In a countering example, case 2:  If your income goes down but deflation is more significant than the change in your income, you’re actually wealthier than you were before even though you have less money — each dollar can now buy more real items.

This is the illusory and deceptive nature of inflation: if the amount of currency has increased, your wealth is less — and although it is openly targeted, inflation is infrequently questioned, because, in our current environment, there is less of an inclination to question the state of things when you have more currency (even though your real wealth has gone down).  The inclination to question the state of things — even though it’s misplaced — seems more natural in case 2 because you have less money.  The education and awareness are not present to raise the flag of warning.  For these reasons, inflation is politically favorable, leading us to the questionable state — and abusive use — of economics.

“And this is precisely its political function.  It is because inflation confuses everything that it is so consistently resorted to by our modern ‘planned economy’ governments.” – H.H.

Get Part 1 Here

Get Part 2 Here

Since the U.S. economic recovery from the 2008 financial crisis, institutional economists began each subsequent year outlining their well-paid view of how things will transpire over the course of the coming 12-months. Like a broken record, they have continually over-estimated expectations for growth, inflation, consumer spending and capital expenditures. Their optimistic biases were based on the eventual success of the Federal Reserve’s (Fed) plan to restart the economy by encouraging the assumption of more debt by consumers and corporations alike.

But in 2017, something important changed. For the first time since the financial crisis, there will be a new administration in power directing public policy, and the new regime could not be more different from the one that just departed. This is important because of the ubiquitous influence of politics.

The anxiety and uncertainties of those first few years following the worst recession since the Great Depression gradually gave way to an uncomfortable stability.  The anxieties of losing jobs and homes subsided but yielded to the frustration of always remaining a step or two behind prosperity.  While job prospects slowly improved, wages did not. Business did not boom as is normally the case within a few quarters of a recovery, and the cost of education and health care stole what little ground most Americans thought they were making.  Politics was at work in ways with which many were pleased, but many more were not.  If that were not the case, then Donald Trump probably would not be the 45th President of the United States.

Within hours of Donald Trump’s victory, U.S. markets began to anticipate, for the first time since the financial crisis, an escape hatch out of financial repression and regulatory oppression.  As shown below, an element of economic and financial optimism that had been missing since at least 2008 began to re-emerge.

Data Courtesy: Bloomberg

What the Federal Reserve (Fed) struggled to manufacture in eight years of extraordinary monetary policy actions, the election of Donald Trump accomplished quite literally overnight. Expectations for a dramatic change in public policy under a new administration radically improved sentiment. Whether or not these changes are durable will depend upon the economy’s ability to match expectations.

Often Wrong, Never in Doubt

The institutional economists searching for a coherent outlook for 2017 are now faced with a fresh task. President Trump and his cabinet represent a significant departure from what has come to be known as “business-as-usual” Washington politics over the past 25 years.  Furthermore, it has been 89 years since Republicans held control of the White House as well as both the House of Representatives and the Senate. The confluence of these factors suggests that the outlook for 2017 – policy, the economy, markets, geopolitical risks – are highly uncertain.  Despite what appears to be an inflection point of radical change, most of which remains unknown, the consensus opinion of professional economists and markets, in general, are well-aligned, optimistic and seemingly convinced about how the economy and markets will evolve throughout the year.  The consensus forecast based upon an assessment of economic projections from major financial institutions appears to be the result of a Ph.D. echo chamber, not rigorous independent analysis.

Economic Outlook – Consensus Summary

After a thorough review of several major financial institutions’ economic outlooks for 2017 and market implied indicators for the year, below is an overview of what 720 Global deems to be the current consensus outlook for 2017.

  • The consensus is optimistic about economic growth for the coming year with expectations for real GDP growth in the 2.0-2.5% range
  • Recession risks will remain benign
  • The labor market is now at or near full employment
  • Wage growth is expected to increase to the 3.0-3.5% level as is customary for the economy at full employment
  • Inflation is expected to reach and exceed the Fed’s 2.0% target level
  • The Fed is expected to raise the Federal Funds rate in 25 basis point increments two or three times in 2017
  • The Fed will maintain the existing size of its balance sheet
  • Some form of fiscal stimulus will occur by the second half of the year
  • Fiscal stimulus is expected to be modest and unlikely to have a big impact on fiscal deficits
  • Tax reform will occur by the second half of the year and is viewed as highly supportive of corporate profits
  • Regulatory reform will begin to take shape in the first half of the year
  • Trade will be affected by some form of border tax adjustment, the economic impact of which is expected to be low
  • The combination of fiscal stimulus, tax reform, and regulatory reform in conjunction with an economy that is growing above trend and at full employment easily offsets Fed rate hikes supporting the optimistic outlook for economic growth

Despite the low probability of accuracy, the consensus outlook for 2017 is the starting point from which a discussion should begin because it is reflective of what markets and investors expect to transpire. Markets are pricing to this set of outcomes for the year.


Having established a consensus baseline, further attention is then paid to those areas where the consensus may indeed be wrong. Will inflation finally exceed the 2.0% level as expected? Will growth for the year end in the range of 2.0-2.5%? Can the new administration negotiate a fiscal stimulus package this year? These and many others are important questions that will dictate the strength of the U.S. dollar, the level of interest rates and the ability of equity markets to sustain current valuations.

If economic growth for the year is stronger than current projections and inflation is higher than forecast, then the Fed will appear to be behind the curve in hiking interest rates. In this circumstance, the Fed may begin to telegraph more than three rate hikes for the current year and a higher trajectory for rates in 2018. The interest rate markets will likely front run growth expectations and push interest rates higher. Given that investors have so little coupon income to protect them from price changes, such a move could occur in a disorderly manner, which will tighten financial conditions and choke off economic growth.

If, on the other hand, economic growth for the year falters and continues the recent string of disappointing, sub-2.0% readings, then fears of recession, and likely an abrupt change in confidence, will re-emerge.

This exercise undertaken each year by economists is akin to a meteorologist’s efforts to predict the weather several weeks in advance.  The convergence of high and low-pressure systems will produce a well-defined outcome, but there is no way to ascertain weeks or even days in advance that those air masses will converge at a precise time and location, or that they will converge at all.  It does in fact, as they say, very much depend on the “whether.”  Whether consumers borrow and spend more, whether companies hire and pay more or even whether or not confidence in a new administration promising a variety of pro-growth policies can fulfill those in some form.

The Lowest Common Denominator

Interest rates have already risen in anticipation of the consensus view coming to fruition.  Although higher interest rates today are reflective of an optimistic outlook for growth and inflation, the economy has become dependent upon low rates. Everything from housing and auto sales to corporate buybacks and equity valuations are highly dependent upon an environment of persistently low interest rates.  So, when the consensus overview expects higher interest rates as a result of higher wage growth and inflation, it is difficult to reconcile those expectations with the consensus path for economic growth.

Investors and markets continue to give the hoped-for outcome the benefit of the doubt, but that outcome seems quite inconsistent with economic reality. That outcome is that policy will promote growth, growth will advance inflation and interest rates must therefore rise.  The problem for the U.S. economy is that the large overhang of debt is the lowest common denominator.  The economy is a slave to the master of debt, which must be serviced and repaid. The debt problem is largely the result of 35 years of falling interest rates and the undisciplined habits and muscle memory that goes with such a dominating streak.  Marry that dynamic with the fact that this ultra-low interest rate regime itself has been in place for a full eight years, and the economy seems conditioned for an allergic reaction to rising rates.

Episodes of rising interest rates since the 1980’s, although short-lived, always brought about some form of financial distress. This time will likely be no different because the Fed’s zero-interest rate policy and quantitative easing have sealed the total dependency of the economy on consumption and debt growth.  Regaining the discipline of a healthy, organic economic system would mean both a rejection of policies used over the last 30 years and intense public sacrifice.


Given the altar at which current day politicians’ worship – that of power, influence, and self-promotion – it seems unlikely that this new Congress and President are inclined to make the difficult choices that might ultimately set the U.S. economy back on a path of healthy, self-sustaining growth.  Rather, debt and deficits will grow, and the enthusiasm around overly-optimistic economic forecasts and temporal improvements in economic output will fade as has been the case in so many years past.  Although a new political regime is in store and it brings hope for a new path forward, the echo chamber reinforcing bad policy, fiscal and monetary, seems likely to persist.






“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me viaEmail, Facebook or Twitter.

In last week’s post, I did a complete sector and major market review. Not much has changed in the past week given the very quiet activity that has persisted. This lack of volatility, while not unprecedented, is extremely long in duration as noted in past weekend’s newsletter, “An Unexpected Outcome:” 

“Speaking of low volatility, the market has now gone 108-trading days without a drop of 1% for both the Dow and the S&P 500. This is the longest stretch since September of 1993 for the Dow and December of 1995 for the S&P 500.”

The issue becomes, of course, which way the market breaks when volatility returns to the market. Over the course of the last three years, in particular, those breaks have been to the downside as shown below.

Given the particularly extreme overbought condition that currently exists, the strongest odds suggest the next pickup in volatility will be in the form of a corrective action to reverse some of that condition. As I detailed on Saturday:

“As noted in the chart below, the market is very close to a short-term ‘sell signal,’ lower part of the chart, from a very high level. Sell signals instigated from high levels tend to lead to more substantive corrective actions over the short-term. I have denoted the potential Fibonacci retracement levels which suggest a pullback levels of 2267, 2230, and 2193. To put this into ‘percent terms,’ such corrections would equate to a decline of -4.7%, -6.2% or -7.8% from Friday’s close.”

“To garner a 10% decline, stocks would currently have to fall 237.8 points on the S&P 500 to 2140.20.  Given there is little technical support at that level, the market would likely seek the next most viable support levels at the pre-election lows of 2075 or a decline of -12.7%.

Such a decline, of course, would not only wipe out the entirety of the ‘Trump Bump,’ but would also ‘feel’ much worse than it actually is given the exceedingly long period of an extremely low volatility environment.”

Of course, it could even be worse as noted on CNBC last week:

Are you ready for a 2,000 point drop in the Dow? That’s what a ‘normal’ correction would look like now. Normal corrections look kind of scary when markets are at these highs.

The Dow hit a new high on March 1 at 21,115. That means a 10 percent drop — what would be considered a ‘correction’ — would be a decline of 2,111 points. Sounds pretty steep, no?

Here’s an even bigger drop: 3,000 points. Dan Wiener, who runs the Independent Adviser for Vanguard Investors and runs money as president of Adviser Investments, pointed out to clients that over the past 30 years the stock market has declined an average of 14.3 percent from high to low on an intra-year basis.

That translates into a 3,019-point decline from the Dow’s March 1 top.”

As I noted previously in “The World’s Most Deceptive Chart” it is the “math” that is the problem. A 10% decline seems relatively minor. By comparison, a 2000-point decline is “psychologically” painful and leads investors to make emotionally driven investment decisions which typically have bad outcomes. 


These short-term declines are why investors are told to just “buy and hold,” and just “ride the markets out” because you can’t effectively “time” these events.

Usually, these comments are attached to the fictional idea that investors actually bought the lows. Like this one:

Finally, here’s an illustration of the power of staying in the market, not trying to time investing, and the beauty of compounding interest. March 9 was the eighth anniversary of the bottom of the market. It was widely noted that the S&P 500 was up over almost 250 percent since then.

Here’s an even more interesting tidbit: It’s up about 310 percent when dividends are accounted for.

That’s the power of compounded interest! That’s about a 19 percent annual compounded gain every year for eight years.

Think about that. Your money would be up an average of almost 20 percent a year when dividends are included and the money is reinvested over the last eight years. That is a remarkable run.”

It’s true…that is quite a remarkable run. In f

act, it is one of the longest-running bull markets in history.

They just never seem to remind you of what has happened next?

More importantly, following these regularly occurring “mean reverting” events, investors were not scrambling to buy the lows. Quite to the contrary, retail investors were often finally capitulating at the lows and liquidating their portfolios with the promise of “never buying stocks again.” 

Generally, they hold good to that promise until the markets rise to the next “bull market” peak and the pressure of “missing out” becomes too great. As shown in Ed Yardeni’s chart below, despite the commentary about how markets have compounded returns in recent years, a lot of investors were VERY late getting back into the investment game.

As I stated, the bull market remains intact currently and should not be dismissed lightly. Bull markets are extremely buoyant because of the underlying “psychology” that promotes it.

As John M. Keynes once quipped: “Markets can remain irrational longer than you can remain solvent.” 

However, there are some warning signs worth watching.

High yield bonds have started to exhibit weakness at a time when the stock/high yield bond ratio is at the highest level since the financial crisis. While, in and of itself, a high ratio is not indicative of a “crash,” it is the “fuel” for a “fire” if one occurs. 

As I have discussed before, the current deviation from the underlying bullish trend has historically been unsustainable over a longer-term period. Like “stretching a rubber band,” the extension must be relaxed either through consolidation or correction before the next advance can occur. 

The Coppock Curve has also recently peaked and has begun to turn lower. This is typical during short-term corrections.

One of the more concerning trends continues to be the deterioration in breadth as the number of stocks leading the market continues to decline despite indices sitting near all-time highs.

Jason Goepfert via Sentiment Trader recently noted that when the CBOE SKEW index climbs this far above the VIX, a downturn has tended to follow in the next 30 to 60 days.

“Historically, when we have seen an extreme in the relationship between the SKEW and VIX, the S&P moves in the opposite direction over the next 1-2 months.”

With the 50-dma of the SKEW/VIX ratio at the highest level of record, this is probably an indicator best not ignored.

Along with the ongoing weakness in the technical backdrop, the fundamental backdrop continues to weaken as shown in the P/E heat map below of the S&P 500.

The same goes for the PEG heat map as well.

The point here is simple.

Portfolios should be allocated to equities currently because the bull market trend is still firmly intact.

However, while I agree that you can not consistently and effectively “time” the market, which is being either “all in” or “all out,” I am suggesting that being prudent about the level of risk you are taking within your portfolio allocation can be curtailed. 

So, just invest and “fuhgettaboutit?”

Probably not the best idea. That approach has tended to yield very poor outcomes when the present conditions have existed previously. 

Importantly, in each period, it was always believed “this time is different.” Unfortunately, it never was.

“Price Is What You Pay. Value Is What You Get.” – Warren Buffett

One of the hallmarks of very late stage bull market cycles is the inevitable bashing of long-term valuation metrics. In the late 90’s if you were buying shares of Berkshire Hathaway stock it was mocked as “driving Dad’s old Pontiac.” In 2007, valuation metrics were being dismissed because the markets were flush with liquidity, interest rates were low and “Subprime was contained.”

Today, we once again see repeated arguments as to why “this time is different” because of the “Central Bank put.” 

First, let me just say that I have tremendous respect for the guys at HedgEye. They are insightful and thoughtful in their analysis and well worth your time to read. However, a recent article by HedgEye made a very interesting point that bears discussion.

“Meanwhile, a number of stubborn bears out there continue to make the specious argument that the U.S. stock market is expensive. ‘At 22 times trailing twelve-month earnings,’ they ask, ‘how on earth could an investor possibly buy the S&P 500?’

The answer is simple, really. Valuation is not a catalyst.”

They are absolutely right.

Valuations are not a catalyst.

They are the fuel.

But the debate over the value, and current validity, of the Shiller’s CAPE ratio, is not new. Critics argue that the earnings component of CAPE is just too low, changes to accounting rules have suppressed earnings, and the financial crisis changed everything.  This was a point made by Wade Slome previously:

“If something sounds like BS, looks like BS, and smells like BS, there’s a good chance you’re probably eyeball-deep in BS. In the investment world, I encounter a lot of very intelligent analysis, but at the same time I also continually step into piles of investment BS. One of those piles of BS I repeatedly step into is the CAPE ratio (Cyclically Adjusted Price-to-Earnings) created by Robert Shiller.”

Let’s break down Wade’s arguments against Dr. Shiller’s CAPE P/E individually.

Shiller’s Ratio Is Useless?

Wade states:

“The short answer…not very. For example, if investors followed the implicit recommendation of the CAPE for the periods when Shiller’s model showed stocks as expensive they would have missed a more than quintupling (+469% ex-dividends) in the S&P 500 index. Over a shorter timeframe (2009 – 2014) the S&P 500 is up +114% ex-dividends (+190% since March 2009).”

Wade’s analysis is correct.  However, the problem is that valuation models are not, and were never meant to be, “market timing indicators.”  The vast majority of analysts assume that if a measure of valuation (P/E, P/S, P/B, etc.) reaches some specific level it means that:

  1. The market is about to crash, and;
  2. Investors should be in 100% cash.

This is incorrect.

Valuation measures are simply just that – a measure of current valuation. More, importantly, it is a much better measure of “investor psychology” and a manifestation of the “greater fool theory.”

If you “overpay” for something today, the future net return will be lower than if you had paid a discount for it.

Think about housing prices for a moment as shown in the chart below.

There are two things to take away from the chart above in relation to valuation models.  The first is that if a home was purchased at any time (and not sold) when the average 12-month price was above the long-term linear trend, the forward annualized returns were significantly worse than if the home was purchased below that trend. Secondly, if a home was purchased near the peak in valuations, forward returns are likely to be extremely low, if not negative, for a very long time.

This is the same with the financial markets. When investors “pay” too much for an investment, future returns will suffer. “Buy cheap and sell dear” is not just some Wall Street slogan printed on a coffee mug, but a reality of virtually all of the great investors of our time in some form or another.

Cliff Asness discussed this issue in particular stating:

“Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again, and rooting for something drastically above the average case from these valuations.”

We can prove that by looking at forward 10-year total returns versus various levels of PE ratios historically.

Asness continues:

“It [Shiller’s CAPE] has very limited use for market timing (certainly on its own) and there is still great variability around its predictions over even decades. But, if you don’t lower your expectations when Shiller P/E’s are high without a good reason — and in my view, the critics have not provided a good reason this time around — I think you are making a mistake.”

While, Wade is correct that investors who got out of the market using Shiller’s P/E ratio would have missed the run in the markets from 2009 to present, those same individuals most likely sold at the bottom of the market in 2008 and only recently began to return as shown by net equity inflows below.

In other words, they missed the “run up” anyway. Investor psychology has more to do with long-term investment outcomes than just about anything else.

What valuations tell us, is that at current levels investors are strictly betting on there always being someone to pay more in the future for an asset than they paid today. 

Huckster Alert…

It is not surprising that due to the elevated level of P/E ratios since the turn of the century, which have been fostered by one financial bubble after the next due to Federal Reserve interventions, there has been a growing chorus of views suggesting that valuations are no longer as relevant. There is also the issue of the expanded use of forward operating earnings.

First, it is true that P/E’s have been higher over the last decade due to the aberration in prices versus earnings leading up to the 2000 peak. However, as shown in the chart below, the “reversion” process of that excessive overvaluation is still underway. It is likely the next mean reverting event will complete this process.

Cliff directly addressed the issue of the abuse of forward operating earnings.

“Some outright hucksters still use the trick of comparing current P/E’s based on ‘forecast’ ‘operating’ earnings with historical average P/E’s based on total trailing earnings. In addition, some critics say you can’t compare today to the past because accounting standards have changed, and the long-term past contains things like World Wars and Depressions. While I don’t buy it, this argument applies equally to the one-year P/E which many are still somehow willing to use. Also, it’s ironic that the chief argument of the critics, their big gun that I address exhaustively above [from the earlier post], is that the last 10 years are just too disastrous to be meaningful (recall they are actually mildly above average).”

Cliff is correct, of course, as it is important to remember that when discussing valuations, particularly regarding historic over/undervaluation, it is ALWAYS based on trailing REPORTED earnings. This is what is actually sitting on the bottom line of corporate income statements versus operating earnings, which is “what I would have earned if XYZ hadn’t happened.”

Beginning in the late 90’s, as the Wall Street casino opened its doors to the mass retail public, use of forward operating earning estimates to justify extremely overvalued markets came into vogue. However, the problem with forward operating earning estimates is they are historically wrong by an average of 33%. To wit:

“The biggest single problem with Wall Street, both today and in the past, is the consistent disregard of the possibilities for unexpected, random events. In a 2010 study, by the McKinsey Group, they found that analysts have been persistently overly optimistic for 25 years. During the 25-year time frame, Wall Street analysts pegged earnings growth at 10-12% a year when in reality earnings grew at 6% which, as we have discussed in the past, is the growth rate of the economy.”

Ed Yardeni published the two following charts which shows analysts are always overly optimistic in their estimates.

“This is why using forward earnings estimates as a valuation metric is so incredibly flawed – as the estimates are always overly optimistic roughly 33% on average. Furthermore, the reason that earnings only grew at 6% over the last 25 years is because the companies that make up the stock market are a reflection of real economic growth. Stocks cannot outgrow the economy in the long term…remember that.

The McKenzie study noted that on average ‘analysts’ forecasts have been almost 100% too high’ and this leads investors into making much more aggressive bets in the financial markets.”

The consistent error rate in forward earnings projections makes using such data dangerous when making long-term investments. This is why trailing reported earnings is the only “honest” way to approach valuing financial markets. Importantly, long-term investors should be abundantly aware of what the future expected returns will be when buying into overvalued markets. Bill Hester recently wrote a very good note in this regard in response to critics of Shiller’s CAPE ratio and future annualized returns:

We feel no particular obligation defend the CAPE ratio. It has a strong long-term relationship to subsequent 10-year market returns. And it’s only one of numerous valuation indicators that we use in our work – many which are considerably more reliable. All of these valuation indicators – particularly when record-high profit margins are accounted for – are sending the same message: The market is steeply overvalued, leaving investors with the prospect of low, single-digit long-term expected returns.

As clearly stated throughout this missive, fundamental valuation metrics are not, and were never meant to be, market timing indicators. This was a point made by Dr. Robert Shiller himself in an interview with Henry Blodgett:

“John Campbell, who’s now a professor at Harvard, and I presented our findings first to the Federal Reserve Board in 1996, and we had a regression, showing how the P/E ratio predicts returns. And we had scatter diagrams, showing 10-year subsequent returns against the CAPE, what we call the cyclically adjusted price-earnings ratio. And that had a pretty good fit. So I think the bottom line that we were giving – and maybe we didn’t stress or emphasize it enough – was that it’s continual. It’s not a timing mechanism, it doesn’t tell you – and I had the same mistake in my mind, to some extent — wait until it goes all the way down to a P/E of 7, or something.”

Currently, there is clear evidence that future expectations should be significantly lower than the long-term historical averages.

Do current valuation levels suggest you should be all in cash? No.

However, it does suggest that a more cautious stance to equity allocations and increased risk management will likely offset much of the next “reversion” when it occurs.

My job is to protect investment capital from major market reversions and meet investment returns anchored to retirement planning projections. Not paying attention to rising investment risks, or adjusting for lower expected future returns, are detrimental to both of those objectives.

Next week, I will introduce a modified version of the Shiller CAPE ratio which is more constructive for shorter-term outlooks.

On Wednesday, as I discussed yesterday, the Fed hiked rates and despite the fact that hiking interest rates further tightens monetary policy, thereby reducing liquidity to the markets, the markets rallied anyway.

With the hopes of accelerated earnings recovery being muted by falling oil prices, higher borrowing costs, and a strong dollar, investors seem willing to forgo the basic fundamentals of investing to chase an already extended and aging bull market cycle.

This was noted yesterday in a note from Goldman’s Jan Hatzius, the chief economist warns that the market is over-interpreting the Fed’s statement, and Yellen’s presser, and cautions that it was not meant to be the “dovish surprise” the market took it to be.

“Surprisingly, financial markets took the meeting as a large dovish surprise—the third-largest at an FOMC meeting since 2000 outside the financial crisis, based on the co-movement of different asset prices.

The committee may have worried that a rate hike—especially a rate hike that was not priced in the markets or predicted by most forecasters as recently as three weeks ago—might lead to a large adverse reaction on the day, and wanted to avoid such an outcome by erring slightly on the dovish side. But we feel quite confident that they were not aiming for a large easing in financial conditions. After all, the primary point of hiking rates is to tighten financial conditions, perhaps not suddenly but at least gradually over time. And even before today’s meeting, at least our own FCI was already fairly close to the easiest levels of the past two years and this was likely one reason why the committee decided to go for another hike just three months after the last one.”

He’s right. The Fed, which is now tightening financial conditions (which should/will push asset prices lower), got the exact opposite result as everything rose Wednesday from stocks, to bonds, to gold.

In other words, market participates took the rate hike as another reason to “just buy everything.” 

Of course, with bullish trends still very much in place, it has been, and remains, very challenging to dispute that point.

Just realize, eventually the mantra of “just buy everything” from overly complacent bullish investors, will change to “just sell everything.” 

Of course, just understanding that particular point is just winning the battle.

Recognizing, and acting, on the change is what “Wins the war.”

Just some things I am thinking about this weekend as I catch up on my reading.



Financial Planning/Retirement

Research / Interesting Reads

“It is well that the people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.” – Henry Ford

Questions, comments, suggestions – please email me.

Future’s So Bright, We Gotta Hike Rates

“The simple message is the economy is doing well. We have confidence in the robustness of the economy and its resilience to shocks.” – Janet Yellen, March 15, 2017.


Because while you saying that the GDP NowCast from the Atlanta Fed just collapsed from nearly 3% at the beginning of the year, to just 0.9% currently.

The problem, as has been a continued issue with the Fed’s projections, is the expanse between the Fed’s “fantasy” and economic realities. This is shown in the table below which documents the median of the Fed’s economic projections versus what actually happens. In every single year, the March projections have consistently been revised lower.

Yet, besides being the world’s worst economic forecasters, the market still believes every statement she makes.

Unfortunately, for market participants chasing asset prices on the back of “Make America Great Again” and Trump’s promise of 3-4% annualized GDP growth, the Fed is maintaining their expectations of the lowest long-term growth rates on record.

Someone is going to be wrong. Quite likely, it will be both of them.

Is Fed Late To The Game?

With the Federal Reserve lifting interest rates by another 0.25%, while also tilting hawkishly into the rest of year suggesting further rate hikes, she noted economic activity had expanded at “moderate pace,” and the U.S. labor market continued to strengthen with job gains remaining “solid”Of course, given the February employment report of 235,000 jobs, and improving manufacturing reports, the move would certainly seem logical

However, all may not be what it appears.

The last couple of months have marked some of the warmest winter temperatures that we have seen since 2011-2012. This is important, because of the “seasonal adjustments” applied to data collected during these typically cold months of the year. These “adjustments” boost the underlying data to normalize it and smooth the monthly volatility of the series into a more usable data set.

Here is the issue. When the winter is unseasonably warm, as it was this past year, workers are able to continue working in areas like manufacturing, construction, etc, where more normal inclement weather would have diminished those activities. So, when the “adjustments” are added to already abnormally high data levels, the data is skewed to the upside. This was something I noted back in 2013.

“I jest, of course, but what is relevant is that the effect of ‘Mother Nature’ has provided the short-term boosts to economic growth which kept a struggling economy above the water line.  How many more natural disasters and warm winters will come to offset the negative economic impact of a zero interest rate environment coupled with a wave of deflationary pressures is unknown. However, you do have to admit that the ‘Mother Nature’ effect is quite interesting nonetheless and wonder, if even for just a moment, if Bernanke has her on speed dial.”

Whether it was an earthquake, typhoon, the nuclear meltdown of Japan, warm winter cycles, Hurricane Sandy, tornado’s in Oklahoma, or just good old fashioned collapses in energy prices, each has had its impact on economic growth. Given the history of warm winter seasonal adjustment skewing, we are likely to see “repayment” coming towards the summer as the “adjustments” begin to run in reverse. 

This is important given the seasonal adjustment phenomenon has likely skewed employment data over the last couple of months giving a false sense of confidence about the Fed’s ability to safely raise interest rates. As shown in the chart below the Fed has NEVER hiked rates previous when employment had already peaked for its current cycle and was beginning to decline.

Furthermore, this same problem presents itself when looking at the Fed’s own Labor Market Conditions Index.

Another problem which is also likely skewing the inflation data has been the rise in oil prices. Since oil prices push through the commodity complex, inflationary pressures have risen in recent months. However, the recent drop in energy prices, and given the massive net long position discussed last weekend which could exacerbate the decline, will likely show up as a deflationary wave.

All of this suggests, the Fed may indeed be very late to the game and find themselves pushing the economy towards the next recession sooner than anticipated.

Something Is Amiss

Of course, at very low rates of economic growth, there is little wiggle room between slowing the economy and pushing it into a recession. However, it is hard to deny the rush of consumer and investor optimism since the election. But something appears to be amiss just beneath the surface.

Credit is the “lifeblood” of the economy, and the recent rate hikes will eventually increase borrowing costs for credit cards and other short-term loans. Unfortunately, bank loans and leases are already on the decline, and delinquencies are on the rise, as higher borrowing costs make fixed investment less profitable. Remember, the REASON the Fed hikes interest rates in the first place is to SLOW economic activity in order to QUELL inflationary pressures. 

Importantly, as noted by Zerohedge, it is not just on the business side of the equation. Consumption, which makes up roughly 70% of economic growth, is also feeling the pinch of a slowing economy and higher borrowing costs as consumers continue to reduce spending at restaurants. This is not a sign of improving “confidence” in their economic outlook.

Of course, the decline in the luxury of “eating out” is not surprising once you realize that debt expansion has come to offset weak wage growth which has failed to keep up with the spiraling costs of healthcare, rent and gasoline prices. 

While it is “hoped” that Trump’s policies will “Make America Great, Again,” there has been reality little change to actual underlying economic activity which is dependent on consumer spending from already “tapped out” consumers.

As noted the problem for both the Fed, and investors, is the detachment between market “expectations” and fundamental “realities.” 

In other words, if you are betting on a strong economic recovery to support excessive valuations and extremely stretched markets, you could be setting yourself up for disappointment.

Oh, and don’t think for a moment that rising interest rates, combined with a strongly rising dollar, is somehow “good for stocks.”

It isn’t.

It has never been.

Just some things I am thinking about.

Villanova versus Kansas

 Outcome versus Process Strategies

It is that time of year when the markets play second fiddle to debates about which twelve seed could be this year’s Cinderella in the NCAA basketball tournament. For college basketball fans, this particular time of year has been dubbed March Madness. The widespread popularity of the NCAA tournament is not just about the games, the schools, and the players, but just as importantly, it is about the brackets. Brackets refer to the office pools based upon correctly predicting the 67 tournament games. Having the most points in a pool garners office bragging rights and, in many cases, your colleague’s cash.

Interestingly the art, science, and guessing involved in filling out a tournament bracket provides insight into how investors select assets and structure portfolios. Before explaining, answer the following question:

When filling out a tournament bracket do you:

  1. A) Start by picking the expected national champion and then go back and fill out the individual games and rounds to meet that expectation?
  1. B) Analyze each opening round matchup, picking winners and advance round by round until you reach the championship game?

If you chose answer A, you fill out your pool based on a fixed notion for which team is the best in the country. In doing so, you disregard the potential path, no matter how hard, that team must take to become champions.

If you went with the second answer, B, you compare each potential matchup, analyze each team’s respective records, strengths of schedule, demonstrated strengths and weaknesses, record against common opponents and even how travel and geography might affect performance. While we may have exaggerated the amount of research you conduct a bit, such a methodical game by game evaluation is repeated over and over again until a conclusion is reached about which team can win six consecutive games and become the national champion.

Outcome Based Strategies

Outcome-based investment strategies start with an expected result, typically based on recent trends or historical averages. Investors following this strategy presume that such trends or averages, be they economic, earnings, prices or a host of other factors, will continue to occur as they have in the past. How many times have you heard Wall Street “gurus” preach that stocks historically return 7%, and therefore a well-diversified portfolio should expect the same thing this year? Rarely do they mention corporate and economic fundamentals or valuations. Many investors blindly take the bait and fail to question the assumptions that drive the investment selection process.

Pension funds have investment return assumptions which, if not realized, have negative consequences for their respective plans. Given this seemingly singular aim of the fund manager, most pension funds tend to buy assets whose expected returns in aggregate will achieve their return assumption. Accordingly, pension funds tend to be managed with outcome-based strategies.

For example, consider a pension fund manager with an 8% return target that largely allocates between stocks and bonds.

Given the current yields in the table above, and therefore expectations for returns on sovereign bonds of approximately 1%, the manager must instead invest in riskier fixed income products and equities to achieve the 8% return objective. Frequently, a pension fund manager has a mandate requiring that the fund hold a certain minimum amount of sovereign bonds.  The quandary then is, how much riskier “stuff” do they have to own in order to offset that return drag? In this instance, the manager is not allocating assets based on a value or risk/reward proposition but on a return goal.

To illustrate, the $308 billion California Public Employees Retirement System (CalPERS), the nation’s largest pension fund, has begun to shift more dramatically towards outcome-based management. In 2015, CalPERS announced that they would fire many of their active managers following repeatedly poor performance. Despite this adjustment, they still badly missed their 7.5% return target in 2015 and 2016. Desperate to right the ship, CalPERS maintains a plan to increase the amount of passive managers and index funds it uses to achieve its objectives.

In speaking about recent equity allocation changes, a CalPERS spokeswoman said “The goal is to eventually get the allocation to the right mix of assets, so that the portfolio will likely deliver a 10-year return of 6.2%.” That sounds like an intelligent, well-informed comment but it is similar to saying “I want to be in Poughkeepsie in April 2027 because the forecast is sunny and 72 degrees.” The precision of the 10-year return objective down to the tenth of a percent is the dead giveaway that the folks at CalPERS might not know what they’re doing.

Outcome-based strategies sound good in theory and they are easy to implement, but the vast amount of pension funds that are grossly underfunded tells us that investment policies based on this process struggle over the long term. “The past is no guarantee of future results” is a typical investment disclaimer. However, it is this same outcome-based methodology and logic that many investors rely upon to allocate their assets.

Process Based Strategies

Process-based investment strategies, on the other hand, have methods that establish expectations for the factors that drive asset prices in the future. Such analysis normally includes economic forecasts, technical analysis or a bottom-up assessment of an asset’s ability to generate cash flow. Process-based investors do not just assume that yesterday’s winners will be tomorrow’s winners, nor do they diversify just for the sake of diversification. These investors have a method that helps them forecast the assets that are likely to provide the best risk/reward prospects and they deploy capital opportunistically.

Well managed absolute return and value funds, at times, hold significant amounts of cash. This is not because they are enamored with cash yields per se, but because they have done significant research and cannot find assets that offer value in their opinion. These managers are not compelled to buy an asset because it “promises” a historical return. The low yield on cash clearly creates a “drag” on short-term returns, but when an opportunity develops, the cash on hand can be quickly deployed into cheap investments with a wider margin of safety and better probabilities of market-beating returns. This approach of subordinating the short-term demands of impatience to the long-term benefits of waiting for the fat pitch dramatically lowers the risk of a sizable loss.

A or B?

Most NCAA basketball pool participants fill out tournament brackets starting with the opening round games and progress towards the championship match. Sure, they have biases and opinions that favor teams throughout the bracket, but at the end of the day, they have done some analysis to consider each potential matchup.  So, why do many investors use a less rigorous process in investing than they do in filling out their NCAA tournament brackets?

Starting at the final game and selecting a national champion is similar to identifying a return goal of 10%, for example, and buying assets that are forecast to achieve that return. How that goal is achieved is subordinated to the pleasant but speculative idea that one will achieve it. In such an outcome-based approach, decision-making is predicated on an expected result.

Considering each matchup in the NCAA tournament to ultimately determine the winner applies a process-oriented approach. Each of the 67 selections is based on the evaluation of comparative strengths and weaknesses of teams. The expected outcome is a result of the analysis of factors required to achieve the outcome.


It is very likely that many people filling out brackets this year will pick Villanova. They are a favorite not only because they are the #1 overall seed, but also because they won the tournament last year. Picking Villanova to win it all may or may not be a wise choice, but picking Villanova without consideration for the other teams they might play on the path to the championship neglects thoughtful analysis.

The following table (courtesy and Koch Capital) is a great reminder that building a portfolio based on yesterday’s performance is a surefire way to end up with sub-optimal returns.

Winning a basketball pool has its benefits while the costs, if any, are minimal. Managing wealth, however, can provide great rewards but is fraught with severe consequences. Accordingly, wealth management deserves considerably more thoughtfulness than filling out a bracket. Over the long run, those that follow a well-thought out, time-tested, process-oriented approach will raise the odds of success in compounding wealth by limiting damaging losses during major market set-backs and by being afforded opportunities when others fearfully sell.






Real Investment Advice welcomes Ben Masters to our growing list of contributors. Benjamin Masters is the creator, designer, and writer for Third Wave Finance, With over ten years of experience working as a lead Portfolio Analyst, Ben brings additional insights into the discussion of economics, markets and portfolio management.

Part 1 Of The Series

The Continuous and Immediate Democracy of the Price System

So often the devastating social and economic events of our past have occurred due to a misplaced desire to “fix” a problem.  For an illustration of the mechanism just look to the disastrous implications of forest fire suppression (also addressed by author and hedge fund manager Mark Spitznagel) — an attempt to prevent damage to ecosystems by only allowing small fires to occur has allowed more kindling to be built up to stoke even larger more disastrous fires.

In a similar fashion, current economic policies have — in an attempt to “fix” a problem — moved the economy away from the continuous and immediate democracy of the price system; a system that can be thought of as a constantly adjusting balance.  Every minute, of every hour, of every day individuals are voting on whether more or less of a product should be produced.  Every time they purchase an item they encourage its continued production at the expense of another item, and every time they decide not to buy they discourage its production, to the encouragement of another.

If more individuals want a particular item, it is difficult to keep it in stock, and the retailer is pushed to move the price up (if they don’t then they will underperform the competition who will move the price up).  But the price moves up because the majority of individuals agree that it should be higher; they desire the product more, which draws individuals into the industry (seeking profits) and increases production to meet demand.  By voting the price higher they are signaling desirability; when the price moves up, the profits of the company selling the product move up, more individuals enter the industry to follow profit potential, and the price then moves down when more have entered the industry than are necessary to meet demand.  It’s a cycle of adjustment based on the continuous and immediate voting of the individual — the voter decides whether the price is reasonable.

The shrinking or expansion of an industry depends on the desires of the majority.  If more people think that industry’s product or service is reasonable, the price transitions up, encouraging individuals to leave less desirable industries behind to pursue the industry with more profits — accommodating the desire of the majority.  If more people think the price is unreasonable, they refuse to buy, the price transitions down, and the industry shrinks as individuals move to pursue other industries that the majority does desire.

So, in this fashion, the decisions of individuals — on a moment-to-moment basis — cause the change in prices and production.  If more people desire computers rather than typewriters, the price of typewriters falls until it reaches the point where they are desirable again, and the typewriter industry is forced to lower prices based on the desire of the majority — the industry shrinks based on the majority’s preference for other items and services.

The continuous and immediate democracy of the price system is what calls into question the results of artificial adjustment schemes — those results being that any adjustment to this voting system would, in effect, benefit a small group of individuals at the expense of the larger group; yet this is the nature of the adjustment schemes championed by all sorts of different groups and governments.  The adjustments pursued include “parity” pricing, tariffs, “stabilizing” commodities, and price “fixing”, among many others; their commonality is that they disrupt the democratic price system, allow a smaller group to inhibit the desires of the larger group, and are still being used.

Leaving a much lengthier discussion to other sources, a few examples may be of use here.  Of the many examples of adjustment (or manipulation) previously listed, one would be the attempt to keep a price level artificially high.  In an attempt to save a dying industry the price for the product is held above the price voted on by the majority.  In this case the industry benefits (a minority of the population) at the expense of the majority who now have to pay more than they would otherwise deem reasonable.  The money above what they were willing to pay will now flow toward the “adjusted” industry and away from a different, more desirable one.

The effect of this attempt to manipulate the democratic price system is a temporary (short-term) benefit to the supported industry (the small group) at the expense of the larger group; yet since the majority is negatively affected, and the smaller group is not isolated (they are also dependent on others), the smaller group will eventually be negatively affected as well as the cycle continues.  This is, in essence, the wildfire suppression scenario — prevent fires (prevent the death of an undesirable industry) only to have to deal with larger fires (the majority is negatively affected and in turn negatively affects the smaller group).

The significance is that the manipulation of the equilibrium moves the majority to a lesser-desired state, encouraging a waste of raw materials and a squandering of time, both of which are used up on industries that are not as desirable as others — a misallocation of capital and an aggregate hindrance to the economy.

Technological Progress: Cessation of Industries = Progress for Others

Unfortunately, due to the custom of “specialization” (a person typically works in one industry), the individual effects of technological progress and invention can often be disastrous for some (those working in the industry with reduced demand), even though the change provides an aggregate benefit to the majority.  By its very nature that reduced demand for the failing industry is due to a demand for other more-desirable items.  This is not a new process.  It has occurred throughout history.  The mechanical revolution displaced so many that people that some thought work would become obsolete.

The same progress has continued to occur: the dwindling of the typewriter industry due to the boom of the computer industry and the loss of cashiers to automation, among many, many others.  But there are other jobs created that are not so easily recognized; the machines created to replace cashiers have also created jobs — designers, manufacturers, etc.  Labor moves to the desirable industries and creates new ones.  Technological advancement can even create demand in an industry if it reduces the price of the item to the point where individuals want more.

The cessation of undesirable industries results in progress for desirable ones; the outcome is a social benefit to the majority and an unfortunate, temporary, expense for a smaller group.  The best solution isn’t to prevent progress, but to allow for mobility between industries — to ease the transition, to encourage movement to existing in-demand industries and to those new industries yet to be created.

Unless everyone’s desires are completely satisfied there is still progress to be made.  It’s when individuals are freed from undesirable industries that their faculties are applied to the desires of the majority.  The worse outcome is for groups and governments to manipulate and encourage undesirable industries to use up finite raw materials and time when the actual demand of the majority lies elsewhere.

“If it were indeed true that the introduction of labor-saving machinery is a cause of constantly mounting unemployment and misery, the logical conclusions to be drawn would be revolutionary, not only in the technical field but for our whole concept of civilization.  Not only should we have to regard all further technical progress as a calamity; we should have to regard all past technical progress with equal horror…

…It follows that it is just as essential for the health of a dynamic economy that dying industries should be allowed to die as that growing industries should be allowed to grow.  For the dying industries absorb labor and capital that should be released for the growing industries.” 

– Henry Hazlitt (H.H.)

Returning to the topic of economic policy, one can see the wildfire suppression scenario occurring once again.  The attempt to pull growth forward by reducing interest rates (and using experimental policies, i.e. large-scale asset purchases) is effectively encouraging short-term benefits (fire suppression) at the expense of long-term benefits (a worse outcome, larger fires).  One could argue that the market crises and stock manias of the 21st century have been more severe because risk (kindling) has been allowed to build.

Since the 1980s the Fed has been encouraging debt-based spending to attempt to counter slowing economic growth — they influence interest rates lower (you get paid less interest in your bank account), and by doing so they’re attempting to make debt more attractive due to it being more “affordable” (individuals pay less in interest when they take on debt); individuals may then borrow more and spend more to boost economic growth.

However there is a “catch”: although more debt and more economic growth may occur temporarily due to the reduction of the interest rate target, the productiveness-of-the-debt determines the long-run outcome.  If the debt is productive — i.e. creates an income stream to repay the principal (original amount borrowed) and the interest on the debt — then long-run growth may not flag due to the debt; yet if the debt is unproductive and/or counter-productive then economic growth is constrained in the long run.  One of the most important measures of the productiveness-of-debt is the velocity of money.

The more serious implications of economic policy, however, are for the broad economy and country (the stock market is only a portion of the economy).  A misallocation of capital and investment, due to economic policy, slows growth and results in zombie industries kept alive by the continued attempt to manipulate the democratic price system; it creates an undesirable imbalance — a temporary benefit to a small group at the expense of a larger group, which in turn inhibits growth.

Get Part 1 Here

…Stay Tuned for Part III

What would you do with three-thousand bucks

And what if this small fortune was out of reach every year until you spent months gathering documents and wasting precious hours, patience or financial resources to prepare for its rightful return?

Consider it money held hostage.

Not just anybody’s money. Yours.

And that’s what most taxpayers, like you, do.

  • The average tax refund is $3,120 and an astounding 83% of tax returns are due a refund, according to the Internal Revenue Service.
  • Half of American households can’t raise 500 dollars in the face of an emergency yet a majority of taxpayers are due money back? Their money back, by the way.
  • An estimated $1 billion in refunds are unclaimed for taxpayers who haven’t filed a return. Ultimately, these funds are surrendered to the U.S. Treasury.

Why do we do exhibit these strange behaviors? Is it fear of owing money and not being able to cough it up? Perhaps a forced savings plan?

Downright Ignorance? 

Is it a mental accounting bias where we falsely believe the IRS refund is a bonus or windfall?

I’m consistently puzzled how happy many of us are to receive refunds and cheerfully share this new with anybody willing to listen.

I seek to help you change your mindset.

Think of it this way: We give a bloated, government bureaucracy the right to use our hard-earned dollars for over a year to have it returned to us, eventually. And that makes us happy!

Heck, this mission is too big for one person to take on. So, if you’ve surrendered to receiving a refund, not willing to check out the IRS Withholding Calculator and file a new W-4 with your employer, let me at least provide 5 money smart uses for the you know –  the return of your money.

Make a big dent in those ‘money-killing’ outstanding credit card balances.

Per 2016 Federal Reserve Consumer Credit Report (the G.19), U.S. credit card debt reached $1 trillion. Yes, that’s trillion with a T. Approximately $650 billion was subject to finance charges with the national average credit card interest rate (APR) now at 15.07%.

A smart money strategy would be to direct the refund to outstanding credit card balances. Hit the card with the highest interest rate, first. You’ve earned a quick double-digit return on your money. Just like that.

Because going forward, you’re not going to earn those kind of dizzy-heights returns in the stock market. As a matter of fact, at RIA, we expect quite the contrary.

The Economic Policy Institute or EPI a non-partisan created in 1986 which focuses on low and middle-income workers produced a report recently that shared interesting facts, many of the same we’ve outlined at  –

Rising inequality means that although we are finally seeing broad-based wage growth, ordinary workers are just making up lost ground, rather than getting ahead. The way rising inequality has directly affected most Americans is through sluggish hourly wage growth in recent decades, despite an expanding and increasingly productive economy. For example, had all workers’ wages risen in line with productivity, as they did in the three decades following World War II, an American earning around $40,000 today would instead be making close to $61,000 (EPI 2017c). A hugely disproportionate share of economic gains from rising productivity is going to the top 1 percent and to corporate profits, instead of to ordinary workers.” 

Unfortunately, we are witnessing an increasing number of U.S. households employ credit cards to make up for a structural wage gap, which makes a tax refund mentality even more confusing to comprehend.

Invest in your greatest asset.

No, it’s not a house. Nor is it your 401(k). It’s you – your skills, and the ability to build upon human capital. Yes, YOU! You are the greatest creator of wealth. A big, lifetime earnings machine. A true investment is one that brings greater income into your household.

As we examine hundreds of company retirement plan accounts monthly, we seek to separate the ‘steak from the sizzle’ as I coin it. We look to gain an understanding of savings habits versus the rates of returns on investments within the plans.

Interestingly, once contributions are isolated, we discover that performance and healthy nest eggs are not the result of asset allocation strategies nor returns on investments. The bulk of returns are comprised of sweat equity, time and compromise undertaken to consistently make saving a priority.

So why not use a refund to fund education that can increase skills and ostensibly, earnings potential?

Last year, Money, along with, created a list of 21 of the most valuable career skills.

Local and online educational courses may range from $2,500-$6,000 and pay off handsomely when compared to the limited future growth potential in the stock market.

Can you fund a Roth IRA? Then, do it.

A Roth IRA allows you to save after-tax dollars and at retirement, withdraw money tax free. Unlike a traditional IRA that may be tax-deductible and is taxed as ordinary income upon distributions, a Roth is unlike your ordinary retirement savings vehicle.

So why is that important? You see, once you intend to re-create a paycheck and focus on portfolio distribution vs. accumulation, having the ability to draw from various buckets that are taxed at different rates or not at all, provides tax control.

As opposed to having every dollar taxed as ordinary income and then forced to take large required minimum distributions at 70 ½ from retirement accounts, what if you had a bucket of after-tax dollars and Roth IRA money to generate a retirement paycheck in the most tax-efficient manner?

For 2017, an individual may contribute $5,500 to a Roth IRA, $6,500 if 50 and older. Unfortunately, the Feds place income limits on Roth IRA contributions as they’re not big fans of tax-free income. For single tax filers, phase-out begins at $118,000 and complete ineligibility begins at $133,000.

All you ever wanted to know about Roth IRAs including information for joint filers, can be found at

 Bolster your emergency cash reserves.

A recent report by Bankrate outlined how six out of ten Americans don’t have enough in savings to cover a $500 to $1,000 unplanned expense.

Don’t be one of the six. Establish or bolster a cash stash to deal with future unexpected events.

Also, there’s (very) little motivation to consider the anemic rates on savings from your typical brick and mortar bank branch. They’re here to stay. It’ll take at least four Federal Reserve interest rate hikes for most national banks to consider increasing rates on savings, checking and money market accounts.

Open an online account with an FDIC-insured ‘virtual’ bank and transfer the rightful return of your money into it, electronically.

Popular choices include and Several virtual banks offer ATM cards, no minimum balances and free checking accounts if you would like to ditch (finally) your prehistoric bank, permanently.

Spend it. Go ahead. But choose with memories in mind.

Invest the funds in those you love and create a memorable family experience. There’s a return on life element that requires nurturing (and money).

To get the most of your travel budget, think “off season.” Per the popular website, the best packages from June through August are available for travel to Miami, Las Vegas and Colorado, respectively.

Taking the off-season path less traveled will result in the greatest emotional return on a refund in the form of less crowds equals less stress. Financial dollars will go further too for airfares, hotels, dining and entertainment.

If there’s a mental lift connected to the receipt of a tax refund, I won’t interfere.

Now’s the time to plan wisely for the lump sum headed your way.

After all, when it comes to making wise financial choices, my money is on you over the federal government – any day of the week.


On the night of the U.S. Presidential election, many investment assets went from a state of sheer panic at the prospect of Donald Trump winning the election, to manic euphoria as the glorious narrative of Reagan-esque economic revival was born with Trump’s victory. Euphoric markets are not generally built on durable substance, and they eventually reconcile with reality as investors come to their senses.

In today’s case, the enthusiasm of pro-growth fiscal initiatives are destined to collide with decades worth of ill-advised economic policies and political obstacles. As such, we created the Trump Range Chart to track the performance of various key indexes and tradeable instruments since Election Day. This tool serves as a gauge of market sentiment and the market’s faith in Donald Trump’s ability to effect real economic change.

We suspect that when economic proposals meet political and economic reality, some markets will begin to diverge from their post-election trends. As is typically the case, it is likely that this will occur in some markets before others. Markets showing early signs of divergence may provide tradable signals. We plan on releasing this data regularly to help our clients track these changes. Based on feedback, we may produce new range charts to include different markets, various time frames, and economic data.

On the following page you will find the range charts showing various market and index moves since the election. Below the chart is a user’s guide on how to read and process the information it offers.

How To Read The Charts

The data in the Trump range chart above is shown in a format that is quite different from what is commonly used to illustrate market changes. This format provides an easy way to view relative performance across a broad number of indexes and securities. It is intended to be a meaningful supplement and not a replacement to the traditional charts most investors review on a routine basis.

The base time frame captured by the graph reflects the market move for each index or security since Election Day, November 8, 2016. This change is represented by the 0% to 100% on the left hand axis. The 0% level reflects the intra-day low of the security since November 8 and the 100% level the intra-day high. For more clarity on the prices associated with the range, see the table below the chart for each respective index.

The (red/blue) bar reflects the price range of the past month relative to the base time frame.  The black “dash” within the 1-month bar reflects the previous week’s closing level (PWC) and the red dot highlights the closing level on the “as-of” date in the top left corner.

The diagram below isolates the chart and data for the Russell 2000 to further illustrate these concepts.





“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.

As I noted last week, the “Ides Of March” is upon us and there is a LOT of stuff going on that could send ripples through the market. Here is a brief listing of the key events to watch out for:

  • The most important, if mostly priced in, event is this FOMC announcement on Wednesday where Traders view a quarter-point Fed hike this week as a virtual certainty and will be watching the central bank’s policy decision for signals on what will come next.
  • The Dutch general election whose results should be known on Thursday morning. Focus will be on the performance of the anti-EU, anti-immigration party PVV, and party leader Geert Wilders’ pledge to hold a referendum on EU membership.
  • On Wednesday the US debt ceiling limit expires and is due to be reinstated on Thursday absent some last minute breakdown in communication.
  • UK Prime Minister May is expected to invoke Article 50 of the Treaty of Lisbon as soon as Tuesday. This begins the long goodbye from the EU.
  • President Trump may also reveal his first budget outline for fiscal year 2018 on Thursday.
  • The G-20 Meeting will convene in Baden-Baden on March 17-18th. This is the first meeting since Donald Trump’s U.S. election victory in November where his protectionist stance on international trade is likely to be a key issue.
  • The BoJ is expected to maintain the status quo for monetary policy, leaving its long rate and short rate targets unchanged at 0.0% and -0.1%, respectively. Watch for a potential reduction to QE programs.
  • The BOE is expected to keep rates on hold.
  • And there is a bunch of economic data out this week with a focus on inflation and sentiment data.

Since the November election of Donald Trump, the investing landscape has gone through a dramatic change of expectations with respect to economic growth, market valuations and particularly inflation. As I discussed previously, there is currently “extreme positioning” in many areas which have historically suggested unhappy endings in the markets. To wit:

“As we saw just prior to the beginning of the previous two recessions, such a bump is not uncommon as the impact of rising inflation and interest rates trip of the economy. Given the extreme speculative positioning in oil longs, short bonds, and short VIX, as discussed yesterday, it won’t take much to send market participants scrambling for the exits.

While I am NOT suggesting that we are about to have the next great market crash tomorrow, the current sensation of ‘Deja Vu’ might just be worth paying attention to.

Even though there was a mild correction last week, the still extreme extension of prices above the 200-dma remains. Such extensions, which are always combined with extreme overbought conditions, have typically not lasted long and have been a good indication to take profits in the short-term. This provides some opportunity to invest capital following a correction to some level of support.

Buy The Dip? Probably. 

Will any correction in the days/weeks ahead be a “buyable correction?”

My best guess is probably for the following reasons:

  • The bullish trend remains intact. (Currently at 2350 short-term, 2250 intermediate-term.)
  • We remain within the seasonally strong period of the year currently. 
  • Investor optimism remains unabashedly bullish.
  • There is little fear of a correction in the markets. 

However, it is important to denote the market is currently more overbought than at any point of over the previous couple of years AS the Fed moves to tighten monetary policy further. As I noted in last weekend’s newsletter:

“This recent pop in rates, when combined with a stronger dollar which drags on corporate exports (roughly 40% of earnings), has historically been an excellent opportunity to add to bond exposure. As shown below, the Federal Reserve, in their eagerness to hike rates, are once again likely walking into an ‘economic trap.’” 

Sector By Sector

With that bit of analysis in place, let’s review the market environment for risks and opportunities.


The OPEC oil cut will likely end over the next couple of months as the ramp up in production continues in the Permian Basin. The Saudi’s are only going to give up so much “market share” before returning back to full production.

Furthermore, a break below $48/bbl is going to start putting pressure on the extreme “long” positioning currently remaining by speculators. There is an extremely high probability the supply increase that is currently happening will not only cap oil price temporarily, but will likely continue to push oil prices lower in the months ahead. 

Energy companies remain extremely overvalued, and disconnected, relative to the underlying commodity price. When the next economic recession hits, energy-related equities will likely once again recouple with its base commodity.


The health care sector moved from laggard to leader, as anticipated, over the last couple of months. With the raging debate over the repeal/replacement of the Affordable Care Act, there is volatility risk to the sector due to the very overbought condition that currently exists.

Current holdings should be reduced to market-weight for now as there is not a good stop-loss setup currently available. A correction to $70-72 would provide an entry point while maintaining a stop at $69.


Financials have weakened as of late in terms of relative performance. However, the sector is currently extremely overbought and very deviated from long-term moving averages. A correction back to support between $20 and $22 could provide for an entry point with a stop at $18.50.

There is a tremendous amount of exuberance in the sector at a time that loan delinquencies are rising and loan demand is falling. Caution is advised.


Industrial stock’s, like Financials, relative performance has begun to lag as of late. However, the “Make America Great Again” infrastructure trade is still on. Importantly, this sector is directly affected by the broader economic cycle which continues to remain weak so the risk of disappointment is very high if “hope” doesn’t become reality soon.

While the sector broke out to new highs, there is not a good risk/reward setup as there is a long way to a good stop level at $56. I would reduce holdings back to portfolio weight for now and take in some of the gains. 


As with Industrials, the same message holds for Basic Materials, which are also a beneficiary of the dividend / “Make America Great Again” chase. This sector should also be reduced back to portfolio weight for now with stops set at the lower support lines $49.00.


Back in January, I discussed the “rotation” trade into Utilities and Staples. That performance shift has played out nicely and the sector is now extremely overbought.

There is not a good stop currently available on a risk/reward basis as it resides all the way down at $45.00. However, a pullback to support between $48 and $49.50, could provide a reasonable entry to point to increase exposure. I would maintain a stop on all positions currently at $47.50.


Staples, have recovered as of late and are now back to extreme overbought, along with every other sector of the market. As with Utilities, there is not a good technical stop available. Set stops for now at $51 and look for a correction to $52 to $53 before increasing exposure to the sector.


Discretionary has been running up in hopes the pick-up in consumer confidence will translate into more sales. There is little evidence of that occurring currently, BUT with discretionary stocks at highs, profits should be harvested.

Trim portfolio weightings should back to portfolio weight with stops set at $80. With many signs the consumer is weakening, caution is advised and stops should be closely monitored and honored.


The Technology sector has been the “obfuscatory” sector over the past couple of months. Due to the large weightings of Apple, Google, Facebook, and Amazon, the sector kept the S&P index from turning in a worse performance than should have been expected prior to the election and are now elevating it post election.

The so-called FANG stocks (FB, AMZN/AAPL, NFLX, GOOG) continue to push higher, and due to their large weightings in the index, push the index up as well. 

The sector is extremely overbought and stops should be moved up to $45 where the bullish trend line currently intersects with the previous corrective bottom. Weighting should be revised back to portfolio weight.


Emerging markets have had a very strong performance and have now run into the top of a long-term downtrend live. The strengthening of the US Dollar will weigh on the sector and will only get worse the longer it lasts. With the sector overbought, the majority of the gains in the sector have likely been achieved. Profits should be harvested and the sector under-weighted in portfolios. Long-term underperformance of the sector relative to domestic stocks continues to keep emerging markets unfavored in allocation models for now.


As with Emerging Markets, International sectors also remain extremely overbought and unfavored in models due to the long-term underperformance. Underweight the sector, take profits, and focus more on domestic sectors for now. 


As stated above, the S&P 500 is extremely overbought, extended and exuberant. However, while a “buy signal” is currently in place, a sell signal registered from such a high level has previously coincided with bigger corrections.

Caution still advised for now.


Small cap stocks went from underperforming the broader market to exploding following the Trump election. However, as of late, that performance has stalled and the sector has now violated a bullish trend line. 

Importantly, small capitalization stocks are THE most susceptible to weakening economic underpinnings which are being reflected in the indices rapidly declining earnings outlook. This deterioration should not be dismissed as it tends to be a “canary in the coal mine.” 

Currently, small caps are back to an oversold condition which suggests the current corrective process is likely near completion. However, a failed rally attempt and a break below $820 would suggest a much deeper reversion is in process. Reduce exposure back to portfolio weight for now and carry a stop at $820.


As with small cap stocks above, mid-capitalization companies had a rush of exuberance following the election. However, Mid-caps currently remain overbought and is threatening to violate its bullish trend-line support. Reduce exposure back to portfolio weight for now and carry a stop at $1675.


REIT’s had been under pressure heading into the Fed’s expected rate hike this week. However, the sector is now oversold and maintained its bullish uptrend. Positions can be added with a stop set at $79.


Like REIT’s, and other interest rate sensitive sectors of the market, bonds are now oversold and sitting on support.  With the massive “short interest” position currently outstanding on bonds, a retracement of the previous decline to anywhere between $126 and $132 is very possible.  Furthermore, bonds are now back to extreme oversold conditions at more than 2-standard deviations below their moving averages.

Stops should currently be set at $115.


If you go back through all the charts and note the vertical RED-DASHED lines, you will discover that each time previously these lines denoted the peak of the current advance. Overall, in the majority of cases above, the risk/reward of the market is NOT favorable.

If, and when, the market corrects some of the short-term overbought conditions which currently exist, equity risk related exposure can be more aggressively added to portfolios.

Just be cautious for the moment.

It is much harder to make up losses than simply adding preserved cash back into portfolios.

Last week, I discussed the “World’s Most Deceptive Chartwhich explored the deception of “percentage” versus actual “point” losses which has a much greater effect on both the real, and psychological, damage which occurs during a bear market. To wit:

The problem is you DIED long before ever achieving that 5% annualized long-term return.

Outside of your personal longevity issue, it’s the ‘math’ that is the primary problem.

The chart uses percentage returns which is extremely deceptive if you don’t examine the issue beyond a cursory glance. However, when reconstructed on a point gain/loss basis, the ugly truth is revealed.”

Of course, there are those that still don’t get the basic realities of math, loss and time and resort to other flawed theses to support an errant view. As shown by a comment received by a reader:

“This is true only for price return, not for total return (dividends included). Since 1926, there has never been a negative 20-year period or 15-year period. There have been only four negative 10-year periods, 1928-1938, 1929-1939, 1998-2008, and 1999-2009.

The same fatal flaw afflicts that last graph. It shows inflation-adjusted price return (dividends not included). Including dividends increases that Mar 2009-Feb 2017 gain from 167% to 218%. Does Mr. Roberts throw away all his dividend cheques? Does anybody?” – Sam Baird

Sorry, Sam, the data WAS total, real returns, but the larger point you missed was the importance of understanding the devastating difference between POINT gain or loss, versus a PERCENTAGE gain or loss.

However, the point Sam made was nonetheless important as it showed another commonly held belief that is a fallacy.

Which bring us to….

The World’s Second Most Deceptive Chart

The following chart is the same real, inflation-adjusted, total return of the S&P 500 index from last week but converted to the compounded growth of a $1000 investment.

Note: The red lines denote the number of years required to get back to even following a bear market.

“See, other than those couple of periods, just buying, holding and collecting dividends is the way to go. Right?”

Again, not so fast.

First, as shown in the chart below, There have currently been four, going on five, periods of low returns over a 20-year period. Importantly, there also HAS been a NEGATIVE 20-year real, total return, holding period average of -0.22%

(Again, sorry Sam.)

I have added the P/E ratio which exposes the issue, once again, of the importance of valuation on future returns. In other words, your investment success depends more on WHEN you start, than IF you start investing.

“But Lance, yes, while there are some low periods, you made money provided you stayed invested. So what’s the issue?”

That brings me to my second point of that nagging problem of “time.” 

Until Death Do Us Part

In all of the analysis that is done by Wall Street, “life expectancy” is never factored into the equations used when presenting the bullish case for investing.

Therefore, in order to REALLY calculate REAL, TOTAL RETURN, we have to adjust the total return formula by adding in “life expectancy.” 

RTR =((1+(Ca + D)/ 1+I)-1)^(Si-Lfe)


  • Ca = Capital Appreciation
  • D = Dividends
  • I = Inflation
  • Si = Starting Investment Age
  • Lfe = Life Expectancy

For consistency from last week’s article, we will assume the average starting investment age is 35. We will also assume the holding period for stocks is equal to the life expectancy less the starting age. The chart below shows the calculation of total life expectancy (based on the average of males and females) from 1900-present, the average starting age of 35, and the resulting years until death. I have also overlaid the rolling average of the 20-year total, real returns and valuations.

If we use the stat and end dates, as shown in the first chart and table above, and calculate real total return based on the life expectancy for each period we find the following.

The horizontal red line is critically important.

One to the most egregious investing “myths” is when investors are told:

The power of compounding is the most powerful force in investing.” 

What the red line shows you is when, ON AVERAGE, you failed to achieve 6%-annualized average total returns (much less 10%.) from the starting age of 35 until DEATH.

Importantly, notice the level of VALUATIONS when you start investing has everything to do with the achievement of higher rates of return over the investable life expectancy of an individual. 

“Yes, but there are periods where my average return was higher than either 6% or 10%. So it’s not actually a fallacy. What am I missing?”


The stock market does not COMPOUND returns. 

There is a massive difference between AVERAGE and ACTUAL returns on invested capital. The impact of losses, in any given year, destroys the annualized “compounding” effect of money.

As shown in the chart box below, I have taken a $1000 investment for each period and assumed a real, total return holding period until death. No withdrawals were ever made. (Note: the periods from 1983 forward are still running as the investable life expectancy span is 40-plus years.)

The gold sloping line is the “promise” of 6% annualized compound returns. The blue line is what actually happened with invested capital from 35 years of age until death, with the bar chart at the bottom of each period showing the surplus or shortfall of the goal of 6% annualized returns.

In every single case, at the point of death, the invested capital is short of the promised goal.

The difference between “close” to goal, and not, was the starting valuation level when investments were made.

This is why, as I discussed in “The Fatal Flaws In Your Retirement Plan,” that you must compensate for both starting period valuations and variability in returns when making future return assumptions. If you calculate your retirement plan using a 6% compounded growth rates (much less 8% or 10%) you WILL fall short of your goals. 

But wait….

It’s Actually Even Worse

The analysis above does NOT INCLUDE the effect of taxes, fees, expenses or a withdrawal rate once individuals hit retirement age.

This was the point I discussed in “Retirees May Have A Spend Down Problem.”

“The chart below takes the average return of all periods where the starting P/E was above 20x earnings (black line) and uses those returns to calculate the spend down of retiree’s in retirement assuming similar outcomes for the markets over the next 30-years. As opposed to the analysis above, I have added a 4% annual withdrawal rate at retirement and included the impact of inflation and taxation.”

“On the surface, it would appear a retiree would not have run out of money over the subsequent 30-year period. However, once the impact of inflation and taxes are included, the outcome becomes substantially worse.”

Time To Get Real

The analysis above reveals the important points that individuals should OF ANY AGE should consider:

  • Expectations for future returns and withdrawal rates should be downwardly adjusted due to current valuation levels.
  • The potential for front-loaded returns going forward is unlikely.
  • Your personal life expectancy plays a huge role in future outcomes. 
  • The impact of taxation must be considered.
  • Future inflation expectations must be carefully considered.
  • Drawdowns from portfolios during declining market environments accelerates the principal bleed. Plans should be made during up years to harbor capital for reduced portfolio withdrawals during adverse market conditions.
  • The yield chase over the last 8-years, and low interest rate environment, has created an extremely risky environment for investors. Caution is advised.
  • Expectations for compounded annual rates of returns should be dismissed in lieu of variable rates of return based on current valuation levels.

You cannot INVEST your way to your retirement goal. As the last decade should have taught you by now, the stock market is not a “get wealthy for retirement” scheme. You cannot continue under-saving for your retirement hoping the stock market will make up the difference. This is the same trap that pension funds all across this country have fallen into and are now paying the price for.

Importantly, chasing an arbitrary index that is 100% invested in the equity market requires you to take on far more risk that you most likely realize. Two massive bear markets over the last decade have left many individuals further away from retirement than they ever imagined.

As shown above, our life expectancy rates are finite and the later we get started saving for goals, the less time we have to waste trying to “get back to even” following a “mean reverting event.”

Investing for retirement, should be done conservatively, and cautiously, with the goal of outpacing inflation over time. Trying to beat some random, arbitrary index that has nothing in common with your financial goals, objectives, and most importantly, your life span, has tended to end badly for individuals.

You can do better.

Next week the Janet Yellen and her minions are expected, with 100% certainty, to lift the Fed funds rate by another 0.25% to 1.00%.

This certainty has been building as of late given the rise in inflation pressures from higher commodity, particularly oil prices, and still rising health care costs as well as a strong market, dollar, and employment data. Speaking of employment data, ADP reported on Wednesday a 298,000 person increase in employment. What is interesting is this was the highest monthly employment rate seen since 2014, 2011, and 2006. In all three previous cases, it was the peak of employment before weakness begin to set in. 

Of course, given the “exuberance” following the election of “the guy that was supposed to crash everything,” it is not surprising that we have seen a pick up in some activity more closely aligned with a boost in sentiment.

The chart below is a composite index of the average of the UofM and CB survey readings for consumer confidence, consumer expectations, and current conditions. The horizontal dashed lines show the current readings of each composite back to 1957.

Importantly, as noted above, high readings of the index are not unusual. It is also worth noting that high readings are historically more coincident with a late stage expansion, and a leading indicator of an upcoming recession, rather than a start of an economic expansion.

The next chart shows the same analysis as compared to the S&P 500 index. The dashed vertical lines denote peaks in the consumer composite index.

Again, not surprisingly, when consumer confidence has previously reached such lofty levels, it was towards the end of an expansion and preceded either a notable correction or a bear market.

But therein lies the other issue. The strength in the recent employment reports will most assuredly push Yellen to hike rates next week. It is worth noting that historically there was a significant gap between the Labor Market Condition Index and the ZERO line when the Fed started a rate hiking campaign (vertical black lines) which provided a buffer until the next recession. That is not the case currently. 

Just some things I am thinking about this weekend as I catch up on my reading.



Research / Interesting Reads

“As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” – Chuck Prince, CEO of Citi in July, 2007.

Questions, comments, suggestions – please email me.

With the Federal Reserve now indicating they are “really serious” about “normalizing” interest rates, read “tightening” monetary policy, there have come numerous articles, and analysis, discussing the impact on asset prices. The general thesis is based on averages of historical tendencies suggesting equity bull markets never die simply of old age. They do, however, die of excessive Fed monetary restraint. As previously noted by David Rosenberg:

“In the past six decades, the average length of time from the first tightening to the end of the business cycle is 44 months; the median is 35 months; and the lag from the initial rate hike to the end of the bull equity market is 38 months for the average, 40 months for the media.”

So, that analysis would suggest that since the Fed hiked in December of 2015, there is still at least two years left to the current business cycle. Right?

Maybe not.

First, averages and medians are great for general analysis but obfuscate the variables of individual cycles. To be sure the last three business cycles (80’s, 90’s and 2000) were extremely long and supported by a massive shift in financial engineering and credit leveraging cycle. The post-Depression recovery and WWII drove the long economic expansion in the 40’s, and the “space race” supported the 60’s.  You can see the length of the economic recoveries in the chart below. I have also shown you the subsequent percentage market decline when they ended.

Currently, employment and wage growth is extremely weak, 1-in-4 Americans are on Government subsidies, and the majority of American’s living paycheck-to-paycheck. This is why Central Banks, globally, are aggressively monetizing debt in order to keep growth from stalling out.

If the Fed continues to hike rates, and the next recession doesn’t occur for another two years as David suggests, this would be the single longest economic expansion in history based on the weakest economic fundamentals.

Secondly, the above analysis misses the level of economic growth at the beginning of interest rate hiking campaign. The Federal Reserve uses monetary policy tools to slow economic growth and ease inflationary pressures by tightening monetary supply. For the last six years, the Federal Reserve has flooded the financial system to boost asset prices in hopes of spurring economic growth and inflation. Outside of inflated asset prices, there is little evidence of real economic growth as witnessed by an average annual GDP growth rate of just 1.3% since 2008, which by the way is the lowest in history since…well, ever.

The chart and table below compare real, inflation-adjusted, GDP to Federal Reserve interest rate levels. The vertical red bars denote the quarter of the first rate hike to the beginning of the next rate decrease or onset of a recession.

If I look at the underlying data, which dates back to 1943, and calculate both the average and median for the entire span, I find:

  • The average number of quarters from the first rate hike to the next recession is 11, or 33 months.
  • The average 5-year real economic growth rate was 3.08%
  • The median number of quarters from the first rate hike to the next recession is 10, or 30 months.
  • The median 5-year real economic growth rate was 3.10%

However, note the GREEN arrows. There have only been TWO previous points in history where real economic growth was near 2% at the time of the first quarterly rate hike – 1948 and 1980. In 1948, the recession occurred ONE-quarter later and THREE-quarters following the first hike in 1980.

The importance of this reflects the point made previously, the Federal Reserve lifts interest rates to slow economic growth and quell inflationary pressures. There is currently little evidence of “good” inflationary pressures outside of financial asset prices, and economic growth is weak, to say the least.

Therefore, rather than lifting rates when average real economic growth was at 3%, the Fed is doing this with rates closer to 2% over the last 5-years.

Think about it this way.

If it has historically taken 11 quarters to go fall from an economic growth rate of 3% into recession, then it will take just 2/3rds of that time at a rate of 2%, or 6 to 8 quarters at best. This is historically consistent with previous economic cycles, as shown in the table to the left, that suggests there is much less wiggle room between the first rate hike and the next recession than currently believed.

Recessions & Bear Markets

If historical averages hold, and since major bear markets in equities coincide with recessions, the current bull market in equities has about 12-18 months left to run. But this also may be a bit overly optimistic.

Given the combination of excessive bullishness, high valuations, weak economic data it is very likely the Fed will trip up the economy, and subsequently the markets, sooner than expected.

While the markets, due to momentum, may ignore the effect of “monetary tightening” in the short-term, the longer-term has been a different story. As shown in the table below, the bulk of losses in markets are tied to economic recessions. However, there are also other events such as the Crash of 1987, the Asian Contagion, Long-Term Capital Management, and others that led to sharp corrections in the market as well.

The point is that in the short-term the economy and the markets (due to momentum) can SEEM TO DEFY the laws of gravity as interest rates begin to rise. However, as rates continue to rise they ultimately act as a “brake” on economic activity. Think about the all of the areas that are NEGATIVELY impacted by rising interest rates:

1) Debt servicing requirements increase which reduces future productive investment.

2) The housing market. People buy payments, not houses, and rising rates mean higher payments. (Read “Economists Stunned By Housing Fade” for more discussion)

3) Higher borrowing costs which lead to lower profit margins for corporations.

4) Stocks are cheap based on low-interest rates. When rates rise, markets become overvalued very quickly.

5) The economic recovery to date has been based on suppressing interest rates to spur growth.

6) Variable rate interest payments for consumers

8) Corporate share buyback plans, a major driver of asset prices, and dividend issuances have been done through the use of cheap debt.

9) Corporate capital expenditures are dependent on borrowing costs.

Well, you get the idea. If real economic growth was near historical norms of 3%, this would be a different conversation. However, at current levels, the window between a rate hike and recession has likely closed rather markedly.

Lastly, it isn’t just recessions that have impacted stocks prices in the past. It is often suggested that stocks can withstand rising interest rates.

This claim falls into the category of “timing is everything.”

The chart below has been circulated quite a bit to support the “don’t fear rising interest rates” meme. I have annotated the chart to point out the missing pieces.


While rising interest rates may not “initially” impact asset prices, it is a far different story to suggest that they won’t.

In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest rate hiking campaign that has not eventually led to a negative outcome.

What the majority of analysts fail to address is the “full-cycle” effect from rate hikes. While equities may initially provide a haven from rising interest rates during the first half of the rate cycle, they have been a destructive place to be during the last half.

It is clear from the analysis is that bad things have tended to follow the Federal Reserve’s first interest rate increase. While the markets, and economy, may seem to perform okay during the initial phase of the rate hiking campaign, the eventual negative impact will push most individuals to “panic sell” near the next lows. Emotional mistakes are 50% of the cause as to why investors consistently underperform the markets over a 20-year cycle.

For now, the bullish trend is still in place and should be “consciously” honored. However, while it may seem that nothing can stop the markets current rise, it is crucial to remember that it is “only like this, until it is like that.” For those “asleep at the wheel,”there will be a heavy price to pay when the taillights turn red.

Just something to think about.

Per a recent survey conducted by, approximately 12 million Americans have concealed a bank or credit card from a spouse or significant other.  

In a recent survey, one in three Americans (31%) who have combined their finances admitted lying to their spouses about money, and another one-third of these adults said they’d been deceived.

The online poll, commissioned by ForbesWoman and the National Endowment for Financial Education (NEFE) and conducted by Harris Interactive, surveyed 2,019 U.S. adults. Among both offenders and victims, the leading money crimes were hiding cash, minor purchases and bills. Meanwhile, a significant number of people admitted hiding major purchases, keeping secret bank accounts and lying about their debt or earnings.

Baby Boomers between the ages of 63 and 71 are four times more likely to succumb to financial infidelity compared to Millennials because they have the resources to do so.

Over the last two decades, I’ve witnessed many a sad aftermath of financial infidelity.

Stealth spending behavior, which never remains hidden, has the potential to cause wide or permanent rifts in even the healthiest of long-term relationships.

It’s never too late – There are effective and simple methods to avoid or detect financial infidelity. Taking these concepts to heart can strengthen the bonds you both share, embolden trust, and over time, improve dialogue around positive money flow which is a collaboration which enhances the ability of willing partners to meet and exceed financial goals.

First and foremost, set boundaries. Successful couples establish clear no-spend territories. Both parties should agree on individual and joint budgetary boundaries around recreational spending in the early stages of a marriage or commitment.

Limits are not designed to be deep, dark lines in a household budget, either. Couples who communicate openly about money understand how life happens and deviations may occur. It’s when individual boundary breaches become consistent enough to endanger the fiscal health of the household that bigger financial infidelity issues begin to emerge.

Trusting partners don’t expect to ask for permission for every purchase made so, decide upon a mutually acceptable monthly allotment of household income for recreational activities and hobbies.

Usually, a couple will follow mutually agreed upon spending guidelines, anywhere from $50-$100 a month, and a joint budget for activities they look to do together which may range on average $80-200 monthly. Of course, your guidelines will differ based on household income, but you get the picture.

Many couples agree to allow breathing room of $20-$30 dollars each for individual boundaries. Most important, expenditures above the limits are disclosed and discussed.

People who practice financial infidelity will discourage conversation or seek to minimize questions. Tactics like making partners appear foolish or feeling insulted should be considered considerable red flags of abhorrent spending behavior.

Practice financial nudity. I strongly encourage swapping in a marriage. Credit report swapping, that is.

Credit reports list all accounts from past to present, including those that exist without the knowledge of both parties. It’s the purest form of financial vulnerability. Credit reports may be accessed annually for free at

Credit report analysis should be part of a yearly financial health checkup.  It’s a crucial step to confirm that information is accurate and at the same time, discourages or exposes financial infidelity. Partners should allow an openly joint investigation to discover overlooked errors or foster questions and discussion about open and closed accounts.

Hold monthly money dates. My friend and fellow Certified Financial Planner Brittney Castro encourages couples to participate in regular money date nights. As an example, scheduled time together to review credit card and banking statements is a simple yet effective exercise in trust and mutual respect.

A couple’s review of spending, savings, investments, along with a commitment to follow a similar money philosophy can bolster the overall health of a union or marriage.

As a financial professional, I’ve been in the middle of conflict between couples with disparate views on finances with zealous savers and profligate spenders pitted against each other.

The outcomes of these discussions are rarely positive. Ostensibly, household net worth pays a price. The strain leads to lower probabilities of meeting important long-term financial benchmarks like retirement.

According to a survey conducted by SunTrust Bank in 2015, finances are a leading cause of stress in a relationship. Some 35% of respondents referenced money as a primary source of friction. They also discovered that 36% of partners did not consult each other about large purchases.

Money dates should be safe space for candid conversation, a time to regroup on mutual financial goals, checks and balances on recreational spending and an overview of the current household budget.

Stay observant – It’s easier than you think to hide in plain sight. You may not be as observant of your surroundings as you believe. A significant other may overlook the signs of overspending out of conflict avoidance or an unwillingness to confront deeper relationship issues.

To uncover financial infidelity, a detective-like mindset is crucial. Have you noticed a partner donning new clothes or jewelry more often? Or maybe an expensive hobby is developing and you’ve seen more than a few Amazon boxes on the doorstep. An observation, no matter how trivial it appears, should be discounted. At the least, your gut should be nagging at you to ask questions and dig deeper.

Recently, I had a female client decide to go through her outside trash receptacles when she felt her husband was spending too much time with his golf buddies.

Her investigative skills paid off.

She managed to find numerous receipts from a retail golf outlet totaling more than $2,000.  They were torn and at the bottom of a plastic garbage bag her husband took out the night before trash pickup.

You may not seek to go to such extremes. However, it’s easier than you think to overlook out of control spending which makes money dates and annual credit report review mandatory in financially noble relationships.

Spending is usually a symptom, but not the real problem. Occasionally, you must look beyond excessive spending to discover the true and most likely, emotional root causes of the behavior.

Job strain, depression, physical health issues, marital stress are formidable catalysts. Spending can be a method to release stress albeit ineffective as it can accelerate financial anxiety.

A partner may ‘excuse away’ financial infidelity when caught as no big deal when in fact, it is.

Regardless of how much in dollars has been spent or credit utilized, financial infidelity creates long-term negative ramifications for a relationship and sometimes irreparable damage to an otherwise strong economic standing of a household.

Rules I share to keep couples on track are built on a foundation of three simple sentiments encompassed in YMB.

YOU: As my partner, you promise to ask my input for financial commitments that breach our agreed-upon boundaries.

ME: As your partner, I promise to share all personal financial matters that may affect you.

BOTH: As a couple, we promise to mutually respect our core, joint money philosophy, agree to share financial documents when asked, hold steady money dates, and work, save, and invest together to meet our financial milestones.

Well, you get the picture.

Plan as one unit to form your own, personalized foundation of YMB.

Striving for open communication and following up with actions that promote full disclosure of individual and joint financial documents and concerns, forges respect and fortifies the emotional and financial ties couples share.

Real Investment Advice welcomes Ben Masters to our growing list of contributors. Benjamin Masters is the creator, designer, and writer for Third Wave Finance, With over ten years of experience working as a lead Portfolio Analyst, Ben brings additional insights into the discussion of economics, markets and portfolio management.

As lackluster results from rather experimental central bank policies continue to emerge, it’s time to readdress the seemingly endless nature of the perpetual-motion machine known as central bank stimulus — to stop and be still for moment and question whether the endlessly spinning wheels should be spinning at all, to question whether the maze is leading us back to the beginning. It’s often difficult to do — to question a lifetime’s worth of custom — but it’s so very important, as even the most advanced civilizations have drifted off course at some point in history.

A brief look at the charts below can give us a sense of the misalignment that is occurring:

1. The experimental monetary policies (Large Scale Asset Purchases / Quantitative Easing) that have been used to expand the monetary base have not met the goal of dramatically affecting the money supply.

2. A misallocation of capital has occurred shifting assets away from the broader economy, and toward a portion of the economy — tradable securities. Since the 1980s, the prices of many tradable securities, including stocks, have seen a significant rise, yet the economy as a whole has been unable to reach previously-attainable levels of growth.

And although the results can be damaging (to be addressed in this multi-part series), the outcome should not be surprising:

When faced with near-zero interest rates, it’s not surprising if banks decide against pursing their low-return commercial banking side, and instead favor leveraged asset speculation via their proprietary trading desks. If the trade-off from low-risk/guaranteed-low-return to high-risk/potential-for-return takes place, it may actually deprive the economy of funds while banks temporarily improve earnings through risk-taking — a point that would be consistent with Robert Hall’s comment at the Jackson Hole Monetary Conference in 2013: “An expansion of reserves contracts the economy”. And in a similar fashion, when savings rates are near-zero, there may be an irresistible temptation for companies and investors to take on unsustainable, speculative, investment risk (in an attempt to try to meet performance and savings goals).

Questions then arise: Why is this form of economics being pursued? Are there other options available? Is economics and central bank policy worthless?

A Starting Point

Although economics is typically addressed without a qualifier to distinguish one version from another, it may be worthwhile to begin the custom as there are many schools of economics — each with strongly opposing views of the world. And if there are many schools of economics (see the video Economics is for Everyone), why should we assume that the choice made by many of the world’s economies — which is to eschew all but one version — is the proper decision? Given that the world is constantly changing, and that each version of economics has its own built in assumptions, it may be naïve to assume that economics in its existing state has reached peak perfection; and based on the charts above, the current form of economics may not even be desirable.

The Questionable State — and Abusive Use — of Economics

A necessary and constant desire to explore alternative viewpoints — as a way to broaden the scope of understanding — has brought me to Henry Hazlitt’s Economics in One Lesson. It aligns with the important recognition that an idea, profession, concept, axiom, or story, should not be seen as a static topic to be memorized and repeated, but as one to be challenged in a constantly evolving process of reeducation, to merge established ideas with novel ones; it should constantly be influenced, adjusted, and questioned. Only then, is the fallibility of any one particular idea realized — its transitory nature recognized.

And this brings us to our current economic environment, where one predominant ethos has been perpetuated, saturating the economic landscape — arguably because its benefits are lucid and ramifications clandestine. That idea is a bizarre version of keynesian economics — not even in its originally intended form — a version that pursues debt-based spending to temporarily boost growth, a version that disregards the quality of debt being taken on and the long-term affects on all other parties; this is the version of economics used by central banks and governments throughout the world. It’s a stagnant policy that has favored the short term over the long term, while creating an illusory environment based on inflation, the results of which are a misallocation of wealth, and social disruptions.

In moving away from the study of classical economics — which also suffers its own drawbacks, showing a certain callousness toward the groups immediately hurt by its attempt to focus on the long term — modern economic policies have reversed course so drastically that they have merely unbalanced the ship to the other side.

“There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: ‘In the long run we are all dead.’ And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.

But the tragedy is that, on the contrary, we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore. The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg, the flower in the seed.

From this aspect, therefore, the whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups.”

– Henry Hazlitt (H.H.)

And the oversight suggested in the last line is the reason that economics and central bank policy are becoming questionable endeavors — not because they are worthless but because they have been abused. The immediate effects of a policy are visible, the affects on one (or a few) particular groups are seen, yet the implications for all remaining groups are overlooked; the chain of events that is set into motion — each causing its own further effects — is forgotten.

“Economics is haunted by more fallacies than any other study known to man. This is no accident. The inherent difficulties of the subject would be great enough in any case, but they are multiplied a thousandfold by a factor that is insignificant in, say, physics, mathematics or medicine — the special pleading of selfish interests. While every group has certain economic interests identical with those of all groups, every group has also, as we shall see, interests antagonistic to those of all other groups. While certain public policies would in the long run benefit everybody, other policies would benefit one group only at the expense of all other groups. The group that would benefit by such policies, having such a direct interest in them, will argue for them plausibly and persistently. It will hire the best buyable minds to devote their whole time to presenting its case. And it will finally either convince the general public that its case is sound, or so befuddle it that clear thinking on the subject becomes next to impossible.” – H.H.

One may stop to ponder on why the immediate is preferred to the future (An innate survival instinct? Merely due to a lack-of-awareness of consequence?), but one point is clear and immovable in our current environment: it is easier to choose the “here and now”.

The Fallacy of Deficit Spending

The fallacy in the concept that a country can borrow money to boost growth (i.e. deficit spending) in an economic downturn is that it assumes that politicians will counter the process in the recovery period to actually slow growth down.

When an individual takes a loan they are able to boost their current spending, yet at the same time they’re also reducing their future spending (future payments toward the loan are reducing their income and ability to spend at that time). Just as an individual can only spend from income, a country can only spend from taxes, so a country that uses deficit spending to boost the economy during a downturn will be forced to slow the economy while the loan is being paid back through increased taxes.

Deficit spending is easy to agree to, but its other side is so very difficult to complete — especially when it’s likely that a different politician will be the one that will need to complete the process. Although it’s possible, what politician would campaign to slow the growth of the country? — yet that’s what is necessitated by deficit spending.

Although deficit spending can be used to boost growth in a deflationary / recessionary / depression-type environment, by doing so the country is pulling growth forward — borrowing from future taxes — and if it occurs over a long enough period of time, the taxes will be placed on a different generation; this is the concept of “generational warfare” — the consequences of a spendthrift generation are passed to another.

Click Here For Part II


“Technically Speaking” is a regular Tuesday commentary updating current market trends and highlighting shorter-term investment strategies, risks, and potential opportunities. Please send any comments or questions directly to me via Email, Facebook or Twitter.

The month of March typically marks the beginning of Spring. This weekend will also mark the loss of an hour of sleep as we set our clocks forward an hour in observance of daylight savings time.

As we will discuss momentarily, the month of March begins following an unseasonably warm winter period that allowed for manufacturing activity to occur during a period where inclement weather normally abounds. This is an interesting point because two years ago, the BEA adjusted the “seasonal adjustment” factors to compensate for the cold winter weather over the previous couple of years which had suppressed first quarter economic growth rates. (The irony here is that they adjusted adjustments for cold weather that generally occurs during winter.) However, the problem with “tinkering” with the numbers comes when you have an exceptionally warm winter. The new adjustment factors, which boosted Q1 economic growth during the last two years now creates a large over-estimation of activity during the first quarter of a year where winter weather is unseasonably warm. 

This anomaly has boosted “bullish hope” as the fear of an economic slowdown has been postponed. At least temporarily until the over-estimations are revised away over the course of the coming months. Of course, with the spread between “hope” and “reality” currently at some of the highest levels ever, it is worth paying attention to what happens. 

However, as of now, the bullish underpinnings of the markets remain.

The rising dashed lines show the bullish trend of the market currently which suggests that a short-term pullback towards 2325 is likely.

The bad news comes from the overbought/oversold indicators again as we head into March. The oversold condition that existed at the beginning of 2016 has been completely exhausted due to the post-election rally. This leaves little ability for a significant rally from current levels and makes a substantial push higher unlikely. Just as an oversold condition provides the necessary ‘fuel’ for an advance, the opposite is also true.

As noted, we are potentially registering an early “sell signal” from a very high level which suggests a potential retracement over the next month to between 2200 and 2275 on a Fibonacci retracement scale. Such a pullback, provided critical support levels are not broken, would likely provide for a tradeable rally through the end of the seasonally strong” period.

Importantly, the trend of the market is still positive, therefore, all pullbacks should remain confined within the overall positive trend. That is…until it eventually changes.

The rules here are very simple:

  1. In rising market trends – buy dips.
  2. In declining market trends – sell rallies.

The Ides Of March

For basketball fans, the month of March brings a lot of excitement as the NCAA heads into their annual tournament. This month also brings the Dutch elections, a Fed rate hike announcement, and a potential “debt ceiling” debate. Any of those last three issues alone could roil the markets, let alone a combination of any two, or all, of them. Furthermore, after a positive return in both January and February, it is hoped that March will be able to continue to the trend.

Now, I realize analyzing market data isn’t as fun as basketball teams, but since you are investing your hard earned savings, it is an exercise worth undertaking.

So, let’s dig into the monthly statistics for March to get a better understanding of what we should expect.

Beginning with the “big picture” perspective, the average and median monthly returns for March have not been terrifically exciting and only slightly better than what we would have expected for February.

However, given that both January and February were positive months, which has occurred 50-times since 1900, the following March month was positive only 29-times.

Of course, what averages and median returns obfuscate are the months when things go exceptionally well and horribly wrong. The next chart displays the best and worst return in March historically.

March has had some big positive return months like 2016’s near 7% gain that almost matched the historic record. It has also had some whopper losses. We can see the entire distribution of returns below.

Wedbush Securities’ Scott Skyrm reminds us:

 “Over the past 20 years, there was a series of market sell-offs during the month of March.

 In 1998, it was the subject of a news story on CNBC. They claimed it’s a combination of the market digesting the February refunding and Japanese investors preparing for Japanese year-end on March 31st.

 These days, world markets are more complex than in 1998, but there continues to be a series of market panics and crashes coincidentally in March.”

Don’t believe the hype? Here’s the last 25 years of March mishaps in stocks and bonds…

  • March 1992: Short-end sells-off, market prices a 75 bps tightening, but the Fed eases in April
  • March 1994: Fed tightens in February and March igniting a sell-off in the long-end of the curve. Mortgage and CMO markets crash. Kidder Peabody is sold
  • March 1995: U.S. dollar crashes. Central banks intervene to support the dollar with large operations
  • March 1996: Large employment number triggers a sell-off across the entire yield curve
  • March 1998: General market sell-off at the beginning of the month
  • Feb/Mar 1999: Bond market experiences a series of 1 point drops
  • March 24, 2000: NASDAQ (technology) market reaches a peak and begins major decline
  • March 2001: Sell-off in U.S. stock market after Fed fails to cut rates aggressively
  • March 2003: After Iraq War starts, bond market sells-off considerably
  • March 2005: After poor earnings from General Motors, corporate and emerging markets bonds sell-off
  • Feb/Mar 2007: Stock sell-off in China sparks global sell-off, flight-to-quality. Sub-prime market stressed
  • March 2008: Liquidity crisis causes the collapse of Bear Stearns
  • March 2009: Sell-off in stocks brings Dow Jones index to a low of 6547; lowest since 1996
  • Feb/Mar 2010: Greek sovereign debt crisis begins
  • Mar 2011: Earthquake in Japan sends higher, leads to both a flight-to-quality & sell-off in the cash market March 20, 2012: Late hour bailout from the Eurozone and IMF saves Greece from default
  • March 20, 2012: Late hour bailout from the Eurozone and IMF saves Greece from default

What we now see more clearly is there are many times that March yields negative rates of return for the month. Since 1900, March has delivered 67 positive months and 50 negative months, giving March a winning percentage of 57.2%. While a little better than a coin toss, it’s not by much.

Since February has typically been a weak performance month for stocks, historically speaking, the month of March has often been a rebound month. This has led to March typically having stronger performance over time. The chart below shows the impact of $100 invested only in the month of March.

While the backdrop currently remains bullishly biased, and argues for maintaining long-biased exposure in the markets, we did take some profits off of the table last week to rebalance portfolio risk.

I have to agree with Jeff Saut’s recent commentary as well wherein he stated:

“In the short term, we do not understand what is going on. Consequently, when we do not understand the current market environment, we tend not to play.”

There are many pieces of evidence which suggest the current market meltup is very akin to what we have seen near previous major corrective market tops in the past. Such price action suggests that overall portfolio risk should be carefully monitored and reduced to more risk-managed levels.

As noted by Business Insider recently, again quoting Jeff Saut:

Corporate insiders sold $7.8 billion of their companies’ stock in February, which was the most in roughly six years.

What do they know that we don’t know? Maybe they know that the Daily Sentiment Survey of Futures Traders shows a 92% Bulls reading. In the three times the reading has been that high since 2011 it has led to declines of 7% (2/11), 8% (5/13), and 3% (11/13). Also of note is that late last week the number of stocks making new 52-week highs on the NYSE collapsed by some 80%.

Then there are the bullish sentiment figures that are at danger levels. All of this continues to leave us in a cautionary stance despite the fact that stance has been wrong for three weeks.

This is the problem with exuberance. It can defy logic much longer than expected, however, it is exactly when investors capitulate into the this is never going to stop going up” mentality…that it does. 

The market is as severely overbought as it has been at every other major market peak throughout history. While it does take “time” for these types of bullish advances to end…they eventually do.

Of course, throughout history, it has been the Fed hiking rates that have eventually done the trick.

As stated above, with the Fed on deck to raise rates, Geo-political election risk as the Eurozone seemingly continues to break apart, and the debt-ceiling hitting its limit all at mid-month, being a bit more cautious temporarily may well pay off.

While many have suggested that investors should “buy and hold” investments and just ride them out over the long-term, that is just half the story. J. Paul Getty provided the full definition of “buy and hold” investing:

It is unfortunate that some many have forgotten what “investing” actually means. Given that investors have piled into the market since the beginning of the year, the question simply becomes who is doing the selling?

I received an email last week which I thought was worth discussing.

“I just found your site and began reading the backlog of posts on the importance of managing risk and avoiding draw downs. However, the following chart would seem to counter that argument. In the long-term, bear markets seem harmless (and relatively small) as this literature would indicate?”

This same chart has been floating around the “inter-web,” in a couple of different forms for the last couple of months. Of course, if you study it at “face value” it certainly would appear that staying invested all the time certainly seems to be the optimal strategy.

The problem is the entire chart is deceptive.

More importantly, for those saving and investing for their retirement, it’s dangerous.

Here is why.

The first problem is the most obvious, and a topic I have addressed many times in past missives, you must worry about corrections.

The problem is you DIED long before ever achieving that 5% annualized long-term return.

Let’s look at this realistically.

The average American faces a real dilemma heading into retirement. Unfortunately, individuals only have a finite investing time horizon until they retire.

Therefore, as opposed to studies discussing “long term investing” without defining what the “long term” actually is – it is “TIME” that we should be focusing on.

Think about it for a moment. Most investors don’t start seriously saving for retirement until they are in their mid-40’s. This is because by the time they graduate college, land a job, get married, have kids and send them off to college, a real push toward saving for retirement is tough to do as incomes, while growing, haven’t reached their peak. This leaves most individuals with just 20 to 25 productive work years before retirement age to achieve investment goals. 

This is where the problem is. There are periods in history, where returns over a 20-year period have been close to zero or even negative.”

Like now.

It’s The Math

Outside of your personal longevity issue, it’s the “math” that is the primary problem.

The chart uses percentage returns which is extremely deceptive if you don’t examine the issue beyond a cursory glance. Let’s take a look at a quick example.

Let’s assume that an index goes from 1000 to 8000.

  • 1000 to 2000 = 100% return
  • 1000 to 3000 = 200% return
  • 1000 to 4000 = 300% return
  • 1000 to 8000 = 700% return

Great, an investor bought the index and generated a 700% return on their money.

See, why worry about a 50% correction in the market when you just gained 700%.  Right?

Here is the problem with percentages.

A 50% correction does NOT leave you with a 650% gain.

A 50% correction is a subtraction of 4000 points which reduces your 700% gain to just 300%.

Then the problem now becomes the issue of having to regain those 4000 lost points just to break even.

It’s Not A Nominal Issue

The bull/bear chart first presented above is also a nominal chart, or rather, not adjusted for inflation.

So, I have rebuilt the analysis presented above using inflation-adjusted returns using Dr. Robert Shiller’s monthly data.

The first chart shows the S&P 500 from 1900 to present and I have drawn my measurement lines for the bull and bear market periods.

The table to the right is the most critical. The table shows the actual point gain and point loss for each period. As you will note, there are periods when the entire previous point gains have been either entirely, or almost entirely, destroyed. 

The next two charts are a rebuild of the first chart above in both percentage and point movements.

Again, even on an inflation-adjusted, total return, basis when viewing the bull/bear periods in terms of percentage gains and losses, it would seem as if bear markets were not worth worrying about.

However, when reconstructed on a point gain/loss basis, the ugly truth is revealed.

It’s A “Time” Problem. 

If you have discovered the secret to eternal life, then stop reading now.

For the rest of us mere mortals, time matters.

If you are near to, or entering, retirement, there is a strong argument to be made for seriously rethinking the amount of equity risk currently being undertaken in portfolios.

If you are a Millennial, as I pointed out recently, there is also a strong case for accumulating a large amount of cash and waiting for the next great investing opportunity.

Unfortunately, most investors remain woefully behind their promised financial plans. Given current valuations, and the ongoing impact of “emotional decision making,” the outcome is not likely going to improve over the next decade.

For investors, understanding potential returns from any given valuation point is crucial when considering putting their “savings” at risk. Risk is an important concept as it is a function of “loss”. The more risk that is taken within a portfolio, the greater the destruction of capital will be when reversions occur.

Many individuals have been led believe that investing in the financial markets is their only option for retiring. Unfortunately, they have fallen into the same trap as most pension funds which is believing market performance will make up for a “savings” shortfall.

However, the real world damage that market declines inflict on investors, and pension funds, hoping to garner annualized 8% returns to make up for the lack of savings is all too real and virtually impossible to recover from. When investors lose money in the market it is possible to regain the lost principal given enough time, however, what can never be recovered is the lost “time” between today and retirement. 

“Time” is extremely finite and the most precious commodity that investors have.

In the end – yes, market corrections are indeed very bad for your portfolio in the long run. However, before sticking your head in the sand, and ignoring market risk based on an article touting “long-term investing always wins,” ask yourself who really benefits?

This time is “not different.”

The only difference will be what triggers the next valuation reversion when it occurs.

If the last two bear markets haven’t taught you this by now, I am not sure what will. Maybe the third time will be the “charm.”

I have a simple question…

If the rally in the market that began following the election was pricing in the expectations for tax reforms, repatriation, building the wall, and infrastructure spending, then what did the rally on Wednesday following Trump’s speech to Congress price in?

With the markets now pushing both a 3-standard deviation extension above the 50-dma AND an almost 9% deviation above the 200-dma, there is little argument of the overbought condition that currently exists.

But such rational logic seems to no longer apply.

At least for now.

There is just one thing to remember. The markets price in future expectations for the impact of expected events. So, a tax cut here, an infrastructure plan there, all suggests a positive impact to the bottom line of corporate earnings and a valid reason for pushing asset prices higher.

No argument here.  I am currently well positioned in portfolios on the long side of the market for now.

The question that must be answered is just how much of the benefit from these fiscal proposals have already been priced in perfection? What happens if tax reform is less than anticipated? Or infrastructure spending is cut from $1 Trillion to $500 billion? Or repatriation only brings back a fraction of the dollars anticipated? 

Let’s zoom out for a second and look at the pre- and post-election through the end of last year for clarity.

Oh, shoot!….Sorry, that was 1999.  Here is last year.

Just some things I am thinking about this weekend as I catch up on my reading.



Research / Interesting Reads

“If I’d only followed CNBC’s advice, I’d have a million dollars today. Provided I’d started with a hundred million dollars.” – Jon Stewart

Questions, comments, suggestions – please email me.